How to fix sold rental property depreciation incorrectly claimed in prior years

[lkmiss]

What is the name of your state? FL

We found out depreciation we took on a rental condo was apparently done incorrectly and we need to fix it. It was converted from personal use to a rental in late 2015. We did not start depreciation until 2016 tax year. The property was sold at a loss last year and we would like to know if we can fix the prior years mistakes on our 2020 taxes or if we have to re-amend prior years (and how far back) as well as how to go about making the corrections.

We depreciated the fair market value of the condo (net the land) at the time it was turned into a rental, so not sure whether that is correct. Appliances were depreciated. We thought the furnishings could also be depreciated, as the property was rented fully furnished/decorated. However, we were told that you cannot depreciate furniture, so that apparently has to be corrected. We did not keep receipts for the appliances or furnishings because they were for personal use at the time they were purchased and renting the property was never the intent so not sure if that is an issue, at least for the appliances.

The rental was purchased for personal use in 2007 and converted into a rental in 2015. The property was sold at a significant loss last year and we included all the furnishings and decor in the sale.

Are these depreciation errors something we can fix ourselves, using our tax software, or is it going to be too complex, requiring a CPA? The rest of our 2020 taxes are straightforward and already completed so it's only the depreciation on the rental property left in question. Note we are under audit for 2017 for what we were told were a couple of common mistakes and one significant error, which caused us to be flagged (just discovered it was caused by the tax software so working with them on it). So the 2017 taxes will be amended by the IRS. We are now probably at higher risk for an audit, so we want to ensure the rental depreciation is properly done, as we account for the sale of the rental on 2020 taxes.

Thank you.

 

[adjusterjack]

A tax attorney participates here and will be along tonight or tomorrow to give you some comments but I suggest you get a tax pro to fix this and stop relying on software.

 

[davew9128]

You'll need to prepare a change of accounting method to calculate the depreciation. I do NOT recommend you do it yourself as the calculation is not for a layperson and I can identify several issues associated with your post, and I would be lying if I said I think you have a deductible loss on the sale.

 

[Just Blue]

@Taxing Matters

 

[Taxing Matters]

Are these depreciation errors something we can fix ourselves, using our tax software, or is it going to be too complex, requiring a CPA?

I think you likely know the answer already. If you knew how to fix it, you'd have gone ahead and done that already. The fact that you say you aren't sure you did it right in the first place and aren't sure what to do now means it's time to see a tax professional for help. It's not something a forum like this can walk you through. Fixing this requires seeing the returns you filed and all the facts regarding the property to figure out what exactly the errors were and then work out how to fix them. The fee you pay to get this right is good insurance against possible problems in a future audit, and may avoid you making mistakes that cost you money in tax, too.

I agree with davew9128 that it seems very unlikely that you'd have a capital loss (much less a deductible one) on a property that you bought in 2007 and sold in 2020. Given the appreciation in real estate in most of the US over the last 13 years, a gain is far more the likely outcome. But again, the details of the property matter a lot — how much you bought it for, how much you sold it for, what improvements you put into it, the proper depreciation during the rental term all matter. The tax pro will help you sort that out.

 

[LdiJ]

What is the name of your state? FL

We found out depreciation we took on a rental condo was apparently done incorrectly and we need to fix it. It was converted from personal use to a rental in late 2015. We did not start depreciation until 2016 tax year. The property was sold at a loss last year and we would like to know if we can fix the prior years mistakes on our 2020 taxes or if we have to re-amend prior years (and how far back) as well as how to go about making the corrections.

We depreciated the fair market value of the condo (net the land) at the time it was turned into a rental, so not sure whether that is correct. Appliances were depreciated. We thought the furnishings could also be depreciated, as the property was rented fully furnished/decorated. However, we were told that you cannot depreciate furniture, so that apparently has to be corrected. We did not keep receipts for the appliances or furnishings because they were for personal use at the time they were purchased and renting the property was never the intent so not sure if that is an issue, at least for the appliances.

The rental was purchased for personal use in 2007 and converted into a rental in 2015. The property was sold at a significant loss last year and we included all the furnishings and decor in the sale.

