How to Calculate the Land Value for Cost Basis and IRS's definition of Rooms?

[Anonymous]

I converted my residence into rental use, so I need to calculate cost basis. My closing document do not show land value. My plan is to pull the land and improvement value from the appraisal district's website to calculate the percentage of land value. Then take the land value out from the purchase price to calculate cost basis. My question is which year of appraisal value should I pull: the year that the property was purchased, or the year that the property is converted into rental use? I noticed that the land value hasn't changed at all on the appraisal district website over the years but the improvement value has increase a lot. That means if I'm allowed to use the more recent data, I could get a higher depreciation (bc the percent of land value in property value would be lower).

The other question is IRS says "The two most common methods for dividing an expense are (1) the number of rooms in your home, and (2) the square footage of your home." What's the definition of rooms? It seems normally people refer to bedrooms. But some posts also mention about living room, dining room, bathroom, etc. should also be considered as rooms.

[MonikaK1]

When you change property you held for personal use to rental use, the basis for depreciation will be the lesser of the FMV or adjusted basis on the date of conversion.

Fair Market Value is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the FMV of the property.

The basis for depreciation is the lesser of:

• The FMV of the property on the date you changed it to rental use; or
• Your adjusted basis on the date of the change—that is, your original cost or other basis of the property, plus the cost of permanent additions or improvements since you acquired it, minus deductions for any casualty or theft losses claimed on earlier years' income tax returns and other decreases to basis. 

Typically, the percentage of land versus building from your local assessor is a good source to determine the percentage of basis attributable to land. You can use the assessment from the time you put the property into service. Remember that depreciation taken will eventually be recaptured at such time as you figure the gain on selling the property.

You would only need to choose a method for allocating the percentage of space per room or in the entire house if you were only converting part of the house to rental use, or using part of the house as a home office. Either square footage or number of rooms is an acceptable method,

See IRS Publication 527 for more information.

See here for more information from TurboTax on rental property.

[Anonymous]

Thank you very much for your advice! Back to the second question: what is considered as a "room" by IRS?  Does the number of rooms only include bedrooms, or should laundry room, living room, dining room, etc also be counted?

[Carl]

When converting the entire property to a rental, the number of rooms and square footage do not matter. It's all 100% converted, and all 100% rental use.  This would be true if you are living somewhere else, and are not restricting access by the tenant to any portion of the property or structure.

If renting out a part of your primary residence while you continue to live in it, things are a bit different.

For cost basis, use the most current tax bill to figure what the percentage of the cost basis is, between the land and the structure(s).  Then you'll use that percentage against your actual cost basis to figure how much is allocated to the land.  (what cost basis to use has already been clarified in this thread)

For depreciation, that gets figured based on the percentage of square footage that is "exclusive to the renter". So common areas are not included. If you live in a 2 bath house and the bedroom you are leasing out has one bath that can only be access from that bedroom, then you can (and should) include the floor space of the bath in figuring your percentage of square footage that is exclusive to the renter. You use the square footage percentage for figuring depreciation you can claim on the SCH E.

For all other expenses, you have two choices, and you don't have to use the same one every year.

1. You can claim the percentage of all other expenses equal to the percentage of floor space exclusive to the renter.

2. You can based your percentage of expense deduction based on the number of people living in the property.  For example, if you and your spouse live in the property as your primary residence and a single renter lives in one of the bedrooms, you can claim 1/3 of your expenses on SCH E.

There is one exception. If the property has a landline telephone you can't claim any of the telephone expenses on SCH E. Doesn't matter if you share it with the tenant or not. The IRS says you can't claim a penny for the telephone service on SCH E. However, if you have a 2nd line installed and it's for the exclusive use of the tenant, you can claim 100% of that cost on the SCH E provided of course, you are the one actually paying for that 2nd line.

Also, in order to claim any portion of an expense on SCH E, the tenant must have access to that utility. For example, if you have Satellite TV and you do not provide the tenant a receiver for the service in their room, you can't claim it on SCH E.

Now with my knowledge of how the program works, when that first year's depreciation is figured by the program, dollars to donuts it's going to be wrong.  Once you confirm it's wrong, let me know and I'll show you how to fix it without disabling your ability to e-file.

To confirm depreciation, see IRS Publication 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf and use the MACRS worksheet on page 37. The table that applies for line 6 of the worksheet is table A-6 on page 71.