Rental Property Cost Basis

[Rob S.]

Hi,

I have an interesting tax problem I was hoping someone could help me understand.  I think I've managed to screw myself over pretty badly, but I'm hoping there's some way to fix it!

Back in 2008 I bought a house as a primary residence for $260k.  3 years later, I ended up changing jobs and moving to a different state.  At the time the house had dropped in value (let's say I could have gotten around $230k), so I decided to make it a rental.

When doing my taxes that year, TurboTax had me choose an initial price for the depreciation.  At the time I had read some documentation saying I should use the assessed tax value of the building from my property tax statement, and I was young and naive, so I ended up using that which was around $120k.  My house is in an area where the tax assessed values are nowhere near the prices received when actually selling a house.

Now, I'm considering selling the rental to use as a down payment for a new house in my current state.  It's currently worth around $320k.  I have always been under the impression that my cost basis for capital gains purposes would be $260k - the depreciation I've taken (around $20k) = $240k.  However, I've been reading lately that my cost basis is actually the figure used for the depreciation, minus the actual depreciation taken.  In my case this would be $120k - $20k = $100k.

Is this correct?  Have I robbed myself of $140k in cost basis with no recompense?  This seems extremely harsh, so I'm hoping I'm mis-understanding something.  That would be an extreme amount and I would lose pretty much all the equity I've built up over the years.

If I am correct and my cost basis is actually $100k, is my only option to avoid a huge tax hit to attempt a 1031 exchange, or are there any other options available?