Filing Taxes as a Home renovator and Landlord

[wrangler18]

How should I file my taxes???

I am amending my 2017 returns and filing my 2018 returns late.

In February 2017 I was not working and decided to renovate my home, Rental Property #1 myself  from February 2017 thru September 2018. I placed the property on the rental market in October 2018.   It rented for December 1, 2018 lease start date.  I did extensive renovations: new kitchen & appliances, 2 gutted bathrooms + new fixtures, new staircase, new recessed lighting, new doors, custom closets, paint job, laundry room,  etc.

In November of 2017, I bought Rental Property #2 - a 3-family rowhouse.  I had tenant’s in place in November 2017.  In October 2018, I began gut renovating the 3rd floor.

I list below the items I believe need to be depreciated over an IRS specified schedule.  Do all these items fall under improvement?  Or can some be regarded as expenses and deducted right away.

Improvements:

• Building materials: studs, sheetrock, fasteners, doors, plumbing pipes, etc
• Fixtures: Toilets, showers, vanities, tubs, lights, faucets, sinks
• Appliances: Stove, wall oven, fridge, dishwasher, washing machine, etc
• Kitchen cabinets & countertops
• Light fixtures
• Demolition

Tools & Equipment

I spent close to $11,000 on tools and equipment (drills, saws, ladders, etc) in 2017 and 2018.  I used these tools on Rental Property #1 and Rental Property #2.  I will use the tools on the next rental property I purchase.  How should I report the tools to the IRS?  As an expense or a depreciable item?  

I put in over 2700 hours of labor (2017 & 2018) which is not reflected in any of the numbers below.  How (if at all) can I expense my labor?  Perhaps I cannot do it for tax years 2017 and 2018, but I’d like to do so going forward since this is my full time job.  I have no other source of income other than the rental income from these rental properties.

[Critter]

Rental #1 ... all of the renovations are added to the cost basis of the home and are entered as an asset to be depreciated when the property is on the market to be rented ... so you have nothing to report on the 2017 return except RE taxes and mortgage interest since it was either your primary home or a second home. 

Rental #2 ... You bought an active rental so it is reported as such on both tax returns ... on the 2017 the total cost of purchase is the  basis for the rental property for depreciation.   Then the improvements made to the third floor are combined when finished and also entered as an asset to be depreciated in the tax year they are completed and a renter can move in. 

Sorry, but at no time is your labor deductible ... it is what they call Sweat Equity. 

However ...   if you start your own separate business then you can pay that business for the work (add it to the cost of the improvements on the Sch E)    and you will report that income on a Sch C where you will pay federal/state and SE taxes on it.   If you do set it up as a separate business then the tools can be deducted from that Sch C income. 

As for the use of the tools on the rentals ... since they have a life time of 7 years you really cannot expense them on the Sch E  but you could enter them as assets and partially depreciate them on the Sch E then move them to the Sch C if you open your own business ( you could also incorporate and file an S-corp).   I highly recommend you seek local professional advice before making any kind of moves at this time as there are too many nuances and discussing them in this forum will not work well. 

[Critter]

FYI ... the appliances can be entered as separate assets from the total cost of the property ... they are depreciated over only 5 years or they can be expensed if they qualify.

[Carl]

Rental Property #1 myself from February 2017 thru September 2018. I placed the property on the rental market in October 2018. It rented for December 1, 2018 lease start date. I did extensive renovations: new kitchen & appliances, 2 gutted bathrooms + new fixtures, new staircase, new recessed lighting, new doors, custom closets, paint job, laundry room, etc.

For starters, repairs costs and cleaning/maintenance costs incurred before the property was placed in service, are not deductible. Period. There are no exceptions. Basically, you just have to "suck it up" so-to-speak.

From your description above, looks more to me like you have property improvements - not repairs. Property improvements are capitalized and depreciated over time and thusly, add to the cost basis of the property. A property improvement can be done at any time during your ownership of the property, regardless of the classificiation of the property at the time of the improvement. It stll adds to the cost basis regardless.

So just enter the *TOTAL* cost of all the work you did in the Assets/Deprecation section for rental property #1. Just label it something akin to "extensive property upgrades", classify it as "Residential Rental Real Estate" and depreciate it over the next 27.5 years.

