Question: Does the IRS require us to take a depreciation deduction on residential rental property, or is it optional? We have been taking depreciation on the appliances but not on the building. When we sell the property will we be penalized by the IRS for not depreciating the house?
Answer: Technically the IRS does not require that you take a deduction for depreciation on the building.
As a practical matter, however, you should be claiming the depreciation because in effect you are penalized on sale of the property if you have not been taking the deduction.
That is, you are required to reduce your cost basis by either the depreciation deductions you have taken (zero in your case) or the amount you were entitled to claim, whichever is greater.
So if you don't take the deduction, when you sell the property you have to subtract from the cost basis the amount you could have claimed, thus increasing the capital gain subject to tax. In figuring the amount of depreciation you were entitled to claim, you use the straight-line method.
You are not permitted to deduct in this tax year the depreciation you failed to claim in earlier years. So I recommend you file amended returns, using Form 1040X, for tax years 1978, 1979 and 1980 and take the deduction, since it will be charged against your cost basis anyway.
IRS Publication 551 is the authority for this requirement, and Publication 534 explains how to handle depreciation. Both pamphlets are available free from any IRS office.
Q: Re: your column of June 15 in which you say "Normally interest and dividends, after a $200-per-taxpayer exclusion . . ." The IRS has been telling me for years that there is no exclusion for interest from savings accounts, T-bills, etc.
A: Funny thing happened on the way to this column. When I first read your letter, I was all set to point out that the IRS had been right all along, but that things were different now.
The rules were changed effective Jan. 1, 1981. For tax years 1981 and 1982 the exclusion had been increased from $100 to $200 per taxpayer, and expanded to include most forms of interest as well as dividends.
But that answer didn't make it into print, because the rules that were in the process of being changed again, as a part of the omnibus tax-cut package, finally passed in early August.
The new law doesn't change the exclusion for 1981. That is, for this tax year only, taxpayers may exclude up to $200 ($400 on a joint return) of income from qualifying dividends and interest.
But for the tax years 1982, 1983 and 1984, the rules that were in effect prior to 1981 are reinstated. The exclusion will apply only to qualifying dividend income, and the maximum exclusion is rolled back to $100 ($200 on a joint return).
Then beginning Jan. 1, 1985 a new interest exclusion will go into effect, separate from the dividend exclusion (which continues unchanged indefinitely).
That new rule will permit a taxpayer to exclude 15 percent of the first $3,000 of net interest income ($6,000 on a joint return). That equates with up to $450 on a single return and up to $900 on a joint return.
"Net interest" means the excess of interest income over qualified interest expense for which a deduction is allowed but exclusive of mortgage interest on the taxpayer's residence or interest expense related to a trade or business.
Since only interest expense "for which a deduction is allowed" must be used to offset interest income, a taxpayer who doesn't itemize deductions (and therefore doesn't take an interest expense deduction) may claim up to the maximum exclusion.
Confusing? Sure, and the many other changes included in the new law are, too. The "Economic Recovery Tax Act of 1981" represents a major restructuring of our tax laws.
In the coming weeks we'll take a look at some of the other provisions of the new tax legislation, with particular attention to the impact on individuals, rather than business.
And the annual Washington Post Tax Guide, planned as usual for publication next February, will provide detailed information on filing your 1981 tax return.