Depreciating Rental Condo - land or no land value?

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  #1  
Old 04-05-19, 09:48 AM
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Depreciating Rental Condo - land or no land value?

(I'm cross-posting this from the taxes board, because when I re-read it, I think it may fit here better)

Hi All,

We used to live in a 2-floor townhouse/condo from 2006 - 2011. In 2011, we moved and converted the condo into a rental unit.

The condominium association itself has something like 15 buildings. Each building is three stories high, with the first floor being a 1-floor unit, and the second and third floors being the 2-floor townhouse units. Each unit has its own outdoor entrance. There are a total of about 20 units in each building, so about 10 ground floor units and about 10 2-floor townhouses. The townhouses do not sit on the land at all, as they sit on top of the ground floor units.

For tax purposes in 2011, our CPA uses the then-fair market value (FMV) as our basis for depreciation purposes (this was lower than our cost + improvements - deductions, etc.). However, he depreciated 100% of the FMV. I'm wondering if he should have depreciated only a percentage of the FMV because land cannot be depreciated. According to the town tax bill, about 60% of the assessed value is "land" and about 40% of the assessed value is "improvements."

Should our depreciation really be calculated as FMV * 0.4 / 27.5 years? Or is it just FMV / 27.5 years?

I've read several places that a condo like ours is considered an "air-lot" and that I don't actually own any of the land (because its owned by the condo association), meaning that I depreciate the full FMV. I've read the opposite in other places. The first one makes the most sense to me for common sense purposes - I'm not actually on land, I'm on top of another unit; and the FMV of my unit includes the opportunity to enjoy the other condo land (e.g., the pool, tennis courts, etc.), with the actual land being owned by the condo - I can't do anything to this land like I could if it was a single home.

Any thoughts on whether my CPA messed up or not? If he did, then that means I've been taking a bit more than 2x the depreciation I should otherwise have taken. Which would mean I would actually owe taxes!

Help!!

Thanks!
 
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  #2  
Old 04-10-19, 06:58 AM
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You depreciate using 40% of the purchase price and closing costs (original basis) and also figure "component depreciation" on the various improvements. For improvements you made inside your unit you would depreciate without the 40% adjustment.

It has generally been accepted that you use the building and land values on your property tax bill for the year you bought the property to figure out your depreciation on the original basis. At least that is what I did for a dozen or so condo. units I have owned over the decades. For one of my units the tax bill gave a land value of zero so I depreciated 100% of the original basis.

"Owned by the association" means the land and other common areas are owned by all of the unit owners in the proportions given by the percentage interests stated in the bylaws.
 
  #3  
Old 04-10-19, 07:32 AM
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Thanks for the response.

I found some old correspondence between me and the CPA. It looks like he did the following calculation to determine the value of our unit for depreciation purposes:
1. Take our purchase price in 2006;
2. Add in our closing costs from 2006;
3. Subtract the value of the land according to the 2011 tax statement from the town (2011 is when we turned the unit into a rental). (Actually, the 2006 and 2011 statements are identical for these numbers).

I'm thinking that this is NOT the correct way to do it because it is not using the 40% percentage. According to the 2011 tax bill, the land was worth $175k, and the improvement was worth $120k. By subtracting the land value from our purchase price, instead of using percentages, he chalked up all the difference between the purchase price and assessed value (i.e., $295k) to the improvement instead of apportioning it. I'm guessing this was wrong.

My biggest (I think!) problem is that he misread the 2011 tax statement from the town. As noted above, it listed the land as being worth $175k; he misread it as $75k, i.e., off by $100k!

So, we have been mis-depreciating the unit by $100k each year. So, $100k / 27.5 = ~ $3,650. Then, $3,650 * 7.5 years = $27k that we have taken as too large of a depreciation expense overall. (We placed the unit as a rental basically mid-way through 2011, so that comes to 7.5 years, as of the end of 2018.)

I currently have a carry-forward (if that's the right term) of approximately -$53k (i.e., all losses on paper that I can't use to offset my regular income because of my other salary).

Am I right that, big picture, we add that $27k back to the -$53k, meaning that I should actually have a carry-forward loss of $26k now? If so, I'm thinking that means I don't owe any back taxes because I'm still at a loss of $27k on paper (i.e., no annual positive rental income overall to tax).

My biggest fear is that we will somehow owe taxes (we are starting a large renovation project on our residence in about 3 weeks - this realization could not have come at a worse time!!!)

(I understand my numbers are off because he just subtracted land value instead of using percentages, but I can calculate that separately - I just want to make sure my understanding is correct.)

Thanks for reading! This is the kind of thing that makes my head spin!
 
  #4  
Old 04-11-19, 11:35 AM
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If you discover an error in your tax return, including for depreciation, then file an amended return.

If it is more than 3 years ago that the return with the error was filed or its due date was, whichever date came later then it might not be possible to amend the return.

The process of fixing the error would be the same whether you made a math error resulting in the wrong land value percentage or whether you forgot to take into account building value versus land value.

Depreciate the correct amount for the current and each future year disregarding whether you made a mistake in a prior year return.

If you deducted too much depreciation for a given year then when you finally sell the property you will pay capital gains tax on the entire amount of depreciation you took, as recapture; Section 1250 gain, etc.

If you deducted too little depreciation for a given year then when you finally sell the property you must pay capital gains tax on the correct amount of depreciation you should have taken, as recapture or Section 1250 gain, etc.

Given the previous two paragraphs here, if you came up with two numbers for depreciation and are unable to figure out which is correct, use the larger depreciation resulting in a lower total tax for that year.

For those years where amending the return was done, the depreciation that must be recaptured etc. for capital gains tax purposes is that on the amended return, not that on the original return.
 

Last edited by AllanJ; 04-11-19 at 12:11 PM.
  #5  
Old 04-11-19, 11:59 AM
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Thanks for the info, Allan. (Although I'm pretty sure my head is spinning right now!)

As I can't amend tax returns that are more than 3 years old, does it make sense to simply amend the last three returns in order beginning with the oldest? That way, the suspended passive loss will be corrected (at least partially, because I can't take into account the previous years, I guess) on the last three returns.

Did I get that right?

If so, does it make sense in one of those years (or more, if necessary) to use a $0 depreciation value so that the combination of the old non-amended returns and new amended returns results in the correct overall depreciation until now? Meaning that starting with next year's returns (I filed this year's a few days ago), I can start depreciating the correct amount and everything will be fine?

Thanks again.
 
  #6  
Old 04-11-19, 12:18 PM
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Do not use an arbitrary or $0. depreciation so the combination or cumulative amount of depreciation is more correct. Each year's return as filed needs to be correct unto itself.

Now it is possible for one year's return to affect a prior or later year's return by using carryforwards or carrybacks.

If I remember correctly the form used to account for passive losses is Form 8582.
 
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