Incorrect basis on a rental that sold

[Tracy Lee]

Client sold her rental for $210,000.00, her purchase price was $110,000.00 in 2003.  She also had $45,000.00 in improvements in 2010, she does not believe she ever expensed them out as repairs either.   Her depreciation schedule shows basis as $24,420.00 and no improvements.  She is positive that the land was not worth $85,580.00 (which also does not appear on the depreciation schedule).  It is a single family dwelling.  How do I go about increasing her basis and adding the improvements so she doesn't end up paying so much capital gain?

[Lee B]

You need closing summary from when property was purchased which the title company would have or alternatively the property records from that year.

You need all of the tax return copies she can find. If you have enough documentation then you could file Form 3115 to catch up all of the expenses and depreciation,

which would be deductible in the current year. Remember it's your client's responsibility to keep all of this stuff. 

 

[Tracy Lee]

So if she can't find any of this information, basis stands as it is on the depreciation schedule and she has to pay the large capital gains?  I really 'picked her brain' and she was coming up with nothing.  She's an elderly lady and I think her husband who passed away in 2020 took care of all that.  There would be no other way to 'add' that extra basis?

[Lee B]

If you have documentation to show that the original land/bldg allocation was done incorrectly and the $45,000 in improvements were never expensed,

then you have something to work with. As a practical matter, rental property that was acquired many years ago, usually has significant amounts of depreciation recapture

and capital gains. Unfortunately, we aren't given magic wands.

[ILLMAS]

Hope you are charging just for thinking about this mess, get compensated, don’t play a super hero for free.

[DANRVAN]

1 hour ago, Tracy Lee said:

She's an elderly lady and I think her husband who passed away in 2020 took care of all that. 

Looks like you have a 1/2 step up basis to start with.

Sounds like a prior tax preparer was involved, can you contact them for any additional information they might have?

As cbslee mentioned, the county should have information on the original purchase price and likely a valuation of the land vs structures.

[Sara EA]

Exactly right!  If it was jointly owned, there is half step up basis.  If the improvements were made prior to his death, his half of those is included in the step-up, but her half should be added to her basis.  If you're really lucky, it was just in his name so you get full step-up and don't have to mess with any of this.

[Lee B]

Once again we have proven two or more heads are better than one

[Pacun]

Let's say you don't want to do a 3115, you ask when the improvement happen, depreciate it all the years in existence and add the remainder to the basis.  You need to add the cost of land also to the bases or list it on its own.

Even if it was under his name completely and get full step up basis, you still have to deal with the depreciation allowed or allowable. 

 

[DANRVAN]

1 hour ago, Pacun said:

Even if it was under his name completely and get full step up basis, you still have to deal with the depreciation allowed or allowable.

retracted my post for further review.

[DANRVAN]

3 hours ago, Pacun said:

Even if it was under his name completely and get full step up basis, you still have to deal with the depreciation allowed or allowable.

I question that.

The tax attributes of deceased spouse do not carry over to surviving spouse.  

For example capital losses and NOL attributable to deceased spouse can not be claimed by surviving spouse after the final joint return for year of death has been filed.

If business or rental property is solely owned by deceased spouse, then surviving spouse gets a full step up in basis.

Furthermore, at the time of transfer, the property has zero adjustments for tax attributes, it does not retain it's character for recapture.

If surviving spouse elects to file a joint return, then the only income and expenses reported by deceased spouse would be those  incurred up to his date of death.

Therefore the sale of the property after DOD is 100% attributable to surviving spouse (under the scenario above) and offset by her basis which does not retain the recapture attributed to the holding period of her husband.

[JohnH]

I'm printing out this thread for further review & consideration.  Very interesting discussion, and may be relevant to a client situation I know is coming up shortly.  Many thanks for all the comments. (I love this forum) 

[TaxGuyBill]

On 3/18/2021 at 7:09 PM, Tracy Lee said:

So if she can't find any of this information, basis stands as it is on the depreciation schedule and she has to pay the large capital gains? 

 

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.

[Pacun]

35 minutes ago, TaxGuyBill said:

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.

I thought 3115 was a fix all form.

I guess you can argue that the improvement doesn't need form 3115 because they simply used 0 basis on the improvement.

[joanmcq]

I don't know why you would say the wrong basis is a 'mathematical or posting error' when there is a specific section of the 3115 JUST for depreciation errors.

[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".

[Pacun]

57 minutes ago, TaxGuyBill said:

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".

No, I believe 3115 is used for any errors you have made in the past. A lot of companies benefited big time by using 3115 to correct depreciation errors.

[Lee B]

My understanding is based on a long presentation and discussion at in all day CPE class sponsored by the OSCPA is that if the error/mistake occurs two years in a row that creates an incorrect method which can corrected by a 3115.  If the error/mistake is a one off (happens once ) then that is corrected by an amended return.

It doesn't matter why the depreciation errors occurred, the fact they did occur and were repeated creates a method which can be corrected with a 3115.

In the presentation, correction of depreciation was used several times in examples. By the way the presenter was the Chairman of the AICPA Taxation Committee.

 

 

 

 

[DANRVAN]

On 3/19/2021 at 7:49 PM, Pacun said:

thought 3115 was a fix all form.

Not at all, that is a common misunderstanding.

As Tax Guy Bill pointed out, 3115 is used to change from an impermissible accounting method to a permissible accounting method.   Failure to claim any depreciation on an asset is an impermissible method, so form 3115 is filed to claim allowed or allowable depreciation under a permissible accounting method.  

On 3/19/2021 at 10:45 PM, joanmcq said:

there is a specific section of the 3115 JUST for depreciation errors.

Corrections due to calculations, posting or math errors are not accounting method changes and cannot be fixed on form 3115.  So for example if an incorrect placed in service date was used, that mistake could not be fixed on 3115.

On 3/20/2021 at 8:51 PM, cbslee said:

error/mistake occurs two years in a row that creates an incorrect method which can corrected by a 3115.

I believe that rule has changed, but only applied to corrections made to change from an impermissible method to a permissible method as Bill pointed out.

Previously, I think the impermissible method had to be used for two consecutive years in order to make the correction on 3115, otherwise the correction went on 1040X.