Inaccurate cost reported for rental property - thought on how to handle.

[ANDYB]

I have a new client who sold rental property in 2021 for $210k. Looking at their 2020 return, I see that the rental started in 2006 with cost allocated $115k for the home (this has been depreciated) and $55k for the land. However the client stated and provide original HUD statement indicating payment for the home was $230k - a difference of $60k. The client only has tax returns for the past 5 years showing the same rental costs as the 2020 return. My question is - how should this sale be reported in 2021?

• Ignore the original HUD statement and report the gain (including depreciation recapture) based on what was reported to the IRS?
• Add the cost difference of $60k to the 2021 return and assume depreciation was taken and use that to compute the gain?
• Add the cost difference of $60k to the return and since no prior depreciation was taken, ignore the depreciation and compute the gain with the $60k added cost?
• Any other way???

Thanks in advance for your thoughts.

[TaxGuyBill]

Before we get to your question, you need to check something first ... Was the home a rental right after it was purchased? Or was it personal use, then converted to a rental? Ask your client what the date was when it was first available as a rental (don't rely on the depreciation schedule). If it was converted to a rental some time AFTER it was purchased, it could be a BIG difference in how to handle things because the depreciable Basis might be different than the Cost Basis..

And ask the client to try to dig up all of the tax returns since 2006.

[ANDYB]

TaxGuyBill, thanks for your response. Client initially lived in the property in 2005 but then got married in 2006, moved into spouses home and started renting the property in 2006. They don't have copies of their ax returns dating back to 2006 - the earliest they have is 2015. I've sent them form 4506-T and asked them to send it to the IRS asking for transcripts from 2006-2009 to try to gauge some history but haven't heard back as yet. What could be the big difference you refer to if property was converted to rental one year later? And if depreciable basis is different than cost basis, how do I report the sale of the property to reflect the appropriate tax due?

[FEDUKE404]

Is there a possibility the value of the property when rental commenced was less than the original cost?
As for the HUD statement, you need to look carefully for any POC costs.
Isn't it easier / faster to get transcripts online? The "humans" at the IRS are hopelessly behind due to COVID issues.

[TaxGuyBill]

As FEDUKE mentioned, for purposes of depreciation, you use the LOWER of the Cost Basis and the Fair Market Value when it was converted to a rental. So in those cases, the Basis for depreciation is different than the Basis for reporting a sale.

But if it was in 2006, it seems unlikely the FMV was less than the 2005 Cost (prices were generally rising dramatically at that time, until they crashed in 2008).


It seems like your house was sold at a GAIN, which means you use the actual Adjusted Cost Basis for purposes of reporting the sale. That is usually the purchase price, plus cost of improvements, minus the GREATER of the (a) depreciation they ACTUALLY took, or (b) depreciation that they SHOULD have taken. *IF* they used the wrong Basis for depreciation (pending on if the FMV was less than the Cost when it was converted to a rental), then you need to calculate what SHOULD have been taken and use that.

If I had to GUESS, I would say the depreciation started out claiming $230-ish with $55 of land, resulting in $175 for the building. And I would GUESS that somewhere along the way a new preparer (or self prepared) took the $175 as the TOTAL, and AGAIN took out $55-$60 of land. But again, that is only a GUESS.

[ANDYB]

From what I understand, transcripts for returns that old can't be obtained on-line - please correct me if I am wrong.

[ANDYB]

Thanks FEDUKE404 and TaxGuyBill. You bring out some interesting possibilities. Let's see what the transcripts indicate - my hope is that there was an overpayment in 2005 and FMV in 2006 was less therefore, no wrong basis was used and I can stick with the price per the HUD statement. Much appreciated.

[TaxGuyBill]

I can stick with the price per the HUD statement. .

Because it was sold at a gain, you need to use the actual purchase price regardless if the depreciation was right or wrong. But the amount of depreciation you use will depend on if they were depreciating it incorrectly or not.

[Kram BergGold]

I would check the state records for the date of purchase and sale price. If that matches the Hud 1 then I would allocate the extra $60k to land and prepare the return.

[TaxGuru]

The first thing that popped into my mind when you mentioned that the depreciation schedule shows a lower cost than the HUD-1 is that the property was a replacement for a like kind exchange, in which case, via Form 8824, the deferred gain from the original disposition would have been deducted from the purchase price of the replacement property. I would ask the client if it's possible that this property had been acquired in a 1031 exchange.