I converted my NYC condo to rental use in 2016 and am in the process of filing for that year. Publication 527 for said year, under "Basis of Property Changed to Rental Use", presents an example that illustrates the exclusion of 'land value' from that basis. In that example, the adjusted basis is calculated using the ACTUAL values of both 'permanent improvements' and 'casualty loss'. This is consistent with the IRS instructions for Line 18 of Schedule E. However, the value used for depreciation on Schedule E (Line 18) in TurboTax is derived from the corresponding value on Form 4562 which, in turn, seems to be taken from the “New Rental Property Worksheet”. On that Worksheet, the percentage calculated for 'Improvements' on line 20 is applied to the entire amount that appears under 'Lesser of Adjusted Basis or Fair Market Value' on line 18. This means that the exclusion for “Land Value” includes a percentage of both 'Increases' (closing costs, capital improvements, etc) and 'Decreases', which do not seem to be associated with “Land Value” in any way. Can anyone explain this apparent discrepancy?
I'm not understanding your concern with casualty loss here. Did you have a casualty loss for which you were NOT reimbursed for by the insurance company maybe?
Generally, the only thing that has a value for the land, is the rental property itself, and that's it. All other assets/property improvements will have a total cost, and zero value for the land, unless the improvement was to the land specifically - which is not common. So property improvements should not, and will not have a land value. Example:
Rental property itself cost $100,000 of which $30K is allocated to the land. So $70K will be depreciated over 27.5 years.
Later, I put a new roof on the property at a cost of $10K. When the asset is entered into TurboTax the cost is $10, and the value of the land is zero. So the $10K for the new roof is depreciated over 27.5 years. There was no land improvement here. Only an improvement to the structure.
TurboTax has a completely separate selection in the Assets/Depreciation for land improvements. Since land is not depreciable, land improvements only add to the cost basis, but are not depreciated.
Remember, depreciation is based on the *lesser* of what you paid for the property, or it's FMV at the time it was placed in service. For most, what they paid for the property will be the lesser amount.
I *think* I understand the question now, having re-read it.
exclusion of 'land value' from that basis
The TurboTax program does that, if you enter the data correctly. When you first enter the property in the Assets/Depreciation section, you are asked for two values. The first value is the total cost of the property in it's entirety. That goes in the box labeled "Cost". The second value goes in the "Cost of Land" box, and the value you enter there is how much of the amount you entered in "Cost" is allocated to the land.
The program then does the math by subtracting the cost of land from the cost, and the result is the amount to be depreciated over 27.5 years.
Thank you for the information as to how to fix this issue.
However, I have some feedback for Intuit/TurboTax in this regard:
The change that you detailed does not alter any of the values in the form named “New Property Rental WorkSheet”. Consequently, the Land/Improvements values on this form now make little or no sense and subsequently seem to be ignored by the software for the remainder of the return.
I went back and deleted the rental property and then reentered it to see why I had entered this information incorrectly in the first place.
These are my observations:
On initial entry, the values to which you refer are not presented for entry. All of the values that I had previously encountered and documented on my original communication regarding “discrepancy” remain, as stated therein.
When I went back to manually change the value using 'Edit' in the “Your Property Assets” section, the “Cost of Land” value was already pre-populated, as before, despite the fact that this screen/page had previously not been presented.
This means that the “Land” value was, indeed, derived from the source that I identified earlier and not from any value that I had entered erroneously.
In order to change the value that TurboTax has calculated, the user has to be aware of this anomaly and manually return to the “Assets/Depreciation” section with no indication that this may be necessary.
I find this situation to be very alarming. Had I not been very thorough in my verification of the results that TurboTax generated , understood what the actual IRS requirements are and the consequences of all of the myriad of various forms and worksheets used by TurboTax, I would not have noticed this 'discrepancy' - a term that I now feel justified in using, albeit an insufficiently extreme one.
In addition, had I not only identified this issue but raised it with Intuit/TurboTax and received an (admittedly) correct and swift response, I (or anyone else, in such a situation) would have found it difficult, if not impossible to rectify this error using this software.
This has destroyed any confidence that I may have had towards the accuracy and use of TurboTax and I am left with the fear that there may be more of these hidden issues that I am unable to identify – not that that should be my responsibility when using (so-called) industry-leading software!
Unfortunately, due to the complexity of the tax-code, there is no alternative but to use software in this regard and I will almost certainly have no option but to continue using TurboTax.
However, if there are any more of these 'quirks' and they lead to an IRS audit or worse, I will have no alternative but to hold Intuit/TurboTax responsible.
In this specific instance, where depreciation is at issue, this error is compounded by the fact that it perpetuates every year with a reduced deductability on each occasion.
In my estimation, this issue represents either a “bug” in the software or, at least, an error in the way that user-entry screens/pages are presented.
While I commend your rapid response, I am extremely disillusioned with this software and its consequences. I am, however, fairly confident that this exact issue will have been experienced by many other users of this product and that most, if not all, of them will be unaware of any potential financial loss that it may have caused them.
I suggest that this “bug” be rectified immediately.
In addition, this issue was only identified whilst verifying the returns for both 2016 and 2017, prior to filing them with the IRS and State. Since the 2017 return was based on the 2016 return, which is now in error, what do I need to change in the 2017 return to correct for this situation without having to re-enter the entire return from scratch?
I eagerly await your response to my observations (and corresponding comments/evaluations) and also to my question.
P.S. This message was initially sent privately, as a reply to the received email which was created as a result of the original post. Having failed to obtain any response and having reached the conclusion that email replies are not being read or processed, I feel that there is no alternative but to post it here in this public forum.
