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Ed Johnson
Ed Johnson, Tax Preparer
Category: Tax
Satisfied Customers: 10760
Experience:  GPHR Cert; U.S. Treasury Tax Advocacy Panel appointee
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I have inherited a new client that was just audited for the ...

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I have inherited a new client that was just audited for the years 2004,2005,and 2006. 2004 was extended so that IRS could complete the audit before the year expired. The prior accountant did not keep depreciation schedules. Subsequent to the audit, we reviewed the 2002 and 2003 tax returns and found that building construction costs in excess of one million dollars was never accounted for either in deductions taken on the return or the non existent depreciation schedules. Can anything be done to recapture the lost deductions and how would you do it?
Submitted: 8 years ago.
Category: Tax
Expert:  Ed Johnson replied 8 years ago.

Dear rlandry,

Thank you for your question.

I need a bit more information:

  1. Are the buildings still owned by the client?
  2. What kind of properties are these? commercial rental, multifamily, multi unit apartments, etc.
  3. Are the buildings owed directly by the clietn or are they owned by a LLC/S, etc?
Customer: replied 8 years ago.
Reply to Ed Johnson's Post: Yes, it is still owned by the client. It is residential rental property and it is in the individual name - not in an LLC or other entity.
Expert:  Ed Johnson replied 8 years ago.

Dear rlandry,

Unfortunately for 2002 it may be too late for anything.

After examining your situation, reviewing the regulations on passive activity losses, and discussing this with the IRS team, I am able to offer this solution.

1. For construction expenses and any other expenses or depreciation that went un reported for three years from the date of filing the return, you can file an amended return. You can only go three years back.

2. this means that the 2002 is still in the window if they filed 2002 late, LIke filing it in July 2003 or later. If not then follow:

3. The only other way is to capture those expenses at time of sale of the property if ever that should happen.

Assuming your client is on a cash accrual basis, then he has to claim it for the year i which the expenses accrued, but he can go back three years to file an amended return.

If the tax preparer then had at least captured it, even if it was unusable, it would have been carried forward. But the IRS does not allow you to go back beyond three years, to capture those expenses, even to create a carry forward.

The best he can do is to do one of the following:

He can include the construction costs as capitalize, that is increasing the cost basis.

NOW FOLLOW: if he has been depreciating the original cost of the building without including the capitalized costs, then he can now begin depreciating those costs. He can do this for the past three years using an amended return, and then continue to take the deprecation for the construction costs until such time that he sales the property.

HOWEVER: if he has already been depreciating the buildings based on the post construction value of the property, he will only be able to wait until sale time and

take the costs as part of the capital gains formula, for figuring adjusted cost basis.

When he sells the property, he will get a one time chance to take any depreciation he failed to take during the life of his ownership of the property.

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