I had just one rental. Bought as a primary residence in 2016, lived in it for 11 months and then converted it to a rental property. in 2019 I sold it. I did renovations before moving out in 2016 and again in 2019 to prepare for sale (these were more minor). I'm filing in my "Rental and Royalty Summary" where I've got the property itself and then within that property I've added a few of those improvements under "Sale of Property/Depreciation" I have the property itself and the assets. My confusion is, when I go to open the assets the % for business use appears random - it's for values less than 100%. But all the assets under this property have been 100% for business use after the date I started renting it, right? Does this mean that I made an error in previous year return and I need to change the auto-populated percentage to 100%? Or, is this somehow an auto calculation based on the time I lived there vs. rented it.
Also, I assume things like cabinets for a kitchen would require special handling as they are "intangible assets not considered section 1245 property"? But I'd appreciate if someone could verify that for me. OR, maybe I mislabeled. I've got cabinets for a kitchen under "F-Rental appliances, carpet, furniture"... I might have done this wrong in past returns. Yikes! Any help appreciated.
Based on your post, it seems apparent to me that your understanding of "how things work" with rental property when it comes to taxes, may be a bit misguided. So let me provide you more focused guidance on that. Then we'll get into the specifics of your situation.
Intangible asset: An intangible asset is something that does not exist in a material form that you can see, touch, or hold in your hand. But it still has monetary value. For example, I am self-employed as a computer consultant - and I am not the cheapest in my field either. People are willing to me a bit more than they'd pay the next guy in my field, because of the reputation of my business. So that reputation has a monetary value. I can't "see' reputation, and I most certainly can't hold or touch reputation. But it still has monetary value and is therefore an intangible asset in my business because it directly affects the income producing ability of my business. The IRS refers to this as "good will". If I were to sell my business, then that is when I would report the sale of "good will" which I would give a cost basis and would either profit from if sold for more than my cost basis, or declare a loss on if sold for less than my cost basis. (Establishing a cost basis for good will is it's own endeavor which I"m not going into here. Just using this to help explain things.)
Tangible asset: A tangible asset is something that you can see, touch, or hold in your hand. There are different kinds/types of tangible assets too. For example, your rental property and the land it occupies (the entire lot that you own) is a tangible asset that you use directly in the production of income - namely rental income. The IRS has defined this type of tangible asset as "Residential Rental Real Estate" in the MACRS tables and it gets depreciated over 27.5 years if located in the U.S.
When you do property improvements, such as new cabinets in the kitchen for example, those new cabinets become "a permanent and physical part of" the building that is used in the production of rental income. Therefore what you paid for those new cabinets, including the cost of delivery and installation, gets classified exactly the same as the asset they become a physical and permanent part of. So your new kitchen cabinets are classified as Residential Rental Real Estate and get depreciated over the next 27.5 years, the same as the building itself does.
Another type of tangible asset would be one that is also used directly in the production of rental income, but it does not become a physical and permanent part of the structure. An example of this would be if you were renting out a furnished apartment. The furniture is not "a physical part of" the structure itself. But it is used in conjunction with that structure in the production of rental income. So the furniture would be classified under the MACRS rules as "appliances/furniture" and their cost would be depreciated over 5 years.
So with the above information shared with you now, you should realize that none of your property improvements qualify for "special handling" of any type.
I did renovations before moving out in 2016
If those renovations meet the requirements to be called a "property improvement" then what you paid for those renovations is added to your cost basis of the property *BEFORE* you rented it out back in 2016. (you'll see my definitions below, which will help clarify things a bit more.) At this point, I can only assume you were aware of that back then, and you did "in fact" add what you paid for those property improvements, to the cost basis of the structure, and not to your cost basis of the land. I also assume you added those costs to your coast basis when you initially entered the property as a rental for the first time back in 2016.
and again in 2019 to prepare for sale (these were more minor).
My definition of "minor" is anything less than $2,500. Is that your definition? I also need a bit more information so I don't waste your time trying to cover all possibilities. If I do that, then about 90% of what I educate you on won't apply to you and will more than likely just add to the confusion.
On what date did the last renter move out?
On what date did you close on the sale?
What was the approximate cost of your property improvements done "after" the last renter moved out?
The above matters so that I don't provide you guidance that while it may be "correct" or the legal front, it might increase your possibility of "raising flags" at the IRS. We want to avoid that. What follows is those definitions I mentioned earlier.
RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED
Property improvements are expenses you incur that 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 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.
Cleaning & Maintenance
Those expenses incurred to maintain the rental property and it's assets in the usable 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.
Those expenses incurred to return the property or it's assets to the same usable 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 3rd 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.
Thanks, Carl!! All that you've said makes sense, but it gets more confusing once I start going through turbotax.
So, I think one place I've gone wrong is to add any of the improvements I made as assets to the property in past returns. I should have added the ones that qualify to depreciate with the property, and not in this Section E Asset summary table. If I put in a radon system (a value of $1,800) before I listed it for rent, then that should not be listed in the Asset table. Is that correct?
Renter moved out mid-June and house closed end of November. It sat vacant in that time, part time on market and part time being renovated again. Individual renovations/payments in this period were all under $2,500, with the exception of one which was repairing window and wall from a leak and cost $2,551. Total renovation last year was about $7.5K. I assume these renovation costs go just into my cost basis (if I'm getting the terms right) so that I'm reducing any gross profits by this amount. Right?
Thanks, Carl! This is helpful.
My original reply got removed for some reason. Hopefully this one passes the test and I can cover the points you made.
I think I've made a mistake to put any of these improvements into the asset table on the schedule e form, is that right? I should only include the assets that were added/improvements made while the property was actively rented. I should have added these to cost basis of the property for 2016 taxes.
For more info on my situation. The renter moved out mid June 2019, and the house sold at the end of November. In that time it was vacant, either while I was deciding what to do with it, renovating, or on market. The total of those renovations were $7.5k and the only payment that was over $2.5k was one for $2,550. I assume from what you've said, that I only put these costs into the expenses of the property in the cost basis calculation (along with purchase expenses and price, etc). Is that correct?