With TurboTax 2016 if you work through the program in interview mode, the way it's designed and intended to be used, the numbers are right. But the problem with the approach used in the 2016, is clarity. COST is total cost. Period. COST OF LAND is how much of the total COST one is allocating to the land. Clarity is lacking on just exactly what is entered in COST, as some folks incorrectly and unknowingly enter only the structure value in that COST box. The issue is addressed in TurboTax 2017 because it handles this completely different.
In TurboTax 2017 you are first asked for the cost - what you paid in full for the property.
Next, you are asked to enter the values from your latest property tax bill. Then the program uses the property tax bill figures to determine what percentage of your tax value is allocated to the land.
Then the program uses that percentage figure to determine how much of the actual cost you entered, is allocated to the non-depreciable land.
Nice try Carl (Catalyst V).
Unfortunately, I can't agree with anything contained in your most recent reply.
I also have the 2017 version of this software, so I tried to enter the same information (with 2016 references changed to reflect 2017) twice: - the first time to see if there were any changes, as you claimed, and the second time to fully document what was really occurring and to isolate the underlying problem.
These are my new observations:
While it is possible that there are slight cosmetic changes in the two versions (2016/2017), they are so insignificant as to be virtually indistinguishable from each other.
I used 'Interview Mode' in both these new tests. I had also done so as the basis for my original complaint regarding the 2016 version.
I was wrong about the problem being one primarily due to screen/page presentation, but you are also wrong about it being an issue with “clarity”. Worse than that, you are wrong when you say “the numbers are right”. They are not! There is, in fact, a logical error in the software. As a programmer, I would refer to that as a “bug”.
Here is the documentation/evidence:
Starting by entering “Update” under the “Rental Properties & Royalties” section, the user is presented with screens/fields to enter General Information that includes Tax Values for both 'Land' and 'Improvement Value'.
Depreciation is then calculated, based on these values, with the sole disclaimer that “You can review your rental property depreciation in the next section”.
This takes the user to “Review Your [property name] Rental Summary”, which includes the sub-section “Assets/Depreciation”, with values already populated from what was already entered.
By again entering “Update” against this entry (although, if no other entries are necessary, there is reason for anyone to do so) , the user is taken to “Your Property Assets”. Once again, values are already populated (in this instance, for Depreciation).
At this point. the user may enter “Edit” against the entry (again, there is no reason for the user to think that there is any such requirement), in which case they are presented with another pre-populated screen containing values for both “Cost” and “Cost of Land”.
At best, your contention is that the user should understand the the “Cost of Land” value should be manually changed from the incorrect value that your software provides here to the correct vale that said user must calculate themself.
My contention is that this is an obvious “bug”, because the value presented is based on the wrong underlying value. It is based not only on the purchase price, but also all of the additional costs, such as closing costs and improvements. It should be calculated based on the purchase price, alone.
The “fix” that you indicated works by overriding an inherent logical error within the software.
If you were unable to recognize this obvious error, what chance does the general public have and where is your QA team?
If my analysis is correct, then my previous comments regarding other potential bugs and inaccuracies become more troublesome, don't you think?
I await a response indicating some sort of error on my part.
Failing that, I would consider this “Game, set and match”.
Your move - to mix metaphores.
So we can agree to disagree. I'm not going to pursue this any further. I've been using TTX desktop since 2003 with self-employment income as well as 3 rental properties and it's done perfect for me every single year. I will say however, that is it a requirement, and not an option, to get the numbers right the very first year a rental property is purchased or placed in service. If they're wrong, especially in the area of depreciation, then the error will just grow exponentially year-to-year. Fixing it years down the road (if it takes that long to catch it) will be costly tax-wise too.
Hi Carl (Catalyst V).
I thank you for this (final) post on this topic and figure that I probably owe you an apology.
My assumption has been that you were an employee/representative of Intuit/TurboTax, rather that a fellow (conscientious) user of their software and hence, some of the language and tone in my most-recent post were, under those circumstances, somewhat inappropriate, for which I am embarrassed and apologize.
In fact, as originally noted, your original post was prompt and informative/useful. In part, this led me to my incorrect conclusion about your identity.
I agree with your comment regarding the compounding nature of this “anomaly” and mentioned it myself, in one of my earlier posts.
As someone whose sole source of income is that from my single rental property, maximizing tax deductions is of paramount importance to me. Hence, my desire to obtain the greatest depreciation possible.
In fact, prior to 2016, I had been using the tax software produced by H&R Block and only started using TurboTax with an actual return in mind (I had used it previously only to cross-check H&R Block software), because I needed software that would accommodate rental property at a reasonable price. I am using the TurboTax 'Premier' product for this.
I do not think that fixing this depreciation problem in a subsequent year would be costly for the user, as they are potentially overpaying on their taxes, rather than the other way around.
It could be argued by some (although not those in my situation), that undervaluing depreciation could be beneficial since, by virtue of this undervaluation, the apparent “Land/Improvements” ratio is weighted more in favor of the “Land” component and may, consequently, reduce the likelihood of an IRS audit.
In addition, since the compounded depreciation is lowered, any tax-liability upon the eventual sale of the property may be reduced, depending on the individual capital-gains threshold applicable at that time.
However, I do not think theoretical benefits outweigh accuracy and, as I stated in an earlier post, if this condition is based on software inaccuracy (as I believe that I have identified), it becomes difficult to retain any confidence in the accuracy of the rest of it's operation.
Unfortunately, due to current circumstances, I do not currently have the time to obtain substitute software and make all the entries necessary to perform a cross-check.
It has been interesting corresponding with you, without which I would not have identified the actual cause of this problem – and, indeed, how to 'override' it.
Thank you again and goodbye.
The IRS (not me) disagrees with your assessment. According to IRS Publication 527, Chapter 4: