Estimating land value for home converted to rental property

[NDiMas]

I converted my previous primary residence into a rental in 2020 and am trying to figure out how much of the property value to attribute to the land.  When working through the TurboTax screens for rental property income, in the section on property info, it first asks me how much I bought the house for and then the value of the improvements I've made (about $59,000 worth) to find my basis.  Then it asks me for the Fair Market Value (FMV) when I converted the house to a rental - which I researched online and believe to be substantially more than my basis.  Then on a later screen it asks me to enter the current value of the land and improvements. I pulled the current value of the land from my local assessor's website, but I don't believe that the assessor's estimate of the value of the improvements is correct because I know I could sell the house for far more than the sum of the assessor's estimate of land plus improvements.  Would it be correct to simply subtract the assessor's value of the land from my estimate of the FMV and attribute the difference to improvements?  That's what I tried, and it seems that using that method, the value of the land is roughly 75% of the total FMV.

When I got to the screens to work through depreciation of the house, I noticed that TurboTax had automatically filled in my basis in the house (purchase price + $59,000 in improvements) and also automatically filled in the value of land included in my basis.  To find the land value , TurboTax seems to have simply multiplied my basis by the same ratio of land value to total value as found on the earlier screen - 75%.  The problem is, this calculation seems to  yield too high a value for the land when I purchased it in 2013.  I have an appraisal report from 2015 that shows the land value to be far less than TurboTax is automatically filling in, and I know that land values in my area appreciated from 2013 to 2015.  In other words, I am positive that the value of the land in 2013 was less than what is shown on the 2015 appraisal report.  Instead of using the amount that Turbo Tax is automatically filling in, would it be appropriate to manually revise the land value downward to match what is shown on the 2015 appraisal report (as even that amount seems to be more than what the land was worth when I bought the house in 2013)?   

[npierson7]

It will be absolutely appropriate to enter that value manually. Since you have your appraisal report, you manually entered numbers will be more accurate. 

[NDiMas]

Thanks!  Was my approach to estimating the current value of the improvements as the difference between the current assessed value of land and current FMV correct?

[npierson7]

When it comes to the improvements, it isn't that simple. Improvements should be capitalized in the year they occurred and properly depreciated over the useful life. 

In other words, the market value of a real estate property is the sum of the value of the land and site improvements on the land, less any accrued depreciation.

[NDiMas]

That makes sense.  But then how do I estimate the value of the improvements at the time I converted to a rental?  Should I just add the amount I spent in improvements after I bought the place to the assessor's current estimate of the value of improvements?  That approach yields a total value less than I would expect to be able to sell the property for.  So then what do I put for the Fair Market Value?

[Carl]

Lets attack this one thing at a time, so as to undo any confusion which I suspect you are now experiencing. 🙂

I converted my previous primary residence into a rental in 2020 and am trying to figure out how much of the property value to attribute to the land.  When working through the TurboTax screens for rental property income, in the section on property info, it first asks me how much I bought the house for and then the value of the improvements I've made (about $59,000 worth) to find my basis. 

The problem with doing it that way is that if the improvements were all structure improvements, the program will incorrectly allocate some of the cost to the land. Likewise, if the improvements were all non-depreciable land improvements, the program will incorrectly allocate a large portion of the costs to the structure. Therefore, I recommend you do not identify any improvements at this point in the program, and enter them later in the Assets/Depreciation section for the type of property improvements they "really" are. This will ensure that depreciable improvements are depreciated based on their full cost, and that land improvements are not depreciated at all.

Then it asks me for the Fair Market Value (FMV) when I converted the house to a rental - which I researched online and believe to be substantially more than my basis. 

This is because rental property is depreciated on the LOWER of what you paid for it, or it's FMV on the date of conversion. Nowadays, it's not common for the value to be less than what you paid for it.This question came about in the program around 2009 with the real estate market crash, when it was very common for the value of real estate placed in service in 2009 and after, to be significantly lower than what was originally paid for it. That can still occur for property placed in service in 2020. But it's not as common as it was from 2009 through 2016-17.

Then on a later screen it asks me to enter the current value of the land and improvements. 

Maybe that screen is not as clear as it probably should be. It's asking for the fair market value, not the tax value.

I pulled the current value of the land from my local assessor's website, but I don't believe that the assessor's estimate of the value of the improvements is correct because I know I could sell the house for far more than the sum of the assessor's estimate of land plus improvements. 

Actually, I'd bet the property tax assessor's values are spot on perfect. The tax assessor only assesses for "tax" value, not the resale or fair market value.  Typically, the tax assessor's value will be on average, 30% "below" the fair market value. Finally, somewhere on the IRS website in one of the pubs (I don't recall which one) I can recall reading something that basically says you can not use the tax values unless and until you have exhausted all other possible sources to determine the FMV of the property. But that's not why the program is asking you for those values. There is a valid reason.

The program will ask for tax values for the sole purpose of determining what percentage of the value is applied to the land, and what percentage is applied to the structure.  Then it uses that percentage to figure out what percentage of your original cost basis will be applied to the land.

