If a rental property is sold without any deprecition taken in the past. Can prior year depreciation amount be entered as 0?

[kwyp]

If a rental property is sold without depreciation taken in the past, can it be correct as "0"  for the prior year depreciation amount?  Under this senario, it seems no ordinary earned income with the return. Only capital gain tax related to this rental sale. 

However, if enter a data for the prior year depreciation amount based on depreciation table, the tax will be included two parts:1.) capital gain amount.  2.) ordinary earned income, which equals taxable income (line 15 1040) -Gapital gain amount (line 8 1040) 

It seems if no depreciation taken in the past, at the year when rental is sold, will result less tax due to no ordinary earned income. 

[BobKamman]

Less tax will also be due if you add amounts to basis for fairy dust.  Imaginary numbers for imaginary improvements.  Some might call it cheating, but if IRS doesn't catch it, do you care? For that matter, if you don't subtract depreciation allowable from basis, what's to prevent you from later filing amended returns to get refunds?  It's not like IRS is going to match up other returns to see if the same property was later sold.  And yes, you could go back 20 years, if taxes are still owed for prior years.  

[sjrcpa]

@kwyp 

You've already asked about this a few times. Here's one:

https://accountants.intuit.com/community/proconnect-tax-discussions/discussion/miss-depreciation-in-...

[taxmo]

When selling a rental property, you have to pay taxes on the recapture of the depreciation that you should have claimed, even if you never actually claimed it.  Yes, that's as bad as it sounds.

There is a solution, but it's complicated.  In the year of sale, the IRS provides the ability to use DCN 107 to fix past depreciation using form 3115.  It's a complicated form to complete, with supporting statements and calculations, but the result is you can claim the past missed depreciation error, and recapture it in the same year.  

[kwyp]

"When selling a rental property, you have to pay taxes on the recapture of the depreciation that you should have claimed, even if you never actually claimed it.  Yes, that's as bad as it sounds"

Here is the fact: If a taxpayer did not claim deprecation in prior years. At the year when he sells his property, prior year accumulated depreciation amount is entered by "0". so related recapture deprecation amount is also 0 instead putting a positive number there. 

It is just a simple math,

capital gain =selling price- buying price. Or 

capital gain= selling price-accumulated deprecation + recapture deprection -buying price

[taxmo]

That's incorrect.  Depreciation isn't optional, that's a common misconception.  Or at least if you don't claim it, the issue is that you are still subject to recapture, and so for that reason it is generally said to be required.  It wasn't devised by the IRS, it is defined by tax law under § 1245 and § 1250.  The reason we have to recapture depreciation even if it wasn't actually claimed is § 1250(b)(3) and § 1245(a)(2) and the terminology "allowed or allowable".  Notice that "allowed or allowable" is repeated multiple times in the tax code, and in IRS publication 544, for example:

"Depreciation allowed or allowable. The greater of the depreciation allowed or allowable is generally the amount to use in figuring the part of gain to report as ordinary income. ... If you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight-line method."

This is a significant and common issue and they were misinformed or unaware of the depreciation requirement.  And then when they go to sell the property they face this issue of depreciation recapture of the "allowed or allowable" depreciation even though they failed to claim it for all the past years should have.  To address this situation, the IRS established that this mistake can be fixed with a DCN 107 accounting method change using form 3115. 

[IRonMaN]

"Deprecation is a thing artificially created by IRS for tax defer purpose. It is up to taxpayers whether take advance of it or not. In case taxpayers do not use it, it will not double bad for them."

Were you talking to your barber to get that advice? 

[kwyp]

Let's assume two cases:

Case 1).  A rental property selling price is 500K, purchase price is 300K, accumulated depreciation is 300K. What is the capital gain amount for selling the property? 

case 2).  A rental property selling price is 500K, purchase price is 300K, accumulated depreciation is 0, What is the capital gain amount for selling the property? 

[taxmo]

The amount of tax due would be the same.  Even if they failed to correctly depreciate it, they still have to pay recapture based on the amount of depreciation they were supposed to have claimed.  

They do have the option to file a 3115 form with DCN 107, which would allow them to simultaneous claim the past depreciation they were supposed to have taken as a current year adjustment. 

