Partial conversion of rental to personal use?

[Minnesota Slim]

My wife and I have been renting a house with an ADU. Midway through 2023, we converted the ADU to personal use -- not our primary residence, but a second home. We are continuing to rent the main house to tenants. Can anyone suggest how to report this using TurboTax Premier?

In hindsight, it might have been simpler if we had treated the main house and ADU as separate properties, but in fact they are a single tax parcel, and we reported them as a single property in 2022.

Thanks in advance for any suggestions!

[PatriciaV]

You may consider amending your 2022 return to report the original home/ADU as two properties. The issue now is that you started depreciation on the entire property and cannot easily change that. It doesn't matter that they are both on the same tax parcel. As long as you can allocate the basis, income, and expenses between the two units, you will be in a better position to report the conversion on the current year tax return.

Your other option is to report that the original property is not used 100% as a rental this year. The new business use percentage would be calculated based on square footage of the house divided by the total square footage. 

1. Enter this percentage for the Rental Asset (Depreciation) on the page "Tell us more about this rental asset."
2. Check the box for "No, I have not always used this item 100% of the time for this business" and for "I first used this item at least part of the time for this business, and also used it for personal purposes." 
3. Enter the new business use percentage in the box "Percentage of time I used this item for business after placed into service in 20XX" (this year).

If you rent the ADU in the future, add this as a separate Rental Property. Depreciation will begin as of that date because you have already reported depreciation on the unit with the residence in the past. Hopefully, you won't sell the ADU separate from the residence, as this would greatly complicate calculating the gain or loss on the sale.

[Minnesota Slim]

Thank you, Patricia -- that's helpful. But I'm still a bit puzzled. Is this situation any different than a duplex or multi-unit apartment building, if we converted one unit to personal use? It would seem odd to report each unit in an apartment building as a separate property, and it seems a little odd in this case too. Because of zoning, we couldn't sell the house and ADU separately even if we wanted to.

[DianeW777]

No, your situation is no different than a duplex, etc. Bottom line is that you cannot depreciate personal use property ever. It's easy to separate the properties as suggest by @PatriciaV. Reporting two separate units is not uncommon or unusual in your situation and it helps to keep the records clear.

You can amend or simply remove the personal use ADU portion for 2023.  Whichever you decide, all the records of depreciation for a future sale.

The tax assessment records would not be a factor in tax law other than to help you with the value of buildings and land, to arrive at the percentage that applies to each.

@Minnesota Slim 

[AmeliesUncle · Accepted solution]

There is no need to amend 2022, but just split the two homes on your 2023 tax return.  Then on the ADU rental, you can say it was converted to personal use.