I inherited a property that I have turned into a rental. Is the Cost-basis the fair market value minus the land value?
I know that any improvements I did before it went into service can be added to the value of cost-basis.
Can other items such as a dumpster rental and utilities before the house went into service able to be added to the cost-basis or are those not deductible at all?
The cost basis is whatever the FMV was on the date the person you inherited it from, passed. Doesn't matter how long ago they passed. That's your cost basis.
Can other items such as a dumpster rental and utilities before the house went into service able to be added to the cost-basis or are those not deductible at all?
With the exception of property improvements, costs incurred before the property was placed in service and available for rent, are not deductible. However, if you paid for property improvements, I would expect things like dumpster rental to be "a part of" the improvement process. For example, if you had a new roof put on, the old roof had to be torn off first of course, and go into a dumpster to be hauled away. In such a case, the dumpster rental along with any disposal costs incurred would be a part of the cost of the new roof.
In case you find it helpful, the below information is provided for your convenience.
Rental Property Dates & Numbers That Matter.
Date of Conversion - If this was your primary residence or 2nd 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 was contracted to move in, and/or "could" have moved in. That would be your "in service" date or after if you were asked for that. Vacant periods between renters do not count for actual days rented. Please see IRS Publication927 page 17 at https://www.irs.gov/pub/irs-pdf/p527.pdf#en_US_2020_publink1000219175 Read the “Example” in the third column.
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, 2nd home, or any other personal use reasons 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 Improve, restore, or otherwise “better” the property. Basically, they retain or add value to the property.
Betterments:
Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. An example of a pre-existing condition or defect in this context would be something such as foundation repair (slab jacking) or some other, hidden and costly, anomaly.
Restoration:
Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.
Adaptation:
Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property. Adding a wheelchair ramp would be an example.
Expenses for these types of costs 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 need to 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 instead of capitalizing and depreciating them, 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 its 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 its 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 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.
Yes, improvements can be added to the Cost Basis; however, expenses like utilities, etc. can't be deducted as Expenses prior to 'date placed in service' and are not added to Cost Basis.
If the property was given to you or if you inherited it, or if you traded another property for the current property, there are special rules for determining your tax basis in your rental property.
1. Yes, the cost basis for the rental property would be the FMV on the date of death, exclusive of the land value.
2. Yes, improvements made before the property went into service are separate rental assets for depreciation. Be sure you use the date you offered the property for rent as the date the improvements were placed in service (start date).
3. Yes, any expenses you incurred before you listed the property increase the basis of the property and should be entered as separate Rental Assets, subject to depreciation. Use the same start date for all rental assets.
Thank you all for your responses.
I think there conflicting answers to if expenses before the in-service date that do are not improvements can be added to the cost-basis. An example is the electric bills for the 6 months before the property went in-service. I'm still not clear if that can be added to the cost-basis.
Understand that property improvements done after you owned the property do add to the cost basis. it "does" "not" "matter" if the property was classified as a rental or not. It still adds to the cost basis of the property.
Other expenses such as repairs, maintenance, utilities that were incurred while the property was *not* classified as a rental are flat out not deductible anywhere at all on the tax return. They are just personal expenses same as buying groceries at the supermarket.
Yes. If you needed the electricity and dumpster to be able to make your capital improvements so that you could prepare the property for rent, then you could use such expenses as a part of the capital improvements added to the cost basis of the property. On the day it becomes available for rent and advertised as such, then you start your depreciation using the full combined amount as your rental cost basis (inherited value, capital improvements and expenses that allowed you to complete the capital improvements). And of course knowing your land value figure that is part of that total.
Carl and @TurboTaxVal explained it in the following way: 'If you paid for property improvements, I would expect things like dumpster rental to be "a part of" the improvement process. For example, if you had a new roof put on, the old roof had to be torn off first of course, and go into a dumpster to be hauled away. In such a case, the dumpster rental along with any disposal costs incurred would be a part of the cost of the new roof.'
If the property was sitting vacant and you were not taking action to prepare it or make it available for rent then none of those expenses would be allowed to be used as an expense or deduction, now or later, as pointed out by @MarilynG1.
...but then why does TurboTax Help say this?
Expenses you pay to prepare a property for rent for the first time are not deductible because there has been no rental activity. These expenses may be added to the cost/basis of the property and recovered through depreciation.
This suggests that expenses for preparing the property (not necessarily for capital "improvements", could just be wallpaper, painting, etc.) are able to be added to the cost basis. True?
Show me where in IRS Publication 527 at https://www.irs.gov/pub/irs-pdf/p527.pdf it says that. I've asked numerous people, including tax experts, to show me. To date, none have.
