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Cost-Basis on Rental Property (items before in-service)

The cost of improvements would be added to basis.

 

An election can be made to capitalize otherwise deductible expenses.

Carl
Level 15

Cost-Basis on Rental Property (items before in-service)

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.

danseurderrick
Returning Member

Cost-Basis on Rental Property (items before in-service)

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…

Carl
Level 15

Cost-Basis on Rental Property (items before in-service)

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.

 

Carl
Level 15

Cost-Basis on Rental Property (items before in-service)

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.

danseurderrick
Returning Member

Cost-Basis on Rental Property (items before in-service)

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...

danseurderrick
Returning Member

Cost-Basis on Rental Property (items before in-service)

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?

Cost-Basis on Rental Property (items before in-service)


@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".

Cost-Basis on Rental Property (items before in-service)

The cost of improvements would be added to basis.

 

An election can be made to capitalize otherwise deductible expenses.

‎April 28, 2023 2:14 PM

 

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?

Cost-Basis on Rental Property (items before in-service)

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?

 

 

https://www.law.cornell.edu/cfr/text/26/1.266-1

kflutke
New Member

Cost-Basis on Rental Property (items before in-service)

i AM A FIRST TIME USER OF TURBO TAX FOR SUB CHAPTER S. HOW DO I ENTER COSTS INCURED OR IMPROVEMENTS MADE PRIOR TO MY USE FO YOUR PRODUCT?

 

PatriciaV
Expert Alumni

Cost-Basis on Rental Property (items before in-service)

For a Rental Property, you would report one asset for the residence itself then as many more as you need to report each improvement made over the life of the property. As you add these assets, TurboTax will calculate an estimate of the total depreciation you should have taken since the asset was first placed in service. If your records show a different amount, you'll be able to enter that number instead.

 

Note that an S-Corp tax return must be prepared using TurboTax Business

 

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