Rental Property "Allowed or Allowable"

[Al Beatty]

I came across a new client recently. Her husband died in March of this year. He self-prepared their returns for many years. They have a rental house they acquired and put in rental use "approximately" 2006. The husband never bothered claiming depreciation. To make matters worse it was acquired by an inheritance. I explained to her that when the property is disposed the calculation will be based on what was "allowed or allowable" for depreciation. I had a similar situation sometime back in the 90s when a taxpayer didn't claim deprecation on a rental and then sold the house at which point he promptly came to me to do the return the year of the sale. As I recall we had to do an accounting method change application, which the IRS did accept. However, I don't know how to approach this. It seems to me I have the following choices:

1. File amended returns (if that is even possible for all of these years & would be a nightmare if so)
2. Start depreciating this year with as best as I can and move forward as nothing has happened in the past
3. Do nothing and just get through this tax year and address next year.
4. Do nothing and hope she never sells it or deal with at the time of the sale if she ever sells it
5. Do noghing and hope I am deceased, which at my age is possible, when she does ever sell it (punt to someone else)

None of these options appeal to me and include ethical and professional concerns.

Has anyone run in to this? Does anyone have any suggestions? I appreciate any and all advice.

Thanks!

[TAXNJ]

Based on your choices listed # 2, 3, 4, 5 and your comments of ethical and professional concerns, either handle it as you did in the 90’s (if still applicable) or refer client to another professional.

[Lion]

Form 3115.

[TaxGuyBill]

As Lion said, you need to do #6: File Form 3115 which can "catch up" on the missed depreciation.

[rbynaker]

IANAL but check your state law on this too. Usually inherited property only belongs to the spouse inheriting it (but they can gift it and retitle it jointly). Work through the timeline of who, what and when. If this was property inherited 100% by him and he died while it was still 100% his, then you're going to have a step-up/down in basis before any sale which I think will make "allowed or allowable" a moot point. That said, there are probably missed depreciation deductions and I would still look to the 3115 route to catch up depreciation. TaxGuyBill is probably more current on the rules than I am, I don't think I've had to do a 3115 in 5 or 6 years.

TTB has a Depreciation publication. I have an older one from 2014 (probably the last year I did a 3115!) and there's a chapter on "Depreciation Changes and Errors" that talks a lot about Form 3115, including examples. Also I've heard great things about Brass Tax but have never used it (google "Brass Tax 3115").

Rick

[Uncle Sam]

I ran into a similar situation like this last year. Clients (MFJ) came to me because their prior accountant died, succeeded by son of deceased accountant, then he left and it was then handed to an employee of same firm.
Situation was - husband inherited a residential rental property from a deceased mother around 2006. In looking at Schedule E - there was no depreciation ever taken. It was gifted by mother prior to deceasing.
The husband had no idea if a gift tax return was ever filed, or how to obtain documents that showed either FMV on date of transfer - or if transferred after death what FMV was DOD. NO idea of attorney who represented mother on transfer of property (to obtain a closing statement copy)
It was a 3-story property - where there were 3 different unrelated tenants - where one unit was rented out (Section 8 housing) with wife's name as lessor as if she was the property owner. (They didn't think it made a difference as they felt it was reported on the same tax return). He couldn't recall when and if major improvements were made under his ownership.
But the point of the story is - in a situation like this where you can't obtain reliable information to arrive at a starting point for properly calculating depreciation - I would tell the client to walk. I did that, and feel a lot better that I did.
Even when you do obtain the property basis - you need to segregate out the basis of the building vs basis of land.

[kkuch]

What state? Forgive me for adding confusion, but wouldn't some step-up basis/resetting of depreciation be involved here? With right of survivorship the wife would get a step-up basis correct?

[Al Beatty]

Thanks to all! Fortunately, or I would think it makes it easier, she inherited it back in 2006 not her husband who passed. It is in OH. Yes form 3115 was what I filed back with my one other case after the this other client sold the property. So it looks like even though this is a little different than the one I did back then I need to go with the form 3115 change in accounting to get this resolved.

[ATSMAN]

Form 3115.

That is the correct choice and it is a pain to do it after the fact but if they want to keep their nose clean with the IRS that is the only way. I have heard and seen other taxpayers completely ignore depreciation hoping IRS will never catch them and given IRS record they may get away most of the times.

I would disengage if client refuses to file form 3115.