buckeyejoe

[hstrang]

Taxpayer is selling rental property that was inherited from deceased spouse several years ago. Taxpayer did not change depreciation basis. When computing gain on property and recapture of depreciation, how does the stepped up basis come into play?

[Bees Knees]

It depends on the ownership of the rental prior to the death of the deceased spouse. If the deceased spouse owned 100% of the rental at death, the entire property received stepped up basis to FMV. If the spouses each owned the rental as joint tenants, the surviving spouse received one-half step up to FMV at the death of the decedent. If they lived in a community property state and the rental property was community property, then 100% of the rental received stepped up basis to FMV.

Once you determine how much of the rental received stepped up basis, you then need to go back and determine the depreciation allowed using FMV on the portion that received stepped up basis as of the date of death. Unrecaptured 1250 gain is based on depreciation allowed, not depreciation claimed.

[Bees Knees]

A positive side of this is that depreciation allowed prior to the date of death on the portion of the rental that received stepped up basis goes away. You do not add that depreciation into the mix for determining unrecaptured 1250 gain.

[JG EA]

Are you saying?

... If the spouses each owned the rental as joint tenants, the surviving spouse received one-half step up to FMV at the death of the decedent. If they lived in a community property state and the rental property was community property, then 100% of the rental received stepped up basis to FMV.

Once you determine how much of the rental received stepped up basis, you then need to go back and determine the depreciation allowed using FMV on the portion that received stepped up basis as of the date of death. Unrecaptured 1250 gain is based on depreciation allowed, not depreciation claimed.

Are you saying that if they owned jointly the TP should have added depreciation onto the rental at DOB like you would adding a room to the rental? (The step up going to both the land and the depreciable part.)

I must admit I never thought of this. I would have thought the FMV when the rental began (or basis whichever was lower) would be continued unless actual dollars were added into the rental property. I would have thought that any step up in basis would be added at the sale.

[veritas]

You should refer to Rev proc 2004-11. You may be able to make a correction to depreciation on the 2005 return. It is somewhat of a process.

I looked in the Tax Book but did not see anything with respect to improper depreciation.

[Bees Knees]

IRS Pub 559 says the following:

“DEPRECIATION. If you can depreciate property you inherited, you generally must use the modified accelerated cost recovery system (MACRS) to determine depreciation.

For joint interests and qualified joint interests, you must make the
following computations to figure depreciation.

* The first computation is for your original basis in the property.

* The second computation is for the inherited part of the property.

Continue depreciating your original basis under the same method you had
used in previous years. Depreciate the inherited part using MACRS.”


IRS Pub 551 explains how to compute the basis in inherited property for depreciation purposes:

“PROPERTY HELD BY SURVIVING TENANT

The following example explains the rule for the basis of property held by a surviving tenant in joint tenancy or tenancy by the entirety.

EXAMPLE. John and Jim owned, as joint tenants with right of
survivorship, business property they purchased for $30,000. John furnished two-thirds of the purchase price and Jim furnished one-third. Depreciation deductions allowed before John's death were $12,000. Under local law, each had a half interest in the income from the property. At the date of John's death, the property had an FMV of $60,000, two-thirds of which is includable in John's estate. Jim figures his basis in the property at the date of John's death as follows:

Interest Jim bought with his own funds - 1/3 of $30,000 cost $10,000
Interest Jim received on John’s death - 2/3 of $60,000 FMV 40,000 $50,000
Minus: 1/2 of $12,000 depreciation ------ before John’s death 6,000
------
JIM’S BASIS AT THE DATE OF JOHN’S DEATH $44,000
======


If Jim had not contributed any part of the purchase price, his basis at
the date of John's death would be $54,000. This is figured by subtracting from the $60,000 FMV, the $6,000 depreciation allocated to Jim's half interest before the date of death.

If under local law Jim had no interest in the income from the property and he contributed no part of the purchase price, his basis at John's death would be $60,000, the FMV of the property.


QUALIFIED JOINT INTEREST

Include one-half of the value of a qualified joint interest in the
decedent's gross estate. It does not matter how much each spouse
contributed to the purchase price. Also, it does not matter which spouse dies first.

A qualified joint interest is any interest in property held by husband and wife as either of the following.

* Tenants by the entirety.

* Joint tenants with right of survivorship if husband and wife are
the only joint tenants.

BASIS. As the surviving spouse, your basis in property you owned with your spouse as a qualified joint interest is the cost of your half of the property with certain adjustments. Decrease the cost by any deductions allowed to you for depreciation and depletion. Increase the reduced cost by your basis in the half you inherited.

[JG EA]

Thank you,

I will now do a search and see if I have any clients affected. I don't think so, but thank you very much for answering and bringing this to my attention. Before I posted I searched but didn't find this in 559 (didn't look in 559).

It makes sense to me now that I see it's not adding basis on - but starting over and refiguring.

Thanks again. Such a wonderful benefit!

JG