Author Topic: A three part question about rental property depreciation - advice needed.  (Read 1683 times)

bittheory

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This is kind of a three part question, all about depreciation, taxes and audit risk. This is mostly due to me jumping into the landlord market a few years ago with absolutely no experience and doing what TurboTax instructed.

PART ONE: I own a rental home that was my primary residence until July 2012. I claimed depreciation on it, but it appears I did not subtract the land value for the cost basis for 2012 or 2013. Is this a problem? It's a rowhome/townhome with a small yard and thus does have "land value" albeit a smaller percentage vs. a single family home.

PART TWO: I did not claim depreciation in 2014 due to accounting/posting mistakes. I was in the process of amending that return to include depreciation (with the correct land value subtraction), but am wondering if it's worth it at this point due to the increased audit risk. The headache of an audit is not worth the $600 I'd get in return. Thoughts here?

PART THREE: It doesn't seem like there's a magical formula at all for discovering the "land value" for my rental property. Some people say call the assessor's office. Some say insurance declarations. Some say 15-20%. Since this is an attached rowhome with a very small yard, I'm not sure any of these are right. Advice on how to proceed? Also, it is a huge red flag if I include the land value on this year's return whereas I did not in the past?

I couldn't sleep last night because I realized I had made all these mistakes in previous years and am working hard to get it right. 

JLee

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Re: A three part question about rental property depreciation - advice needed.
« Reply #1 on: February 11, 2016, 10:01:36 AM »
This is kind of a three part question, all about depreciation, taxes and audit risk. This is mostly due to me jumping into the landlord market a few years ago with absolutely no experience and doing what TurboTax instructed.

PART ONE: I own a rental home that was my primary residence until July 2012. I claimed depreciation on it, but it appears I did not subtract the land value for the cost basis for 2012 or 2013. Is this a problem? It's a rowhome/townhome with a small yard and thus does have "land value" albeit a smaller percentage vs. a single family home.

PART TWO: I did not claim depreciation in 2014 due to accounting/posting mistakes. I was in the process of amending that return to include depreciation (with the correct land value subtraction), but am wondering if it's worth it at this point due to the increased audit risk. The headache of an audit is not worth the $600 I'd get in return. Thoughts here?

PART THREE: It doesn't seem like there's a magical formula at all for discovering the "land value" for my rental property. Some people say call the assessor's office. Some say insurance declarations. Some say 15-20%. Since this is an attached rowhome with a very small yard, I'm not sure any of these are right. Advice on how to proceed? Also, it is a huge red flag if I include the land value on this year's return whereas I did not in the past?

I couldn't sleep last night because I realized I had made all these mistakes in previous years and am working hard to get it right.

Re: part three, what I did with mine is took the percentage of land value assigned to the overall property value from my pre-purchase appraisal and applied that percentage to my purchase price.  For example, the appraisal came in at $150k with a $30k land value (20%).  My actual purchase price was $140k, so I used $112k as my depreciation number ($28k, i.e. 20%, as land).

That was the best solution I was able to come up with, and at the very least I feel it is defensible if it is ever questioned. If there is a superior alternative, I am all ears - I haven't filed yet (I still need to file for prior year depreciation for 2013 and 2014).

zephyr911

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Re: A three part question about rental property depreciation - advice needed.
« Reply #2 on: February 11, 2016, 10:40:47 AM »
Friggin' TurboTax. *sigh* they make everything sound so easy....

I've never been audited myself but back when I was a paid tax preparer I had some clients who were. It's only painful if you were trying to get away with something. This is minor, and it will probably be correctly perceived as a good-faith effort to correct a mistake.
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PART ONE: I own a rental home that was my primary residence until July 2012. I claimed depreciation on it, but it appears I did not subtract the land value for the cost basis for 2012 or 2013. Is this a problem? It's a rowhome/townhome with a small yard and thus does have "land value" albeit a smaller percentage vs. a single family home.
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PART TWO: I did not claim depreciation in 2014 due to accounting/posting mistakes. I was in the process of amending that return to include depreciation (with the correct land value subtraction), but am wondering if it's worth it at this point due to the increased audit risk. The headache of an audit is not worth the $600 I'd get in return. Thoughts here?
These are two flavors of the same problem. First, they are both inaccurate, and second, your adjusted basis at sale time will be calculated on the depreciation you should have claimed and not what you did claim. You might overpay capital gains, or you might underpay; either way, someone's not happy.

I don't think you should make this decision primarily based on audit risk. First of all, if the only change in your return is adding depreciation to a rental property, I can't see them wasting their limited resources on an audit. You're expected to claim it, and you're correcting your error. Don't do it for the $600, do it to correct the record.
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PART THREE: It doesn't seem like there's a magical formula at all for discovering the "land value" for my rental property. Some people say call the assessor's office. Some say insurance declarations. Some say 15-20%. Since this is an attached rowhome with a very small yard, I'm not sure any of these are right. Advice on how to proceed? Also, it is a huge red flag if I include the land value on this year's return whereas I did not in the past?

Any reasonable estimate that can be substantiated with records will work. There is no scientific process specified by the IRS to determine land value, but they do specify what does and doesn't count toward the total cost basis, so make sure you get that right first.

Here's the bottom line. If you're using MACRS straight-line, your claimed depreciation should be the same every year unless you add to your basis via major improvements (CAPEX). So, if you really want to do this right, start here: 1) carefully recalculate your total cost basis and write that number down; 2) pick a method for land-value determination, write down how you calculated it and why, and keep that; and 3) use the above to determine a defensible value for improvements, and write that down too.

NOW, every year that you have this rental, except for the prorated first and last years, you should use that same basis for depreciation (unless you add improvements, which you will depreciate separately on their own schedule and to each year's total). Once you figure out that amount, amend your returns to match. While you're at it, make sure you prorated your 2012 depreciation for the partial year. This all may be a pain in the ass but it will square you with the IRS now and at the time of disposition. Going forward, set up a spreadsheet to track the amount you claimed for each year so you can reconcile the total when you sell.

And finally, relax a little and don't stress too much over this. You're doing the right thing. It's tedious but it won't kill ya. :)

bittheory

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Re: A three part question about rental property depreciation - advice needed.
« Reply #3 on: February 11, 2016, 10:59:04 AM »
zephyr911. Thank you for the excellent response. You help me put at ease. Sounds like I have some work to do. Do you recommend I work with a tax professional to get everything worked out?

Overall, I just wish I'd done the basis of the property correctly in 2012 when it became a rental. Can I even amend 2012 at this point? Does it even matter? Mistakes mistaken.

zephyr911

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Re: A three part question about rental property depreciation - advice needed.
« Reply #4 on: February 11, 2016, 11:25:19 AM »
zephyr911. Thank you for the excellent response. You help me put at ease. Sounds like I have some work to do. Do you recommend I work with a tax professional to get everything worked out?

Overall, I just wish I'd done the basis of the property correctly in 2012 when it became a rental. Can I even amend 2012 at this point? Does it even matter? Mistakes mistaken.
The time limit depends on the reason for the amendment. I know it's a max of 3 years to claim a refund, but more for other situations.

I haven't amended for this specific reason so I don't know how much work it is... if it means redoing several forms, the bill could be hundreds for just an hour's work, so at least consider DIY. If you're outside your comfort zone and can't get enough info to feel confident about your accuracy, consider pro help.