I did some major home improvements like fixing the foundation but also bought some new furnitures and other equipments before placing my rental property in service
My question is
When Turbotax asks me about "What improvements did you make before renting out my property", should I include the cost of new furnitures with other major home improvements? (They will be depreciated in 27.5 years together)
Or should I added the cost of new furnitures separately because furnitures will be depreciated in 7 years.
I googled and found someone said in this scenario separating the depreciation of personal properties like furnitures will bring tax benefit when selling the house because things like furnitures can be sold at a loss.
I am not sure about it.
@wleuter wrote:......things like furniture can be sold at a loss.
You can separate personal property from real property to get the shorter recovery period on the former (instead of 27.5 years), but within just a few years the basis of your furniture will be reduced to $0.
As a result, if you receive any price higher than $0 for the furniture when you sell, you will have a gain and that would be a Section 1245 gain where the tax rate on recapture is not limited to 25% as it is on Section 1250 property.
Additionally, if you purchase the furniture and then later place it into service in your rental property, you are required to use the lesser of your cost or fair market value at the time the furniture is placed in service.
Chances are you will have to use the fair market value rather than cost since furniture depreciates in value rapidly (for tax purposes and otherwise).
Just as a very rough example, a couch that cost you $1,000 might only be worth $700 a year later when it is placed in service and, in that event, you would use $700 as your basis for depreciation.
The furniture is not what is referred to as improvements - there is no permanent attachment to the land or building. add them separately. furnishings are 5 year property which Turbotax will use when you select rental furnishings or appliances, caroet, furniture (depends on version you using) as the property type. the basis for depreciation is the lesser of your cost or fair market value when you place it into rental service. while Tutbotax asks for cost there is a side note that says (this conforms to the tax laws)
When you convert personal use property to business use (or for the production of income), the basis for depreciation is the LESSER OF:
* the fair market value on the date you placed the property in service (if you are converting your vehicle to business use, you may use the blue book value at the time of conversion to determine its fair market value), OR
* your adjusted basis on the date you placed the converted asset in service.
Understand that depreciation is not a permanent deduction. When you sell rental property (or any other property used for business) you are required to recapture all depreciation taken in the year of the sale, and pay taxes on it. If you do not depreciate the property, then you are still required to recapture and pay tax on the depreciation you should have taken. Two things happen in the year of sale with depreciation recapture.
1) Recaptured depreciation is added to your AGI for that tax year.
2) The recaptured depreciation has the potential to bump your AGI into the next higher tax bracket. Weather it does or not, depends on the numbers.
But the recaptured depreciation itself will be taxed anywhere from 0% to a maximum of 25%. What rate you get, just depends on the numbers.
@Carl wrote:....the recaptured depreciation itself will be taxed anywhere from 0% to a maximum of 25%. What rate you get, just depends on the numbers.
The maximum tax rate of 25% (if you're following along) is applicable to Section 1250 property, essentially real property.
There is no maximum tax rate (i.e., no 25% cap) with respect to depreciation recapture for Section 1245 (personal property); it is taxed at the taxpayer's marginal tax rate (up to 37%).
@Carl wrote:
Understand that depreciation is not a permanent deduction.
Not true as a blanket statement. It is a permanent deduction if:
1) You die owning the property upon which depreciation deductions were taken; or
2) You scrap the property; or
3) You sell the property for your adjusted basis or less.
How about the remodeling and repair in the same year before the conversion to rental property, such as replacing kitchen cabinets and counter, range, garbage disposal, bathroom toilets, shower door, etc.? Can these be depreciated separately from the house itself, and use bonus depreciation? Is there a IRS list describing how to categorize them? or all of them has to be depreciated in 27.5 years together with the house?
You can do cost segregation for some of those assets (items), but it's most likely not worth the time and effort.
Rather, you can add the costs of the assets to the structure and depreciate the resulting figure over the standard 27.5-year recovery period.
@Anonymous_ Thanks for your answer!
You mentioned
"
You can separate personal property from real property to get the shorter recovery period on the former (instead of 27.5 years), but within just a few years the basis of your furniture will be reduced to $0.
