I didn't know I HAD to take depreciation

Tax, SDIRAs & Cost Segregation
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I didn't know I HAD to take depreciation

Stanley Crawford
Real Estate Agent · Ivor, VA · Member since 2011 · 73 posts · 21 votes

I would like to blame Turbotax for this mess but I know it my fault.  First let me explain how I got in this mess and hopefully someone has some good advice on getting out of it. I started buying buy and hold rentals in 2011. I bought and rehabbed 8 but I sold 2 in 2017..These are all very cheap propeties with an average basis of $18K after repairs that rent for around $550 each . I knew back in 2012 that my taxes were getting complicated but I didnt know where to get tax help I mean I went to HR Block but the lady there seemed to know less than me about business taxes and was talking about $2000 and up.(about 10 percent of my profits) So I started using Turbotax and I thought everthing was going fairly well. Until a couple of days ago when I watched a podcast and found out that depreciation was actually manadtory ie the IRS will assume you took it even If you did not. Turbotax does not tell you this and I was trying to keep it simple and I never took any. So now for the last 24 hours I have been trying to figure out how to fix it...Some tax gurus say to amend returns others talk about a 3115 but I cant even get close to figuring out how to fill that out. I know I need a CPA and I have an appointment with one but I live out in the sticks and i am not sure he is going to know much about real estate taxes himself....Unfortunatly I have a complicated tax return without the kind of income that makes a 2 or 3K per year CPA make sense. I only make about 50K per year with 20K coming from the rentals..The CPA websites I have seen seem to be geared for investers with a lot more income. 

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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y

@Stanley Crawford

First, there're LOTS of people who miss depreciation, and unfortunately even CPAs miss it, not to mention the franchise shops like H&R Block. Don't kick yourself. Now, let's get the concepts right. 

1. By not taking depreciation you only hurt yourself. You could deduct it, but you did not, so you have been paying more taxes than you should have. With cheap properties, those were small amounts, so maybe not that much was lost. You can start taking depreciation now and possibly decide to just let the old errors stay. It's not like you're breaking the rules or cheating the IRS. You're cheating yourself.

2. Where it becomes a problem is when you sell a property. The IRS rules will tax you on that old depreciation - as if you did take it. As in - maybe you borrowed $100 from me, and maybe you did not - but you still owe it to me. Unfair, I know. But the IRS goes like - hey, you could take it, so we assume you did, and if you did not - it's your problem, not ours.

3. Because of the #2, most people want to fix this problem when they discover it. People who don't know enough suggest that you redo ("amend") your old returns. Wrong. First, you can only go back 3 years. Second, it is specifically not allowed by the IRS. The right way to fix it is via Form 3115. It is a very complicated form, and very few people know how to do it right. Doing it wrong is not worth it. I would not entrust it to some random tax person if I were you. This is one of those situations where professional help is needed. And not just any professional help - a real expert.

4. The timing of Form 3115 matters. In a low-income year, you do not want to do it. This form creates a large one-time deduction, so you better choose a high-income year for this procedure.

5. Whenever you're ready, I recommend you hire one of the tax professionals from this BiggerPockets forum. There are some 20 of us here, working with clients remotely, no need for a face-to-face. Most of us have experience with 3115. Your local CPA may or may not. If you go local, quiz him about 3115 and make sure he knows how to do it.

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    8y
    Well, the good need is they were cheap properties, only about $600/yr in depreciation each. You could amend your last 3 years if it makes sense....your tax on the depreciation recapture will be your ordinary income tax rate up to a max rate of 25%. I’m not an accountant and not familiar with that form.
    1Reply
  • Yonah WeissPro Member
    Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
    8y

    @Stanley Crawford I'm sorry to hear about your tax mishap, but I trust it's nothing that good CPA can't get you out of. Check out some of the great regulars here on BP, most of them work remotely, like @Daniel Hyman 

    1Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    8y
    This why you pay a professional to do your taxes.
    1Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    8y

    maybe just do it right going forward  its not a lot of money.. and not sure its worth spending a bunch to correct.. just thinking..

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    8y

    @Stanley Crawford

    First, there're LOTS of people who miss depreciation, and unfortunately even CPAs miss it, not to mention the franchise shops like H&R Block. Don't kick yourself. Now, let's get the concepts right. 

