I would amend the 2002 - 2004 returns to correct the basis
and pay tax on 2/3 of the gain. I would pay tax on the
depreciation part of the 1/3 used as a principal residence
before 2002 because this should be corrected on the 2002
-2004 amended returns.

Here is how I look at it. Reg 1.121-1(e)(3) requires that
the sales price be allocated the same way the basis was
allocated for depreciation. But Reg 1.121-1(e)(3) assumes
that you allocated the basis for depreciation correctly.
This is not the case. Let's assume that instead of
depreciating 100% of the basis only 50% of the basis was
depreciated. Does this mean that you will pay tax on 1/2 of
the gain? I think not.

I would think that you could also not amend the 2002-2004
return and pay taxes on the depreciation part of the 1/3
used as a principal residence for all years. If the IRS
for some reason audited the 2002 - 2004 years and changed
this then I would amend the 2005 return to reflect this.

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I would file form 3115 and add back the excess depreciation
as income to the 2005 schedule E as a Section 481
adjustment. You are changing from an unallowed accounting
method (claiming 100% depreciation) to an allowed method
(the correct %).

See: http://www.irs.gov/faqs/faq-kw42.html

Don in Colorado

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Drew Edmundson wrote:

- quote -

I don't think correcting by amending is a change in accounting method;
just changing to the correct figures, which of course should be done
for 2002-4.

And then of course calculate the correct gain had everything been
done correctly.

ChEAr$,
Harlan Lunsford, EA n LA

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I have met with a client who owned a triplex. She lived in
one unit and rented the other two out. The property was
sold in 2005. When it was setup for depreciation the prior
accountant took the cost of the entire building, less the
land, and depreciated it. The taxpayer took over return
preparation but continued to depreciate 100% of the basis.
Everything else that related to the entire property was
split 1/3 personal and 2/3 rental (e.g. a roof repair,
mortgage interest, taxes).

Reg 1.121-1(e)(3) requires that the sales price be allocated
the same way the basis was allocated for depreciation. So
it looks like she is stuck paying tax on all the gain.
Perhaps part can be allocated to the gain on the 1/3 of the
land the residence is on and excluded.

The statute has run on the initial return. So is there any
way to argue that she can amend the open returns to correct
the basis? I can't find anything that discusses whether
this is a change in accounting method or not. If we can
amend the 2002-2004 returns to correct the basis will she
then only pay tax on the depreciation on the 1/3 used as a
principal residence (and of course tax on all the other 2/3
of the gain)?

TIA

---
Drew Edmundson, CPA
Cary, NC

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