Investors & landlords

Your remodel is actually property improvements that add to your cost basis of the property. Normally rental property improvements are depreciated over time starting on the date those improvements are placed "in service" as a rental asset. However if your case your property improvements were never placed in service. Therefor they are not depreciated. Yet they still add to your cost basis of the property regardless.

There are a number of ways to report this. But regardless of the way you report it, there is absolutely no need to include these property improvements on your 2019 tax return if you don't want to. However, if you can if you want, and it might be a good idea to do so. Therefore I am recommending that you do. Before I get into how to do that correctly, some explanation concerning depreciation is called for here.

As you know, you are required by federal law to depreciate rental assets. However, by that same law land is not depreciated when utilized in the production of rental real estate income (commercial or residential.)  Then in the tax year you sell that property you are required to recapture all depreciation taken on the property and pay taxes on it. Recaptured depreciation is added to your AGI and has the potential to put you in a higher tax bracket. Therefore, if you are not required to depreciate the property, then you definitely don't want to do that.

Residential rental real estate property depreciation starts on the first day that property or property improvement is placed "in service" and becomes available for rent. SInce you made no attempt to rent the property after the last renter moved out in 2019, I highly recommend you convert the entire property and any depreciable assets that existed prior to the last renter moving out, back to personal use. This will stop depreciation on that day. Your date of conversion back to personal use needs to be no sooner than one day *after* the last renter moved out.

First, I will discuss how to convert the property back to personal use. Then I will discuss how to add your property improvements as assets in a way that will increase your cost basis in the property, without depreciating those property improvement assets that were completed after the last renter moved out.

Converting the property to personal use:

Start working through the rental "as if" nothing changed. About the third screen in (the property profile section) is titled "Do any of these situations apply to this property?"

On that screen select "I converted this property from a rental to personal use in 2019"

If you have passive carry over losses from IRS form 8582 on your 2018 (twenty eighteen) tax return, you'll also select the option for "I have passive activity real estate losses carried over from a prior year."

Then continue working it through, and enter your carry over losses if applicable and if you have any. Continue working it through "as if" nothing changed, reporting all rental income and rental expenses. Keep in mind that you can only claim those rental expenses incurred up to the date of conversion to personal use. (no, you're not going to "lose out" on expenses incurred after the renter moved out in Nov 2019. Those are dealt with differently. )

On the screen, "Was this property rented for all of 2019?" select NO.

For "days rented" the day count starts on Jan 1st and ends on the day the last renter moved out.

For "Personal use during the year" the number you enter here is ****ZERO****. The program is asking you for days of personal use *WHILE* *THE* *PROPERTY* *WAS* *CLASSIFIED* *AS* *A* *RENTAL*. What you used it for *after* you converted it to personal use *DOES* *NOT* *COUNT*. Period. End of story.

When you get done with rental income and rental expenses, the next section is "Assets/Depreciation". Start working through that section. Elect to edit/update the assets/depreciation section. If asked if you want to go straight to your asset summary, select YES. Now you have to work through each individual asset one at a time, and do the below for each individual asset listed here. At an absolute minimum, the property itself will be shown in the "Your Property Assets" list.

Elect to edit/update the first asset and begin working it through.

On the screen, "Did you stop using this asset in 2019?" select YES.

For the "date of sale or disposition" the date entered here must be at least one day after the last renter moved out. The date you enter here will be the date depreciation stops on this specific asset. So you want to enter the same date for all assets to keep things consistent. Leave the "date acquired" alone.

On the "Special Handling Required?" screen, select YES. If you select NO then you will be "forced" to enter sales information. Since you did not sell the property in 2019, you can't enter sales information on your 2019 return. So you must select YES on this screen.

The next screen shows you the depreciation on this asset for 2019, and the amount is based on the date you converted it to rental. Click Continue and repeat the above for the next asset, if you have other assets listed.

Once you have completed all the above for all assets listed, click the DONE button.

Now if at any time in any year you claimed any vehicle use for this property, even if less than 100% business use, you "must" work through the vehicle section and show your disposition of this vehicle. More than likely, you will just indicate that it was removed for personal use and be done with it.

This completes converting the property from rental business use, to personal use. Now lets add the property improvements you did after the last renter moved out.

Now back on the "Review.....Summary" screen elect to start/update the Assets/Depreciation section again. If prompted to go straight to your asset summary, select YES and continue. Now you're back on the "Your Property Assets" screen, and everything listed there has already been converted to personal use. Let's add those property improvements now.

Keep in mind that we really aren't "that" concerned with the MACRS asset classification for your property improvements, since they are not being placed in service, and will not be depreciated.

Click the "Add an Asset" button.

Select "Rental Real Estate Property " and continue.

Select "Residential Rental Real Estate" and continue.

Now enter a description for your property improvement. For all improvements that were completed after the last renter moved out, you can just group them all together. It makes your life easier in the long run, and since we're not going to depreciate them anyway, it's not going to matter.

For the cost of these property improvements, this will include not only what you paid for the asset, but also the cost of shipping, delivery, labor for installation, the electric and water bill used by the workmen in their labor process, etc.

Now enter in the "Cost of Land" box the same exact amount you entered in the COST box. What this does is allocate the entire amount entered in the cost box, to the land. Since land is not a depreciable asset, that means that no matter what "in service" date you enter, this asset will not be depreciated. I suggest you enter an in service date of Dec 31, 2019 in the box for "date purchased or acquired". Then continue.

Select "I purchased this asset new" and then for the sole sake of simplicity, select that you used the asset 100% of the time for this business. Then give it a start date of 12/31/2019 and continue.

If offered the "Special Depreciation Allowance" you will note the amount allowed is $0. Select NO and continue.

On the Asset Summary screen you'll see the depreciation amount is $0. If you select show details, you'll see the amount added to your cost basis, and no type of depreciation is taken or allowed. That's exactly what you want. Finish working this through and you're done.

If offered the "safe harbor" option, select "None of these apply" and continue.

Finish working things through to the "Rental and Royalty Summary" screen. Then to save everything and completely exit the SCH E section of the program click the DONE button.

Now you can continue with the rest of your tax return as needed or required. If you have done everything completely and correctly, then this particular property should "NOT" be imported into your 2020 tax return when you start it next year. THerefore, there a three documents that you will need to print a hard copy of, *AFTER* you have completed your return, filed it with the irs *AND* it has been accepted by the IRS.

Once your return has been accepted by the IRS, elect to save a copy of *EVERYTHING* as a PDF file. Not just the forms needed for filing, and not just the forms needed "for your records". You want to save "EVERYTHING" in PDF format so that you can open and print the pages you will need, using either the Edge browser, or the free Adobe Acrobat Reader program.

The documents I'm instructing you to print here will be *REQUIRED* when you report your sale of this property on your 2020 tax return. Without the information provided on these 2019 tax forms, it will be impossible for you to correctly and completely report the sale.

First, you need to print the two IRS Form 4562's for this specific rental property. Both of these 4562's print in landscape format. One is titled "Depreciation and Amortization Report" and the other is titled "Alternative Minimum Tax Depreciation".

The other form you will need is the IRS FOrm 8582. This form will only exist in your 2019 tax return if you have carry over losses that could not be used in 2019. So if the form 8582 does not exist in your PDF copy, that means either you have no carry over losses, or if you had carry over losses from 2018 they were all used up in 2019. This can and does happen. But it's not all that common.

File both 4562's and the 8582 (if applicable) with your 2020 tax data. You will need information off those forms when you report your 2020 sale of the property on your 2020 tax return that you will complete next year.