I purchased rental property in Dec but only started to rent out in Jan. How can I deduct cost/lose?

[Wenfang]

In 2020 I only have cost (closing cost + others), no income for this property. However when I entered all cost, it shows as lose but I cannot deduct any tax. How can I deduct tax from this lose? 

[ColeenD3]

Unless you were actively seeking to rent in December 2020, you can't take any expenses. Closing costs are added to the basis of the property, they are not deductible.

However, you can reduce the selling price of the rental property by the amount of the sales expenses, including the realtor fees. Doing this will either reduce your capital gains or increase your loss on the property, depending on your individual circumstance- either way it may reduce the amount of taxes to be paid on the sale. TurboTax will make these calculations for you, you just need to enter the data.

Sales Expenses for selling your property include:

• Sales commissions
• Advertising Expenses
• Legal Fees
• Broker Fees
• Transfer taxes

[Carl]

If the property was not "available for rent" (meaning it was move in ready) on or before Dec 31 of the tax year, then you have nothing concerning this property to report on SCH E on your 2020 tax return.  The only things you can deduct on your 2020 tax return are SCH A itemized deductions. Those two items would be property taxes and mortgage interest. That's it.

Most likely, you did not receive a 1098-Mortgage Interest Statement for 2020, because my bet is, your first mortgage payment was not due until "AFTER" Dec 31, 2020. So your SCH A deductions of mortgage interest and any property taxes you paid at the closing, will be on your closing statement only.

I would suggest you bookmark this thread for next year, so you can refer to it when asking for help completing your first SCH E on this property for your 2021 tax return; which you will not deal with until next year.

[Wenfang]

I did actively looking for tenant and had cost associated with it. but the lease starts in Jan. Can I report all relevant cost as 2021 instead of 2020 for next year's reporting? Or, can I carry 2020 lost to 2021 when I report 2021 tax? 

[Wenfang]

I actually received 1098 for partial Dec interest payment. Also the house was available for rent in Dec. so what should be my best option here? can I hold on all cost (other than closing cost for depreciation) to 2021 tax reporting instead? 

[Carl]

If the house was in fact available for rent in Dec, then you can go ahead and report it on SCH E. Some things to point out though.

- Number of days rented "MUST" be at least one day. If you enter ZERO for days rented, you will be "forced" to delete the SCH E.

- Rental income "MUST" have a digit in it. Even if that digit is a round circle ZERO. You just can't leave it blank.

- Yes, it is perfectly possible and feasible to have a property rented for one day in a tax year (dec 31) and still have zero income for that tax year. Zero income is exactly what it would be, if the renter did not pay the rent until Jan 1st, right?

Finally, note that when completing the SCH E for the very first time in that very first year for a rental property, absolute and total perfection is not an option. It's a "MUST". Even the tiniest of mistakes will grow exponentially as the years pass. Then when you catch your error years down the road, if the IRS doesn't catch it first, the cost of fixing it will be high. So ask questions when you're not sure. The only dumb question is the one you never asked. It's not like you learn this stuff through osmosis. I most certainly didn't.

The below information is provided to you, because in my personal opinion (and we all know what opinions are like.) the program does not provide you clarity on some things, that I think it should and would like it to. So I do my best to provide you that clarity here. But even so, if you have questions please ask... or forever lose your wealth to the IRS.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence or 2^nd 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.
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 for any type of personal pleasure use 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, 2nd home, or any other personal use reasons 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 PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that “better” the property. Basically, they retain or 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 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, 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 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 deductible.

Repair

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 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 3^rd 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.

[Wenfang]

thank you so so much for your detailed answer. As a newbie, I'm trying to understand here. So my house was closed on Dec 10th, on Dec 14th we put on sign for available for rent, but my tenant moved in Jan 15th and I got my first payment in Jan. For this case, can I say number of days rented as 17 and rental income 0? or I should enter vacant period? (I didnot find where to enter vacant period for rental property in TT though).  also for property improvement (I added gutter), it is under 2500,  shall I use "safe harbor di-minimis"?

[Carl]

can I say number of days rented as 17 and rental income 0?

Yes, you can.

also for property improvement (I added gutter), it is under 2500, shall I use "safe harbor di-minimis"?

Understand that just because something cost less than $2,500 does not mean it qualifies for safe harbor. The TTX program has no way of determining if what you enter actually qualifies for the safe harbor election. So you have to determine that yourself.

Basically, if the new gutters were installed to replace the old gutters, then you can apply safe harbor. At least, I don't see anything in the safe harbor rules that would make me think or believe otherwise. But those rules aren't exactly written in plain english either. 🙂

Typically, if there were no gutters before, this would be a property improvement and entered as such. Now you don't have to enter it as a physically separate asset, if the work was done "before" the property was available for rent. You can just add that cost to your cost basis of the structure (not the land) and you're fine.

Typically, for someone starting out as you are, the only reason for entering a property improvement as a physically separate asset is if.

1) The class life of the asset is different from the class life of the structure or;

2) The asset was not placed "in service" on the same date the property was.

So if the gutters were installed before the property was available for rent, that means the in service date for the gutters is exactly the same as the in service date of the property at a whole. Additionally, the gutters become "a physical part of" the structure. So while I"m not sure on that, I think the fact that they are "new" as opposed to a "replacement" of the old gutters means it's not eligible for safe harbor.

So you can just add the cost of the gutters to the cost basis of the structure. Here's how you do that in TurboTax.

In Turbotax, you will be asked for the "COST". This is the entire amount you paid for the property. Then on the same screen you are asked for "COST OF LAND". For the cost of land, you enter the amount of the total COST entered above that, which is allocated to the land.

