Renovation Between Tenants

[pmkwong]

My first tenants moved out near the beginning of the year. We renovated the house for a few months before a second set of tenants moved in within the same year. Can we claim that the house was a rental for 100% of the year per IRS rules? Will I be able to write off the expenses (either as expenses or add to basis of the house) on the improvements made during the time of renovation when there were no tenants?

[PattiF · Accepted solution]

Yes, you can claim that the house was a rental all year. And you are definitely able to write off all of your expenses for the renovations (as either expenses or depreciable improvements). It is considered to be a rental all year even if it was not rented for the entire year.

[Carl]

When it comes to the "day count" for the number of days rented, in the first year a rental property is rented that day count starts on the first day a renter "could" have moved in.

After that, vacant periods between renters also counts for "days rented", provided you did not utilize the property for any type of "personal pleasure" use (including using it as your primary or 2nd home) during that period of vacancy.

So in your case, the property was rented every day, or for the entire tax year in 2020. All of your rental expenses are deductible. But one thing I want to point out.

We renovated the house

Your renovations are more than likely not "expenses" per-se. But are property improvements.  Property improvements aren't "deducted" in the traditional sense as other rental expenses are. They get capitalized and depreciated over time. So those expenses for your "renovations" that are property improvements get entered in the assets/depreciation section and depreciated over time.  The definition of property improvement versus rental expense is below.

RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that “better” the property. Basically, they retain or 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 retain or 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.

There are rules that allow you to just flat-out expense and deduct some property improvements, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.

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.

[Anonymous_]

I would respectfully suggest using the following for classification as a repair or improvement.

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.

See https://www.irs.gov/publications/p527#en_US_2020_publink1000280324

[Carl]

Hey I like that! Definitely going to use it too! I do have one thing though.

include expenses for fixing a pre-existing defect or condition,

I can see how someone can quite easily confuse that with a repair, such as replacing a broken doorknob.  (like I just did.) Is there another way to word that maybe, so as to remove (or at least significantly reduce) doubt on that?  Just the word "fix" kinda seems synonymous with the word "repair" and is actually interchangeable in that statement as worded. I think that's because the "pre-existing" part doesn't specify something that was pre-existing at the time of acquisition, or at the time placed in service. I myself am not really sure in what context (for lack of a better word) that "pre-existing" is being used here. (I'm finding it really hard to explain this mental issue I'm having with it.)

[Anonymous_]

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@Carl wrote:

.....Is there another way to word that maybe, so as to remove (or at least significantly reduce) doubt on that? 

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You would have to ask the IRS since the italicized verbiage in my post was taken directly from one of their publications. 

Whenever I think of pre-existing condition or defect in this context, I think of the likes of foundation repair (slab jacking) or some other, hidden and costly, anomaly.

Also, recall that property owners do not even need to elect the de minimis safe harbor for repairs (or whatever) that cost less than $200.