Calculating cost basis for rental property purchase with renovation

[jack73]

How about the Intuit/TurboTax chat with a CPA advice? Expenses incurred in preparing the property for rent all fall under "improvements" and adds to the cost basis for depreciation starting on the placed into service date? @Carl @ColeenD3 

[ColeenD3]

There is also a reference that states if a repair can't be separated from a major improvement, add it in with the improvement. I would have to do some research to find the IRS reference.

In the meantime, see this LINK.

[Carl]

IRS Pub 529 at https://www.irs.gov/pub/irs-pdf/p527.pdf page 4, bottom of first column.

Pre-rental expenses.You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent.

I can't find anything, anywhere that allows you to claim in any way, the cost of preparing the property for rent for that first time between the time you acquire the property and the time it is available for rent, , or between the time personal property is converted to rental use and the time it's available for rent. Could I have missed it? Of course. But I doubt it.

Also can't find anything that lets one add the cost of those items that are clearly repairs and/or maintenance expenses to the cost basis. However, if a repair is done as "a part of" a property improvement that's going to be capitalized anyway, then common sense says you include that repair as "a part of" the capitalized improvement.

Example:

I'm adding an counter-top island in the kitchen which will undoubtedly add value to the house. My cost of doing this (includes materials, supplies and labor) gets capitalized and depreciated of course. In the process of doing this build-out I accidently punch a hole in a kitchen wall I'm not working on for this project. Now I have to fix this hole with a small piece of sheet rock, a few screws, plaster, sheet rock tape and paint.

Technically, this is a repair. But I can include the cost of that repair in the cost of the property improvement since I fixed it as "a part of" doing the improvement.  It'll more than likely cost less than $100 for me to fix this hole, and it's not like I have to itemize every teeny-tiny thing with the IRS.

Are you "getting my drift" now? 🙂

From what I see this is probably what is commonly referred to as a "grey area" and I recommend that folks stay out of the grey. Besides, when you have a depreciable cost basis of say, $120,000 or more, increasing that basis by one or two thousand won't even put a dent in your tax liability over the years, since rental property (with a mortgage) is 100% guaranteed to operate at a loss (on your taxes) every single year.

The killer will be when you sell the property and have to recapture the depreciation. It's taxable in the year of sale and gets included as a part of your AGI for that year - thus making it likely you'll get bumped into a higher tax bracket.

I myself prefer to keep my depreciation as low as I legally possibly can for that very reason.

[jack73]

Okay, so if I think of it as a house I just bought for myself, and then converted to a rental, this makes more sense. I guess I just to use that mindset. In that situation, I don't get to deduct utilities, repairs, maintenance, or insurance, but I would track capital improvements, which increase my basis in the property.  I'd also track mortgage interest under the "second home" category, I guess (which may reach the new max limit, when combined with my personal mortgage). Tracking mortgage interest for a few months and splitting it between pre and post "Ready to rent" is doable, but a bit of a pain. Guess you do the same for property taxes? 

[Carl]

Understand that the date the property is converted to a rental (can be the date purchased) and the date the property is available for rent can be (and sometimes are) two different dates. Your allowed rental expenses that you can deduct, along with depreciation starts on the date the property is available for rent. For property improvements, the available date just doesn't come into play.

One thing I've seen others do with no problems is to include a "reasonable" amount of the cost of utilities (mainly electricity) in the cost of a property improvement. It takes power to run saws, floor sanders, cement mixers and the such.

[jack73]

" For property improvements, the available date just doesn't come into play."

But doesn't it, if, "depreciation starts on the date the property is available for rent."

Property improvements, by definition is what must be depreciated, correct?  If I can't begin depreciating the building until it's available for rent, then the available date should also affect the new flooring (for example) that was installed between date of purchase and date available. I wouldn't expect to begin depreciating the flooring until the available date. 

[Carl]

I meant to type "the purchase/acquisition date doesn't come into play"

I wouldn't expect to begin depreciating the flooring until the available date.

Of course. So if you tell the program you "acquired" the asset on 1/1/2019, and it was "available for rent" on 7/1/2019, depreciation starts on 7/1/2019. It really is that simple.

Now if this was a case of you purchased the property on 1/1/2019, installed the new flooring on 2/1/2019 (when the project was completed) and it was available for rent on 7/1/2019, I wouldn't bother entering the floor as a separate asset since depreciation on the property and the floor starts from zero at the same time. I'd just add the cost of the new floor to the cost basis of the structure and call it good.

For example,

Purchased property on 1/1/2019 for $200,000

Allocated $50K to the land (which is not depreciated of course)

The program "does the math" and figures that $150K goes to the structure for depreciation.

On 2/1/2019 installation of new flooring was completed at a cost of $10K. This makes my cost basis in the property $210,000.

When entering the property into TurboTax I'll enter $210,000 in the COST bos and $50,000 in the COST OF LAND box. The program will "do the math" and depreciation on $160,000 will start on my in service date of 7/1/2010. For depreciation, the fact that I 'acquired" (paid for) the new floor a month after I purchased the property has no effect what-so-ever on deprecation, since the property was not placed into service until after the property improvement was completed.