Are these depreciation errors something we can fix ourselves, using our tax software, or is it going to be too complex, requiring a CPA? The rest of our 2020 taxes are straightforward and already completed so it's only the depreciation on the rental property left in question. Note we are under audit for 2017 for what we were told were a couple of common mistakes and one significant error, which caused us to be flagged (just discovered it was caused by the tax software so working with them on it). So the 2017 taxes will be amended by the IRS. We are now probably at higher risk for an audit, so we want to ensure the rental depreciation is properly done, as we account for the sale of the rental on 2020 taxes.

Thank you.

How much total depreciation have you accumulated (however incorrectly) and how much of a loss did you have on the sale? Did you take selling expenses into consideration as part of your loss? You wouldn't need a CPA but it's possible that you might want to use a tax professional this year, rather than attempting to do it on your own. You would need someone experienced in dealing with rentals.

Are you actually under audit or did you get a CP-2000 letter?

 

[davew9128]

I agree with davew9128 that it seems very unlikely that you'd have a capital loss (much less a deductible one) on a property that you bought in 2007 and sold in 2020. Given the appreciation in real estate in most of the US over the last 13 years, a gain is far more the likely outcome. But again, the details of the property matter a lot — how much you bought it for, how much you sold it for, what improvements you put into it, the proper depreciation during the rental term all matter. The tax pro will help you sort that out.

I think the other issue is that the FMV at the time it was made a rental is almost assuredly LOWER than the price paid for it.

 

[LdiJ]

I think you likely know the answer already. If you knew how to fix it, you'd have gone ahead and done that already. The fact that you say you aren't sure you did it right in the first place and aren't sure what to do now means it's time to see a tax professional for help. It's not something a forum like this can walk you through. Fixing this requires seeing the returns you filed and all the facts regarding the property to figure out what exactly the errors were and then work out how to fix them. The fee you pay to get this right is good insurance against possible problems in a future audit, and may avoid you making mistakes that cost you money in tax, too.

I agree with davew9128 that it seems very unlikely that you'd have a capital loss (much less a deductible one) on a property that you bought in 2007 and sold in 2020. Given the appreciation in real estate in most of the US over the last 13 years, a gain is far more the likely outcome. But again, the details of the property matter a lot — how much you bought it for, how much you sold it for, what improvements you put into it, the proper depreciation during the rental term all matter. The tax pro will help you sort that out.

2007 was right before the 2008 real estate bust...when prices were sky high. It's not impossible that the property never fully recovered to that same level. It is also possible that a deteriorating neighborhood, or damage to the condo would lead to it selling at a loss.

 

[Taxing Matters]

2007 was right before the 2008 real estate bust...when prices were sky high. It's not impossible that the property never fully recovered to that same level. It is also possible that a deteriorating neighborhood, or damage to the condo would lead to it selling at a loss.

Yes, prices were high compared to the prices after the crash. However, with the recovery nationally housing prices are today higher on average than in 2007. Of course there are going to be local variations in that and the other factors that you mentioned. But the odds are there's a gain here.

I think the other issue is that the FMV at the time it was made a rental is almost assuredly LOWER than the price paid for it.

That too.

 

[lkmiss]

Thank you for your responses. We will seek out a CPA at this point. For those that asked, yes, we did take a loss on the sale. Purchased for $245K in 2007 and sold, fully furnished, for $225K in 2020. Still have commissions to deduct on top of that, as well as HOA fees and maintenance/repair fees for a couple of things that broke. It was a unique studio loft that would only appeal to a certain subset of buyer. Also, the builder filed for bankruptcy in 2008/2009 and the remaining lofts were sold for $100K. For those who paid top dollar in 2007, the values never recovered and have been underwater ever since. No one is selling because they can't pull their equity out. We just had to finally cut our losses. We didn't even qualify to refinance when the HARP program was enacted because it was not ensured by Fannie Mae or Freddie Mac. Despite renting it out, we ended up with negative monthly cash flow because we could not rent it out for high enough to cover the mortgage or the HOA fees.

 

[davew9128]

Thank you for your responses. We will seek out a CPA at this point. For those that asked, yes, we did take a loss on the sale. Purchased for $245K in 2007 and sold, fully furnished, for $225K in 2020. Still have commissions to deduct on top of that, as well as HOA fees and maintenance/repair fees for a couple of things that broke.

You have a loss. I still don't think you have a deductible tax loss where your depreciable rental basis is less than your purchase price. Yours is an unusual situation but yes, I agree, speak to a qualified tax pro.