Investors & landlords

I converted my previous primary residence into a rental in 2020 and am trying to figure out how much of the property value to attribute to the land.  When working through the TurboTax screens for rental property income, in the section on property info, it first asks me how much I bought the house for and then the value of the improvements I've made (about $59,000 worth) to find my basis. 

The problem with doing it that way is that if the improvements were all structure improvements, the program will incorrectly allocate some of the cost to the land. Likewise, if the improvements were all non-depreciable land improvements, the program will incorrectly allocate a large portion of the costs to the structure. Therefore, I recommend you do not identify any improvements at this point in the program, and enter them later in the Assets/Depreciation section for the type of property improvements they "really" are. This will ensure that depreciable improvements are depreciated based on their full cost, and that land improvements are not depreciated at all.

Then it asks me for the Fair Market Value (FMV) when I converted the house to a rental - which I researched online and believe to be substantially more than my basis. 

This is because rental property is depreciated on the LOWER of what you paid for it, or it's FMV on the date of conversion. Nowadays, it's not common for the value to be less than what you paid for it.This question came about in the program around 2009 with the real estate market crash, when it was very common for the value of real estate placed in service in 2009 and after, to be significantly lower than what was originally paid for it. That can still occur for property placed in service in 2020. But it's not as common as it was from 2009 through 2016-17.

Then on a later screen it asks me to enter the current value of the land and improvements. 

Maybe that screen is not as clear as it probably should be. It's asking for the fair market value, not the tax value.

I pulled the current value of the land from my local assessor's website, but I don't believe that the assessor's estimate of the value of the improvements is correct because I know I could sell the house for far more than the sum of the assessor's estimate of land plus improvements. 

Actually, I'd bet the property tax assessor's values are spot on perfect. The tax assessor only assesses for "tax" value, not the resale or fair market value.  Typically, the tax assessor's value will be on average, 30% "below" the fair market value. Finally, somewhere on the IRS website in one of the pubs (I don't recall which one) I can recall reading something that basically says you can not use the tax values unless and until you have exhausted all other possible sources to determine the FMV of the property. But that's not why the program is asking you for those values. There is a valid reason.

The program will ask for tax values for the sole purpose of determining what percentage of the value is applied to the land, and what percentage is applied to the structure.  Then it uses that percentage to figure out what percentage of your original cost basis will be applied to the land.

Would it be correct to simply subtract the assessor's value of the land from my estimate of the FMV and attribute the difference to improvements? 

No.

When I got to the screens to work through depreciation of the house, I noticed that TurboTax had automatically filled in my basis in the house (purchase price + $59,000 in improvements) and also automatically filled in the value of land included in my basis. 

Yep. ...and as you now see, that justifies my response above as to why you don't include property improvements in your original cost basis.

To find the land value , TurboTax seems to have simply multiplied my basis by the same ratio of land value to total value as found on the earlier screen - 75%.  The problem is, this calculation seems to  yield too high a value for the land when I purchased it in 2013. 

That's because you "did the math" on top of the math the program should have accomplished for you.

I have an appraisal report from 2015 that shows the land value to be far less than TurboTax is automatically filling in, and I know that land values in my area appreciated from 2013 to 2015. 

 Put that appraisal away for two reasons. 1) It's more than 2 years old and means nothing for 2020.  2) It doesn't reflect a cost that is less than what you paid for the property.

The best thing to do is to delete the property entirely and start over. Then trust the program. By "trust" I don't mean implicit trust either. It's more like "trust, but verify".  When entering data do not read "between the lines" that which is not physically there in black and white. Enter what the program asks for. Nothing more. Nothing less. For many, the small print on a screen helps clarify things a bit - but not always. That's why this forum exist. 🙂

Basically, work through the program and when asked about improvements, state that you have none. Then when you get to the Assets/Depreciation section you'll see that the property itself is arleady entered then. Then youenter your property improvements there as a physically separate entry from the property itself, so that everything gets depreciated based on it's "true" depreciation value.

Now below I've added a boilerplate that helps clarify things that in my personal opinion, the program just doesn't do it as well as we'd like it to.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence or 2^nd home before, then this date is the day AFTER you moved out, or the date you decided to lease the property – whichever is later.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter "could" have moved in. That should be your "in service" date if you were asked for that. Vacant periods between renters count also PROVIDED you did not live in the house for one single day during said period of vacancy.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days you lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence or 2nd home, after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.

RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that “better” the property. Basically, they retain or add value to the property. Expenses for this are entered in the Assets/Depreciation section and depreciated over time. Property improvements can be done at any time after your initial purchase of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.

To be classified as a property improvement, two criteria must be met:

1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.

2) The improvement must retain or add "real" value to the property. In other words, when the property is appraised by a qualified, certified, licensed property appraiser, he will appraise it at a higher value, than he would have without the improvements.

There are rules that allow you to just flat-out expense and deduct some property improvements, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.

Cleaning & Maintenance

Those expenses incurred to maintain the rental property and it's assets in the useable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent are not deductible.

Repair

Those expenses incurred to return the property or it's assets to the same useable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent are not deductible.

Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.

However, when you do something like convert the garage into a 3^rd bedroom for example, making a  2 bedroom house into a 3 bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.