Rental property depreciation after dual conversion of use

[Anonymous]

Hi all,

I have a question about residential rental property that was twice-converted in terms of usage. The owners acquired the property via a 1031 exchange with the following (example) details:

• Adjusted tax basis of 100k from the 1031 exchange
• Purchase price of 200k
• A new assessed property value of 150k for improvements (depreciable part; 75% of purchase price) and 50k for land (non-depreciable)
• Rented out for 1 year after purchase and depreciated normally (over 27.5 years)

After 1 year of renting, the owners moved in and lived there for 4 years. Now, after those 4 years, they moved out and rented it out again.

My question is about how to depreciate the property today now that the property is generating rental income.

1. Do they continue the existing depreciation schedule (26.5 years left)?
2. Do they start a new depreciation schedule (27.5 years) with the new adjusted basis after that first 1-year rental?
3. Did either conversion [(1) rental property to personal use and (2) personal to rental] trigger the need to record and use the then-current market value of the property for depreciation purposes?
4. Are there other considerations?

Any insights help. Thank you!

[Critter-3]

This forum is mainly for the DIY TT user and not tax pros  so you may not get an answer for this difficult question.  If your own research has not been satisfactory then maybe the forum for the professional program you use may be a better place to ask this question or an organization like NATP. 

[tagteam]

I agree with @Critter-3; an in-person consultation with a tax professional is required in this instance.

There are a couple of depreciation options following an exchange (see link below) and the option that was chosen is unknown.

https://www.1031.us/PDF/Depreciationof1031.pdf

As an aside, when property is converted from rental use to personal use and then back to rental use, depreciation generally starts over at the same initial recovery period (27.5 years for residential real estate), but at the lesser of the fair market value at the time of conversion back to rental use or the adjusted basis of the property.

[Carl]

1. Do they continue the existing depreciation schedule (26.5 years left)?

No.

1. Do they start a new depreciation schedule (27.5 years) with the new adjusted basis after that first 1-year rental?
   

Yes. The new cost basis on the structure only, will be the prior cost basis on the structure only, minus the prior depreciation already taken.

1. Did either conversion [(1) rental property to personal use and (2) personal to rental] trigger the need to record and use the then-current market value of the property for depreciation purposes?

Not likely. When the property is placed in service you depreciate based on the *LESSER* of a) what you paid for the property or b) the FMV of the property on the date placed in service. Since I doubt the FMV today is less than what you originally paid for the property, it's FMV today is irrelevant and does not come into play for anything.

1. Are there other considerations?

Understand the cost basis originally assigned to the land will not change. Only the cost basis of the structure and any other assets on which prior depreciation has been taken will change. The cost basis of the structure and any other assets depreciated in the past will be reduced by the amount of that depreciation already taken. Then depreciation starts over from day 1 for the next 27.5 years.

[Critter-3]

What also worries me it the changes in the insurance,  the mortgage (if the broker knew of the change) and the RE taxes/Homestead exemption.  Flipping back and forth can be costly. A talk  to your mortgage holder, insurance agent and the county tax assessor may also be needed. 

[tagteam]

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@Anonymous wrote:

After 1 year of renting, the owners moved in and lived there for 4 years. Now, after those 4 years, they moved out and rented it out again.

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If they rented out the (replacement) property for one year after the exchange and then moved into the property as their principal residence, the owners really need to consult with a tax professional. This arrangement violates the IRS safe harbor (link below) for not challenging the validity of a 1031 exchange.

See https://www.irs.gov/pub/irs-drop/rp-08-16.pdf