Would it be correct to simply subtract the assessor's value of the land from my estimate of the FMV and attribute the difference to improvements? 

No.

When I got to the screens to work through depreciation of the house, I noticed that TurboTax had automatically filled in my basis in the house (purchase price + $59,000 in improvements) and also automatically filled in the value of land included in my basis. 

Yep. ...and as you now see, that justifies my response above as to why you don't include property improvements in your original cost basis.

To find the land value , TurboTax seems to have simply multiplied my basis by the same ratio of land value to total value as found on the earlier screen - 75%.  The problem is, this calculation seems to  yield too high a value for the land when I purchased it in 2013. 

That's because you "did the math" on top of the math the program should have accomplished for you.

I have an appraisal report from 2015 that shows the land value to be far less than TurboTax is automatically filling in, and I know that land values in my area appreciated from 2013 to 2015. 

 Put that appraisal away for two reasons. 1) It's more than 2 years old and means nothing for 2020.  2) It doesn't reflect a cost that is less than what you paid for the property.

The best thing to do is to delete the property entirely and start over. Then trust the program. By "trust" I don't mean implicit trust either. It's more like "trust, but verify".  When entering data do not read "between the lines" that which is not physically there in black and white. Enter what the program asks for. Nothing more. Nothing less. For many, the small print on a screen helps clarify things a bit - but not always. That's why this forum exist. 🙂

Basically, work through the program and when asked about improvements, state that you have none. Then when you get to the Assets/Depreciation section you'll see that the property itself is arleady entered then. Then youenter your property improvements there as a physically separate entry from the property itself, so that everything gets depreciated based on it's "true" depreciation value.

Now below I've added a boilerplate that helps clarify things that in my personal opinion, the program just doesn't do it as well as we'd like it to.

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 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 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.

[Carl]

I converted my previous primary residence into a rental in 2020 and am trying to figure out how much of the property value to attribute to the land.  When working through the TurboTax screens for rental property income, in the section on property info, it first asks me how much I bought the house for and then the value of the improvements I've made (about $59,000 worth) to find my basis. 

The problem with doing it that way is that if the improvements were all structure improvements, the program will incorrectly allocate some of the cost to the land. Likewise, if the improvements were all non-depreciable land improvements, the program will incorrectly allocate a large portion of the costs to the structure. Therefore, I recommend you do not identify any improvements at this point in the program, and enter them later in the Assets/Depreciation section for the type of property improvements they "really" are. This will ensure that depreciable improvements are depreciated based on their full cost, and that land improvements are not depreciated at all.

Then it asks me for the Fair Market Value (FMV) when I converted the house to a rental - which I researched online and believe to be substantially more than my basis. 

This is because rental property is depreciated on the LOWER of what you paid for it, or it's FMV on the date of conversion. Nowadays, it's not common for the value to be less than what you paid for it.This question came about in the program around 2009 with the real estate market crash, when it was very common for the value of real estate placed in service in 2009 and after, to be significantly lower than what was originally paid for it. That can still occur for property placed in service in 2020. But it's not as common as it was from 2009 through 2016-17.

Then on a later screen it asks me to enter the current value of the land and improvements. 

Maybe that screen is not as clear as it probably should be. It's asking for the fair market value, not the tax value.

I pulled the current value of the land from my local assessor's website, but I don't believe that the assessor's estimate of the value of the improvements is correct because I know I could sell the house for far more than the sum of the assessor's estimate of land plus improvements. 

Actually, I'd bet the property tax assessor's values are spot on perfect. The tax assessor only assesses for "tax" value, not the resale or fair market value.  Typically, the tax assessor's value will be on average, 30% "below" the fair market value. Finally, somewhere on the IRS website in one of the pubs (I don't recall which one) I can recall reading something that basically says you can not use the tax values unless and until you have exhausted all other possible sources to determine the FMV of the property. But that's not why the program is asking you for those values. There is a valid reason.

The program will ask for tax values for the sole purpose of determining what percentage of the value is applied to the land, and what percentage is applied to the structure.  Then it uses that percentage to figure out what percentage of your original cost basis will be applied to the land.

Would it be correct to simply subtract the assessor's value of the land from my estimate of the FMV and attribute the difference to improvements? 

No.

When I got to the screens to work through depreciation of the house, I noticed that TurboTax had automatically filled in my basis in the house (purchase price + $59,000 in improvements) and also automatically filled in the value of land included in my basis. 

Yep. ...and as you now see, that justifies my response above as to why you don't include property improvements in your original cost basis.

To find the land value , TurboTax seems to have simply multiplied my basis by the same ratio of land value to total value as found on the earlier screen - 75%.  The problem is, this calculation seems to  yield too high a value for the land when I purchased it in 2013. 

That's because you "did the math" on top of the math the program should have accomplished for you.

I have an appraisal report from 2015 that shows the land value to be far less than TurboTax is automatically filling in, and I know that land values in my area appreciated from 2013 to 2015. 

 Put that appraisal away for two reasons. 1) It's more than 2 years old and means nothing for 2020.  2) It doesn't reflect a cost that is less than what you paid for the property.

