How do you compute cost basis for rental home, which is going to be used to calculate depreciation.

[huberpw]

I bought and used home as primary residence in 2000.  Refinance in years 2010 and 2018 while living in home.  Converted to rental property July 2022.  How do you calculate the adjusted cost basis used for determining depreciation of the rental property?

I understand you can add certain closing costs (attorney fees, title insurance, surveys) for buying house in year 2000 to original purchase price of house to calculate the cost basis, but can you also add refinancing closing costs in years 2010 and 2018 (title insurance, etc) to that cost basis?  

Thanks.

[DavidD66]

No. Your cost basis is the amount you paid in 2000 (including qualifying closing costs), plus the costs of any improvements.  You cannot add the closing costs from refinancing to your cost basis.  Be sure to set up the land and the structure as separate assets.  You will need a property tax bill to allocate the cost between land and improvements.

[Carl]

Here's some details in addition to what's already been provided that I'm sure you'll find helpful.

Cost basis is the *lesser* of:

1. What you paid for it when you originally purchased the property or;

2. The FMV of the property on the date it was placed in service.

I have no doubt that what you paid for the property when originally purchased back in 2000 is the lesser amount. Therefore, you'll use the original purchase price. Refinancing "does not" figure into this equation at all.

Basically, your cost basis will be what you paid for the property originally, plus the cost of any property improvements you paid for at any time during your ownership. (for example, if you put a new roof on in 2010, that would be a property improvement.)

I find the program is not very good at provided clarity on some things, and that can, and will hurt you financially down the road. When setting up a rental property for the very first time in TurboTax, perfection is not an option; it's a must. Even the tiniest of mistakes can and will grow exponentially over time. Then when you catch your error years down the road, usually in the year you sell it, the cost of fixing it "will" be high. So if you have questions as your work this through the program, by all means, ask.

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 was contracted to move in, and/or "could" have moved in. That would be your "in service" date or after if you were asked for that. Vacant periods between renters do not count for actual days rented. Please see IRS Publication927 page 17 at https://www.irs.gov/pub/irs-pdf/p527.pdf#en_US_2020_publink1000219175 Read the “Example” in the third column.
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, 2nd home, or any other personal use reasons 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 Improve, restore, or otherwise “better” the property. Basically, they retain or add value to the property.

Betterments:
Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. An example of a pre-existing condition or defect in this context would be something such as foundation repair (slab jacking) or some other, hidden and costly, anomaly.
Restoration:
Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.
Adaptation:
Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property. Adding a wheelchair ramp would be an example.

Expenses for these types of costs 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 need to 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 instead of capitalizing and depreciating them, 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 its assets in the usable 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 for the very first time are not deductible.

Repair

Those expenses incurred to return the property or its assets to the same usable 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 for the very first time 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.

[Opus 17]

Some closing costs of refinancing can be added to your basis I believe, but not all your closing costs.  See publication 523 on page 8.

https://www.irs.gov/forms-pubs/about-publication-523

Also note, improvements must be part of the property to count as a basis adjustment.  For example, if you replaced the roof in 2005 and again in 2020, only the cost of the 2020 roof is includable in the basis.

[Carl]

Closing costs basics.

cost associated with acquisition of the property are added to the cost basis of the property so they get capitalized and depreciated over time.

cost associated with acquisition of the loan are amortized and deducted (not depreciated) over the life of the loan. Amortization of loan costs start on the date the property is placed in service, regardless of the origination date of the loan.

Here's what I'm not clear on.

A 30 year loan was acquired in 2000. Property placed in service in 2022. With 8 years left on the loan, when asked for "life of loan" would you use 8 years since that's all that's left on the current loan? Or would you indicate the original 30 years and the program takes into account the actual origination date of the loan with the in service date?

[Opus 17]

@Carl 

The items that can be used as cost basis when buying a personal home don't get amortized over 30 years, they just get added to the basis.

• Abstract fees (abstract of title fees),

• Charges for installing utility services,

• Legal fees (including fees for the title search and pre- paring the sales contract and deed),

• Recording fees,

• Survey fees,

• Transfer or stamp taxes, and

• Owner's title insurance.

(Other closing costs are not deductible and are not included in the basis, for a personal buyer.)

Now, if I pay those fees on a refinance, they either get added to the basis again, or they are disregarded.  I think they are added to the basis.  They are not amortized over the life of the loan on personal property.

I agree that if this taxpayer refinances again after turning the house to a rental, those costs would be amortized.  But I think for purposes of calculating "the lower of his present cost basis or FMV" for depreciation, he would be entitled to include the original purchase price, listed original closing costs, improvements, and the closing costs on their refinances prior to placing the home in service as a rental. 

[huberpw]

Hi thanks for all the help.