A side note, technically depreciation recapture isn't called "capital gain", because it's not taxed at the capital gains tax rate, it's taxed at your ordinary income tax rate (but capped at a maximum of 25% for section 1250 property, meaning real estate. 

If you Google something like "depreciation recapture of unclaimed depreciation" you can find numerous articles about this.

[TaxGuyBill]

---

@kwyp wrote:

What is the capital gain amount for selling the property? 

---

Are you ignoring your other post when we discussed that?

https://accountants.intuit.com/community/proconnect-tax-discussions/discussion/miss-depreciation-in-...

[kwyp]

Case 1) Capital gain =selling -accumulated dpreciation+depreciation recapture -purchas price

  =500K-300K+300K-300K=200K

Case2) =500K-0+300K-300K=500K?

500K includes 300K ordinary income and 200K capital gain? (assume taxpayers do not plan to file form 3115)

[taxmo]

To see how the gain is calculated, see lines 20-24 on page 2 of form 4797.   But you could say it's roughly this:

Gain = sales price - (cost - depreciation)

So, in this example:  Gain = 500k - (300k - 300k) = 500k

Which makes sense, because if your purchase price is 300k, and you depreciated all 300k of it, then your gain is the whole sale price.

Case 2 is the same.  Every number is the same because "depreciation" in that formula is the depreciation you claimed... or should have claimed.  So it doesn't make a difference whether it's accumulated depreciation, or just the total of what you should have claimed.  You can't report the sale of a rental property that was rented for any length of time and report $0 depreciation.  Well, you can, but it's not correct, and would be disallowed if audited (which, I know, that rarely happens). 

--

Ok, that's not the whole story because that's a simplification, and this is where it gets interesting in my opinion.  Like I said, it's not all actually "capital gains", because recapture isn't taxed at the (lower) capital gains tax rate, it's taxed at your (higher) ordinary income rate (but capped at 25%).  So in the above scenarios, part of it is capital gains, but part of it is recapture, and those are at different tax rates. 

I actually setup 3 scenarios in my tax software (and I added $200k of W-2 income), and the results are interesting.  

• Experiment 1:  If they had been claiming correct depreciation all along and have $300k of accumulated depreciation:  $169,909 total tax due. 
• Experiment 2:  If they never claimed depreciation, and we are refusing to properly claim it on the sale either, which isn't correct, but we're just going to risk it:  $76,000 total tax due.
• Experiment 3:  If you do the correct thing and file a 3115 form to claim all that past depreciation that should have been claimed in the past years:  $75,717 total tax due. 

Note that applying a 3115 form results in nearly the same total tax bill as not claiming the depreciation at all, but it's the correct method and avoids a very costly tax bill and huge penalty in the event of an audit (because you can't apply a 3115 form later once it's past the final tax deadline).   Also note that correct depreciation results in a bigger tax bill when you sell the property, but don't forget that they got to claim all that depreciation all those years. 

[kwyp]

 IRonMaN

People come here for providing kind and generious help not for wasting their time to mock others. 

If you cannot answer any posted questions directly, you'd better be silent to keep your precious energy or do anything else for fun. 

Please do not create a negative atmosphere here to yourself and to others. 

[IRonMaN]

"If you cannot answer any posted questions directly, you'd better be silent to keep your precious energy or do anything else for fun."

Sorry, I guess I don't know how this place works.  It's a good thing that you have been helping out so many people for so long.  I'll try to be more like you in the future.

Cheers Leaderboard - Intuit Accountants Community

[abctax55]

Jeff... mic drop extraordinaire 

[IRonMaN]

I do my best  😁

[sjrcpa]

@kwyp  It's not capital gain either. The amount  of gain above that attributable to depreciation allowed or allowable is Section 1231 Gain.

[robert26]

No, you cannot enter "0" for prior depreciation if none was taken in the past. The IRS requires you to account for allowed or allowable depreciation when selling a rental property, even if you did not claim it. This results in depreciation recapture, which is taxed as ordinary income. Therefore, skipping the depreciation claim in prior years won't eliminate ordinary income tax; you'll still face recapture and capital gains taxes.