The best thing to do is to delete the property entirely and start over. Then trust the program. By "trust" I don't mean implicit trust either. It's more like "trust, but verify".  When entering data do not read "between the lines" that which is not physically there in black and white. Enter what the program asks for. Nothing more. Nothing less. For many, the small print on a screen helps clarify things a bit - but not always. That's why this forum exist. 🙂

Basically, work through the program and when asked about improvements, state that you have none. Then when you get to the Assets/Depreciation section you'll see that the property itself is arleady entered then. Then youenter your property improvements there as a physically separate entry from the property itself, so that everything gets depreciated based on it's "true" depreciation value.

Now below I've added a boilerplate that helps clarify things that in my personal opinion, the program just doesn't do it as well as we'd like it to.

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 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 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.

[NDiMas]

OK, thanks for that explanation.  I think I follow what you are telling me to do.  Basically, on the property info section, I ignore the program when it asks me for the value of the improvements.  Then when I get to the screen that is asking for the value of land and improvements, I just enter the info that the assessor provided so the program can get the ratio of land value to improvement value.  Then later, on the depreciation screen for the house, I enter all the improvements I've made one by one, including those that I made while I was living in the house as an owner occupant.  Is that all correct?

I can tell you right now that all my expenses plus a little bit of this depreciation will more than offset the income I made from renting the property in year 1.  In other words, I'm going to show a loss on this property in year 1, and I don't need all this depreciation for that to be the case.  I'm not sure I'm going to keep it any further.  I may just sell later this year.  Do I have to take all this depreciation?  And if I do it this way, when I go to sell, am I going to get dinged for depreciation recapture for improvements I made to the house when I was still living there as an owner occupant, even though I didn't need that depreciation to show a loss on my first year as a landlord? 

[Carl]

Basically, on the property info section, I ignore the program when it asks me for the value of the improvements.

Correct. You'll enter those improvements later, in the Assets/Depreciation section.

Then when I get to the screen that is asking for the value of land and improvements, I just enter the info that the assessor provided so the program can get the ratio of land value to improvement value.

Just to clarify, there is (or should not be) any screen asking you for "land improvements". But there is a screen that will ask you for property tax values from your latest tax bill. I assuming that is the screen you are referring to. If so, then yes, you'll enter the property tax bill values so the program can use those values to figure what percentage of your cost basis gets allocated to the land.

Then later, on the depreciation screen for the house, I enter all the improvements I've made one by one, including those that I made while I was living in the house as an owner occupant. Is that all correct?

Just to clarify, when you get to the "assets/depreciation" section, in that section you will see the property itself, and "ONLY" the property itself listed. On that screen where you see "only" the property itself listed, there will be an "add another asset" button. You will click that button and add your property improvements.

Now take note that it "does not" matter when a property improvement was done. It could have been done before you converted the property to a rental, or after. It "still" adds value to your cost basis. But as I understand your post, you did not do any property improvements after you converted it to a rental.

So the date you "acquired" the asset (such as a new roof for example) may have been in 2018. But the date you placed the asset "in service" is the first day a renter "could" have moved in. Depreciation of the asset starts on the "in service" date, not the acquisition date (unless of course, both dates are the same).

   It is vitally important that for all assets that were "acquired" before the in service date, all have the same "in service" date. In your particular situation, every asset you list "must" have the same in service date as the property itself does, since you did not do any property improvements after the property became available for rent.

I'm going to show a loss on this property in year 1,

On contraire! If you have a mortgage on the property, you're going to show a loss "on paper" on the SCH E every single year it's a rental. I can "almost" guarantee it.

and I don't need all this depreciation for that to be the case.

Unfortunately, we don't have a choice on the depreciation factor, and are required to take/claim that depreciation every year the property is a rental, weather we want to or not. If you like, I can explain how that can (and probably will) bite you in the future when you sell or otherwise dispose of the property. But for now, lets stick to the matter and hand.

[NDiMas]

Ahh, thanks for the clarification on the in-service date.

"If you like, I can explain how that can (and probably will) bite you in the future when you sell or otherwise dispose of the property."

Yes, please!

[Carl]

Many have the false belief that depreciation is a permanent deduction. It is not. When  you sell or otherwise dispose of the property, all prior depreciation must be recaptured in the year of the sale. Then you pay taxes on that recaptured depreciation in the year of the sale. That recaptured depreciation does two things.

1) It's included in your AGI in the year of sale and;

2) It has the potential to bump you into the next higher tax bracket.

There is one rule though that pertains to 2nd item. Recaptured depreciation taxation is capped at a maximum of 25%. So if you're already in the 26% tax bracket, you'll only be taxed at 25% on the depreciation recapture.

Whereas if you're in the 12% tax bracket and the recaptured depreciation puts you in the 22% tax bracket, the amount of your taxable income that exceeds the 12% cap of $40, 25 (for single filers) of your taxable income will be taxed at 22%.

Now that's and "extremely" rough statement. There's all kinds of rules that would require me to write a novel to take them all into account. But I think you get the idea.