In 2018 we had rental income on a property. The property was servery damaged by hurricane Florence and has been under repair for all of 2019. Due to the damage there was no rental income for 2019. Can we deduct any expenses (unities, insurance, depreciation, etc.)? If so how do I enter them in TurboTax? If I say the property was not available for rent TurboTax deletes it.
If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. However, you can’t deduct any loss of rental income for the period the property is vacant.
In the program you must put at least 1 day of rental for the sch E to continue ... this is OK and you will be able to deduct the normal handling costs during the repair timeframe.
The property remains classified as residential rental real estate *PROVIDED* you do not live in it as your primary residence, 2nd home or vacation home for one single day during the period of vacancy. Now there is a "glitch" in the program that will *REQUIRE* you to indicate that it was rented for one single day in 2019. That's not a problem at all. YOu'll indicate that it was rented for one day, and zero days of personal use. Then for rental income you'll have a zero. (You *MUST* enter something in the rental income section - even it it's the digit zero.)
Then you'll enter your rental expenses of course.
Now note that if the property is not habitable because of the damage, I seriously doubt you have only "repairs" to do. More than likely you have what the IRS will classify as a property improvement, regardless of the reason for that improvement. Here's the IRS definitions of property improvements and repairs.
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 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.
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 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.
Thank you for your replies. It is correct that we are majorly improving the property. Not only repairing hurricane damage but since the property is almost 40 years old we are doing renovations at the same time. We received insurance money and my intent is to capitalize as an improvement any costs in excess of insurance received. I was basically making sure I could deduct utilities, insurance and depreciation during 2019 while we were unable to rent th property. Thank you.
I was basically making sure I could deduct utilities, insurance and depreciation during 2019 while we were unable to rent th property. Thank you.
I just want to ensure you understand how this works, so you're not shocked when you see your rental expenses have absolutely no impact on your 2019 tax liability.
First, you have absolutely no rental income for 2019. Understand that rental income is passive income. Therefore your rental expenses are also passive. Passive expenses can only be deducted from passive income. So while you will "claim" your rental expenses, since you're not a real estate professional those expenses won't be "allowed" since you have no passive income to deduct them from. Those claimed but unallowed expenses will be "carried forward" to the next year where you can deduct them *if* you have the passive income to deduct them from. But if you don't "claim" your 2019 rental expenses, then you flat out can not carry them forward to 2020. Period. So while you'll claim them, don't be surprised when it makes no difference to your tax liability.
Additional information: It is *EXTREMELY* rare for rental property to ever show a taxable profit "on paper" at tax filing time. That's because when you add up the allowed deductions each year of property taxes, mortgage interest, insurance, and the depreication you are required to take by law, those four items alone will almost always exceed whatever amount of rental income you received for the year. Add to that your other allowed rental expenses (repairs, cleaning, maintenance, etc.) and you are practically guaranteed to "never" have a tax profit for every single year you own that property.
What happens every year is that once your rental deductions gets your taxable rental income to zero, the excess deductions are carried over to the next year. As this continues over the years you'll note that your carry over losses on the rental get larger and larger with each passing year. You can see your passive carry over losses on IRS Form 8582.
All those carry over losses can not be realized until the tax year you sell the property. Here's how the losses help you (and the depreciation hurts you) in the tax year you sell the property.
-First, all prior depreciation is recaptured. The recaptured depreciation will be taxed anywhere from 0% to a maximum of 25%. the simplest way to took at it, is to reduce your cost basis in the property by the total of all depreciation taken. So if you paid $100,000 for the property and in the year you sell you have $20,000 of depreication, your cost basis for the purpose of determining your taxable gain on the sale is $80,000. So even if you sell it for the $100,000 price you paid for it, you have a $20,000 taxable gain. Period.
- Next, all of your carry forward losses from the IRS Form 8582 are subtracted from the taxable gain you made on the sale, thus reducing the amount of that gain that is taxable.
- Next, if those carry forwards reduce your taxable gain on the sales proceeds to zero and there are still losses left to claim, the remaining losses can be claimed against other "ordinary" income, such as your W-2 taxable income. There's a limit of $3000 that can be claimed against that other ordinary income (unless you are a real estate professional). So any losses left to claim once that limit is reached, is just carried forward to the next year where you can deduct it once again from other "ordinary" income... and so on and so on until all the losses have been used up.
Finally, in your case you have an insurance payout. Since your insurance premiums you paid for that insurance on the rental property in each tax year you paid those premiums was a deductible rental expense on the SCH E, that means the insurance payout is reportable (and taxable) income to you. If you need help to correctly report this, let me know and I'll help. It's also common for rental property insurance policies to include a payout for "loss of rent". Commonly insurance companies will pay a maximum of 85% of the monthly rent for an average of 6 months. So you "MUST" report that as rental income on your tax return, on the SCH E in the tax year you received that payout.
