How to report Rental Property expenses during a lengthy renovation – Property tax, insurance, HOA dues, Utilities, etc.

[Kayteem]

I’ve read several posts on this topic, but there seems to be different circumstances and differing approaches, so I’m not able to determine which advice to follow. I’m hoping to give the right amount of information and make it easier for a clear answer.

A tenant moved out of a rental property in May 2021, so there is rental income for the first part of the year. The property is 33 years old and needed some major work. Unfortunately, the work was not completed until February 2022, mostly because of very long scheduling delays, supply chain issues, other vendor problems, etc. It was not possible for a tenant to occupy the property during the renovation project. I entered a previous post which answered my question around depreciation of the renovation project, but now I’m confused on how to deduct  (or depreciate) my necessary expenses during the renovation project, such as property tax, insurance, HOA dues, utilities, etc. since the property was empty. Here are some facts:

• The intent was for a longer than normal tenant turnover since there was more work than usual, but not a 9-month marathon.
• The property was not used for personal use.
• The property was rented for the first 5 months in 2021, then not occupied for the remaining 7 months of 2021.
• The expense items listed above were necessary to keep the property during the renovation. All other costs will be added to the renovation asset and depreciated in 2022.
• Any expenses incurred while the property had a tenant (jan – may) are out of scope for this question since they are certainly deductible in 2021.
• The property has been in service as a rental since 1998.

From what I’ve read in the posts, I think these are the possible options:

1. Deduct all of the property tax, insurance, HOA dues, and utility expenses in 2021 since the intent was not take it out of service, having no idea how long it would take. Keep the rental in service and take the normal depreciation for the building. Basically, business as usual. Note: This would result in a passive loss.
2. Carry over to 2022 the expenses while the property was not occupied (jun – dec) to the overall renovation project and depreciate in 2022 when the project is completed. Also, keeping the property in service with normal building depreciation. Do not convert the rental to personal use. I'm not sure how to handle yearly expenses such as property tax and insurance. Prorate?
3. Remove the property from service in May 2021, add the expenses while the property was not occupied to the renovation project and depreciate in 2022. Add it back to service in February 2022. No idea what to do with the building depreciation. I really hope this is not the answer, since I think it would need to be converted to personal use and back again, which could make this very complicated.

Please advise on the right option.

Thank you in advance!

[DianeW777]

Yes you can deduct the ordinary expenses during the year while it was vacant. You retire property from service when you permanently withdraw it from use, which is not the case in your situation. 

Per IRS Publication 527, Residential Rental Property  

Vacant rental property:  If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. However, you cannot deduct any loss of rental income for the period the property is vacant.

This means option 1 is allowed.

• Deduct all of the property tax, insurance, HOA dues, and utility expenses in 2021 since the intent was not take it out of service, having no idea how long it would take. Keep the rental in service and take the normal depreciation for the building.

2022:

1. Your total renovation cost that is capital improvements to the building itself (attachments to the building such as roof, cabinets, etc) will be depreciated when they are placed in service (upon completion of the project and ready for use).
2. If you added new appliance they should be listed separately from improvements because they have a much lower recover period for depreciation (5 years vs 27.5 years).Again when they are ready for use.

Please update if you need further assistance.

[Kayteem · Accepted solution]

Thank you, Diane. You've been very helpful. I'm probably making this more difficult than necessary by reading too many questions and answers.

[hahnmon]

What if the property was out of service for the entire tax year for renovations? Turbo Tax has asked me to delete the property since it was not rented the entire year, but these erases all of the information needed for the following year when we put it back in service. What to do in that case? I have settled for putting zero expenses and zero income for last year, then I will add the renovations to TT when it goes back in service. Is this ok?

[JotikaT2]

If your intent is to rent the property out once the renovations are done and the property never changes from being a rental to a personal use property, you can keep the Schedule E rental schedule on your tax return.  You cannot deduct the cost of "lost" rent when the property is being renovated.  But any expenses such as mortgage interest and property taxes, as well as any other routine and necessary expenses to maintain the rental property would still be deductible during this time period.  You should not delete the Schedule E as you still intend to rent it out once the renovations are completed.  If you did not have any expenses at all, you can enter zero for both income and expenses.  However, most rental properties will still have depreciation expense as well as property taxes that can still be deducted.  Be sure to include those expenses.  

Please see Tax Deductions for Rental Property Depreciation to guide you as you make these renovations to track the costs and report them correctly.

@hahnmon