Rental Sale Question

[Gary]

I have a client that sold a rental house he has owned and rented for 6 years. I prepared his 2008 return, but a CPA prepared all previous returns. His income is so large that he has not been able to take advantage of the passive losses in excess of his rental income, but will get them from the sale. That is not my problem.

The return I prepared last year included 33-1/3% personal use because his son, who is in college, lived in the house with two roommates that paid rent. I was under the assumption that this was true only for 2008. All previous returns by the CPA assumed 100% rental (I'm not blaming the CPA because I don't know if the client told him otherwise). I now found out that the personal use varied from year to year from 33-1/3% to 16-2/3% (5 roommates). I'm sure that the proper course of action is to amend each years' returns to get the proper depreciation, but at about $800 a return (very complicated), i hesitate to even suggest this.

I realize that the personal portion goes on Schedule D and the rental portion on 4797. How do I handle the varying personal portion? How do I enter the proper depreciation on the 4797? What do you all suggest? Please help.

Thanks,

Gary

[DMICPA]

Passive loss depr.

What a deal!

Another thought would be to adjust the passive loss to be recognized as the prior years had overstated the depreciation. There were no tax ramifications in the prior years as the enitre loss was passive and the amount was carried forward.

[Burke]

And I believe you can adjust or correct prior depreciation via 3115 without amending old returns. Recalculate passive loss carryforward and report proper gain on 2009.

[Gretel]

Yes, Form 3115 is what the IRS wants to see for correcting depreciation error that go back 2 or more years.

[Kram BergGold]

question

you are sur the son paid no rent?

[Gary]

Thanks, but more Questions

Thanks for the replies. I have never filed Form 3115, and it is the most confusing form I have ever seen. Part I, line 1(a) requires a change number. No 7 is depreciation (impermissible) and No. 8 is depreciation (permissible). The depreciation used throughout the rental period was allowed. The only problem was the percentage of rental use, which varied from year to year because the number of the taxpayer's son's roommates varied. Which would be the correct number?

Is the appropriate place to report the change in depreciation over the years Part III, Section B, line 11 which says "depreciation", or Part III, Section C, line 10 which says "depreciation not included in Section C line 11?

Again, Thanks.

Gary

[BHoffman]

Gary - not sure about the details, but you might want to consider whether the son lived at the rental house in exchange for providing services. Like, perhaps he protected the property from damages that might be caused by the roommates as a Caretaker. This might make it possible to forego the allocation of personal use.

[Gary]

Barter?

Would the son taking care of the property be considered as barter so that he would have to declare the rent he did not pay as income?

[BHoffman]

Would the son taking care of the property be considered as barter so that he would have to declare the rent he did not pay as income?

I don't know, Gary. I guess I might be looking at the materiality at this stage and try to figure out how to cause the least amount of damage for everyone concerned. We do the best we can. Good luck and please keep us informed.

[S T]

Passive Losses

Sounds like the Dad (your taxpayer) purchased this property as an investment and to defray living expenses of his son going to college. Therefore the room mates. So depending on the number of roomates you have anywhere from approximately 20% to 50% personal use during each of the years.

I think DMICPA and Burke's post is pretty much on target - you will have to do some recalculations on both the expenses and the depreciation to correct passive losses (suspended)

However, if all was reported and suspended (reported on 8582) would it be possible to just do the recalculation and not file a form 3115

Not sure if the 3115 form still has to be filed on that theory or not.



Sandy

[Bees Knees]

Several issues involved:

1) If prior depreciation (correct and incorrect) is suspended under passive loss rules, then there is no prior year depreciation to correct. Simply adjust the passive loss carry forward to the current year for the correct amount of depreciation that should have been claimed in the prior years.

2) Yes, Form 3115 is technically the correct way to handle incorrect depreciation from prior years. But in the year of sale, prior year depreciation whether it is correct or incorrect becomes irrelevant. The reason is that in the year of sale, all depreciation claimed in prior years, whether it was allowed or not, increases the gain recognized in the year of sale.

Example: Rental house sells for $100,000. Original basis = $80,000. Prior year depreciation claimed = $20,000. Assume the correct prior year depreciation that should have been claimed = $15,000. Thus, prior year depreciation claimed was $5,000 more than what should have been claimed.

If you ignore Form 3115, gain reported on Form 4797 = $40,000 [$100,000 minus ($80,000 minus $20,000)]

If you file Form 3115, you report $5,000 of income on the other income line of Sch E (the Section 481 adjustment), and gain reported on Form 4797 = $35,000 [$100,000 minus ($80,000 minus $15,000)].

Income under either method is the same ($40,000) (Yes, I know about the 4 year reporting issue with a Section 481 adjustment, but lets ignore that rule for now.)

3) The only difference in number 2 above is the type of gain reported. If you ignore Form 3115, $20,000 of the gain is Unrecaptured Section 1250 gain (the 25% rate), and the other $20,000 of gain is capital gain. If you file Form 3115, $5,000 of the income is ordinary income, $15,000 is Unrecaptured Section 1250 gain, and $20,000 of gain is capital gain.

One way to get the type of gain correct without having to go through the hassle of filing Form 3115 is to show the incorrect depreciation from prior years as Section 1245 property rather than 1250 property. Section 1245 property depreciation is recaptured as ordinary income (the same as reporting it on the other income line of Schedule E). Although the reporting is technically incorrect, the tax paid in the current year will be calculated correctly.

For example, let’s ignore Form 3115 in my example above and simply call $5,000 of prior year depreciation Section 1245 property (the depreciation claimed that should not have been claimed). The result is $5,000 of the gain is reported on Form 4797 as ordinary income (the Section 1245 depreciation recapture), $15,000 is Unrecaptured 1250 gain (the 25% rate), and $20,000 is capital gain.

You get the same results as you would get by filing Form 3115.