As a result, if you receive any price higher than $0 for the furniture when you sell, you will have a gain and that would be a Section 1245 gain where the tax rate on recapture is not limited to 25% as it is on Section 1250 property.
"
I want to know if when selling my house, the buyer does not want me to keep any furniture inside, how much gain will I get and have to pay tax for?
Is the gain the total depreciated number of the furniture?
Thank you!
@wleuter wrote:I want to know if when selling my house, the buyer does not want me to keep any furniture inside, how much gain will I get and have to pay tax for?
Is the gain the total depreciated number of the furniture?
I'm not sure I understand the question in the sense of precisely what happens with respect to the furniture if the buyer (of the house) does not want to keep it.
Do you have to move it out of the house when you sell (because the buyer doesn't want it)? If so, do you scrap it? Do you convert it to personal use? Do you sell it to a third party (i.e., a party other than the buyer of the house)?
If the furniture is scrapped (you get $0 for it), then there is no gain, no recapture. If the furniture is converted to personal use, there is also no gain nor recapture (unless and until you sell it to another party). If the furniture is immediately sold to another party, then the gain (which is 100% Section 1245 gain) will be taxable to the extent the sales price is more than $0 (which is your adjusted basis).
@Anonymous_ Thank you for your response. I grasp that a cost segregation study might not be worthwhile. Here's another question: since I completed these repairs and remodeling in the same year I first rented out the property (1 or 2 months before it became available for rent), do I still need to conduct a cost segregation study if I want to list these items separately? Can I simply itemize them in the 'Improvements, furnishings, and other assets' section on TurboTax?
That would be up to you; either itemize (list them separately) or group them.
If I choose to itemize them separately, do I still need to conduct a cost segregation study, or can I rely on my purchase price? Thanks
or you do a 1031 like exchange and avoid the taxes all together and do a cost seg on the new property.
It may be worth noting that when selling real estate "Like-Kind Exchanges Sec 1031" may be utilized to DEFER tax, but does not eliminate a tax burden which will need to be addressed SOMEDAY.
If that is something you consider when planning to sell real estate, be sure you use someone that understands how a 1031 exchange works.
Depreciation recapture is more an issue with Real Estate than it is with other assets, such as furniture, because Real Estate tends to INCREASE in value whereas other assets, such as furniture, wear out.
"I googled and found someone said in this scenario separating the depreciation of personal properties like furnitures will bring tax benefit when selling the house because things like furnitures can be sold at a loss."
If a rental with furnishings were sold, most likely you would allocate the selling proceeds to eliminate the remaining value of the furniture. For example- if I sell a rental for 100,000 with furniture that has a remaining basis of 5,000, I would allocate 5,000 to the furniture, and split the remaining 95,000 between land and house. If you only allocated 4,000 to the furniture, you would have a 1,000 loss on the furniture, but now 96,000 to split between the house and the land, so the bottom line would be somewhat similar. Yes, the loss on the furniture could reduce ordinary income, but you would be subject to "Netting and Look-Back".
If you wanted to go this route, you might want to have a Bill of Sale for the furniture separate from the contract for the real estate.
Depreciation is meant for decreasing the value of an asset over time, allowing a Taxpayer to spread that expense over years to offset the revenue that asset produces. When the asset is disposed of, or sold, any depreciation taken that is realized in the sale is "recaptured". This philosophy works well with things like furniture and equipment, but sometimes back-fires with real estate and vehicles, especially if the Taxpayer uses Bonus Depreciation and or Section 179 Deduction because the taxpayer takes TOO MUCH depreciation and is "on the hock" to pay some of that back when the asset is sold/disposed of.
Additionally, be aware that using Bonus Depreciation or Section 179 Deduction may cause a loss for the rental activity and that loss may be limited.
Any labor you provide is of no monetary value, only work done by a contractor whom you pay qualifies as an expense and if that was done before the house was available for rent, it would need to be added to the basis of the property.
DON'T FORGET TO VALUE THE LAND AND THAT WILL NEVER BE DEPRECIATED.