Schedule E

[rlkatz]

I acquired a vacation home in November 2018 and spent five months remodeling the house and began renting it in April 2019. Should I file a Schedule E for 2018 or start the Schedule E in 2019?

[DoninGA]

Since the rental property was not placed into service until April of 2019, then you will report the rental property income and expenses on a 2019 Schedule E.

[rlkatz]

Dear DoninGA,

Thank you for your reply.  It is very helpful.  Is there any problem deducting expenses incurred in 2018 for the acquisition and remodeling on the the 2019 Schedule E?

Rick

[Carl]

The below information will help clarify things for you, as your remodling costs are not deductible. They add to the cost basis. Check out the below and then if you have more questions, by all means please ask them.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence before, then this date is the day AFTER  you moved out.
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 "could" have moved in. That should be your "in service" date if you were asked for that. Vacant periods between renters count also PROVIDED you did not live in the house for one single day during said period of vacancy.
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 or 2nd home, 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 POPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that add value to the property. Expenses for this 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 must 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 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.

Cleaning & Maintenance

Those expenses incurred to maintain the rental property and it's assets in the useable 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 are not deductible.

Repair

Those expenses incurred to return the property or it's assets to the same useable 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 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.

[rlkatz]

Carl,

Thank you for your reply. It was very helpful.  It doesn't seem to answer the listing of expenses for furnishing and equipping the house which is rented as furnished and equipped.

Rick

[Anonymous]

the costs of acquisition and remodeling are generally capital expenditures.  some of the acquisition costs  would be allocable to non-depreciable land on a prorata basis  - FMV of land to total purchase cost.   the rest of these costs to the house.  all the remodeling costs that don't qualify as repairs or cleaning and maintenance,  would be part of the cost of the house.

IRS Publication 527 (2018), Residential Rental Property

Pre-rental expenses.
You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent. 

so 2019 is the proper year to deduct these expenses and also things like insurance,   reale estate taxes, utilities, etc.  

[tagteam]

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@rlkatz wrote:

....the listing of expenses for furnishing and equipping the house which is rented as furnished...

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You have a few options here.

First of all, furniture, appliances, carpeting, et al, that is used in residential rental property is considered 5-year property (so full cost recovery is only 5 years).

Further, you can use the special depreciation allowance, which generally allows you to immediately expense 50% of the cost of the property purchased in the current tax year.

See https://www.irs.gov/publications/p527#en_US_2018_publink1000255996

Further still, you can use the Section 1.263(a)-1(f) De Minimis Safe Harbor election for items that cost $2,500 or less.

See https://ttlc.intuit.com/community/business-expenses/help/what-can-i-expense-or-depreciate-with-the-b...

[Carl]

Having re-read your post and the additional replies to it raises another concern for me. You specifically and explicitly state "VACATION" rental.  So not I'm thinking this is not a SCH E property at all, but a SCH C property if conditions are met.... and they may be. This really matters big time if your state taxes your personal income to. In other words, you may have to report as a hotel would have to, and use SCH C... not SCH E.

Basically, if you provide your tenants recurring services then you have an actual SCH C business. For example, if you have someone staying there for two weeks and during that time you provide daily or weekly cleaning services to make the beds, clean the kitchen, re-stock the towels and toilet paper in the bathrooms, etc. then you have a SCH C business that has to follow the same rules just like a hotel does.

Overall I would suggest you seek professional help, as in my opinion a SCH C business is the better way to go in the long run. That's because with a SCH C business while your income is subject to the "regular" income tax, it's also subject to the additional 15.6% self-employment tax. The SE tax is basically your medicare and social security. Those "taxes" get credited directly to your social security account and will help qualify you for more SS in your retirement years.

Additionally, unlike a SCH E business, the SCH C business income *IS* included when figuring your maximum allowed contributions to an IRA. Even a solo 401(k) if you elect to go that route.

So overall I would suggest you seek professional help in your state to learn the nitty-gritty about all the options that may be available to you that can help you not only now, but also give you a little more "bright light" in the future.

Now laws on this rental stuff differ from state to state, so that's the main reason for my recommendation. For example, in my small town in FL the county classifies a short term rental is anything that is rented out for less than 30 days for any one period during the calendar year. So that means if I rent out a property for 29 days of the year, and then rent it to another for the remaining 336 days of the year, then the property is considered short term for the *entire* year.  (This is because my county imposes a $3/night bed tax on hotels.)

[tagteam]

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@rlkatz wrote:

I acquired a vacation home......

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Regarding the Schedule E versus Schedule C reporting, I would recommend seeking professional assistance if you are at all in doubt about your particular scenario.

This debate has been raging just about forever, there are a variety of "opinions" on the matter, and not a whole lot of actual guidance beyond "rental periods of 7 days or less" and "providing substantial services" (and both of those are somewhat nebulous as to their actual application in terms of reporting requirements).

Providing substantial services is defined in Publication 527 as follows:

If you provide substantial services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C.

However, Example 4 in Treas. Reg. §1.469-1T(e)(viii) states in relevant part:

The taxpayer is engaged in an activity of owning and operating a residential apartment hotel. For the taxable year, the average period of customer use for apartments exceeds seven days but does not exceed 30 days. In addition to cleaning public entrances, exists, stairways, and lobbies, and collecting and removing trash, the taxpayer provides a daily maid and linen service at no additional charge.... The value of the maid and linen services (measured by the cost to the taxpayer of employees performing such services) is less than 10 percent of the amount charged to tenants for occupancy of apartments. Under these facts, neither significant personal services.....nor extraordinary personal services....are provided in connection with making apartments available for use by customers. Accordingly, the activity is a rental activity.

[0302]

Thank you for stating BIG ZERO, saved me hours of work.

[Carl]

If you declare the furnishings as separate assets, they're 5 year assets as you know. Be aware that in some locales (counties, cities, towns, townships, etc) those 5 year assets are considered "equipment" used in the production of income, and the locale may impose a yearly "tangible property tax" on said equipment. That tax can basically offset if not cost more than any "savings" realized by depreciating it.