@Carl wrote:
Show me where in IRS Publication 527 at https://www.irs.gov/pub/irs-pdf/p527.pdf it says that. I've asked numerous people, including tax experts, to show me. To date, none have.
You cannot rely on the IRS instructions to encompass everything written in the Code and Regulations; there are hundreds of pages of the former but thousands of pages of the latter.
Section 1.266-1, in relevant part, essentially states that an expense can be added to basis (capitalized) if that expense is otherwise deductible. In general, until rental is placed into service as a rental, typical rental expenses are not deductible.
. In general, until rental is placed into service as a rental, typical rental expenses are not deductible.
that's what I'm saying. Repair/Maintenance expenses incurred before the rental is placed in service are not deductible,nor can they be added to the cost basis.
@Carl wrote:
. In general, until rental is placed into service as a rental, typical rental expenses are not deductible.
that's what I'm saying. Repair/Maintenance expenses incurred before the rental is placed in service are not deductible,nor can they be added to the cost basis.
Correct, and I think the guidance in TurboTax is simply inartfully worded:
"...Expenses you pay to prepare a property for rent for the first time are not deductible because there has been no rental activity...."
How about, ".....not deductible because the rental has not yet been placed in service...." (actually, the program assumes rentals are not placed in service while repairs are being made and there is no authority for that proposition).
From what I see in Pub 527, the IRS defines when an asset is considered placed in service.
You place property in service in a rental activity
when it is ready and available for a specific use
in that activity. Even if you aren’t using the prop-
erty, it is in service when it is ready and availa-
ble for its specific use.
As I see it, the key words are "ready" and "available".
@Carl wrote:
From what I see in Pub 527, the IRS defines when an asset is considered placed in service.
You place property in service in a rental activity
when it is ready and available for a specific use
in that activity. Even if you aren’t using the prop-
erty, it is in service when it is ready and availa-
ble for its specific use.As I see it, the key words are "ready" and "available".
Understood, except, what is your point? A rental can be ready and available despite the fact that repairs are being made on the property. I have actually seen exactly the foregoing in practice.
Also, the original post in this thread, now marked as the best answer, contains some inaccuracies.
Regarding this: "Section 1.266-1, in relevant part, essentially states that an expense can be added to basis (capitalized) if that expense is otherwise deductible. In general, until rental is placed into service as a rental, typical rental expenses are not deductible."
Are you saying that *if* you have deductible cleaning/maintenance/repair expenses (i.e. the property *is* in service), then you can choose to add to basis instead of deducting as expenses? I thought the only expenses you can usually add to basis are "capital improvements", in other words not repairs...?
The cost of improvements would be added to basis.
An election can be made to capitalize otherwise deductible expenses.
I thought the only expenses you can usually add to basis are "capital improvements", in other words not repairs...?
For the most part, yes. But for every rule, there is an exception.
For example, if you're selling a property such as your primary residence, and the buyer wants you to replace a broken door knob to which you agree. Technically, that's a repair. However, because it was a condition of the sale, the cost of replacing that broken door knob can be added to the cost basis of the property.
Whereas when you are converting your primary residence to a rental and need to replace a broken door knob on the front door that will not lock for example, that is a repair expense. Since you did the repair before you made the property available to rent, it's just flat out not deductible at all.
On that same front, if you replaced the carpet in the house after you moved out and before it was available for rent, that is a property improvement that can be added to the cost basis of the property when you convert it to a rental.
Got it. But in your example of fixing the door knob before converting to rental…it’s not deductible and it’s not able to be capitalized as part of basis…but could you amortize it as a start-up cost for your rental business?
I guess I should also lose the hypotheticals and say, I qualify as real estate professional for 2021 only, and spent a lot preparing my property for rent. I was sleeping in the property to work on preparations, but kept a primary residence elsewhere. Purchased on 4/16/2021 but didn’t have renters until November (who paid me in September), and I started advertising on AirBnB starting in May, altho I had to cancel a booking in July because property was not truly ready (and I had to subcontract another home for my first November renters because condition of home was still not 100 and they would not be satisfied…was dealing with so many COVID supply chain issues). Anyway the question is (A) what the hell is the in-service date (because AirBnB listing was up when property was still not “ready”), and (B) can I take the $5k start-up deduction and amortize other early expenses before that date? It’s odd because I was spending on things like “Advertising” costs before I even closed on the property (working on pricing and direct website). At least there’s bonus depreciation for all the furniture and furnishings, so dates don’t matter too much there, but dates for expenses are all over and I don’t know where the dividing line is and how to treat expenses on either side…
could you amortize it as a start-up cost for your rental business?
