How to figure basis including capital improvements to rental before placing into service? Is depreciable basis of improvement reduced by the land/buildings allocation?

[jpartsch]

Hello,

I'm a bit stuck. I am trying to add to my basis the costs of a renovation to my rental property prior to placing it into service. I am using the property tax land/building allocation percentage from the previous year. This assessed values do not take into account the cost of the improvements, so when I enter the cost of the improvement the depreciable basis is reduced according to the allocation percentage from my property taxes. This doesn't seem right - shouldn't improvements to the building be fully depreciable?

I note that the in TT Premier interview dialogue it states: "Your property tax bill may not show reliable assessed values if you've recently purchased a newly built house of made improvements to the property. If your assessed values don't reflect the full value of improvements to your property, you can still use the assessed land value."

Does this mean that I can add the cost of my capital improvement (renovation) to the building value from my property taxes on the "Enter Property Tax Values" screen so that the entire cost of the renovation is depreciated?

[Critter]

The total  basis includes = Purchase price + costs to buy + improvements made prior to the start of renting.  Out of the total you will need to breakout the land value in any reasonable way you choose to do this ... keep records of your calculations incase the IRS was to question it.  The balance will be the depreciable portion of the property. 

[Anonymous]

despite what TT may say, assessed values seldom reflect the depreciable basis.  part of the question is did you buy the property for rental and make improvements before renting it?  then your basis is your cost less land.  subsequent changes in assessed value do not change the depreciable basis.  Or did you use it for personal purposes such as your home before renting it?  in that case. the depreciable basis of the home is the lower of Fair Market Value on the day you offered it for rental or your total cost less land.  Again subsequent changes in appraised value do not change your depreciable basis. 

[Carl]

I am trying to add to my basis the costs of a renovation to my rental property prior to placing it into service.

There is a problem with doing it the way the program wants you to do it. Let me start by explaining how the program does it, assuming no property improvements were done prior to placing the property in service.

The program will ask you what you paid for the property, along with closing costs and the such to establish a base cost basis.

Next, you are asked for information from your latest tax bill. Now the assessed value of your tax bil is *NOT* used for the cost basis in any way. But if you look at the tax bill you will probably have a total assessed value of the property which includes the value of the land and the value of the strudture. These values are for *PROPERTY TAX PURPOSES ONLY! and absolutely nothing else. But you'll notice on that property tax bill that there is a breakdown of some sort for the structure and/or land.

For example, the tax bill may show a total value of $100,000 and a structure value of $70,000. Simple math indicates the tax value of the land is $30,000. More math indicates that 70% of the value is for the structure, and the remaining 30% is for the land.

Now lets say you paid $150,000 for the property and that's your cost basis. Based on your tax bill allocations, 30% of that $150,000 gets allocated to the land. So that means the cost basis in the land is $45,000 while the cost basis is the structure is $105,000. It's the structure cost basis that will be depreciated over the next 27.5 years. Now lets throw in say, $50,000 of property improvements you did before you converted it to a rental.

That makes your cost basis in the property as a whole, $200,000. Using the percentages of your tax bill, 30% of $200,000 is $60,000 with the remaining 70% ($140,000) allocated to the structure. But wait! That's not right! You're $10,000 short on the $50,000 property improvement you made! So how can we make the program do it right? Simple.

Enter the property improvement done before you converted it to a rental as a physically separate asset. Classify it as Residential Rental Real Estate, give it a COST of $50,000 with a Cost of Land amount of $0. The in service date for this asset will be the same as it is for the property itself. This will correctly add that $50,000 of property improvements to your cost basis, and more importantly, it will be "correctly" allocated for depreciation over the next 27.5 years, as it should be.

[jpartsch]

Okay, so my understanding is that, yes, I should be able to fully depreciate the value of the property (less value of the land) at the time of acquisition - it was inherited and I got an appraisal at that time. AND, I should be able to fully depreciate the cost of the renovation I completed prior to putting the property into service. Correct?

The only/best way to do this in TT Premier is to enter the renovation costs as a SEPERATE real property asset with 100% of the renovation cost assigned to "improvements" (i.e. buildings) and %0 assigned to land. Is this correct? This seems pretty messed up! I would think my situation is pretty common and TT should include a proper method to enter these figures.

[jpartsch]

Okay, so, I have another question also: my market value appraisal from a licensed appraiser, I mentioned I had done immediately after inheriting the property, allocates a higher percentage of the property value to the site improvements (structures) than does my tax bill assessment. Can I use the percentages from my private appraisal to set my basis for depreciation, or do I have to use the property tax assessment percentage breakdown?

[RobertG]

Yes, you can use the appraisal. 

It is a better method than using the property tax bill.

[Critter]

@jpartsch 

You are diving too deep into the pool ... come up for air.