Generally the insurance company will send you some type of tax reporting document or a "letter in lieu" of a tax reporting document that will detail how much of the payout was for lost rent, and how much was for your property loss. You "must" report the amount they say as lost rent, as rental income on the SCH E in the tax year you receive that payout.
Again, if you need help with this, just let me know. Been there, done that, got the T-shirt. 🙂
If you or your spouse actively participated in a passive rental real estate activity, the amount of the passive activity loss that is disallowed is decreased and you therefore can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing the passive activity loss.
If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance can’t be more than $12,500.
The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your modified adjusted gross income that’s more than $100,000 ($50,000 if you’re married filing separately). If your modified adjusted gross income is $150,000 or more ($75,000 or more if you are married filing separately), you generally cannot use the special allowance. This is because the special allowance is reduced to $0 since the modified adjusted gross income is over the $100,000 amount.
@Carl This is by far the best and most detailed response I've seen regarding a rental property that has damage and unavailable for rental for an entire year. I have clients in the same situation except it has taken them all of 2018, 2019 and this year to get the house back together to rent. (Frozen pipe burst in an old farmhouse so I believe they decided to do major upgrades at the same time.) They have repairs, supplies and ordinary expenses for 2018 and 2019 (they haven't filed 2018 yet). Are the expenses for repairs and supplies reported on their Sch E? In 2018, they have $43k in "supplies". I want to make sure the returns are correct for them. Thanks for any advice you can give me. It's much appreciated!
If the property was not rented for more than a year because of upgrades and repairs being done, it "sounds" to me like damn near all of the costs would qualify as a property improvement.
they have $43k in "supplies".
While I"m not doubting that as a possibility, I do question that as a reality. I don't spend anywhere near even 1/4 of that amount in one year on my own 4 bedroom 3 bath primary residence for "supplies". I get the impression that you are breaking down expenses into more detail than necessary. For example, in the process of replacing sheetrock on a wall that was water damaged by a burst pipe in that wall, I'm going to be purchasing new pipe, and new sheet rock, along with connectors for the new pipe, and nails for the sheet rock. The cost of all of that material is a property improvement expenditure with no doubt. But I"m also going to be purchasing paint for the new wall, masking tape to tape things off for mailing, maybe a drop cloth to put down so I don't get paint on the wood floors, along with rags, mops and other things I"m going to need in order to complete the work in it's entirety and clean up afterwards so I leave no evidence of my presence.
Now why the rags, mops, buckets, paint and other "supplies" I'm going to need could be classified as supplies, the fact is that cost was incurred as "a physical part of" the property improvement. Therefore the entire total cost of "everything" is the cost of the property improvement.
You can also include in that property improvement costs the cost of what's called "consumables". These are things that are "consumed" in the process of doing the property improvement. For example, things like electricity costs and water costs, up to a "reasonable" amount.
For utilities, if the house was "NEVER" lived in during the upgrading/updating period by anyone as their second home, vacation home, or any other "personal pleasure" use, then the cost of water and electricity could be 100% deductible for the billing period of that utility in which the work was actually performed.
For a property that was "off the market" for more than a year with the primary reason for being off the market was to perform property improvements, I would recommend the house be converted to personal use one day after the last renter moved out. This will stop depreciation.
When the property is placed back on the market again and "in service", that's when you continue the depreciation. But with property out of service for more than a year, you have to do that a different way.
Basically, since the property was taken off the market in 2018 (I presume, since you mention the 2018 taxes were not filed yet) convert it to personal use one day after the last renter moved out. If they moved out prior to 2018 then convert it to personal use on Jan 1 of 2018 (unless that was already done in a prior tax year.) Then in 2020 when the property is back "in service" again, here's how you start the depreciation back up.
You enter the property as a "new" property, and you "MUST" subtract the total amount of prior depreciation on the property, from the original cost basis of the property that was used for depreciation in the past. You only lower the amount in the "COST" box, and you do not change the amount in the "Cost of Land" box. That reduces the cost basis of the structure only. Then depreciation starts all over for the next 27.5 years on the new, reduced cost basis.
You then enter your property improvements in the assets/depreciation section with the same "in service" date (or you can just add those costs to your "new" cost basis") and those too get depreciated over the next 27.5 years.
New appliances get depreciated over 5 years, so those would have to be entered separately. Just be aware that a new hot water heater is a "grey area" in the IRS pubs. The way I see it, is that a new hot water heater becomes a permanent part of the plumbing system, which makes that hot water heater "a physical part of" the structure. So it's classified as rental property and depreciated over 27.5 years. (As stupid as that is, that's how I interpret the IRS pubs.)
