Is using the placed-in-service date (when the property became available for rent) rather than the purchase date the correct starting point for depreciation?
Yes. And in fact, if you have a property that you bought and you're still getting it ready during the tax year and it's not placed in service at all during that year, then you have nothing at all you can report about it on your tax return. You have to wait until it's placed in service as a rental, and then depreciation starts on that date and expenses before that date are handled differently than expenses after, and I'll cover that later.
For residential rental property, is it correct that only the building value (purchase price minus land value) is depreciated over 27.5 years?
Yes. Unless it's a short-term rental with an average day of less than 30 days, and then it has to be depreciated over 39 years. (That's one of the things that TurboTax doesn't do a good job of guiding users on when they have a short-term rental, so I always try to mention that so people are aware of that issue. )
Is it normal for a first-year rental property placed in service late in the year to show a Schedule E loss due to depreciation and startup expenses?
Yes. Probably the majority of rentals show a tax loss in most years, including the first year. By the way, that tax loss doesn't necessarily reduce your taxable income. Depending on whether or not you qualify for an exception, it may just get suspended and carried forward (on form 8582) until it can offset future rental income, or when you sell the property.
Are operating expenses deductible starting when the property was available for rent, even if it was vacant briefly before the tenant moved in?
Yes. All that matters is the placed in service state, which is when it is ready for someone to move in and you have advertised it somewhere as being available. So for example, if it's available and ready to be rented and you have it listed as for rent (you are genuinely trying to rent it out) and no one rents it that year, it's still placed in service as a rental from the date it's available to potentially be rented.
Are minor repairs and preparation costs before the tenant moved in generally deductible expenses rather than capital improvements?
By default, any expenses before the placed-in service date, you can't deduct as an expense. And the default treatment is to add those costs to the cost basis of the building, and they are depreciated along with the building.
But if you buy items that qualify as 5-year depreciation items such as furniture, appliances, and miscellaneous supplies, those items you can enter as a 5-year asset (and those will also qualify for a bonus depreciation, which means currently you get to deduct the full cost in the current year). But you do still have to enter them as depreciation assets. You can group them together if you have a group of 5-year assets that are all placed in service at the same time (which in this case will be the placed in service date of your rental). Side note, furniture in a rental property is depreciated over 5 years, not 7 years as you may have seen (that applies to office furniture).
But other expenses before the placed in service date you will generally just add to the cost basis of the building, or depreciate in that same 27.5 or 39 year class.
This is optional, but you can elect to also deduct startup costs under (section 195 of the tax code). This allows you to deduct startup costs for expenses before it's placed in service as a rental. TurboTax doesn't walk you through this, but you can add another expense to your rental property expenses called "startup costs". You can only deduct up to $5,000 this way. And then if you have additional startup costs above $5,000, the excess has to be amortized over 15 years (but I don't know if there is a way to do that with TurboTax). It's important to be aware that the tax code doesn't allow property taxes or mortgage interest to be included in the startup costs. Property taxes or mortgage interest attributed to the time before it was placed in service as a rental can only be added to the cost basis of the building.
In case there's any uncertainty about the legality of using section 195 for rentals, this treatment is supported in a number of tax court cases, including McPartland v. Commissioner, T.C. Sum. Op. 2012-88 and Charlton v. Commissioner, 114 T.C. 333, 338 (2000).
David O
