Refinancing Fees when converting rental to personal use

[canyak]

We have a rental we have kept empty since mid September to do work on. Since it is not offered for rent and some of our work would be considered "improvements" and we stayed in it for a few months while we did some of the work, I assume we have to convert it to Personal Use for that time. When the repairs and improvements are done, we intend to rent it again. 

When converting it to personal use, I have to "dispose" of all the associated things that were depreciating. When it comes to our Refinancing Fees, the program is asking what to do with the remaining $5k of refinance fees, whether to (a) transfer to Other Expenses for the rental or (b) I'll enter them myself later/I refinanced with the same lender. The page seems to be the same one you get if you are disposing of the Fees because of a re-fi, but that's not what I'm doing. I know the fees are normally amortized over the life of the loan and you can expense them if you re-fi to another lender, but should I be expensing them when I convert the property to personal use? Should I pick (b) and just not put them anywhere and create them again when I convert back to a rental? 

[Carl]

We have a rental we have kept empty since mid September to do work on.

That would be September of 2019 I assume?

Since it is not offered for rent and some of our work would be considered "improvements" and we stayed in it for a few months while we did some of the work, I assume we have to convert it to Personal Use for that time.

Sounds to me like your assumptions are wrong. If you did not live in the house as your primary residence, 2nd home, vacation home or other personal use, then there's no need to convert the property to personal use. If the *PRIMARY* *REASON* for staying in the house was to do the work on it (repairs, property improvements, etc) then that is not personal use of any type and there is no need to convert anything to personal use. For example, if you still maintained a primary residence elsewhere, that property that's "elsewhere" remains your primary residence. TO further support that, you did not change the address on your drivers license, you did not change your voter registration (assuming the rental property is in a different voting district from your residence), you did not turn off or change the name on the utilities at your primary residence, you did not move your kids to a different school if the rental property is in a different school district, and you did not remove any homestead exemption from your primary residence, or transfer said exemption to the rental property. Finally, you went into this with the intent to rent it out again, even if it doesn't get put back "on the market" until 2020, and as of this very minute that intent has not changed.

When the repairs and improvements are done, we intend to rent it again. 

...and that statement supports my assumption of your future intent with the property.

It is not at all uncommon for a rental property owner to live in the property for the period of time they are doing repairs and/or property improvements. I see this all the time with rental property owners who may own property that's say, 100 or so miles away from their primary residence, or even in another state. If the *primary* reason for living in the rental property is for the purpose of maintaining, repairing or improving the property between renters, that does *NOT* make it personal use. However, if the *PRIMARY* reason for living in the property is for some type of personal pleasure, then that DOES make it personal use. But you don't have to convert it to personal use. You simply keep it classified as Residential Rental Real Estate, and report number of days of personal use. That's all.

Besides, with the TurboTax program if you convert it to personal use, when you convert it back to rental property later the program *CAN* *NOT* handle that situation correctly at all, as the depreciation will be all screwed up and you flat out can "NOT" do anything to make the program adjust the depreciation correctly when you convert it back to a rental.  Therefore, if you "REALLY" "DO" have personal use here, leave it classified as a rental and just report the number of days of personal use. With that, the program *WILL* adjust the depreciation correctly and the program *WILL* keep the correct amount of prior year's depreciation already taken.

Now the below information is provided "in case" you "REALLY" "DO" have personal use. But understand that if you actually "covert" the property to personal use, you *WILL* have unfixable problems with depreciation that will *REQUIRE* professional help to fix.

When converting it to personal use, I have to "dispose" of all the associated things that were depreciating.

No, that's wrong (in a sense). You don't "dispose" of anything. All assets are converted to personal use and depreciation stops on the date of conversion. But the assets remain on the tax return *FOREVER* if you intend to convert it back to a rental. Just keep in mind you can't use TurboTax when you convert it back to a rental, because the program is incapable of doing the math correctly. The program will incorrectly (and uncorrectably) assume depreciation stopped on Dec 31 of the year prior.

So the bottom line is, if you wish to continue using the TurboTax program in future years and you intend to rent the property out again in 2020, then do not under any circumstances convert the property to personal use.  Instead, leave it classified as a rental and *ONLY* if you *REALLY* have personal use days, just tell the program the property was NOT rented the whole year and follow the prompts from there to enter the number of days rented, and number of days of personal use. That way, the program will not only correctly figure the depreciation allowed for 2019, it will also correctly  pick up where depreciation left off, when you report days of personal use and days rented on your 2020 return.

When it comes to our Refinancing Fees, the program is asking what to do with the remaining $5k of refinance fees, whether to (a) transfer to Other Expenses for the rental or (b) I'll enter them myself later/I refinanced with the same lender.

If you refinanced the property, assuming you will "in fact" leave it classified as a rental, here's how the refinancing fees work.

 - If you refinanced with the same lender the remaining fees on the original loan are added to the fees of the new loan, and that total is amortized (not capitalized) and deducted (not depreciated) over the life of the new loan.

