Bonus/Special Depreciation on Rental Property

[Helpless4]

Hi,

I converted a single family residence to a rental property in 2022. I had a cost segregation study done and have separated out 5, 15, and 27.5 year depreciable items. I would like to take 100% bonus depreciation on the 5 and 15 year items. Under the asset section of Turbotax Premiere (online), I enter each (5, 15, and 27.5 year) separately and check the "special depreciation" box for the 5 and 15 year. However, after getting everything in and hitting continue, it doesn't seem to register. The 27.5 year items keep disappearing every time I log in; and while the 5 and 15 year items remain, the special depreciation doesn't change the taxable income listed, which should be very negative.

Am I going about this correctly? How do I get the bonus/special depreciation to work?

[Carl]

In the assets/depreciation section, enter the property itself first. Work it through and it'll set things up based on your selections, for the 27.5 year depreciation. When you're done with that entry, leave it alone. You'll see it listed when you return to the assets/depreciation list upon completing the entry. Then click the "Add Another Asset" button and press on with your next asset. Understand that anything you classify per MACRS as "residential rental real estate" will be depreciated over 27.5 years, and SEC179 and SDA is not an option.

Typically, 5 year property are things like appliances, and 15 year property are things like land improvements; such as a retaining wall.  Things classified under MACRS as appliances while depreciated over 5 years, should give you the option of selecting accelerated depreciation, such as the SDA. I'm not sure about 15 year assets.

Just be aware that most likely, all this work to separate things out is not going to have any impact on your tax liability anyway, since long term residential rental real estate with a mortgage on it is practically guaranteed to operate at a loss anyway.

[Helpless4]

Hi @Carl ,

Thanks for the reply. I deleted all asset information and restarted by first adding the "27.5 year structure" (total cost minus the cost of segregated 5 and 15 year items). I then went back in and added the 5 and 15 year items, as furnishings, appliances, etc., and land improvements. These do show as depreciable over 5 and 15 years in TurboTax, as desired, and allow special depreciation to be selected.  Picture below shows the summary.

What confuses me is that fact that this doesn't seem to count against my taxable income. My other property, that I've had for a few years (straight line depreciation, no bonus or segregation) shows up as a net negative (loss) because of the depreciation, and thus reduces my total taxable income (W2 and other investments included), and results in a larger tax return.

I'm not seeing that with this property. Rather than showing as negative, it just shows zero, not allowing me to take full advantage of the depreciation. Perhaps I am mistaken, but all of the research I have done led me to believe that the bonus depreciation would cause the property to show up as a large loss on my return and result in a much smaller taxable income, which can then be reinvested. Am I misunderstanding?

[Anonymous_]

@Helpless4 

What you are seeing is your property asset summary in the interview section of the program.

Check your Schedule E and/or your Schedule E Worksheet. 

Note that your net loss is going to be limited since losses from residential real estate are passive. You may (probably do) qualify for the special allowance for active participation (see link below), but that is limited to a maximum of $25,000 (that you can deduct from other income) and the rest of the loss will be carried forward.

Active Participation allowance: https://www.irs.gov/publications/p527#en_US_2022_publink1000219124

[Carl]

What confuses me is that fact that this doesn't seem to count against my taxable income.

This is one of many reasons why I try to keep my depreciation as low as I legally can. Many folks are of the incorrect impression that depreciation is a permanent deduction. It is not. You are required to recapture and pay taxes on that depreciation in the tax year you sell or otherwise dispose of the property. Two things about depreciation recapture.

1. Recaptured depreciation is added to, and therefore increases your AGI in the year of recapture. (Usually the tax year you sell the property.)

2. That increased AGI has the potential to bump you into the next higher tax bracket.

While recaptured depreciation can only be taxed at ordinary income tax rates up to a max of 25%, other income (such as gain from the sale) can be taxed at the higher tax rate.  How it works out just depends on the numbers in the year you sell the property. For many, those numbers are impossible to predict.

My other property, that I've had for a few years (straight line depreciation, no bonus or segregation) shows up as a net negative (loss) because of the depreciation,

May have to do with the fact that you have not yet completed your return. Per the IRS (can't recall the publication), you can deduct a maximum of $25K of your passive losses against "other" ordinary income (such as W-2 income). But to do that, you have to have the "other" taxable income to deduct it from. Once you reach that $25K limit, any remaining loss is carried over.

Additionally, if your income is above a certain threshold (don't recall that amount) you don't qualify for that $25K against other ordinary income.

As for depreciation, I would not expect it to make any difference in your overall tax liability. When you add up the deductible rental expenses of mortgage interest, property taxes, insurance and depreciation, those four items alone are usually enough to exceed the total rental income received for the tax year. Add to that your other deductible rental expenses (HOA fees, repairs, maintenance, etc.) and you're practically guaranteed to show a loss on rental property every single year.

Now like I said, for those passive losses that exceed the passive income, you can deduct a maximum of $25K from other ordinary taxable income. But, you have to have the income to deduct it from, and your AGI has to be below a certain threashold.

Either way, anything not deducted on the 2022 tax return is automatically carried over to next year. You'll see that on the form 8582-Passive Activity Loss Limitations.

Just remember, the program can only work with the numbers it has "at" "this" "specific" "point" "in" "time". so until you've entered all of your income and all of your expenses (such as SCH A itimized deductions) the numbers will not be anywhere close to what you may expect.

