I moved to this property in June 2016. I converted the garage into an apartment for my personal use, repaired the upstairs living area (fully funtional two bedroom home) and continue to rent the upstairs. We share the utility costs. My personal portion of the total living space is 40% and the upstairs is 60%. I plan to continue this indefinitely. I have appropriated all the expenses into three main groups; rental maintainence/repair for upstairs, conversion of space (Residental Rental Real Estate), and shared expenses including taxes, utilities, insurance, ect. For the last group of shared, I have taken the first six months of expense as rental, and for the second half, applied the 60/40% split and then added the rental together. Does that make sense and is it legal?
Cost basis is what you paid for the house (or what your mom paid for it in your case) plus the cost of any property improvements incurred after the original purchase (by your mom in this case). It's important to know what qualifies as a property improvement.
Read *ALL* of the below so you can get on the same page as me.
Rental Property Dates & Numbers That Matter.
Date of Conversion
- If this was your primary residence before, then this date is
the day AFTER you moved out.
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 POPERTY 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 classified as cleaning/maintenance costs. They are instead classified as startup costs, amortized as such and depreciated over time.
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 classified as startup costs, amortized as such and depreciated over time.
Please note that if residential rental income is not your PRIMARY business, and your PRIMARY source of income, then your rental business is considered to be passive, and you flat out, no way, no how , are not allowed to deduct your startup costs. Period. The IRS says so. See https://www.irs.gov/pub/irs-drop/rr-99-23.pdf and please take note that rental property produces “passive” income, while other types of businesses produce “active” income. Your rental property is not classified as your “active” business, unless you are a real estate professional, an active participant in the management of the property, and it provides a substantial (more than half) amount of your taxable income for the year. All three requirements must be met. There are no exceptions
Start up costs are expenses incurred while preparing the property for rent, with the express purpose being to prepare it for rent, before it is available for rent. These costs do include repair, cleaning and non-recurring maintenance cost. It does NOT include property improvements. With a normal business that produces active income (rental income is passive) you would amortize these costs over 15 years. But you can’t do that with a rental property. However, you can deduct a maximum of $5000 in startup costs in the first year the rental is available for rent, PROVIDED your total startup costs do not exeed $50,000. This is reported on line 18, “Other Expenses” of SCH E, and should be labeled “start up expenses”.
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.
A) It's FMV at the time the property was placed in service
B) What you paid for it, plus the cost of any property improvements you paid for.
99% of the time, item B is the lesser.
Are you saying you did not claim depreciation for 2014 and 2015? If so, that needs to be corrected by the long, complicated Form 3115. TurboTax does not support that, so I would recommend going to a tax professional that is experienced with catching up on depreciation using Form 3115.
Sort of. Form 3115 will 'catch up' on the missed depreciation by adding it to your 2016 tax return. So it will effectively give you a larger 2016 refund (or less owed).
As Carl said, you depreciate the LOWER of the Adjusted Basis and the Fair Market Value. That means you need to first find out the Adjusted Basis of the person who gave you the property.
No, you can't do that. Your cost basis is the *LESSER* of what you paid for it, or the FMV at the time it was placed in service as a rental. Since this was gifted to you and you assume the giver's cost basis, there is no question that what the giver of the gift paid for it, is the lesser. The IRS specifically states that you can not use the tax assessment value, except under extreme circumstances. Your circumstances are not even anywhere close to extreme.
"plus what I spent to build the house"
Wait a minute. YOu said earlier the house was gifted to you. Now you say you built it. What's the scoop here and what's going on? Before you answer, give me a minute to provide you some information that I'm sure will help you to clarify things. I have to provide this in an answer box, vs a comment box, because I can't highlight things in a comment box.
So the total purchase price of all of the land was $20,000. Then if your mother gave you exactly half of the land, your 'cost' would be $10,000 (assuming both lots of land were of similar value).
Yes, you then add the cost of building the house to the cost of the land. That is your "Cost Basis". Once you have that, then you can determine which is lower, your Cost Basis or the Fair Market Value when you started to rent it.
I have read through the info you kindly sent. Improvements I made in the conversion include plumbing changes, electrical changes (sub-panel and wiring), installed small kitchen, washer/dryer hook-ups, wall partions, replace garage door with windows, HVAC split unit. These were not "start-up" costs but were necessary for me to have a place to live. Still, they are part of the house overall and increase the value of the house. BTY, I will NEVER sell this place. Gave up a LOT to keep it in the divorce.
In what city/state/town/township/etc is the property located?