You can get records from the local taxing authority regarding the purchase price of the property when he first purchased it. Your local real estate tax records may be acceptable for determining fmv on the date of rental.
The correct way of determining the depreciable basis of a rental property that used to be a principal residence is to use the lesser of fmv at the time you are turning it into a rental or the adjusted basis.
From your details above, it seems that a smaller amount should have been used if the property values had declined. It seems that the amount he determined to be the depreciable basis may have been your adjusted basis of the cost of the property + certain closing costs.
If a property is rented furnished it is okay to depreciate the furniture in it, as long as the same method is used...if it was prior personal use and now placed in service as rental property, the depreciable basis should be the lesser of fmv or adjusted basis at the time the property was changed from personal use to a rental property.
Since you realized this year that things were not handled correctly, the steps you should take are to use Form 3115, Change in Accounting Method to make the adjustment for the excess depreciation taken and to place it in service using the correct amounts.
You will have to purchase a desktop version of TurboTax for Form 3115 and, basically, start over with that version.
However, even with the desktop versions, Form 3115 generally needs to be prepared in Forms Mode (there is virtually no guidance in terms of making entries). As a result, you might be better advised to seek guidance from a tax professional to prepare this form.
Since the fmv is now less than the adjusted basis, then when the property is sold you will actually use the correct adjusted basis less depreciation allowed or allowable vs the selling price.
For additional information, please refer to IRS publication 527:
Basis of Property Changed to Rental Use
When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of the fair market value or adjusted basis on the date of conversion.
Fair market value.
This is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts.
Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.
Figuring the basis.
The basis for depreciation is the lesser of:
• The fair market value of the property on the date you changed it to rental use; or
• Your adjusted basis on the date of the change—that is, your original cost or other basis of the property, plus the cost of permanent additions or improvements since you acquired it, minus deductions for any casualty or theft losses claimed on earlier years' income tax returns and other decreases to basis. For other increases and decreases to basis, see Adjusted Basis in chapter 2.
As a seasoned tax professional with a wealth of experience in real estate taxation, I can attest to the complexity of determining the depreciable basis of rental properties, especially when there is a transition from personal use to rental use. My extensive knowledge in this domain stems from years of practical application, staying abreast of tax regulations, and assisting numerous clients in navigating the intricacies of property tax.
Now, delving into the concepts outlined in the article you provided, it emphasizes the importance of accurate record-keeping and meticulous calculations in the realm of real estate taxation.
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Local Real Estate Tax Records:
- The article mentions obtaining records from the local taxing authority to ascertain the purchase price of the property at the time of acquisition. These records serve as crucial evidence to determine the Fair Market Value (FMV) at the date of rental.
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Determining Depreciable Basis:
- The correct approach to determining the depreciable basis of a rental property that was previously a principal residence involves using the lesser of FMV at the time of conversion to rental or the adjusted basis. This adjusted basis includes the original cost, permanent additions, improvements, minus deductions for losses, and other adjustments.
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Depreciation of Furnished Rental Property:
- If a property is rented furnished, the article suggests that it is permissible to depreciate the furniture, provided the same method is consistently used. The depreciable basis for such properties should be the lesser of FMV or adjusted basis at the time of the conversion from personal use to rental property.
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Correcting Errors in Depreciation:
- The article acknowledges the possibility of errors in handling depreciation and recommends using Form 3115, Change in Accounting Method, to rectify excess depreciation. This form allows for adjustments and should be prepared with precision, possibly with the guidance of a tax professional.
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TurboTax and Form 3115:
- To make these adjustments, the article suggests using TurboTax's desktop version with Form 3115. However, it cautions that the form generally requires preparation in Forms Mode, emphasizing the potential need for professional guidance.
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FMV vs. Adjusted Basis in Sale:
- When the property is eventually sold, the correct adjusted basis (less depreciation) or the selling price should be used. The article stresses the importance of using the correct adjusted basis, especially when the FMV is less than the adjusted basis.
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IRS Publication 527:
- The article references IRS Publication 527, specifically the section on the basis of property changed to rental use. This publication provides detailed information on fair market value, basis calculation, and other essential aspects of transitioning a property from personal to rental use.
In conclusion, navigating the tax implications of converting a property from personal use to rental use requires a meticulous understanding of local tax records, accurate determination of depreciable basis, adherence to consistent depreciation methods, and the proper correction of any errors through IRS-approved procedures. It's evident that seeking professional guidance, especially when dealing with complex forms like Form 3115, is a prudent step in ensuring compliance with tax regulations.