If you inherited the home which has a FMV  of which a % belongs to the land (hint ... you want a generous land value so you have some basis left when you sell for a better tax rate) and then you put in money to improve the property.   SO simply add up the inherited price + improvements for the single basis and back out the land value in the asset section using any reasonable method available to you ... just keep records to support your figures. 

[jpartsch]

Okay, I think I see the problem now:

There is screen in the interview, under the "Wages & Income > Rental Properties and Royalties > Property Profile" section, titled "Any Property Improvements Made?", that states "Enter the costs of any additions or improvements made prior to when the property was available for rent" and has a space to enter "remodeling" costs, but this is NOT where such costs should be added IF they are not included/considered in the source (property tax bill/appraisal) one is using for the land/improvement breakdown percentages.

INSTEAD, these remodeling/renovation costs should be entered in the "Wages & Income > Rental Properties and Royalties > Assets/Depreciation" section. This first screen in this portion of the interview, titled "Your Property Assets", states "Enter all of your major improvements, assets for rental buildings, or mortgage refinance fees be selecting Add and Asset." Here, a new "asset" can be added that will be automatically associated with the property detailed in the Property Profile mentioned earlier. The "asset" (i.e. renovation cost) added here will then be FULLY (100%) depreciated IF no portion of this asset's value is assigned to "land".

This is not actually "gaming" a poorly-designed interview to make it come out correctly; this is actually the way it was designed to be input. What is poorly designed, and highly ambiguous, is the language in the two different areas where renovation/remodeling costs can be input. There is basically nothing to differentiate these two areas from the language used in the interview.

Have I got this right?

[Critter]

In your situation you will make ONE entry for the property using the total cost prior to rental use ... stop using all the boxes later ... only make the one basis entry and the land breakout and leave the rest alone... you are getting to deep into the weeds for no reason.   I suggest you delete the assets already entered and start again and go simple. 

[jpartsch]

@Critter, it seems better to set this up the way that @Carl described it - that way the value of the inherited property and the value of the renovation are broken out separately on the return. Thus, if there is any question about the matter on the part of the IRS (perhaps if they compare your return to your property taxes and wonder why you have a higher valuation for the buildings vs the land in your return) you can right away see that it is due to a renovation that wasn't considered in the property tax assessment. So, you don't have to remember  that you added in this cost. Instead, it's spelled out for you, so you will know right away to go to the invoices and receipts for the renovation to prove your case. Right?

[Critter]

You know the IRS gets one figure on the form 4562 in the end  ... the program gives you many ways to that end ... choose whatever path you like and keep a PDF with all the worksheets so you can refer back to the path you took since the IRS will never know it.  

[jpartsch]

@Critter thank you. It's my first time with a filing this complex. Since I am using the interview method, it wasn't clear to me that it all appears the same on the final form. In any case, I think I prefer doing it @Carl's way - I went through the whole thing using your method and Carl's, and the depreciation deduction amount and tax refund amount came out exactly the same in both cases, so it doesn't seem to matter. Thanks for your help!

[Carl]

the depreciation deduction amount and tax refund amount came out exactly the same in both cases,

Understand that it's not a deduction amount. It's a "depreciation" amount. Here's the difference.

A deduction is an amount that is subtracted from your taxable income and remains so permanently and forever. Depreciation merely reduces your cost basis, and you get to subtract that cost from your income. However, in the future when you dispose of the property (sell it, donate it, etc.) that depreciation is recaptured and taxed in the tax year you dispose of the property. So while a deduction is permanent, depreciation is not.

Now the depreciation amount means nothing really. What does mean something is if between the two methods, are there different amounts on the 4562 in the COST (net of land) column and LAND column of the 4562 titled "Depreciation & Amortization Report".

If between the two methods the amount in the LAND column remains the same, then you're good as that means the programmers have fixed this issue. But I still need to run a scenario to confirm that for myself, which I will do soon.

[Carl]

I just ran two scenarios to check this out, and the problem still exists.

IN scenario 1 I paid $100,000 for the property. My tax bill valued the property at $50,000 with the land being allocated 30% of that, which is $15,000.  Based on that percentage, the program correctly figured $30,000 for the land and $70,000 for the structure.

In scanario 2 I paid $100,000 for the property, and when asked if I did any property improvements said yes, and told the program I did $50,000 in property improvements bringing the total cost basis on that first asset entry to $150,000. The program then allocated $45,000 to the land and $105,000 to the structure, which is incorrect. Based on the percentages of the property tax bill, if the original structure was valued at $70,000, the program did not add $50,000 to that value. It only added $35,000 to that value and the remaining $15,000 was incorrectly added to the land.

Then entire $50,000 should have been added to the structure value to make that amount $120,000, leaving the land value at $30,000.