 - If you refinanced with a different lender, then the refinancing fees of the old loan are fully deductible as an expense in the year of the refi. Then the fees on the new loan are amortized and deducted over the life of the new loan.

Now another thing about refinancing rental property that matters also. If you refinanced for the balance on the original loan and nothing more, then your mortgage interest on that new loan is fully deductible.

However, if you refinanced for more than what you owed on the original loan and "cashed out" that changes things. (with exceptions discussed below). You can only deduct the percentage of interest on the new loan that equals the percentage of the new loan amount that paid off the old loan.  For example:

If you owed $50K on the old loan and refi'd for $100K taking a "cash out" of 50K for your wallet, that means only 50% of the new loan is for the rental, while the other 50% went to you wallet. Therefore, only 50% of the mortgage interest paid is deductible on the SCH E (every year for the life of the new loan). Now for the exception.

Same scenario as above where you "cashed out" $50K. However, you used that entire cash out amount for maintenance, repairs and property improvements on that rental, and "ONLY" on that rental property.  In this scenario, the mortgage interest paid is fully deductible on SCH E.

I know the fees are normally amortized over the life of the loan and you can expense them if you re-fi to another lender, but should I be expensing them when I convert the property to personal use?

I strongly encourage and recommend that you do "NOT" convert the property to personal use. Another thing that happens if you do, is that "NOTHING" concerning your refi will be a SCH E expense if the closing date on the refi occured after the date of conversion to personal use. Just don't go there, as all you're doing is creating a headache for your future sell that no amount of Excedrin will make better.

[Carl]

We have a rental we have kept empty since mid September to do work on.

That would be September of 2019 I assume?

Since it is not offered for rent and some of our work would be considered "improvements" and we stayed in it for a few months while we did some of the work, I assume we have to convert it to Personal Use for that time.

Sounds to me like your assumptions are wrong. If you did not live in the house as your primary residence, 2nd home, vacation home or other personal use, then there's no need to convert the property to personal use. If the *PRIMARY* *REASON* for staying in the house was to do the work on it (repairs, property improvements, etc) then that is not personal use of any type and there is no need to convert anything to personal use. For example, if you still maintained a primary residence elsewhere, that property that's "elsewhere" remains your primary residence. TO further support that, you did not change the address on your drivers license, you did not change your voter registration (assuming the rental property is in a different voting district from your residence), you did not turn off or change the name on the utilities at your primary residence, you did not move your kids to a different school if the rental property is in a different school district, and you did not remove any homestead exemption from your primary residence, or transfer said exemption to the rental property. Finally, you went into this with the intent to rent it out again, even if it doesn't get put back "on the market" until 2020, and as of this very minute that intent has not changed.

When the repairs and improvements are done, we intend to rent it again. 

...and that statement supports my assumption of your future intent with the property.

It is not at all uncommon for a rental property owner to live in the property for the period of time they are doing repairs and/or property improvements. I see this all the time with rental property owners who may own property that's say, 100 or so miles away from their primary residence, or even in another state. If the *primary* reason for living in the rental property is for the purpose of maintaining, repairing or improving the property between renters, that does *NOT* make it personal use. However, if the *PRIMARY* reason for living in the property is for some type of personal pleasure, then that DOES make it personal use. But you don't have to convert it to personal use. You simply keep it classified as Residential Rental Real Estate, and report number of days of personal use. That's all.

Besides, with the TurboTax program if you convert it to personal use, when you convert it back to rental property later the program *CAN* *NOT* handle that situation correctly at all, as the depreciation will be all screwed up and you flat out can "NOT" do anything to make the program adjust the depreciation correctly when you convert it back to a rental.  Therefore, if you "REALLY" "DO" have personal use here, leave it classified as a rental and just report the number of days of personal use. With that, the program *WILL* adjust the depreciation correctly and the program *WILL* keep the correct amount of prior year's depreciation already taken.

Now the below information is provided "in case" you "REALLY" "DO" have personal use. But understand that if you actually "covert" the property to personal use, you *WILL* have unfixable problems with depreciation that will *REQUIRE* professional help to fix.

When converting it to personal use, I have to "dispose" of all the associated things that were depreciating.

No, that's wrong (in a sense). You don't "dispose" of anything. All assets are converted to personal use and depreciation stops on the date of conversion. But the assets remain on the tax return *FOREVER* if you intend to convert it back to a rental. Just keep in mind you can't use TurboTax when you convert it back to a rental, because the program is incapable of doing the math correctly. The program will incorrectly (and uncorrectably) assume depreciation stopped on Dec 31 of the year prior.

So the bottom line is, if you wish to continue using the TurboTax program in future years and you intend to rent the property out again in 2020, then do not under any circumstances convert the property to personal use.  Instead, leave it classified as a rental and *ONLY* if you *REALLY* have personal use days, just tell the program the property was NOT rented the whole year and follow the prompts from there to enter the number of days rented, and number of days of personal use. That way, the program will not only correctly figure the depreciation allowed for 2019, it will also correctly  pick up where depreciation left off, when you report days of personal use and days rented on your 2020 return.

