TaxGuyBill

No, the section of Form 3115 is not for depreciation "errors", it is to change the "method of accounting", such as from an "impermissible" method to a "permissible" method. Not claiming depreciation is an "impermissible" accounting method. Using the wrong Basis is merely a "mathematical or posting error".

When reporting the sale, you use the ACTUAL Basis, regardless of what the depreciation schedule says. For determining the Adjusted Basis you do need to use the depreciation that SHOULD have been taken (including the depreciation on any improvements). Form 3115 does not apply. Using an incorrect Basis for depreciation is a "mathematical or posting error", not a "method of accounting", so Form 3115 does not apply. As was pointed out above, if the husband died before the property was sold, the Basis gets a 1/2 step-up if they were in a non-community property state, or a full step-up if in a Community Property state. As Dan mentioned, the step-up gets rid of the prior depreciation for the portion that is stepped up.

The sale is supposed to be on Form 4797, just like any other rental. The amount of Unrecaptured Section 1250 Gain is shown on page 2 of Schedule D, and is actually calculated on one of the capital gain worksheets. The exclusion should also be entered on Form 4797. https://www.irs.gov/instructions/i4797#idm139902460554688

As was mentioned above, it is distributed (essentially 'sold') to the taxpayer/shareholder at Fair Market Value. That is required. The individual person is a separate taxpayer/entity. They will restart depreciation using their 'purchase' cost. After 20 years, and factoring in 20 years of depreciation, do you really think there won't be much of a gain? That would be ideal, but I suspect the gain due to the depreciation could be large.

LOL. That really doesn't make sense, does it? :-) I think I originally typed "the instructions don't say this". When I changed it, I MEANT to say "I don't think the instructions say this", but I forget to delete the "don't".

I realize that I'm 3 weeks late, but I have a slight clarification for when the dependent's MAGI needs to be added: It's when the dependent's "taxable income" (Line 43 of the 1040) is more than $0. There are other circumstances when a dependent is required to file a tax return (such as self employment), but they don't have any "taxable income". In these cases, the dependent's MAGI is NOT added. I don't think the instructions don't really say this, but the gobbledygook in the Tax Code does.