The total amount spent will include your demo costs too. But do understand that "YOUR" labor is not deductible. Since *YOUR* labor can not be taxed, you can't claim it as a deduction. You can only claim the total amount your *actually* *spent* and paid to other entities for all the work done - including the demolition.

Now for the appliances, you can depreciate them separately if desired. But I recommend you don't do that and just include the cost of those items in your total renovation costs. Here's why.

Appliances are depreciated over 5 years. Keeping in mind that you are required to recapture and pay taxes on all depreciation taken when you sell or otherwise dispose of an asset, you may lose more in the long run, than you can possbly gain short term. Many local taxing authorities impose what is called a "tangible property tax" each and every year on equipment that is used to generate income. Appliances would be considered equipment. So what you "save" by depreciating the appliances/equipment, you end up giving to the local taxing authority in the form of that tangible property tax.

Additionally, when you have an appliance break and you need to replace it, you can quite easily find yourself in a paperwork nightmare at tax filing time, going through the disposition process of the "old" equipment and then adding the new, replacement equipment. In my 25 plus years as a landlord with 3 rental properties, I can tell you right now it's not worth the hassle.

How should I report the tools to the IRS? As an expense or a depreciable item?

You won't report them at all. Unless you are "in the business" of renovating properties and report that business income on SCH C (at least), your tools are exactly that.... *YOUR* *TOOLS*. If you claim them as a rental asset, then all you're doing is creating a future paperwork hassle, as well as exposing them to a potential intangible property tax by your local taxing authority.  Besides, your tools don't qualify as a rental asset or rental expense, because your tools are not "for the exclusive use of the renter."  They are for your own personal use as you see fit. The fact that you may only use them for the rental property is irrelevant.

I put in over 2700 hours of labor

Since your labor can not be taxed by any taxing authority, you have nothing to deduct for your labor. You would have been better off tax-wise paying someone else to do the work so you could deduct the labor cost you would have paid for, instead of using that money to buy personal tools with and doing it yourself. But then, hindsight is always 20/20.

Again, you can 't claim anything for the cost of the tools on any tax return. That's because those tools are not for the exclusive use of the renter. So if you want to recover anything from the $11K you spent on tools, you might want to consider a garage sale - keeping in mind that income from such an endeavor is reportable income and therefore taxable.

I have no other source of income other than the rental income from these rental properties.

Not one single penny of other income for "anything"? If so, I would "HIGHLY" advise you get with a CPA or Tax Attorney in *your* local area. (CPA would be cheaper).  While I think the possibility is extremely unlikely, you very well might be better off if you meet other qualifications to classify this as a full time self-employment job that gets reported on SCH C. But it depends on the laws of your state. I doubt you would qualify. But you won't know "for sure" until you get with a tax professional that is well versed in "YOUR" local and state laws governing this.

[wrangler18]

Great answer.  I have some questions about some of things you've said:

1. How should I report the tools to the IRS? As an expense or a depreciable item?

You won't report them at all. Unless you are "in the business" of renovating properties and report that business income on SCH C (at least), your tools are exactly that.... *YOUR* *TOOLS*.

**This is where I'm confused.  I am in the business of renovating properties.  They also happen to be my properties.**  

2. I have no other source of income other than the rental income from these rental properties. 

I misspoke.  I make about 14K from interest and dividends.

[Critter]

1)  if you are only filing a Sch E you are NOT in the business of renovating properties ... you are an investor who fixes up rentals to rent ... this is why I mentioned setting up a totally separate business where the rentals can pay the Sch C business for the work you do  and where you can deduct the tools properly.  Putting income on the Sch C you will be self employed and pay fed/state and SE taxes that way.

[Carl]

Assets listed on the SCH E are for the sole and exclusive use of the renter only. Therefore you will not and can not claim your tools in any capacity on the SCH E. Not as an asset, and not as a rental expense.

If you are in the business of renovating property, then at an absolute minimum you are filing a SCH C to report business income and expenses (rental income/expenses are not reported on SCH C). You would claim your tools on the SCH C then. But if the SCH C has no business income (remember, rental income can not be reported on the SCH C) then you have no business income from which to claim the cost of your tools against, in any capacity - be it as a depreciated asset or a business expense.