Rental Property Over Depreciated - Now What?

[48Fire]

It appears that my parents rental properties were over depreciated by $51,000.

Tax preparer A did their taxes for 36 years, and fully depreciated two properties over 27.5 years. Tax preparer A died, and Tax preparer B starts depreciating the properties again at $8500 per year for 6 years. We only discover this after we sell the properties and the end of last year, and Tax preparer B starts calculating the Capital Gains taxes.

They tell us we owe an additional $40,000 - $60,000 more than Tax Preparer C estimated, but they haven't given us a final number. They also say that to make things right, they need to submit a Form 481A.

I'm not sure why we can't do amended returns on the six years that were in error. I would think the impact would be on the order of 15% of the $51,000, or $7,600. With six weeks left until April 15th, my 88 year old Dad is going a little crazy. And advice? Thank you

 

[cathy63]

There is a limit on the number of returns you can amend to correct depreciation calculations. You can't amend all six erroneous returns, I think the max is three prior years, but I am not certain of that and it may be that you can only amend 2022 right now.

Since this has been going on longer than that, you have to file Form 3115 to fix it. (Section 418(a) is the relevant part of the tax code, not the form number.) Usually if you file a 3115 and you have to declare more income as a result, you can spread it over the next 4 years, but I am not sure what happens if you dispose of the depreciated asset before the 4 year period expires. It's possible that you may have to take it all in the year of the disposition.

I'm sorry to be vague on this, it's a pretty rare situation. I would suggest taking everything to a CPA with a specialty in business taxes to see if they have another suggestion. This is probably beyond the typical tax preparer who is not specially trained.

I don't see why you would owe $40K to $60K in additional tax on $51K of improper depreciation though. If you recapture it all as ordinary income this year, the most it can be is 37% of that. The correct depreciation that is recaptured will be capped at 25% and the capital gain at 20% plus 3.8% if NIIT applies. Maybe the $40K to $60K includes all three components of the net proceeds?

 

[48Fire]

There is a limit on the number of returns you can amend to correct depreciation calculations. You can't amend all six erroneous returns, I think the max is three prior years, but I am not certain of that and it may be that you can only amend 2022 right now.

Since this has been going on longer than that, you have to file Form 3115 to fix it. (Section 418(a) is the relevant part of the tax code, not the form number.) Usually if you file a 3115 and you have to declare more income as a result, you can spread it over the next 4 years, but I am not sure what happens if you dispose of the depreciated asset before the 4 year period expires. It's possible that you may have to take it all in the year of the disposition.

I'm sorry to be vague on this, it's a pretty rare situation. I would suggest taking everything to a CPA with a specialty in business taxes to see if they have another suggestion. This is probably beyond the typical tax preparer who is not specially trained.

I don't see why you would owe $40K to $60K in additional tax on $51K of improper depreciation though. If you recapture it all as ordinary income this year, the most it can be is 37% of that. The correct depreciation that is recaptured will be capped at 25% and the capital gain at 20% plus 3.8% if NIIT applies. Maybe the $40K to $60K includes all three components of the net proceeds?

Thanks, very helpful. I asked for a breakdown of the numbers, but they didn't provide them. Our first step was to verify that Tax Preparer A had, in fact, depreciated the two properties to zero. Fortunately, my Dad still had all of the records. Tax Preparer B is not a CPA, and is relying on a newly hired CPA, who is probably very smart, but very young.

 

[48Fire]

I'm sorry to be vague on this, it's a pretty rare situation. I would suggest taking everything to a CPA with a specialty in business taxes to see if they have another suggestion. This is probably beyond the typical tax preparer who is not specially trained.

I'm glad you said that, because I want to do exactly that. When we talked to Tax Preparer C back in October to give us an estimate, she was surprised that the properties were still being depreciated at $4,500 annually even though they were put in service 34 and 45 years ago. I had noticed the same thing the day before we met. So I want her to give us another opinion.

 

[brydanger]

Step one: Fire preparer A & C

 

[Out-to-Lunch]

Tax preparer A died,

Step one: Fire preparer A & C

Umm... A little late. Plus A did nothing wrong.

 

[Sunset]

I'm glad you said that, because I want to do exactly that. When we talked to Tax Preparer C back in October to give us an estimate, she was surprised that the properties were still being depreciated at $4,500 annually even though they were put in service 34 and 45 years ago. I had noticed the same thing the day before we met. So I want her to give us another opinion.

Normally the depreciation is over ~27.5 years (going by memory).

In special circumstances (rare, for example in foreign country) can be over 40 years.

No wonder she was surprised.

 

[48Fire]

Umm... A little late. Plus A did nothing wrong.

Exactly. Preparer A was amazing. He was a retired, Bank Manager, who did taxes just to keep himself busy. I think he was around 85 years old when he died.

Tax Preparer C has just provided an hour or two of work at no charge. Her Mom listed and sold the two rental properties.

 

[cathy63]

Does Preparer B have errors and omissions insurance? You obviously will have to pay the tax that should have been paid during the time that the rentals were over depreciated, but if you end up owing more total tax or penalties than you would have if the prior returns had been done correctly, you might be able to get Preparer B to pay the difference.

 

[48Fire]

Normally the depreciation is over ~27.5 years (going by memory).

In special circumstances (rare, for example in foreign country) can be over 40 years.

No wonder she was surprised.

Yeah, and I was, too! We had rental properties as well, and I did my own taxes, so I was aware of the 27.5 years.

 

[48Fire]

Does Preparer B have errors and omissions insurance? You obviously will have to pay the tax that should have been paid during the time that the rentals were over depreciated, but if you end up owing more total tax or penalties than you would have if the prior returns had been done correctly, you might be able to get Preparer B to pay the difference.

That's a great question At this point, we're just trying to figure out the right answer, but I will bring that up at some point. My Dad is struggling to get his baseline inputs in, and he's promised them to them by this Friday. Maybe by the following Friday, we'll know the real numbers, and whatever penalty and interest is due. Thanks

 

[Sunset]

Are you parents alive ( or the parent that owned the properties ) ?

I wondering if there is an escape hatch in this mess..

 

[48Fire]

Are you parents alive ( or the parent that owned the properties ) ?

I wondering if there is an escape hatch in this mess..

Yes, both. Dad is 88, and Mom is 86. They've been landlords for 60 years. They're not on the top of their game.