a 2 house property that has been subdivided, how to claim rental income / depreciation

[jaysiz]

Hi Guys. I'm working on my taxes and I bought a property that had 2 houses on it. it started at a rental that I purchased for $570k. I finished subdividing the property and am trying to figure out how to claim the new property as a new rental, as before I was claiming it as a single property, multifamily initially on my 2019 taxes. For my 2020, it's 2 different properties, and I want to claim them separately, claiming rents on both, I'm trying to determine how to adjust or make sense of the adjusted depreciation / initial cost into turbo tax for the 2 separated houses. Is it possible? or do I just claim the new adjusted as a new property with no initial cost? 

for easy math sake, let's say property 1 new tax assessed value is at 170k, and property 2 is at 400k. 

any help is appreciated. Thank you. 

[Carl]

There are several ways to do this. I will cover the easiest/simplest.

Indicate that you converted the multi-family unit to personal use in 2020. (You pick the date, based on your paperwork for sub-dividing).  When done, with that conversion entirely, work through the assets/depreciation section and for each individual asset write down the total depreciation taken. The total depreciation taken will include prior year's depreciation, and the current year's depreciation up to the date you converted it to personal use.

You will also need your cost basis on the property, which is sown on the screen with COST and COST OF LAND on it. Those values will matter. COST is what you paid for the property in it's entirety when initially purchased. COST OF LAND is that portion of COST that was allocated to the land.

Now you will enter two entirely new rental properties, one at a time.

Fist, you must divide your COST between the two by whatever you determine is reasonable and realistic. It could be a 40/60 split, or something else. then you will reduce the cost basis for each individual property by the depreciation already taken. You can split the depreciation between the two properties, using the same percentages that you split the cost basis.

Then you have to assign a portion of that cost for each individual property, to the land for each individual property.  Now here's the tricky part.

For both of the "new" properties, when you add together the value of the land for each, the total must equal the original value of the land when it was a multi-family unit. This is because land is not a deprecated asset.

The "new" value in the "COST" box for each property will be reduced by the amount of depreciation already taken on that property. Then depreciation will start over from the new "in service" date. That new "in service" date for each property, must be at least one day "AFTER" you converted the multi-family unit to personal use.

Depreciation for each property will start over and will be depreciated based on the new "adjusted" cost basis for each property, over the next 27.5 years.

[jaysiz]

Wow Carl, thanks! that definitely makes sense. 

[Carl]

Glad to help. Just understand that this means for 2020 you will have three rentals on the SCH E. The multi-family setup will be in column A, and the "new" unit 1 (for lack of a better name) will be in column B, with the "new" unit 2 in column C.

I do want to stress that you make absolutely certain that on the multi-family setup, you convert "everything" to personal use. Each individual asset, one at a time. Also, if you claimed any vehicle use on the multi-family unit, you must also show that vehicle removed for personal use. Doesn't matter that it was less than 100% business use, or that you only claimed it in a tax year prior to 2020. If it's not done right, then the multi-family will be imported into your 2021 taxes next year.

Now there are situations where you do "in fact" do everything correctly. Yet, the property that is no longer a rental gets imported anyway. When that happens, and you are 100% certain you did everything right the prior year, you can just delete that property from the 2021 tax return and press on with life. You'll be fine.

[jaysiz]

Thanks for that! I would of definitely missed this. 

[chunhuach]

Hi Carl,

Thank you very much for the detailed answer. I am in a similar boat but with some differences. 

My property has 2 houses on it, I subdivided the property into 3 lots, 2 with houses and 1 vacant lot. this will be done in 2022.

I can follow your advice to convert old property to personal use, then create 2 new rental properties.  I plan to allocate part of the original cost basic as the cost for the vacant lot, I will also roll all my subdivision cost into the vacant lot. For the vacant lot, I don't need report anything in TT. 

I plan to convert the old property to personal on 12/31/2022, and "acquire" the 2 rentals on 1/1/2023.

I also remodeled one of the house in 2022, I plan to add that as remodel cost as basis for that property in TT.

Do you see everything I plan to do is correct?

Anywhere I maybe should pay attention to or change the way I do it? 

Should I add the remodel cost to the old property, depreciate it, and then do the conversion?

Thanks!!!!

[Carl]

@chunhuach everything looks good. But I want to clarify a few things since you didn't mention them, or clarify them enough for me to be sure I understand.

I can follow your advice to convert old property to personal use, then create 2 new rental properties. I plan to allocate part of the original cost basic as the cost for the vacant lot,

What I see as the important thing here, is that when you add up the cost basis of the land for all three lots, the total will be exactly the same as the cost basis of the land before subdividing.

I will also roll all my subdivision cost into the vacant lot. For the vacant lot, I don't need report anything in TT.

While I personally don't see a problem with that, I do question if doing it that way will be acceptable to the IRS, and I question if the IRS will even look at it. I just don't know. I would expect not, as you may have to spread it among all three lots. I just don't know the definitive acceptable process on that or if your subdividing costs are even deductible or can be added to the cost basis.  With the IRS hiring another 87,000 agents, they're not doing that to go after the rich people. So I would suggest you either do further research in the IRS pubs, and/or seek the advice of a tax professional that you can hold legally liable and financially culpable for the information they provide you.

plan to convert the old property to personal on 12/31/2022, and "acquire" the 2 rentals on 1/1/2023.

Just remember, you have to manually keep track of the depreciation taken prior to this, outside of TurboTax. You will be required to recapture it and pay tax on it when you sell the property in the future.

I also remodeled one of the house in 2022, I plan to add that as remodel cost as basis for that property in TT.

If the remodeled structure was "in service" in 2022 after the remodel, you'll have some depreciation for 2022. You can just reduct the cost basis of that remodel by the depreciation taken, and then "roll it" into the structure cost for that property. That way, you start 2023 with a single asset listed for that property, which will be the property itself, only.