Does the federal tax statute of limitations apply to the keeping of depreciation records?

All depreciable asset records should be retained for at least three years after the asset is disposed of.

That could mean that if you hold the asset for 50 years, you have to keep records for 53 years.

But I disagree. Most states have a 4 year statute of limitations. So I'd change Bill's reply above from three to four.

There's a case before the US Supreme Court now on whether overstatement of basis, which results in less income, is allowed when applying the 25% rule that if you understate your income by more than

Different situation.

I thought we are discussing how long to hold records even if the IRS audits within three years of due date. Isn't that what the 53 above is referring to?

On Oct 7, 2:19 pm, snipped-for-privacy@panix.com (Arthur Kamlet) wrote: situation.

Yes, but if overstatement of basis triggers the understatement of gross income test then the retention period for all those years of documentation is at least 6 years after the year of disposition.

Also, if the property were obtained in a tax deferred exchange (1031 or 1033 or gift, as examples) the starting point for record retention could easily be much earlier than when the current taxpayer took title to the current property.

Can you be more specific by what you mean by "depreciation records"? You mention "tables" above, do you mean the standard depreciation rate tables published each year by the IRS?

As a practical matter, it's the original basis and subsequent non-depreciation adjustments you really need to keep supporting records for (plus any elections you made that determined the method of depreciation). These are the things that represent real-world events, that the IRS wants to know are not just pure fiction.

Annually published depreciation rate tables and arithmetic calculations can be reliably reproduced. You should only need just the beginning of year basis, end of year basis, and summary adjustments applied during the year. For example, instead of keeping records of twelve monthly (mid-month convention) straight-line depreciation adjustments, I'd just keep a record of the total amount for the year as a single number.

This is similar to your actual tax calculation based on the IRS tax tables - I don't think anyone would claim you need to keep copies of the tax tables for each year as part of your tax records.

When you dispose of the property (or reduce its tax attributes, e.g. after cancellation of debt exclusion), if it's fully depreciated, I also don't think the IRS is going to argue you still have basis just because you don't have records to show it's fully depreciated.

You need to keep any records that apply to calculating your tax for Year N until Year N+6. If you own the property for 80 years and then sell it, the tax due on sale depends on the non-depreciated cost, plus all additions to basis that haven't been depreciated, so you'd need to keep those records for up to 86 years.

Seth

See recent court cases, especially this year's Supreme Court docket, for answers.

I wouldn't consider that safe. As this is real estate, I'd keep the records for as long as I own the property plus 6 years after its sale.

But related.

The keeping of depreciation records certainly is related to the asset's subsequent sale.

Yikes!

I understand what you mean by 'disposed' of (which is to sell or trade the asset); but isn't the asset (essentially) disposed of when it is fully depreciated?

So, in your example, if you held the asset for 50 years, and then, say, you sold it, wouldn't your asset have already depreciated to zero on the 27.5 year mark (for regular taxes) or on the 40-year mark (for AMT taxes)?

Given that, wouldn't the 'disposition' date (for record-keeping purposes) be when the asset depreciation declined to zero?

Or does the fact the asset is fully depreciated that not matter at all for record-keeping purposes?

Not for all purposes, such as establishing the correct gain or loss at disposal time.

Even so, still need to be prepared to show your gain or loss is correct.

If it's depreciated to 0, there couldn't be a loss on disposition. Won't the IRS always accept 0 as the basis without documentation?

Seth

Lots of things can happen.

For example, the sale can be reported not by the true owner, but by a lower tax bracket taxpayer.

Grandma might have given away the property to get it out of her Medicaid total resources, but this is still within the look back interval.

Simply reporting stuff on a tax return does not make the facts/circs true.

So? If it's a gift, doesn't the recipient get the giver's cost basis?

Likewise; what does this have to do with the amount of income tax due on it? Suppose the taxpayer (who reports the sale) doesn't have the records; how much tax will/can the IRS assess over the 0 basis?

Seth

More important in a practical sense: if the IRS audits a return, and the taxpayer says "I have no records so I used a cost basis of $0" can the IRS assess more taxes? On what basis/by making what change to the return?

Seth

Yes, it does mean exactly that.

And you'd be mistaken about it.

The particular case you're referencing is very narrow and does NOT apply to this situation. That case focuses on the basis of an investment for capital gains. The rules on that are somewhat muddled because of the way GROSS income is defined. For most purposes GROSS income means how much came in. But for capital gain purposes gross income means the NET CAPITAL GAIN - sale price less basis. That is entirely different from the situation here.

You need to keep all the records associated with any item that you still own for NO LESS than 3 years AFTER the date you dispose of that item. The IRS has three years, under normal circumstances, to audit your returns. If you bought a house 50 years ago (I actually have a client who's been in his house that long).

Even without the IRS issue, if you don't have (let's say) your stock purchase confirmations or settlement sheets from when you bought 40 years ago, how will YOU know how much gain or loss you have when you sell?

Gene E. Utterback, EA, RFC, ABA

There's be a lot of back and forth on the statute of limtations for depreciation records and after reading some 15 posts and responses I thought I'd take a minute and try to summarize the entire situation and clarify the issue.

