Hello,

I would greatly appreciate someone's expert help here:

We bought a house in 2006 for $120,000 with a mortgage.
We lived in it until end of 2011 when we moved to another city.
Unable to sell it, we rented out in early 2012
Tenants lived there until 1st quarter 2014.
We moved back to the city and back into the house in mid-2014 because a job opportunity in the city coincided with the house's vacancy.
We rented the house out again in 2016 as we bought a bigger home.

So it went from primary residence, to rental, to prim. res., and back to rental.

Our area was hard hit by the 2008-09 real estate bubble and recession and has not recovered like some parts of the country. The house/property we paid $120K for was worth only about $$75K-80K at the time it became a rental, and is worth maybe $95K-$105K today.

As the basis for depreciation, we used the value of the building from the County Auditor's site the first time we did our taxes as a rental, as the current FMV was lower than our actual basis in the property.

We will probably be selling the house to our current tenants this year or next, and I don't understand how the recapture works, and if I made any mistakes thus far, I want to correct them asap.

The first time we did taxes on this as a rental was in March of 2013, for the tax year 2012, the year it was first rented. I just realized now that when I looked on the County Auditor's site back then, I had used the current (March 2013) value of the house, but the auditor had lowered it significantly in Oct. 2012. Using the County Auditor's info, the house's value (building/structure only, not land) at the time we put it into service as a rental was $75,500, but we mistakenly used its value as of March 2013, $56,700, as the basis for depreciation.

Questions based on the paragraph above:

1) Should I get this fixed? Is having started with too low of a figure for depreciation going to cost us, or is it all going to even out in the end when we sell?

2) I briefly spoke with a tax professional today, and she said we should have used the purchase price as the basis for our depreciation. This surprised me, as I thought you used the lower of actual basis vs. FMV. Is this right, and again, should I get this fixed?

3) How do we handle the depreciation for the two years we lived in the house between tenants. We did not claim depreciation for that time period. Should we amend? Or will it all even out when we sell?

4) We expect to sell the house for around $100K-$110K if we are lucky, before realtor fees. We will definitely be taking a loss compared to what we paid for the house, never mind the capital improvements made. But since we have been depreciating from a basis of $56,700, are we going to have a huge capital gain when we sell on a house we actually lost a ton of money on? (i.e. difference of depreciated value vs. sale price?) Or will we calculate the actual loss ($120K plus capital improvements, minus selling price/fees) and then reduce our loss by the amount we depreciated? This area is new to me, and I would like to understand it now so I know what to do when the time comes.

Thank you!

Layperson's guess;
1-Yes, make corrections to your old income taxes and get that fixed because most likely you should have deducted more; so the result is you are due more tax return money from previous years.

2-Tax guy is right. your basis when you buy is what counts, then you deduct from that your depreciation taken (or allowed whether you claimed it or not). Market fluctuations have no effect on your tax basis or taxable gain. The IRS does not use market value when calculating gain/loss; just the purchase and sale price.

3-you should go back and fix it. There is no depreciation when you're living there. Depreciation only counts when you are renting. There might be a tax pub (544 or similar) at the IRS site to help you determine conversion from home to rental to home to rental, etc.

4-if you sell for less than you purchased it for, you will not have capital gain; what you will have is depreciation recapture at your ordinary income rate (must more costly).

It is most important to figure out the CORRECT basis; do the IRS calculations. Typical depreciation is 3.63% from original purchase price per year; i.e. 10.89% of the home value if you rented it out for 3 years. you don't depreciate land; usually we assume 20% land, 80% house; So most likely your basis is $120K - (96K x 10.89%) = $109K.

If that is true; you sell for $109K you pay no tax! no recapture, no gains, no B.S.

sounds like a dream, right? no, it's where you would be if you had a qualified tax preparer doing it in the first place!

Best of luck for 109K and ZERO taxes!