My main concern is that if you claim $43K of "supplies" for a single rental property, I see that the same as hanging out a sign that reads "HEY ! IRS! AUDIT ME NOW! PLEASE! HURRY! QUICK! FAST! I WANT TO PAY LOTS OF FINES, PENALTIES AND BACK TAXES!" Especially for property that was not actually rented for more than a year, I would expect that to be a huge flag raiser with the IRS.
Keep in mind that unlike you and I, there are a fair number of people out there that truly believe depreciation is a permanent deduction. They just are not aware that when the sell the property they have to recapture that depreciation "AND" pay taxes on it in the year of sale. In many cases, that recapture is enough to put them in the next higher tax bracket. So this is why I myself try to keep my depreciation as low as legally possible. Even so, I would still show passive losses on paper at tax filing time that would get carried over. (Don't have carry overs anymore though, since I paid off one of my 3 rentals a few years back.)
A couple more questions for you:
If I convert the rental back to personal use to stop the depreciation, what happens to all of the expenses they are incurring to get the house back to being habitable for rent?
Is this kind of the same situation as "house flipping"? I've a another client who does this on the side so I know how to account for his flips on the tax return.
In regards to the $43K in supplies, I will ask the clients to help me break it down a little better since we will have more time to classify whether it belongs in the Asset section or a true supplies unless you have a recommendation for taking a percentage? Since it would be an improvement to the property I already know it will be the life of the rental property of 27.5 years. How specific do I need to be? I do not want to raise that red flag to the IRS. 🙂
I can always file the return and file an amendment even though I hate doing that. Ugh! Not sure if Turbo Tax allows this but you can reach me directly at jilrappe @ gmail . com. Any more help you can provide would be greatly appreciated!!
If I convert the rental back to personal use to stop the depreciation, what happens to all of the expenses they are incurring to get the house back to being habitable for rent?
I take note that you are not the one who started this thread. So my first thought here is exactly what are *YOU* calling expenses? I have absolutely no clue what *YOUR* specific and explicit situation is. I would suggest you start a new thread (and you can tag me in it if you like) and explain all of "your" specific details. What happened? When? What was damaged so as to make the property unrentable for a prolonged period of time? Was there an insurance payout? What specifically was the payout for?
When you "tag on" to a thread you did not start, this inevitably leads to confusion by all parties participating in the thread. So if you'll start your own new thread and tag me in it, I'll be happy to address your specific situation.
When dealing with something akin to hurricane damage or a fire that renders the property uninhabitable, you're dealing with two separate things. First there's your loss. Second is your "gain" on the insurance payout and the work done with that money to make the property habitable again. If there was no insurance payout, you still have a "gain" on what you paid for the property improvements in the form of an increased cost basis on the property.
It can get complicated. But if you take it "one" "step" "at" "a" "time" it's perfectly doable with TurboTax. Overall though, if you haven't filed your 2019 tax return yet, then you're late. If you believe you will owe the IRS additional tax for 2019 then you should seek professional help so this can be taken care of ASAP. The sooner you file and pay, the sooner the late filing penalties and interest stops accumulating.
However, if you are confident you will be getting a refund, then a late filing will not result in any fines, penalties, late fees or interest. But you have 3 years from the due date (Jun 15, 2020) to file. If you file after three years, you forfeit any and all refund money you may be due.
I am a tax pro looking for advice for my client. I don't use TT. I have my own software to use. As I stated, I stumbled upon this Community looking for advice to file my client's return properly. I read your response regarding the hurricane damage/repairs and it fit my situation "loosely" but now we are off on another topic. That is why I gave you my email address to continue this offline. I don't want to break any rules though.
I don't respond to e-mail addresses, as it negates the purpose of this public forum. Take note that I make no claims to being a trained tax professional of any caliber either. I just have 3 rental properties of my own with 30 years of experience with them and have been doing my own taxes since 2003.
Bottom line is, expenses incurred while property is not classified as a rental is just flat out not deductible. Period. But that's why I question what you call "expenses". If a property is not inhabitable for an extended period of time, it's not because "repairs" need to be done most likely. It's because the damage is so extensive that the work done to report it to a habitable condition would be considered property improvements.
For example, if the roof is torn off in a hurricane and the property is moved off it's foundation, that would make it uninhabitable.While moving the property back onto it's foundation and securing it there, and putting on a new roof may be called "repairs" by you. But the fact is, it adds to the cost basis of the property. Therefore, the cost is capitalized and depreciated. It would not matter if the property was converted to personal use or not. The cost of the property improvement is still capitalized.
But to have the property remain classified as a rental in excess of a year while it's uninhabitable can hurt in the long run when you sell the property and have to recapture that depreciation in the year of sale. It's also likely to get the attention of the IRS if you have depreciation for year or more, yet no rental income.