Best way to handle this mess ?

[Twin Turbo Z]

Have a potential new client that just sold a rental that they have had for 6 years. The prior preparer had entered the cost of the property as $120,000, which is what the client told the preparer they paid for it. Well that is not what they paid !! They paid 35,000 for it !! It was appraised for $120,000 when they bought it. So that is what they told the preparer the cost was. I told them you should have used the actual cost - land value. Well they sold the rental for $45,000. What a mess. Would tell them to go back to the prior preparer, but he passed away !! And a 1099S was issued for the sale. Im thinking, just do the math and make them recapture the depreciation used. And of course not allow the loss, that would be in error.

[Lion]

You could make them pay you for Form 3115 to straighten out their mess.

[Twin Turbo Z]

You could make them pay you for Form 3115 to straighten out their mess.

Thanks. Never had the need to mess with form 3115 before. Will start reading up on it, for my own benefit. But, will probably pass on them.

[TaxGuyBill]

No need for Form 3115 (it really shouldn't be used anyways in this situation).

Just use the depreciation that they actually claimed (roughly $26,000, if no land was subtracted). The makes the Adjusted Basis to be about $9000 ($35,000 - $26,000). That will give them a gain of $36,000.

There could be "Additional Depreciation" involved, but if the taxpayer's tax bracket will be 25% or less, I would just ignore that unless your software makes it easy. If their tax bracket will be over 25%, then you may need to figure out the depreciation that SHOULD have been claimed (will be taxed as Unrecaptured Section 1250 Gain, at up to 25%), and the 'extra' depreciation is "Additional Depreciation", taxed at regular tax rates.

[Roland Slugg]

What you described isn't really such a mess. They bought property costing $35k, rented it for 6 years, taking (too much) depreciation during that time, then sold it for $45k.

Just report the sale, starting on Part III of F-4797.

All the depreciation taken will be characterized as "Unrecaptured §1250Gain," and your tax prep software should classify this for you automatically. I disagree with TaxGuyBill where he says there is "additional depreciation" that is to be separated from the "legitimate" depreciation somehow.

They paid 35,000 for it !! It was appraised for $120,000 when they bought it.

If the property was appraised at $120k when they bought it, how did they manage to pay only $35K?

[JohnH]

Maybe they were really good negotiators (or at least they thought they were). Looks like market forces revealed something to them.

[TaxGuyBill]

All the depreciation taken will be characterized as "Unrecaptured §1250Gain," and your tax prep software should classify this for you automatically. I disagree with TaxGuyBill where he says there is "additional depreciation" that is to be separated from the "legitimate" depreciation somehow.

"Additional Depreciation" is depreciation of §1250 property in excess of straight-line depreciation. To me, that seems to fit this situation.

Additional Depreciation is "recaptured", similar to §1245 property, and is taxed as ordinary income.

The tax on the gain based on Straight-Line depreciation of §1250 property is "Unrecaptured Section 1250 Gain", and is taxed at ordinary rates, up to 25%. It is also technically a capital gain, so any carryover losses may be able to offset Unrecaptured Section 1250 Gain. I don't think the carryover losses would offset Additional Depreciation.

[Twin Turbo Z]

Thanks for the replies. Our area was hit hard by the housing crisis (still is) and descent property is being abandoned or repossessed by mortgage companies. Many guaranteed by fannie or freddie. So the gov. agencies and many banks are letting these properties go for next to nothing. So thats how they got a great deal on it.

I think I will take them on and forgo the 3115 form and recapture the excess depreciation and figure the gain as others mentioned. Thanks again for all the input.

[Roland Slugg]

"Additional Depreciation" is depreciation of §1250 property in excess of straight-line depreciation. To me, that seems to fit this situation. Additional Depreciation is "recaptured", similar to §1245 property, and is taxed as ordinary income.

That's an interesting theory, and I agree that it would result in a more equitable result. However, it is contrary to Code §1250(b)(1) and §1250(b)(3).

I wonder, too, if there would even be a way to get any tax prep software to recognize that excess the way you suggest. Maybe I will try it on a "dummy" taxpayer I use for various "what-if" situations such as this.

[TaxGuyBill]

That's an interesting theory, and I agree that it would result in a more equitable result. However, it is contrary to Code §1250(b)(1) and §1250(b)(3).

I wonder, too, if there would even be a way to get any tax prep software to recognize that excess the way you suggest. Maybe I will try it on a "dummy" taxpayer I use for various "what-if" situations such as this.

I wonder if we are misunderstanding each other. §1250(b)(1) and §1250(b)(3) are exactly what I was referring to for my point to show that it is Additional Depreciation. Additional Depreciation is the amount that "exceed the amount of the depreciation ... under the straight line method".

Although they did use the straight line method, the depreciation exceeded the proper amount using straight line, so I would think it would still apply.


The sale of the rental home is reported in Part III of Form 4797. Line 26a is specifically for Additional Depreciation, so hopefully everybody's software would be able to handle that.

[Twin Turbo Z]

Using ProSeries, will find out once I get into it.