[Helpless4]

Thanks @Anonymous_ 

I was unaware of that cap. As disappointing as it is, I'd still like to take advantage of what I can.

I recall the question as to whether I took an active role being asked, and I did select "yes." Perhaps this exception does not apply to special depreciation, and special depreciation cannot be deducted from regular income at all, thus I need to use straight line depreciation? I guess I'm trying to figure out how to apply the special participation allowance for this property, as even that doesn't seem to be registering. It simply shows up as net $0, rather than the negative value that would be expected after all deductions and depreciation.

[Anonymous_]

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@Helpless4 wrote:

Thanks @Anonymous_ 

I recall the question as to whether I took an active role being asked, and I did select "yes." Perhaps this exception does not apply to special depreciation, and special depreciation cannot be deducted from regular income at all.....

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The exception for active participation does, indeed, apply to bonus depreciation.

The problem is you might be running into the $25,000 loss limitation. You can use up to $25,000 in net rental losses to offset your other income and then any excess above $25,000 is carried forward to the next tax year. 

For example, if you had total rental losses of $60,000, $25,000 could be used to offset your other income and the remaining $35,000 loss would be carried forward to the 2023 tax year. 

The bottom line here is simply that you will not gain anything by using straight-line depreciation.

[Anonymous_]

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@Carl wrote:

This is one of many reasons why I try to keep my depreciation as low as I legally can. Many folks are of the incorrect impression that depreciation is a permanent deduction. It is not.

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You need to fully understand the time value of money to appreciate this form of cost recovery system. The amount of income tax saved as a result of depreciation deductions can immediately be invested.

The accumulated deductions may be subject to recapture, but any tax due thereon will almost certainly be paid back in cheaper dollars than when the deductions were taken.

[Helpless4]

@Carl @Anonymous_ 

Hey guys,

Sorry for the long delay. I wanted to take Carl's recommendation and get all of my other income in there to see if that resolved the problem before pressing forward with any more questions, which meant waiting for the last few documents. Unfortunately that didn't seem to help. My MAGI is low enough to allow me to take a significant portion of the special allowance, but not all of it. I got all of my income in there and even moved on to the deduction section, but no luck. The second property is still showing as $0, when it should be showing an operating loss. Based on the IRS document linked earlier, I still have plenty of room to take additional allowance, so capping that out is not the problem. It does seem to be registering some amount of the depreciation, as without it the property is a little profitable, and it does drop it to zero. It just won't go below zero.

Is there a way to override this? Is it possible that I made a prior selection that prevents it from showing an operating loss? I can't imagine what that'd be.

Thanks again for all the help.

[Anonymous_]

With respect to your bonus depreciation assets, have you entered them as "Other expenses" on Schedule E?

Regardless, how much of the $25,000 are you using? You should absolutely not do any overrides with respect to this issue.

[Helpless4]

I'm using the online version. Is there a way to view the actual forms prior to submitting? This is how I entered everything in the software. It is under the Schedule E section, but it doesn't seem to state the exact field it's going into. If I were to click on the "edit" button for the "assets," I would get the screen posted before with the breakdown of 5, 15, and 27.5 year depreciable assets.

As for how much of the allowance I will be using: I have a W2 Income of $138,082. I have a taxable state refund of $515. I had a big stock market loss this year, so I'm using the full $3k capital loss. This should put my MAGI at $135,597. According to IRS publication 527 (linked earlier), I can deduct passive losses equal to half of the difference between $150k and my MAGI. ($150,000-$135,597)/2 = $7,201.50 in potential passive losses to deduct. However, the second image below is what shows for my rental income. The first property is correct, but the second won't drop below zero. Obviously, summing the numbers in the first snip below, and coupling that with the depreciation breakdown posted previously, I should be maxing out the allowable $7,201, and the second property should show a loss of -$5,677.50.

[AmeliesUncle]

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@Helpless4 wrote:

I converted a single family residence to a rental property in 2022.

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When it asks for the number of rental days and the number of personal days, are you entering ZERO personal days?  You should be.

As a side note, those summary screens in TurboTax are sometimes faulty, so be sure to look at the actual tax forms themselves (Schedule E for your rentals).

[Anonymous_]

@Helpless4 

You should double-check your figures and the manner in which you entered them, including a check of all of the answers you provided in the Rentals section of the interview.

I quickly plugged in your numbers into my test copy of Home & Business and received the correct results (i.e., a net loss of $7,202). Go back through the Rentals section and proceed carefully.

[Helpless4]

@AmeliesUncle @Anonymous_ @Carl 

AmeliasUncle, that was the issue! I converted this property from my primary home to a rental this year, so I split it up accordingly when asked about personal use vs rental days. I missed the stipulation that said not to include days that you lived in the property (although I'm not sure what else would be considered personal use). I corrected that to only list the portion of the year that the property was rented, and it seems to have fixed the issue.

Thankyou all for the help.

[Carl]

I missed the stipulation that said not to include days that you lived in the property

A vast majority do miss that, as they don't read the small print.

(although I'm not sure what else would be considered personal use).

A personal use day would be any day you lived in the property as your primary residence, 2no home, vacation home, or any other type of "personal use", *after* you converted it to rental property.  So if you lived in the home for say, 2 weeks for the primary purpose of performing repairs, maintenance, and/or property improvements, those days would not be personal use days.