I have personal property that was converted to a rental unit in 2015. When determining the depreciation basis for this property, I used the Fair Market Value, as suggested to me by a TaxAct representative who quoted page 15 of IRS publication 527.

I later read that page myself, and found that this quoted text omitted a later example explaining that the land value of the home must be deducted from the Fair Market Value to arrive at the depreciation basis.

The net result is that I want to correct for this. Scouring Google results suggests that I may be able to file Form 3115 with a positive Section 481(a) adjustment (described on page 8 of Form 3115), and then report that adjustment as additional income on this year's Schedule E. As there is no 'Additional Income' line on Schedule E, it looks like perhaps I'll need to attach a detail schedule to accommodate this.

If it sounds like I'm answering my own question, the thing is, I don't know if I am.

I tried calling the IRS through a few channels, to check my reasoning. As soon as I explain the problem to a representative, they politely explain that they 'no longer answer that kind of problem'. (I find this to be a bizarre response from an organization that I'm certain will not hesitate to brutally 'correct' me should they decide that I answered the question improperly).

Looming IRS ethics questions aside, can anyone advise? Is the solution that I've described above reasonable?

  • Tip #1: If the IRS cannot give you an answer in writing, you cannot accept it as fact. An individual agent can be wrong, and you will not necessarily have proper defense if it comes up under audit later. This would likely be why they 'no longer answer that type of question', because they can't handle the liability of being wrong. Mar 3 '17 at 18:44
  • Tip #2: This website also cannot give you audit-proof recommendation. If someone posts an answer to this question that you think is correct, you will need to follow their sources, and document your choices yourself. Only a tax professional that you pay to give you a 'correct' answer can reduce your liability in being wrong. If your aunt is a CPA who gives bad advice, you still have a risk. If you pay a CPA to write you a position paper on something, you might eliminate your liability, meaning that if the IRS audits you and penalizes you, the CPA might be obligated to cover you. Mar 3 '17 at 18:47
  • Understood, Grade -- I appreciate the tips. The nebulous form of these tax rules bothers me, but it seems that there's no way around that. I'll be sure to keep careful records as I work through this.
    – FenTheta
    Mar 3 '17 at 19:00
  • @FenTheta, I would not be concerned generating an audit. People make mistakes on tax returns all of the time and practically speaking, due to lack of resources, the IRS doesn't perform as many audits as they did say 10-15 years ago.
    – mikeford
    Mar 3 '17 at 19:57

To fix this you will need to file an amended return for 2015 (use Form 1040X) in order to correct the error of including the land value as part of the rental property basis. Form 3115 is for a change in accounting "method", not to correct errors (code section 481 as you have noted).

  • It does look like a 1040X would do the trick, as the two years needed to establish an incorrect accounting method have not yet passed. So it looks like I'd file a 1040X for 2015, and then correct the 'accumulated depreciation' and basis used for the 2016 returns before filing?
    – FenTheta
    Mar 3 '17 at 20:07
  • Yes. Preparing the 1040X for 2015 will give you the correct number for cost and accumulated depreciation (A/D) and then you can use those numbers as the beginning numbers in your 2016 return so the A/D and depreciation for 2016 will be calculated correctly.
    – mikeford
    Mar 3 '17 at 20:41

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