Rental Depreciation without Rental Income or Expenses?

[CAErinB]

I have a new client this year (we’ll call her Sarah) who has always prepared her own return. I realized that Sarah was 50% owner of a condo that was purchased in 2006 and sold in 2016. Neither Sarah nor the other owner (we’ll call him Steve) ever personally used the residence, it has been rented for their entire period of ownership.

Sarah has never filed a Schedule E. Sarah says that Steve “always handled everything” and that Steve had reported the rental proceeds and expenses on his personal return.

But now the condo has been sold, and I believe Sarah is subject to depreciation recapture despite never having claimed depreciation.

Steve did depreciate his share of the condo.

Sarah’s cost basis is ~$50K; the accumulated depreciation after 10 years is almost $20K.

The obvious solution would be to file a Form 3115 with Sarah’s return, for the automatic change of accounting method from an impermissible method to a permissible one, and shield Sarah from the $20K in capital gain.

But, can Sarah file a Form 3115? The tax definition of depreciable property is “an asset used in a trade or business,” which the condo technically is, but one of the factors which disqualify an asset for depreciation is not currently making use of it to produce income.

Sarah has never declared any income or expenses associated with the rental.

So, my question is: Is Sarah’s half of the condo even depreciable property despite not being associated with any income or expenses on her return? Can a co-owned rental be depreciable for Steve but not for Sarah?

[spanel]

Did sara get 1/2 the rental income? Did she ever have to pay for any expenses? RE taxes, Insurance, Etc?

Chris

[taxmom34]

you need to know how "Steve" filed his tax returns. Did he claim 100% rental and use 100% rental depreciation. it looks like he claimed all income & expense, why not all depreciation?

[Lion]

Was it a partnership or joint venture or did Sarah just loan Steve funds for a downpayment? What does their operating agreement say about Sarah's percentage of income, loss, and capital? Is Steve's story the same as Sarah's? Did Steve report 100% of the sale or 50%? You're saying he depreciated only 50% of the condo, right? But, he reported 100% of the income and expenses and actually PAID 100% of the expenses and RECEIVED 100% of the income without sharing with Sarah? Did Steve share his Schedules E and depreciation schedules with Sarah? I would want to get the facts covering all the ownership years in writing from Sarah. Maybe, signed by Steve as agreeing that they were his understanding also. Do you really need this client? Will she return or just needs you for this sale year? I might send her to Steve's preparer!

[TaxGuyBill]

How was the title of ownership held? Did she actually own 50% (tenants in common) or was it held in Joint Tenancy?

[CAErinB]

Sarah has received none of the income from the rental and has paid none of the expenses over the past 10 years.

This rental activity was not a business arrangement, nor was it the original plan. There is no partnership agreement nor any other documentation of the situation. Sarah and Steve were dating, and purchased the condo intending to move in together, but they split up before that ever happened. Sarah and Steve do not communicate at all anymore.

Sarah received a form 1099-S for her share of the sale proceeds, so I believe I can count that as confirmation that she was, in fact, listed on the title.

[spanel]

Sarah has received none of the income from the rental and has paid none of the expenses over the past 10 years.

This rental activity was not a business arrangement, nor was it the original plan. There is no partnership agreement nor any other documentation of the situation. Sarah and Steve were dating, and purchased the condo intending to move in together, but they split up before that ever happened. Sarah and Steve do not communicate at all anymore.

Sarah received a form 1099-S for her share of the sale proceeds, so I believe I can count that as confirmation that she was, in fact, listed on the title.

Did she receive the money shown on the 1099s?

If yes, I would treat it as an investment property and her cost is what she paid for it originally.

Chris

[CAErinB]

Yes, Sarah received her portion of the sale proceeds.

So, treat it as an investment property, with no basis reduction for depreciation allowed or allowable?

[TAXNJ]

Yes, Sarah received her portion of the sale proceeds.

So, treat it as an investment property, with no basis reduction for depreciation allowed or allowable?

Ask the reply poster what source the reply poster's suggestion is based on?

[spanel]

Ask the reply poster what source the reply poster's suggestion is based on?

No source. Silent investor, didn't share income expenses.

Sticking with my answer

Chris

[TAXNJ]

No source. Silent investor, didn't share income expenses.

Sticking with my answer

Chris

Would a ”Silent investor” share in the Income & Expenses ? Or was the ”Silent investor's” share contribution a Loan?

Think the Original Poster has limited information with this scenario and raises some concerns to make an informed decision. Based on that, think reply poster LION’S post is very important to consider.

[taxea]

Get a copy of the purchase and sale HUD-1. The escrow company for the sale could answer several questions. Did Sara sign any papers for the purchase or the sale? Did she get 50% of the sale proceeds? What do the title docs say?

[CAErinB]

Get a copy of the purchase and sale HUD-1. The escrow company for the sale could answer several questions. Did Sara sign any papers for the purchase or the sale? Did she get 50% of the sale proceeds? What do the title docs say?

I have a copy of the closing docs. What should I look for?

[Rapid Robert]

you need to know how "Steve" filed his tax returns. Did he claim 100% rental and use 100% rental depreciation. it looks like he claimed all income & expense, why not all depreciation?

This, and similar from Lion, is the only one of several suggestions made in this thread that I don't understand.

Steve might not be willing, or reliable, as a source of info. How much time and effort will be involved? And for whose benefit? Do you think in an audit that the IRS is going to rely primarily on what the taxpayer says Steve did? Not to mention the need for at least one Sec 7261 consent to be signed.

The taxpayer (and preparer) are going to have to take a position on the return. If a large amount of gain is in question, take the extra precaution of disclosing the position via Form 8275. But I don't see any net gain from dragging Steve into it, unless Steve himself thinks there is a benefit to him (for example, if he thinks he should be amending or filing 3115).

[TAXNJ]

This, and similar from Lion, is the only one of several suggestions made in this thread that I don't understand.

Steve might not be willing, or reliable, as a source of info. How much time and effort will be involved? And for whose benefit? Do you think in an audit that the IRS is going to rely primarily on what the taxpayer says Steve did? Not to mention the need for at least one Sec 7261 consent to be signed.

The taxpayer (and preparer) are going to have to take a position on the return. If a large amount of gain is in question, take the extra precaution of disclosing the position via Form 8275. But I don't see any net gain from dragging Steve into it, unless Steve himself thinks there is a benefit to him (for example, if he thinks he should be amending or filing 3115).

The posts you reference are very understandable. The reply posters suggest important information a tax professional may ask a client in doing their "due diligence" to get the necessary information from the potential client to make an informed position on how to/not to proceed with the engagement.

So to the other reply posters good suggestions.