Should adding a depreciation expense increase taxes?

[TimTheLandlord]

I own a profitable 3-family rental, and in 2021 I did a major renovation ($20k).  So I was playing around with TurboTax 2021 to see the difference in long term depreciation vs. one-time deduction if it qualified.  The odd thing was that my owed taxed increased (the realtime update TurboTax does at the top of the page) when I added a new depreciation line item of $20k.   

Do I have some error somewhere in TT that would cause that, or is that expected? 

[Anonymous_ · Accepted solution]

There is always the possibility of an input error, so check your return thoroughly.

Also, there is the possibility that the deduction could subject you to AMT (alternative minimum tax), eliminate certain tax credits, etc. 

[TimTheLandlord]

Thanks for the quick response.  Assuming no errors and I am subject to AMT (very likely), it sounds like I would be better off not depreciating the improvements then.  If I don't enter the renovation costs to avoid paying more taxes now, how would that impact me when I sell the rental property in 5-10 years (my target timeline to sell it)?

Tim

[Anonymous_]

There will be recapture of the depreciation deductions you either took or should have taken (i.e., that were "allowable"). 

[Mike9241]

if you capitalize them you must depreciate them.  the tax laws say should you sell the property you must take into account the depreciation that should have been taken on them to figure the taxable gain/loss. to fix this problem in the year of sale can be a hassle and may require professional help. and not only is your tax return affected in the current year but also every year until you sell..  yo should look through the return with and without to see what lines are changing. however, I understand that if you are using the online version you need to pay before you can see the actual return.

[Carl]

sounds like I would be better off not depreciating the improvements then.

Depreciation really isn't an option per-se. If you don't depreciate the asset, then in the tax year you sell or otherwise dispose of the property, you are required to recapture the depreciation you should have taken, and pay tax on it.

Property improvements add to your cost basis of the property. If you don't enter them in the tax year placed in service, it can create a real nightmare dealing with it later; especially in the tax year you sell the property. Now outside of the AMT tax (which may kick in here, depending on the numbers), that refund or tax due number you see on the screen is really meaningless until you have completed your tax return in it's entirety. During the data entry process you'll see that number go all over the place - literally! So you really shouldn't pay much attention to it. Until you finish the return, when that number changes all it really means is "the program did something" and that's pretty much it. Remember, as you work through the program and see that number change, whatever is changes to is based "only" on the information the program has "at this specific and exlicit point in time". For example, if you're entering data in the program the way it's designed and intended to be used, you'll be entering your rental data long before you enter any of your "personal" income, and definitely before you enter anything under the Deductions & Credits tab. So don't let that refund/tax due number phase you at all until you have finished your tax return entirely.

Also keep in mind that if you're also doing a state return, it's not at all uncommon for things to change on that "finished" federal return as you work through the state return entering data. That's the primary reason why you should not file "any" return, until you have completed, checked and verified "all" returns you are completing with the program. This really comes into play when one is filing more than one state return.

[TimTheLandlord]

I took my filed 2021 TT (I'm using Premier not the online version) and I'm just running through some scenarios for this year, so I'm 99.99% confident it's correct, and I do make a enough income that I generally don't get a tax break, TT normally informs me of that after I enter all my income for the rental section. 

I did triple check everything and when I enter a $20k remodeling depreciation federal tax owed goes UP $26, after entering the new asset, I also went through the state review and did a final check twice and TT does not report any errors. 

Assuming its the AMT that is getting me, it seems like I'd be better off not claiming this expense.

[Anonymous_]

Do you have Form 6251 in your tax package?

[VolvoGirl]

So far one thing I can think of........If you add more expenses or depreciation it will reduce your income and you may not be getting as many credits as before.

Are you testing in a copy of your real return?  Print it out before adding the depreciation and then print  it out after and compare them to see what's all different.  

[Anonymous_]

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@VolvoGirl wrote:

Are you testing in a copy of your real return? 

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That is actually a good idea. Since you are using Premier desktop, you can access Forms Mode. Check the forms and schedules.

[VolvoGirl]

Found another note I was thinking of.....

Maybe you are already getting back all you can and more deductions won't increase it. Some Deductions are limited. Or you still owe for something else. Also after you reduce your income to zero there is no more refund to get back but you still may owe for other things like self employment tax or the 10% early withdrawal penalty from 401k or IRA accounts.

[TimTheLandlord]

No I do not have form 6251 anywhere used. 

[TimTheLandlord]

I made a file copy from my actual return and I'm only changing the adding $20k remodeling deprecation asset.  

Good idea about printing them side-by-side to see the differences - I do have dual monitors so I can save a small tree. 🙂 

Tim

[TimTheLandlord]

I did a side-by-side comparison, here is what I found out.

Adding a $20k 5yr depreciation improvement to my rental changed the following on my 1040.

Line 13 decreased $800 (Qualified business income deduction from Form 8995 or Form 8995-A)

on form 8995-A
Line 2 decreased $4000 (I'm assuming is related to the $20k / 5yr) Qualified business income (QBI) from the trade, business, or aggregation.
Line 3 decreased $800
So basically almost every other line on form 8995-A is decreased by $800.

Basically the QBI is getting reduced $800 when I add the $20k improvement asset. Is that normal?

[Mike9241]

adding a 5 Year $20,000 improvement increases depreciation by $4,000  (20% of the $20K) and reduces your rental profit by the same amount. you designated the rental as being eligible for the Qualified Business Income Deduction (form 8995), thus the QBI deduction on line 13 is decreased by 20% of the $4k depreciation increase or the other way around is decreased by 20% of the decrease in profit of $4K - the $800. so net your taxable income went down $3200 (1040 - line 15). but this does not explain your statement that taxes went up that's line 24 (lines 16,17,19, 20 and 23)