Fix rental cost basis without changing prior year depreciation

Forum|Forum|3 years ago
August 29, 2022
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I brought a rental 4 years ago and entered the purchase price of $385k as the cost. I then added the closing cost of $12k and water heater $2k as additional assets for 27.5 yrs depreciation. I did NOT update the rental cost basis to include them. I am selling the rental now and just learnt that these should be included in rental cost basis in order to get the accurate capital gain. How do I fix the cost basis without affecting previous depreciation? Thanks

Best answer by Anonymous_

Thank you for confirming I don’t need 3115. I want to know how TurboTax calculate my capital gain. Recap with sales detail:

- 2018 brought rental $385k + $12k closing + $900 w.h. Each as separate asset and deprecated appropriately from 2018 onward

- 2022 Selling rental for $470k with closing cost, commission, repairs, etc. to $40k. Closing date will be Oct 2020.

How will TurboTax calculate my capital gain amount? Should my capital gain on selling this rental be $470,000 - $40,000 - ($385,000 + $12,000 + $900) = $32,100?

should I amend tax from 2018 to include the closing close of $12k as part of the original rental purchase price in order to get the correct capital gain?

Thanks

@michash2998

Based upon the original figures you posted earlier, it appears as if you have omitted the cost of land from your basis in your latest post. You need to factor that into your equation.

Also note that you cannot deduct "fix-up" expenses as selling expenses.

Further, you will most likely have an unrecaptured Section 1250 gain (depreciation recapture) component as well as a capital gain component. The former is taxed at ordinary income tax rates up to a maximum of 25%.

With respect to the $12k in closing costs that you depreciated separately, that component should be factored into your recapture and gain equation. Since you have be depreciating those costs as a separate component, there is no need to amend and add it to the original cost basis.

Opus 17

Employee

You need to see an accountant, there are some concepts you haven't addressed.

1. The basis of your depreciation is what you actually paid. This includes the purchase price, and some (but not all) of your closing costs. Allowable closing costs for a home are listed in publication 523 on page 8. But since land doesn't depreciate, you have to reduce your depreciation basis by the value of the land.

2. If the hot water heater was part of the property at closing, you don't include it separately, it is part of the overall $385K price. If you purchased it after you placed the property in service as a rental, you list it as a separate asset with a recovery period of 27.5 years. However, if the cost is less than $2500, you may qualify for a safe harbor that allows you to deduct it as an expense, rather than taking depreciation. Expensing the hot water heater is more advantageous because you don't have to recapture depreciation when you sell.

3. To correct prior depreciation, you either have to file amended returns for all those years, or you need to file form 3115, Application for Change in Accounting Method. This form is not easy to fill out and is not supported by Turbotax.

I suggest you need a professional tax preparer to get you out of this mess so you can correct the prior depreciation and pay the least tax on the sale of the property.

Carl11_2

Employee

Since you used the wrong cost basis for 2 or more years for depreciation, amending is not an option. Per IRS Publication 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf on page 14:

The following are examples of a change in method of accounting for depreciation.
• A change from an impermissible method of determining depreciation for depreciable property if the impermissible method was used in two or more consecutively filed tax returns.

So the IRS Form 3115 would need to be used. This form is not simple by any stretch of the imagination, and I highly urge you to seek professional help. This is especially true if your state also taxes personal income.