    1. By not taking depreciation you only hurt yourself. You could deduct it, but you did not, so you have been paying more taxes than you should have. With cheap properties, those were small amounts, so maybe not that much was lost. You can start taking depreciation now and possibly decide to just let the old errors stay. It's not like you're breaking the rules or cheating the IRS. You're cheating yourself.

    2. Where it becomes a problem is when you sell a property. The IRS rules will tax you on that old depreciation - as if you did take it. As in - maybe you borrowed $100 from me, and maybe you did not - but you still owe it to me. Unfair, I know. But the IRS goes like - hey, you could take it, so we assume you did, and if you did not - it's your problem, not ours.

    3. Because of the #2, most people want to fix this problem when they discover it. People who don't know enough suggest that you redo ("amend") your old returns. Wrong. First, you can only go back 3 years. Second, it is specifically not allowed by the IRS. The right way to fix it is via Form 3115. It is a very complicated form, and very few people know how to do it right. Doing it wrong is not worth it. I would not entrust it to some random tax person if I were you. This is one of those situations where professional help is needed. And not just any professional help - a real expert.

    4. The timing of Form 3115 matters. In a low-income year, you do not want to do it. This form creates a large one-time deduction, so you better choose a high-income year for this procedure.

    5. Whenever you're ready, I recommend you hire one of the tax professionals from this BiggerPockets forum. There are some 20 of us here, working with clients remotely, no need for a face-to-face. Most of us have experience with 3115. Your local CPA may or may not. If you go local, quiz him about 3115 and make sure he knows how to do it.

    8Reply
  • Stanley Crawford
    OP
    Real Estate Agent · Ivor, VA · Member since 2011 · 73 posts · 21 votes
    8y

      @Michael PlaKs   Thanks You  Any guess how much I could be looking at to get a knowledgeable CPA to do a 3115 and get this straightened out? I mean are we talking $500 or $3000 or $5000?   I sold 2 propertie last year so I assume I am gonna hear from the IRS soon wanting more money.  Can I just start deperciating everthing next year? 

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  • Colleen Goldstein
    Real Estate Broker · Matthews, NC · Member since 2017 · 135 posts · 99 votes
    8y
    Find a real estate investor CPA. Nowadays, you don’t need to meet in person to do business, therefore just meet over Skype / phone and explain the situation. I’d recommend finding one with the specific background as their very familiar with the industry and hopefully if you use them go forward (which sounds like you should) they’ll save you more money.
    0Reply
  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    8y
    Good to know you can’t amend back 3 years due to missed depreciation.
    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    8y

    @Stanley Crawford

    Every accounting firm has its own policies and pricing. The only way you can find out is by contacting some. 

    If you already filed your taxes for 2017 - then I'd recommended getting it looked over by an expert. Like I said, there're quite a few of us here. Some will agree to have a look for free, and others will charge. 

    As to the prices to prepare Form 3115 - $500 sounds low to me, for a job well done. $5,000 sounds excessive. But prices vary on all professional services, as you know. This is a one-time and an important task, so I would not choose on price alone if you're going to compare.

    Nobody is going to quote you publicly, and it may even be against BP policies. So contact privately those of us who you consider doing business with.

    0Reply
  • Yonah WeissPro Member
    Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
    8y
    Originally posted by @Wayne Brooks:

    Good to know you can’t amend back 3 years due to missed depreciation.

     You can't amend...and probably shouldn't amend. But filing form 3115-change in depreciation method, allows you to claim depreciation, and different methods of depreciation (like accelerated,double-declining balance, etc.), that you missed, without amending previous year's returns. You can go back many more than 3 years.

    1Reply
  • Paul Caputo
    Cost Segregation Specialist · Naperville, IL · Member since 2016 · 204 posts · 168 votes
    8y
    Form 3115 is your best (and only allowable) option here. You’ll get a significant tax benefit from the catch-up depreciation from $0 to the allowable amount. If you filed an extension you still have the opportunity to file it with your return and lower your tax bill or even get a refund. If you file the 3115 at any other time the tax benefits are credited against future taxes which would likely lower or eliminate the next few quarterly tax payments. Another benefit would be that in addition to the 2 units you sold in 2017 you’ll be able to catchup on the remaining units as well. As Michael Plaks said there are several CPAs on BP that can help you with this, but make sure they have experience with the form and real estate knowledge. Their fees will be money well spent in tax savings.
    1Reply
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