When it comes to our Refinancing Fees, the program is asking what to do with the remaining $5k of refinance fees, whether to (a) transfer to Other Expenses for the rental or (b) I'll enter them myself later/I refinanced with the same lender.

If you refinanced the property, assuming you will "in fact" leave it classified as a rental, here's how the refinancing fees work.

 - If you refinanced with the same lender the remaining fees on the original loan are added to the fees of the new loan, and that total is amortized (not capitalized) and deducted (not depreciated) over the life of the new loan.

 - If you refinanced with a different lender, then the refinancing fees of the old loan are fully deductible as an expense in the year of the refi. Then the fees on the new loan are amortized and deducted over the life of the new loan.

Now another thing about refinancing rental property that matters also. If you refinanced for the balance on the original loan and nothing more, then your mortgage interest on that new loan is fully deductible.

However, if you refinanced for more than what you owed on the original loan and "cashed out" that changes things. (with exceptions discussed below). You can only deduct the percentage of interest on the new loan that equals the percentage of the new loan amount that paid off the old loan.  For example:

If you owed $50K on the old loan and refi'd for $100K taking a "cash out" of 50K for your wallet, that means only 50% of the new loan is for the rental, while the other 50% went to you wallet. Therefore, only 50% of the mortgage interest paid is deductible on the SCH E (every year for the life of the new loan). Now for the exception.

Same scenario as above where you "cashed out" $50K. However, you used that entire cash out amount for maintenance, repairs and property improvements on that rental, and "ONLY" on that rental property.  In this scenario, the mortgage interest paid is fully deductible on SCH E.

I know the fees are normally amortized over the life of the loan and you can expense them if you re-fi to another lender, but should I be expensing them when I convert the property to personal use?

I strongly encourage and recommend that you do "NOT" convert the property to personal use. Another thing that happens if you do, is that "NOTHING" concerning your refi will be a SCH E expense if the closing date on the refi occured after the date of conversion to personal use. Just don't go there, as all you're doing is creating a headache for your future sell that no amount of Excedrin will make better.

[tagteam]

With respect to "personal use", you would not count any day that you spend working substantially full time repairing and maintaining (not improving) your property.

See https://www.irs.gov/publications/p527#en_US_2019_publink1000219188

[canyak]

I have read that, but most of our time was spent on “improving” (replacing a linoleum bathroom floor with a radiant heat system and marble tile mosaic flooring). They specifically say “not improving”. When you dig further into it, the reasoning seems to be more about making you depreciate improvements instead of expensing them. I don’t understand why they put that under whether your time is personal use or not, but they did. I had planned to de minimus expense the cost anyway, not depreciate it, but the way they wrote it led me to believe the time spent had to be counted as personal use. 

[tagteam]

---

@canyak wrote:

....I don’t understand why they put that under whether your time is personal use or not, but they did.....

---

That is derived from the Proposed Reg (1.280A-1(e)(4) - see link below) which only makes mention of "repairs and maintenance". If you read the entire section closely, it appears as if they are more concerned with the amount of time spent (e.g., 8 hours or 2/3 of the time on the property) than the actual nature of the work.

https://www.bradfordtaxinstitute.com/Endnotes/Prop_Reg_1_280A-1e.pdf

[Carl]

There is a clear difference between property improvements, and other types of rental expenses. The line is "VERY" clear.

Property improvement. To be classified as a property improvement, two criteria must be met.

1) The improvement must become "a physical part of" the property. This would without doubt include everything you did with the bathroom floor.

2) The improvement must add "real" value to the property. In other words, when appraised by a qualified, licensed property appraiser they will appraise the property at a higher value with the improvement, than they would have without it.

So property improvements add value to the property, regardless of the status of the property at the time of the improvement. So it does not matter if the property was personal use or rental use at the time of the improvement. It *STILL* adds "REAL" value to the property.

Property improvements are capitalized and depreciated over time with depreciation starting on the date it was placed in service, which could be months or even years after the work was actually done and paid for.

Rental expenses are only deductible if incurred while the property was classified as a rental. Expenses incurred while the property was not classified as a rental are just flat out not deductible; not one single penny.

[tagteam]

I agree that the flooring would be considered an improvement but disagree as to the criteria stated which, according to the IRS, is as follows:

Improvements.

You must capitalize any expense you pay to improve your rental property. An expense is for an improvement if it results in a betterment to your property, restores your property, or adapts your property to a new or different use.

Betterments.

Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property.

Restoration.

Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.

Adaptation.

Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property.

https://www.irs.gov/publications/p527#en_US_2019_publink1000219015

[Carl]

All four of those meet the requirements of a property improvement that is capitalized and depreciated. No need to potentially confuse the issue really, by breaking down every little tidbit.

[tagteam]

The stated criteria are directly from an IRS publication rather than having been concocted and restated in a purported effort to simplify them but simplifying to the point of being factually inaccurate (e.g., there is no requirement that an improvement must add "real" value).