So when you include closing costs (home purchase or refinance) as part of cost basis calculation, you cannot include lender’s title insurance correct?  But you can include owner’s title insurance?!  Or can you include both?

Thanks

[henrysf]

>>You will need a property tax bill to allocate the cost between land and improvements.

For huberpw's case, is property tax bill of the year 2000 (when the property was brought) needed?  

[Carl]

No. Use the most recent tax bill available to you.

[henrysf]

Value in Property tax bill from the year of 2022 can be significantly different than that from the year of 2000.  I thought the property was brought in 2000, so cost basic/cost of land/cost of improvements should be from the same year as well.  I do notice that TurboTax asks me to have current property tax bill ready though. 

[Carl]

The property tax bill is used for one thing only by the turbotax program. That is to determine what percentage of your cost basis gets allocated to the land. That's it. None of the numbers on the property tax bill get reported to the IRS. That's because there is a difference between tax value and fair market value. Typically, I see tax values average about 30% lower than the fair market value. But the difference between the two can vary much more significantly, depending on the location of the property.

When it comes to taxes, you use the *LOWER* of either the original purchase price, or the FMV at the time of conversion, for depreciation.

It is more common for the original purchase price to be lower than the FMV at the time of conversion. The tax bill is used *ONLY* to determine what percentage of the cost basis used, gets allocated to the land since land is not depreciated. For that, you use the most current tax bill available. If the most current available is from 10 years ago, then use it. For most, the most corrent tax bill available will be the one they received/paid in the prior tax year.

[henrysf]

>>The tax bill is used *ONLY* to determine what percentage of the cost basis used, gets allocated to the land since land is not depreciated. 
I think I got it now.

let's say a house was brought for $500,000 back in 2000.

current property tax bill from 2022 say land value is $20000(200K) and improvements value is $490000(490K).  TurboTax uses that to calculate improvement ratio is 490000/(200000+490000)=~0.71.

Improvements value (to be depreciated in 27.5 years) of the house would be calculated as 500000*0.71=355000.

Is that right?

If $20000 (20K) was spent for remodeling in 2000, that would be added on top of the purchase cost of $500000.  Wait, as it's for improvements, it should be added to the $355000 directly, right?

[Carl]

let's say a house was brought for $500,000 back in 2000.

current property tax bill from 2022 say land value is $20000 and improvements value is $490000.

In one area of your response, you use a figure of $20,000 (twenty thousand). In another you state $200,000 (two hundred thousand.)  I'm going to assume you mean the latter of $200,000 (two hundred thousand) for the land value on the tax bill, and that you simply left a zero out in what I pasted above.

I do the math a bit different. But still arrive at the same end result.

From the tax bill: 200,000 plus 490000 equals 690000. If 200,000 is land value, then 200000 divided by 690000 equals .28.9 or 28.9%. It's fine to round to the nearest whole number. So we'll say that 29% is allocated to the land with 71% to the structure.

For the actual purchase price of $500,000, 29% of that is 145,000.

So in the COST box you'll enter $500,000 and in the COST OF LAND box you'll enter 145,000. Then the program (not you) will do the math to arrive at a cost basis of $355,000 for the structure. That is the amount that will be depreciated over the next 27.5 years. Those numbers will *never* change under any circumstances, for so long as the property remains under your ownership and classified as a rental.

[henrysf]

Yes, you got it.  I missed a zero at some places.

Would it impact the final value for depreciation, for example, $20000 (20K) was spent on remodeling the house in 2000 (or any year before the house was rented out)?

[Carl]

Would it impact the final value for depreciation, for example, $20000 (20K) was spent on remodeling the house in 2000 (or any year before the house was rented out)?

Assuming your remodeling costs are property improvements to the structure, and further assuming this was done "before" you converted the property to a rental, that gets added to the total cost basis. So that would change the math percentages. For example, if you paid $50,000 a few years back to remodel the kitchen and bath, your new cost basis is what you paid for it originally $500,000) plus the cost of any property improvements ($50,000) for a cost basis of $550,000.  That changes the land value since the most recent tax bill shows 29% for the land.  Doing the math, 29% of $550,000 is $159,500 for the land value.

But lets say 2 years from now you put a new roof on the property at a cost of $75,000 in tax year 2024. Since the property would already be a rental and being depreciated, under no circumstances would you change the values of the existing asset. No exceptions. Doing so will completely screw up the depreciation history and all future depreciation going forward will flat out be wrong.  You'd simply enter the new roof as a completely new and separate asset in the assets/depreciation section, and depreciation on that roof would start on the date placed in service. That's usually the date it's completed and approved by your local building authority who verifies it's built to the local/state/fed building codes that apply. I know in my county where I've put new roofs on my rental properties over the last few years, it was inspected/approved the next business day after the work was completed. So that's my official "in service" date for that asset.