Rental Depreciation Taken For Only One Year, Never Rented Again, and Sold in 2021

[TaxNC]

A personal residence was rented for exactly one year (365 days) in 2018 and never rented again. $3,500 depreciation was reported on the return, but that amount did not change the bottom line (amount
owed).
The home was sold in 2021.
Should the 2018 return be amended to remove the depreciation? Or would it be acceptable to just not recapture the depreciation and just take into account the nonqualified use (365 days) for the sale?
I am not sure yet whether the depreciation recapture will affect the bottom line on the 2021 return.
Thanks.

[Lion]

Allowed or allowable.

[Rapid Robert]

"$3,500 depreciation was reported on the return, but that amount did not change the bottom line (amount owed)."

The purpose of depreciation is not to get a tax deduction (even thougb that's what Congress seems to think for the last fifteen years). The purpose is to correctly match an expense (wear, tear, and obsolesence of a tangible asset) to the revenue it produces, in other words it is to reflect economic and accounting reality. In fact, you could switch your statement around and say just as accurately that $3,500 of income was reported on the return, but that amount did not change the bottom line. Would that mean one should go back and amend the return to remove the $3,500 of income?

[TaxNC]

My question is being misinterpreted. The property, I learned, was never intended to be rented out more than the one year (and was not) so I assume it should not have been depreciated. I am not questioning
the purpose of depreciation.

[TaxGuyBill]

As far as I can tell, real estate is still depreciated even if it was "placed in service" and taken out of service in the same tax year. So you can't remove the depreciation because it was correct.

If the depreciation was/is allowed as a deduction, it does not matter if it lowered the tax due or not. That depreciation still lowers the Basis of the property and will be taxed upon the sale (assuming the property was sold at a gain).


On another note, you said it was a personal residence, but you didn't mention if it was their Principal Residence or not, or if you are trying to use the $250,000/$500,000 exclusion.

If it was their Principal Residence, did they make it their Principal Residence again after it was rented? If so, you have "Nonqualified Use", which will prorate things, so the $250,000/$500,000 exclusion won't cover all of the gain.

[Rapid Robert]

"As far as I can tell, real estate is still depreciated even if it was "placed in service" and taken out of service in the same tax year."

Perhaps. Relying on the plain language explanation from the IRS pub, it comes down to the difference between "disposed" and "retired from service" which are often, but not always, the same thing.

FWIW, my tax software does NOT generate any depreciation deduction if I show rental real estate put in service and taken out of service (but not disposed) in the same calendar year, and that is how I would have filed the return in the OP scenario (no depreciation). In that case, I would be tempted to do what the OP is asking about, namely ignore the depreciation for the prior year when calculating this year's gain on sale.

Now, one remaining thing is that we don't know why the depreciation deduction did not change tax liability in the prior year. Was it because of suspended passive losses? If so, those losses would now be freed up and would essentially offset the gain due to depreciation (Sec 1250 gain).

Pub 946:

Even if the requirements explained in the preceding discussions are met, you cannot depreciate the following property.
• Property placed in service and disposed of in the same year.
[...]
You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events.
• You convert the property to personal use.

[TaxGuyBill]

Relying on the plain language explanation from the IRS pub, it comes down to the difference between "disposed" and "retired from service" which are often, but not always, the same thing.

FWIW, my tax software does NOT generate any depreciation deduction if I show rental real estate put in service and taken out of service (but not disposed) in the same calendar year,

For depreciation purposes, converting it to personal use is considered a "disposition".

I think the Publication is wrong when it states that. I have looked extensively for the basis of that, that the only place I find it is in the Regulation about Half-Year and Mid-Quarter conventions. However, real estate does not use the Half Year or Mid-Quarter convention, so as far as I can tell, depreciation is allowed. And ProSeries (and TurboTax) allows the depreciation for real estate in those circumstances.