Legal Settlement associated with rental property

[ggtax]

I recently settled a multi-year lawsuit associated with my rental property. I have incurred legal and capital repair expenses that greatly exceed the legal financial settlement.  Cost of legal and capital repair are 100% greater than the settlement. I'm assuming the settlement is considered income but how should the expenses be handled? If the repair is considered a capital improvement is there a nuance related to future capital gains tax on sale of the property. 

[ColeenD3]

Repairs are expenses unless they are part of a greater improvement project. If so, the improvement is depreciated over 27.5 years, the same amount of time as the original building. The settlement is income. Legal fees are an expense.

The improvement is added to the basis of the building, thereby reducing capital gains at sale.

[ggtax]

Thank you so much for the reply. The large, unforeseen expense was incurred due the negligence related to the settlement. It would be classified as a large improvement project. So I'm assuming based on your response, the amount would be classified differently and depreciated over a period of time. 

[ggtax]

Am I defining the improvement as a new rental asset as part of filing?

[Carl]

Basically, the settlement amount you received gets included as rental income, in the rental income section.

Your legal expenses associated with this are claimed the Rental Expenses section. The last screen in that expenses section is "Any Miscellaneous Expenses?" and that is where you would enter your legal costs.

If you did a repair to something, as opposed to the property improvement, that's deductible as a repair expense.

For the property improvement costs, that gets entered in the Assets/Depreciation section and depreciated over 27.5 years.

Overall, I would recommend that you report as much as you can as a property improvement, as the increase in basis will reduce your taxable gain when you sell.

Example: You had to replace a window, frame and all. That's a property improvement. Part of replacing that window was repairing a 1 inch hole in the sheet rock. That's "technically" a repair. But the window replacement and hole repair was done as a part of the same project. So I'd just include the cost of all of it in the property improvement.