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Need help figuring the cost basis for personal property that was converted to a rental.

I inherited a house that I lived in for 6.5 years.  The house was transferred into my name in May of 2014 and the date of death value was 160k.  I converted the house to a rental in Jan 2015. The was roof replaced, added a new AC, new carpet, paint, garage door and extensive landscaping before I converted the property into a rental. I don't have receipts for any of the work. How do I figure out the cost basis?
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8 Replies
Carl
Level 15

Need help figuring the cost basis for personal property that was converted to a rental.

You have a lot to learn about rentals and being a landlord when it comes to the tax front. But don't let that intimidate you. At least you're asking questions. Not the right ones yet, but you'll get there. My first question is this:
Was all the property improvements done *before* the appraisal that gave it a 160K value (your cost basis)? Or was it done after? That matters big time.

Need help figuring the cost basis for personal property that was converted to a rental.

Thanks for the response. The major work was done before the appraisal such as the roof and AC.
Carl
Level 15

Need help figuring the cost basis for personal property that was converted to a rental.

Then your cost basis is $160K. Period. You don't list the property improvements separately in your case, because the appraised value already includes those property improvements. You simply list the property itself, with a cost basis of $160K making sure you allocate an appropriate amount to the value of the land. That does it. So when you start off reporting this rental on your 2015 or 2016 return, (I"m not sure which year you placed the property in service) the absolute only thing you should see under the Assets/Deprecation section, is the property itself, and that's it. Your "cost" entered in the cost box will be $160K and the "cost of land" will be whatever portion of that $160K you allocate to the value of the land. It's that simple.
Now depreciation is figured on the "LESSER" of what you paid for it, or it's FMV at the time the property was placed in service. In your case, what you paid for the property is the FMV on the date of passing of the prior owner who I understand is now deceased. So if you placed the property in service in 2016 for example, property values have without question, gone up since you inherited it. So there's no need to waste your time trying to determine it's value at the time you placed the property in service, since we know that value would be higher. Below is some additional information and clarifications of stuff that you will fine informative, educational and helpful. If you have questions, PLEASE ASK! You positutely absitively MUST get things right the first year, without question. If you get something wrong that first year with the numbers, then your initial "minor" error will get bigger exponentially each year. So if that happens and you don't catch the error for a number of years down the road, correcting that error will be VERY COSTLY! So I reiterate again, after reading the below if you have questions ASK THEM NOW during the initial setup of your rental property on your tax return. Remember, the only stupid question is the one you don't ask. Besides, I didn't learn this stuff through osmosis. I've been a landlord for 25 plus years now, and I've been there, done that, and even got the T-Shirt.

Need help figuring the cost basis for personal property that was converted to a rental.

I'll be sure to ask if somethig comes up. Thanks Carl!
Carl
Level 15

Need help figuring the cost basis for personal property that was converted to a rental.

            • 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 Improvement.

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.

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 classified as startup costs, amortized as such and depreciated over time.

Startup Costs

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.


Need help figuring the cost basis for personal property that was converted to a rental.

Hi @Carl, I have a follow up question on this topic with regards to startup costs.

Pub 535 says that utilities are start-up costs.

This is the scenario this year:

* This year I'm converting a second personal property to a rental property.

* This property is not considered a home this year (pub 527).

* This property is converted to a rental on Aug 20.

 

Question: Are the utilities (water, electric, gas, sewer) I paid from Jan til Aug 20 considered startup costs?

Thanks in advance.

Carl
Level 15

Need help figuring the cost basis for personal property that was converted to a rental.

Pub 535 does not apply to a SCH E business. (Yes, rental property is a type of business). Start-up costs are not allowed for long term rental property reported on SCH E.  Never have been.

Now you'll see numerous websites, as other posts in this forum that say rental property startup costs are deductible on line 19 of the SCH E.  This is not true for SCH E rental property that produces passive income. There's been discussion on this over the almost 20 years I've been using TurboTax. For those who have done it, I've yet to hear of anyone being audited on it. However, with the IRS currently hiring an additional 87,000 agents to the almost 80,000 they already have, claim startup expenses on SCH E at your own risk.

Basically, start-up costs are expenses paid in the process of getting a business to a state of "open for business".  When it comes to a rental, there's no way on this green earth you'll convince anyone that 8 months worth of utilities was "required" to be paid as a condition of being "open for business". In fact, you don't even need the utilities turned on at all before a tenant moves in. The tenant can (and usually does) take care of that.

Now your utility costs are deductible from the date the property was "available for rent". But it's not a start up expense. It's included as a normal rental expense on line 17 of the SCH E.

It's not all that uncommon for a landlord to have utility expenses either. With my three rentals, utilities are in the tenant's name. When they move out they don't do a cut-off. Instead, we work together and the utilities are transferred to me. Typically, billing to me as the landlord starts on the move-out date.

When I get a new tenant contracted to move in, I make sure they know I'm requesting a cut-off for their move-in date. Then they contact the utility companies, provide a copy of their rental contract, and change my cut-off order to a transfer to them.

So for the period of time the property was vacant, I will have valid and deductible utility expenses.

Basically, you can deduct utility expenses on line 17 of the SCH E, starting from the date you put the "for rent" sign in the front yard. Don't worry about prorating based on the billing period. It's not going to make enough of a difference to matter really.

Say your billing period ends on the 20th of each month and you put the rent sign in the front yard on the 1st of August and get a renter moved in on the 15th. When you received the bill for August, go ahead and claim the entire bill. You'll be fine.

 

Need help figuring the cost basis for personal property that was converted to a rental.


@Carl wrote:

......you can deduct utility expenses on line 17 of the SCH E, starting from the date you put the "for rent" sign in the front yard.


The date a "for rent" is placed in the front yard is simply not the necessary, or otherwise official, date the property is "available for rent"; no "sign" is required (many HOAs and even some municipalities even prohibit such signs).

 

In fact, the property can be "available for rent" even if repairs or improvements are in the process of being made to the property.

 

Here, @oneacross  stated that the property was no longer a "home" beginning on January 1 of 2022 so the question is how, exactly, was the property being used starting on that date and through August 20th.

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