So if you add what you paid for the gutters to the COST box, that will not (and should not) change the amount in the "cost of land" box. But it will increase the amount that is allocated to the structure, and that's exactly what you want. This is because only the value/cost of the structure gets depreciated over 27.5 years. Land is never depreciated.

Another thing I want to point out also, even though I doubt it applies to you when it comes to safe harbor elections, is water heaters. Typically a new water heater can cost around $700, and that includes the installation costs. This is a "grey area" in the rules. While it does meet the cost requirements of being under $2,500, there is absolutely no question that it becomes "a permanent part of" the plumbing system, which itself is quite obviously "a permanent part of" the structure.

Now my interpretation (which may not be the same as others, and I'm personally fine with it.) is that a new hot water heater is not eligible for safe harbor. But my problem with that, is that depreciating a $700 dollar "property improvement" over 27.5 years has absolutely no impact on your tax liability during those 27.5 years. Not one single penny. You're talking around a $25 a year deduction. That's not going to make a sqat of difference in your tax liability.

However, a hot water heater can be considered an appliance - though I myself question that. Appliances are depreciated over 5 years. Additionally, an appliance can qualify for the SDA (Special Depreciation Allowance) that allows you to depreciate the asset 100% in the first year it's placed in service.

Take note that "residential" rental property (as opposed to business rental property) and a vast majority of "any" rental assets associated with it, just flat out does not qualify for the SEC 179 deduction. But it can qualify for the Special Depreciation Allowance. (SDA).

Just my thoughts. I'll stop rambling now. 🙂

[Wenfang]

thank you so so much, I think I got much better idea now. Appreciate all of your reply! 

[A-A-ron-14]

@Carl I found your previous posts on this really helpful, and I wanted to ask for your advice on something similar. 

I did a 1031 like-kind exchange from a previous rental condo into a rental house in November 2021. The received property was rentable the day we took ownership, but we chose to spend about 4 months fixing it up before we put it on the market. We listed in March 2022 and started receiving rental income in April 2022. I have recorded the disposition of the old property and exchange in TurboTax for 2021. That all seems good. But when I go to add the received property in Schedule E, it won't let me add it because it wasn't available for rent in 2021. We did have mortgage, tax, and contractor expenses in 2021, but no rental income, and it wasn't really listed for rent then.  

I see two options:

(1) Don't file the new Schedule E for 2021. Start up the Schedule E for the new property as part of 2022 filing. Add the remodel costs to the basis at that time. Cons: Would this fail to show completion of the 1031? Are there expenses we had in 2021 that we won't be able to deduct?

(2) Establish the new Schedule E for 2021. State that the property was available for rent for 1 day and we received zero income. Adjust the basis by the work done in 2021. Then next year adjust the basis again by the remaining work completed in 2022.  Cons: Not really true that we tried to rent. We could have, but the intent all along was to fix before renting.  Pros: Seems more true to the rules on depreciation. 

I'm leaning toward option 1, but pretty unsure. Thank you!

[Carl]

I don't know enough about 1031 exchanges to be of any help on that front. But as I interpret your post, that's not really the issue. The information I'm providing may be wrong "BECAUSE" this is a 1031 exchange. But it's what I know to be correct without taking the exchange rules (which I'm not up to date on) into account.

when I go to add the received property in Schedule E, it won't let me add it because it wasn't available for rent in 2021.

Correct. If the property was not "in service" and "available for rent" in 2021, then you have absolutely nothing to report on SCH E concerning this newly acquired property.

We did have mortgage, tax, and contractor expenses in 2021, but no rental income, and it wasn't really listed for rent then.

As far as I'm concerned (based on what I know) the property was personal use from the date of acquisition in 2021 until you actually placed it "in service" in 2022.  Therefore, you have absolutely nothing concerning this property to report on SCH E on your 2021 tax return. The only expenses you can claim as SCH A itemized deductions are:

 - Mortgage interest (if any) paid in 2021

 - Property taxes paid in 2021

Also note that those will be SCH A itemized deductions - meaning they make no difference in your tax liability if the total of all your SCH A itemized deductions does not exceed your standard deduction.

That's it. Note that repair and maintenance cost incurred before the property was "in service" are never deductible. Never have been.

Now if you have property improvements that you paid for, those are depreciated over time and depreciation starts the date you place the property in service. Since that didn't happen until 2022, you won't deal with property improvements until you do your 2022 tax return next year. Do note that property improvements to the structure add to the cost basis of the structure - not the land. That means any property improvements done prior to placing the property in service don't need to be listed separately in the assets/depreciation section. You can just add them to the cost basis of the structure in that first tax year you place the property in service.

Would this fail to show completion of the 1031?

I just don't know the definitive answer to that question.

Are there expenses we had in 2021 that we won't be able to deduct?

I think I addressed that above - but since this is a 1031 exchange I can't vouch for the accuracy of my response on that.  There are others in this forum who, when they see this thread, will confirm or correct my information if necessary.

[SriSriSri]

Could you please refer me to IRS section where it allows us to consider number of days available for rent as days rented. I thought fair Rental Days refers to the number of days that the unit was actually rented out- rather than the total time it was available to be rented. I have a property that was vacant for 4 months, rented at the end of december with occupancy start date from Jan 1st.  I want to be able to carry forward the losses with depreciation, HOA, Utilities and advertising fees. But if I enter 0 turbo tax is making me remove rental property. I also recieved Advance and security deposit in December. I do not know where to report those if I remove the property.