RE Broker to prepare new rental unit tax deductions question

[leptserkhan]

I can't seem to get a straight answer about this issue: I am a Real Estate broker and own a condo.  In 2023 I conducted repairs and improvements to the property so that I could put it on the market for the *first time* in 2024.  I claimed no deductions in 2023 for this work.  Now I'm hearing different stories about if I can or cannot take any deductions, capital improvements or any tax benefits in year *2024* for those repairs and improvements done in 2023.  Some people say that since I work in the business as a broker I can take some or all of the enhancments to the property executed in 2023 as depreciation going forward or write them ALL off as capital expenses over 27.5 years.  Others say no I can't do that.  Any sage advice much appreciated.  Thank you.

[MinhT1]

A property becomes a rental property only from the day it is available for rent on the rental market. Before that date, no rental expenses or depreciation can be claimed.

The improvements you made to prepare your property for rental can 't be claimed as rental expenses. But they can be added to the cost basis of your property, to be used for depreciation from the day it is put on the rental market.

Please read this TurboTax article for more information.

[leptserkhan]

Please confirm when you say "added to the cost basis of the property" that means the market value of the property when I inherited it?  Yes, this is an inheriance.  

I was under the impression that preping and prepairing a property for rent that all of those expenses are somehow tax deductble in the year the work was done, but if the work occured over two years (which it was) then only those repairs and such are deductable for that year.

Can transportation costs, food, lodging, etc. be partialy or wholey deducted as well?

Thank you.

[AnnetteB6]

The market value of the property at the time you inherited it does come into play (that is your basis before property improvements were made), but so does the fair market value of the property on the day that it is placed into service as a rental property.  The basis of the property for depreciation is the lower of those two values.  Then, you can add the cost of the improvements to that basis.  

The cost of the improvements cannot be deducted in the year that the work was done because the property was not considered to be a rental property until it was being advertised and made available for rent.  Until it is placed into service as a rental, any expenses you incurred in getting the property ready to be rented are personal expenses and are not deductible.  This includes transportation, food, and lodging.  These kinds of expenses are only deductible if you incur them after the property has been placed into service as a rental and the expenses are related to your maintaining or repairing the property at that time.  

Improvements made to the property before it is a rental are allowed to be added to the basis for depreciation because they become a component of the property itself.  This would be true even if you never actually rented the property, but instead you sold it.  The costs of the improvements would be added to the basis in that case as well.

To learn more about the basis for depreciation for the rental property, take a look at this information from IRS Publication 527.

@leptserkhan 

[leptserkhan]

Thank you so much for the clarity.  Much appreciated.

I see why I'm confused - there are numerous postings on the internet, including within tax account sites, that seem to say someone who is in the *business* of renovating buildings for rentals can deduct all the costs associated with the renovation *because that is their business*.  

But you are saying "Until it is placed into service as a rental, any expenses you incurred in getting the property ready to be rented are personal expenses and are not deductible. "

Furthermore, I guess, the only expenses that can be deducted are for improvements.

Would rebuilding a bathroom that had a collapsed floor, adding a new toilet and sink and shower stall count as an improvement or repair?  It is improved from it's former self. . . 

[PaulaM]

Your costs associated with the getting the property in a rentable state, are not recoverable until the property has been placed in service (available to rent), as MinhT1 and AnnetteB6 have stated above. 

These costs are added to your property basis and recoverable over time through depreciation and are not direct rental expenses that are generated through the normal operation of a rental unit.

Rebuilding a bathroom is an improvement that would be added to your basis if done prior to the rental being placed in service. If the remodel, takes place after the rental is placed in service (in between tenants), it is still an improvement and is a depreciated asset. Improvements are recoverable over time. 

[leptserkhan]

Here is where the confusioin arises.  The parties responding to this post are using the word "improvements" and "costs" interchangeably in regards to when the property is put on the market, even though the rules applying to improvements are different than general "costs" and it would appear are sensitive to when the property is placed on the market.  

I get that.

For example, one respondent said: "Your costs associated with the getting the property in a rentable state, are not recoverable until the property has been placed in service (available to rent) "

Please note that part of my question was in regard to costs (not improvements) incurred before it was rented - so when respondent state "Your costs associated with the getting the property in a rentable state, are not recoverable until the property has been placed in service (available to rent)" it sounds as if those costs (the ones expended before it was rented) can be deducted or added to the basis or capitalized.  Yet I'm also reading that those costs are not deducted, added to basis or capitlized because the property was not rented yet.

Apologize for the nit-picking but use of language is similarly specific just like the U.S. tax code is.

I'm just trying to understand it.

[PatriciaV]

Are you in the business of renovating rental properties? If so, general expenses you incur would be deductible business expenses in the year they are paid. Improvements would still be treated as capital additions to the property, even if you did this for a living.

Otherwise, expenses incurred before the property is listed as available to be rented can only be capital additions for the property.

Under the IRS rules, a property is improved when it undergoes a "betterment," an "adaptation," or a "restoration." Each of these terms are defined in the IRS rules. In simple terms, any expenditures that improve the property (add to its potential market value) must be capitalized and depreciated. These costs add to the property basis and are entered under the Assets/Depreciation section of Rental Property in TurboTax.

A repair is any expenditure that is not an improvement but instead returns the property to its former condition. If the property is available to be rented (or has a tenant), these costs are entered under Repairs in the Rental Property Expenses section of TurboTax.

Additional Information:

• IRS Pub 527 Repairs and Improvements (see Table 1.1 Examples of Improvements)
• IRS Pub 527 - Pre-rental Expenses

[leptserkhan]

Here is what chatgbt says, and now I understand.  Thanks everyone for your patient and feedback:

The IRS distinguishes between business expenses and capital expenses, and the way you deduct them depends on how you're treating this rental activity.

1. Business vs. Investment Activity
If you are in the business of regularly renovating and renting properties (i.e., you're operating as a real estate professional with a trade or business), then general expenses related to your rental activities (e.g., gas, tolls, meals) may be deductible as business expenses under Schedule C (Profit or Loss from Business).
However, if this is your first rental property and you are not yet operating an established business, the IRS may consider it an investment activity rather than a business, meaning deductions would generally be reported under Schedule E (Supplemental Income and Loss) instead.

2. Expenses Before the Rental Begins
Expenses incurred before the property is available for rent (e.g., travel for renovations, meals, etc.) are typically considered start-up expenses rather than immediately deductible business expenses.
Start-up expenses (up to $5,000) can be deducted in the year the business starts, with any remaining amount amortized over 15 years.

3. Deductible vs. Capitalized Expenses
Deductible Expenses (Generally for an Active Rental Property)

Gas, tolls, mileage (for business use of your vehicle)
Advertising for tenants
Utilities (if paid while looking for tenants)
Insurance
Maintenance and repairs (not improvements)
Property management fees
Capital Expenses (Must Be Depreciated)

Major renovations or improvements (e.g., new roof, HVAC, structural upgrades)
Property purchase costs
Major appliances or fixtures

4. What About Meals?
Business meals are only deductible (at 50%) if they are directly related to your real estate business, such as meeting with a contractor or property manager to discuss renovations. If you're simply eating while working on the property, those costs are considered personal and not deductible.

5. Timing: When Can You Deduct?
If your property is not yet rented but actively listed for rent, certain expenses related to securing a tenant (like advertising and travel for showings) may be deductible.
If you are still in the renovation phase and the property is not yet available for rent, expenses related to improvements should be capitalized.