The OP asked how long he needed to keep records for depreciable property, specifically a rental house. The answer is "until at least 3 years AFTER the property is disposed of". The reason is because you need to be able to calculate your gain or loss on the sale and you need to be able to support that calculation if asked to do so by the taxing authorities.

The taxing authorities normally have three (3) years to audit a tax return under most normal circumstances. However, if there is a substantial UNDERSTATEMENT of income that statute jumps to six (6) years and if they can effectively assert a fraud argument there is NO statute of limitations UNLESS the fraud is corrected by the original due date of the return WITHOUT REGARD to any extensions.

Two responders reference a pending case where the IRS asserted that an overstatement of basis amounted to an understatement of income which effectively extends the statute of limitations to six years. However, that case (assuming we're talking about the same one, I just read it and do NOT have the cite handy) is very narrow - in a previous post I made I said it did NOT apply to this case. I said that because the issue for the OP was about recordkeeping BUT on reflection it could come into play.

In the case I read the overstatement of basis that resulted in an understatement of income which extended the statute to six years focused on a capital gain. Generally GROSS income is defined (over simplified) as what came in or what you got when you collected money. BUT for capital gain purposes gross income is defined as NET CAPITAL GAIN, not gross sales price. So overstating your basis results in a lower net gain, or larger net loss, which gets treated as an understatement of income sufficient to extend the statute of limitations.

Part of the problem here is that the District Courts are split on how to address this issue. Some have ruled that an overstatement of basis does NOT create an understatement of income and others have ruled exactly the opposite. There is an old Supreme Court case that addressed the issue (I don't recall the year but I'll try to find it next week), but the regulations have been updated since then so some arguments say it doesn't apply - hence the recent Supreme Court Case.

And its important to keep in mind that the U. S. Tax Court is a court of GEOGRAPHICAL jurisdiction tied to the Federal Circuit Court system. This means that the U. S. Tax Court MUST BY LAW rule in a manner consistent with how the Federal Circuit Appelate court has ruled before. If the Federal courts have ruled differently in different jurisdictions then the Tax Court WILL issue different opinions for different taxpayers engaged in exactly similar circumstances but who live in different Federal Circuits where the appelate courts have ruled differently - WHO says taxes ain't fun!

Some responders raised the possibility that this would not matter if the asset were fully depreciated, and I disagree with that position. The underlying issue here is the GAIN from the sale. Without the underlying records supporting the basis you cannot accurately either compute or support any number for basis.

This extends further for a depreciated asset. Gain from the sale of a depreciated asset is split into two parts - gain from appreciate which is taxed currently at long term capital gain rates, and gain from recapture of depreciation which is taxed at a flat 25% (I think that's the rate, though your tax bracket may come into play I am trying to keep this simple). So again, if you don't know, or can't support, your basis, because you don't have the underlying records, how can you calculate any gain or loss?

One other posted commented that if an asset is depreciated to ZERO there can't be any loss on disposition. This isn't entirely accurate because on disposition you get to factor in disposal costs. So it is possible to have a loss on the disposition of totally depreciated asset.

Additionally, I think there was one question about basis when the property was gifted. The basis in the hands of the recipient is determined by the basis in the hands of the donor BUT can fluctuate depending on the sale price and the FMV of the asset at the time of the gift. For example, FMV is $100K but adjusted tax basis is $50K and I gift the property to my daughter. Her basis gets determined by her sale price when she sells it. If she sells it for MORE THAN $100K she can use $100K as her basis and reports a gain, but if she sells it for less than $50K she uses $50K as her basis and reports a loss. If she sells it for anywhere between $50K and $100K she'll report the sale and the basis as the same number - ignoring any depreciation she may have claimed if she kept in service. Gift basis is also adjusted by any gift tax that is paid on the gift when the lifetime exclusion is used up.

On the other hand, for property that is transferred by inheritance depreciation evaporates and the property transfers at full FMV at the time of death, or the alternative valuation date if elected by the executor/personal representative.

Do keep in mind that while I only post what I believe to be accurate it is wise on your part to confirm everything via your own research. Good as I am, I have been known to make the occassional mistake.

Gene E. Utterback, EA, RFC, ABA

Thanx, it helps.

Slight correction: gross income includes net capital gain, but not less than zero. A loss from sale of property does not reduce your gross income.

I disagree (agree with Seth). If you don't have any records (which, incidentally, is not a criminal offense), what is the default? Obviously the IRS has a way to compute basis in this situation, and I don't think it involves negative basis. In fact, CP-2000 letters are routinely issued where basis is assumed to be zero because the IRS has no other information.

It's a *maximum* of 25%, but not more than your ordinary tax rate. It would only be to the benefit of the taxpayer to classify any of the gain as unrecaptured Sec. 1250 gain, so why would the IRS do that in case of missing records? They don't normally choose any tax treatment that benefits the taxpayer, do they?

So, again, what is the IRS going to do? Claim you have negative basis? You only have to keep records of disposal costs for 3-4 years after they occur, based on the general comments in this thread. Whether or not you have records of depreciation does not change the tax impact of your disposal costs, remember a net loss from a sale does not reduce gross income.

Oops, I got carried away there. Yes, being taxed at ordinary tax rates (even capped at 25%) could be worse than LT cap gains rate. So, absent records, one might lose the benefit of LT gains rates, but a default calculation can still be made.