No. When it comes to rental property, amortized costs are those costs associated with acquisition of the loan, if there's a mortgage on the property. Whereas those costs associated with acquisition of the property are capitalized. Since you already own the property, and repairs have nothing what-so-ever to do with acquiring the loan/mortgage you may have on that property, you can't claim it.
Note also that in the IRS publications (namely Pub 527) there are no start-up costs associated with rental property mentioned anywhere in that pub. I've also never seen it in any other pub related to rental real estate property.
Just because you were staying at the property after the move out, does not mean it was still your primary residence, as you stated your primary reason for being there was to work on the property and get it ready to rent.
started advertising on AirBnB starting in May, altho I had to cancel a booking in July because property was not truly ready
With that statement, I see no way the property was move-in ready until the work was completed.So even though you were advertising in May, the property was not "ready to rent" until sometime after the work was completed, which according to you,was not before August.
Don't know if this will be helpful new information for you, but here it is just in case.
Rental Property Dates & Numbers That Matter.
Date of Conversion - If this was your primary residence or 2nd 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. Though if you started advertising before it was ready, and that advertisement included a "can move in on" date, then you use that date provided the property really was move-in ready on the advertised date.
Number of days Rented - the day count for this starts from the first day a renter was contracted to move in, and/or "could" have moved in. That would be your "in service" date or after if you were asked for that. Vacant periods between renters do not count for actual days rented. Please see IRS Publication927 page 17 at https://www.irs.gov/pub/irs-pdf/p527.pdf#en_US_2020_publink1000219175 Read the “Example” in the third column.
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, 2nd home, or any other personal use reasons after you converted it to a rental. Living there for the primary reason of getting the property ready is *NOT* a day of personal use.
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 Improve, restore, or otherwise “better” the property. Basically, they retain or add value to the property.
Betterments:
Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. An example of a pre-existing condition or defect in this context would be something such as foundation repair (slab jacking) or some other, hidden and costly, anomaly.
Restoration:
Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.
Adaptation:
Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property. Adding a wheelchair ramp would be an example.
Expenses for these types of costs 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 need to 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 instead of capitalizing and depreciating them, 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 its 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 its 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 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 for all your advice, I'm learning a lot.
I would say though, the more I think about it, I may be comfortable calling my property "ready and available" from its initial listing on AirBnB because there was no CapEx work or major improvements that prevented anyone from renting it, it was cosmetic and decorative stuff...I chose to cancel the booking because I was embarassed about the condition and my AirBnB rating, but like, it was safe and habitable, it just wasn't fully painted and furnished the way I wanted it...some rooms missing wallpaper or with temporary beds, etc. So much gray area here...I guess I just need to be able to support whatever I do should I get audited. I don't know how they can expect anyone to truly make sense of their convoluted rules and exceptions and such...
One more question...I received a $20,000 credit towards closing costs from the seller. That basically "covers" a lot of the transfer taxes and stuff that can normally be added to basis. Do I still get to add those costs to the basis even though I did not pay them, technically? Or rather, I paid them out of a seller credit?
Likewise with points...I purchased a half point basically, but the seller credit covered that, too. Conversely to the above, if the seller pays a point for me that *lowers* my basis, right?
@danseurderrick wrote:I would say though, the more I think about it, I may be comfortable calling my property "ready and available".........
You are the owner and the one who has to decide whether the property is "ready and available".
The cost of improvements would be added to basis.
An election can be made to capitalize otherwise deductible expenses.
Can you clarify that? I have been reading for over an hour trying to find the answer. This is close, but there are conflicting answers. If an expense is otherwise deductible, it can be capitalized by election. That would mean anything that goes on a Sch E can be capitalized, including interest, property taxes, utilities, travel expenses, -everything. Yes, or no? We are talking of a period when the house is not in service but will be.
People keep saying you can't add anything but improvements to basis during this time. It can't be both ways. Need a straight up answer.
Other question: how do you go about doing a capitalization of deductible expense election? Is there a certain form? Do you simply add a statement page to your taxes? How?
I think I have found a partial answer to my Q: taxes and interest can be added to basis; in service or not as far as I can tell. So I will post the link for others who seem to be trying to get the same answer. However, I would still like feedback on my above question about capitalizing deductible expenses in general. Also, if I elect to capitalize expenses, it seems I should add it as an asset to my property, but how many years? I am in my 5th year this property as far as the house depr. Just classify it as 20 year?