conversion of personal property to rental for short-term (few years)

[gcordelli]

We own a condo that we originally bought for my mother-in-law, since passed.  It's been empty for the last few years, but we kept it with the idea we would retire to it.  Now we have an opportunity to convert it to a rental in the interim -- perhaps 3 years? -- before converting it back to personal use when we retire.

We are making some renovations to the property that serve the double purpose of making it more appealing to the renter (already known) as well as more appealing for us at retirement.  Does it make more sense to set the conversion date so that these changes are "in preparation for renting" and deduct the depreciation of the remodel costs from the rental income for a few years, or set the conversion date after the remodel is complete and let that increase the cost basis of the property, deduct no depreciation for the remodel, and then if we don't end up moving in upon retirement we can sell the place without dealing with recapturing the depreciation (if I understand this nonsense, the costs would simply increase our "basis" when figuring the capital gain at the time of the sale)?  I'm just not sure if this is one of those things where this depreciation is worth it if its only for a few years (also, it is quite likely that we will barely break even on the rental income/expense, and our overall income precludes our being able to deduct any losses for the rental, so "extra" depreciation seems meaningless.  I don't really know.  All I'm sure of is that the tax code is too complicated for the average person to know how to run their own life...

[Critter-3 · Accepted solution]

When you finally put the rental on the market (day you first advertise it for rent and it  is in  rentable condition)    you will use the LESSER of the Fair Market Value as of that date of conversion  OR   your cost basis in the property.

Cost basis =  purchase price + cost to buy + improvements made while you owned it including the fixing up expenses you are doing now.  

[Carl]

When it comes to property improvements (which are not the same as other rental expenses) it flat out does not matter when those improvements are done and it does not matter if the property is classified as rental property or personal use. Those property improvements add to the cost basis of the property *no* *matter* *what*.

Additionally, when converting personal use property to rental property, the date of conversion can not be earlier than the earliest date a renter "could" have moved in. So if you're gutting the kitchen starting on say, Feb 1, and the work is not completed until Feb 15th, then there's no way possible the property can be "in service" before Feb 15th.  You'll also find the below information helpful, as it clarifies quite a bit that the TTX program does not clarify.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence or 2^nd home before, then this date is the day AFTER you moved out, or the date you decided to lease the property – whichever is later.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter "could" have moved in. That should be your "in service" date if you were asked for that. Vacant periods between renters count also PROVIDED you did not live in the house for one single day during said period of vacancy.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days you lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence or 2nd home, after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.

RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that “better” the property. Basically, they retain or 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 retain or 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.

There are rules that allow you to just flat-out expense and deduct some property improvements, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.

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 for the very first time are not deductible.

Repair

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 for the very first time 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 3^rd 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.