Vacation Rental Condo Depreciation

[willem82]

I'll try and make this short. I formed an LLC. Purchased a condo to rent as a short-term rental in January. Spent $80k on the purchase. I did no major improvements to the condo immediately after purchase. Covid hit. I agreed to rent out the condo for 1-month. I charged $900. Soon after the renter moved in, a tornado damaged the unit. I refunded the renter the complete rental amount. I received about $10,500 from the insurance company as a payout. I assume that payout should go into “rental income”. Of that, I spent about $7,700 on rehab and improvements (New flooring, cabinets, countertops, painting, beadboard, trim, kitchen sink, faucet, toilet). That also included appliances. 

Should I use the purchase amount of $80K as one asset to depreciate and then add each improvement as a unique real estate asset? $1,700 for the countertop? $1,200 for the flooring? .. etc, or should I just total everything together $80k + the amount spent on real estate improvements and use that as the depreciable amount. It seems like overkill to list each improvement and different date of installation, but because I had a renter (even though I refunded their rent) do I need to?

Also, things like a new mattress, a new chair, new TV. I know these are things most people probably expense, but shouldn’t they be individually listed as capital improvements and depreciated?

[Carl]

Here's how I would do it.

The property is "in service" as of the date it was "available for rent". Period.

Since you refunded the renter the entire rental amount they paid in 2021, and you refunded it to them in 2021, I would not bother including that income in the total rental income received in 2021.

You are correct in that the insurance payout would be included in rental income.

Your cost to repair/restore the property back to a habitable condition is a property improvement. You can lump those costs all together (with exceptions) and enter them as a 2nd asset in the assets/depreciation section. Depreciation on this asset begins the day the property is available for rent, which of course has to be on or after the date the work was completed.

Furniture/appliances are depreciated over 5 years. Typically you can lump them together as a single asset entry. But that can (and most likely will) cause problems down the road. For example, if you lump all the kitchen applies together (fridge, stove, microwave, dishwasher, etc) and say 2 years later the microwave goes and you need to replace it with a new one, this can (and will) create a paperwork nightmare on the tax front.

With furniture/appliances that cost less than $2,500 you can just expense them under the safe harbor deminimus act and be done with them. But they need to be itemized on the invoice showing the cost of each item at less than $2,500 for that specific item.

Now understand that not all items under $2,500 can be expensed under safe harbor. For example, a hot water heater is one of those "grey areas" in the IRS pubs. It costs around $800. But since that becomes "a physical part of" the structure as a part of the plumbing system it gets classified as residential rental real estate and depreciated over 27.5 years.

[MarilynG1]

If this is the first year you will report your Rental Property, you could add your Improvements to your Purchase Price to determine your Cost Basis for Depreciation.  

You would report your Casualty Loss for a Business Property, using a Value Before of $7,700 and a Value After of $0.  The difference between the $7,700 you spent to restore the property and the $10,500 you received as an insurance settlement would then be reported as a Capital Gain. 

Click this link for info on Insurance Proceeds for a Rental Property.

This article has detailed info on the difference between Improvements and Repairs you may find helpful. 

[willem82]

If I can choose to expense or depreciate items under $2,500 and I will be taking a loss for the year either way, are there pros and cons to both options going forward. If I expense as much as possible and take as big a loss as possible, can I carry that loss into next year and offset profit? 

[ThomasM125]

If you expense the assets, they may only generate a tax deduction in the current year. You can deduct up to $25,000 of a rental loss each year, but this deduction is phased out with adjusted gross income of $100,000 to $150,000. If you can't take the full deduction in the current year, it is applied to future years, but only against rental or other passive income.

If you choose to depreciate the assets, then they will be deducted from rental income in the current and future years. I you think your income in future years will be significantly greater, to the extent you are pushed into a higher tax bracket, then you would normally choose to depreciate your assets, to reduce future income that is taxed at a higher rate.

So if your income is under $100,000 and your rental loss is under $25,000, you may want to expense the assets so as to get a full tax deduction for their cost in the current year. Otherwise, it may be better to depreciate them.