Rental property converted back to primary residence after two failed sales

[jsm_tt25]

Hello Experts,

I have (had) a rental property (last tenants lease ended 3/31/24) that I decided to sell.  I did some work on the house to prep it for sale and listed it for sale on April 18, 2024.  I received two offers but both fell through for various reasons. After the second sale fell through I decided to move back in (September 5, 2024) and make it my primary residence again.   Here are my questions:

1.  When does the rental depreciation stop, 4/1/24 (after lease ended) or 4/18/24 when it was listed for sale or 9/5/24 when I moved back in (Pub 527 Idle Property and Retired from Service)

2. Can I deduct any expenses related to the sale prep since it never sold, would it still have been considered a rental during that time (Pub 527 Vacant while listed for sale)?  

3. I received due diligence money with each sale offer which the prospective buyers had to forfeit.  Is that money considered ordinary income or capital gains?

Thank you!

[MindyB]

The rental depreciation should stop on the day you decide to convert the investment property into a primary residence. ‌The date of move-in (9/5/24) is likely after the decision was made to cease seeking a buyer. 

Yes, you can deduct the expenses related to the sale preparation as it was still considered an investment property at that time. Keep in mind these expenses may be limited because of passive activity loss rules, and the fact that the property wasn't disposed of. ‌If you are in the situation where you have losses, I would suggest reviewing this article: IRS Form 8582: Calculating Passive Activity Losses for Real Estate.

The receipt of due diligence money is considered ordinary income. For this to be reportable as a capital gain on Schedule D, the rental home would need to be a capital asset. ‌The IRS specifically excludes depreciable property from its definition of a capital asset in Section 1221(a)(2). In order to report this in TurboTax, navigate to Federal; Wages & Income. Scroll to the bottom of the page and choose Less Common Income. Lastly, choose Other Reportable Income, then enter a brief description and the amount.

[jsm_tt25]

Thank you very much Mindy, that was very helpful!

I have another question related to the depreciation of remaining finance fees.  

-2012 refinanced GMAC loan with GMAC: When I edit this asset to indicate i have converted to personal use it states I have $474 of refinance fees from my prior loan which can be used as an expense this year as long as the new loan was not with the same bank.  What do I do with the $474 since the refi was with the same bank as the original loan?  

-2015 I refinanced the loan (GMAC became Ocwen) with Capital One. When I edit this asset do the remaining refi fees get used as an expense since it was a different bank?  

Here are the instructions from TurboTax:

Remaining Refinance Fees with the Same Lender

Charges paid by a borrower to get a mortgage refinance for a rental must be amortized over the life of the loan. In the year you refinance to a new loan (and retire the prior loan), any existing refinance fees from any prior refinances become an expense unless the mortgage is financed with the same lender. If you used the same lender for the refinance, the unamortized fees on the first loan must be deducted over the term of the new loan.

How Do I Do This in TurboTax?

Points and other mortgage refinance fees are entered in the same area of interview where you track the depreciation of your rental property, or rental furnishings. Go to the Asset/Depreciation topic and select the new loan fees you entered for your new loan. Add the remaining fees to the cost of the new loan fees.

Does this last statement in bold mean I add the $474 from the first refi to the second refi and then all of that amount  gets used as an expense?

Thank you!

[PatriciaV]

Yes. The remaining unamortized fees are assigned to the new loan (with the same lender). If you paid refinance fees for the new loan, add the balance from the old loan to the new fees. Amortization will be calculated on the total and is reported as an expense each year.

[jsm_tt25]

Thank you Patricia. 

I'm sorry but I still don't know exactly how to handle this. Let me try and spell it out a little differently:

Home purchased 2006, converted to a rental 2010, converted back to primary residence 2024

Refi #1 2012 (original loan with GMAC and refi'd with GMAC)-TurboTax indicates I have $474 of refinance fees from prior loan (Refi cost =$807, Prior deprec = $317, $16 deprec for 2024)

Refi#2 2015 (refi'd with Capital One)-TurboTax indicates I have $1201 of refinance fees from prior loan (Refi cost = $1738, Prior deprc = $503, $34 deprec for 2024)

In both cases I have the option to choose 1. "Transfer these fees for me to Other Expenses" or  2. "I'll enter these fees on my own later/I refinanced with the same lender. 

What do I choose for Refi #1?

What do I choose for Refi#2? 

What, if anything, from refi #1 gets added to refi #2 and which of those numbers specifically gets added together?

Thank you so much for the help!  This is the first time I have gone through this process.

[DianeW777]

The first refinanced loan was with the same lender so you have calculated the appropriate amortization assuming you stopped it in August.

• If a mortgage loan is refinanced with the same lender, any remaining points must be added to the points on the new loan if applicable, then divided by the loan term to determine the monthly amount you can deduct.  If there is a full year of mortgage payments then it would be 12 months deduction as points. For the first year it would be the number of months remaining in the year beginning with the first month payments begin and ending in December of that year.  

The second refinance was with a different lender and you were allowed to deduct the remaining points for the previous loan in the year of refinance. In your example $1,201 was allowed to be deducted in 2015. A new amortization would have occurred with the new lender for any points on that loan if applicable (Capitol One).

• When a mortgage loan is refinanced and it is with a different lender, then any remaining points that have not been deducted under the first lender can be deducted in the year of refinance.

For the tax return for this year.  

1. Stop the amortization as of August 31st.
2. The remainder is not deductible because it is no longer a rental property.
3. Indicate the property was converted from rental to personal use. This will eliminate any sales questions.
4. You could choose to capture the $1201 for 2024 with an accounting change using Form 3115 specifically for the amount of $1,201 that was not yet used due to the refinance with another lender.  It must be reduced for any amount of depreciation on that amount alone that has been used from 2015-2023. See below.
5. No deduction is allowed for the remainder of the amortization on the rental activity after August, 2024.

Next, for the prior amortization you have not used of the $1,201.  

• You can use the following form to correct the depreciation for your rental property. Take any amount not previously expensed on prior returns, as an expense on the current year tax return as 'Other Expenses'.

Form 3115 Instruction: By including this with the current year tax return, you can complete everything on the 2024 tax return.

• Adopt a change in accounting method: This option allows you to go back as far as you need. Make the adjustment on your current year tax return to expense the missing amortization.
  • Why am I adopting a change in accounting method? Not claiming amortization in two or more years indicates that you've chosen an accounting method without allowed amortization. In this case, you must now elect to change your accounting method to include amortization expense.
• You must use the TurboTax Desktop ‌ to complete this form. TurboTax doesn't help you with this form. And your return must be mailed because this form is not supported through e-file.

This must be completed and filed with the return on time.

You can change to TurboTax Desktop if you choose.

• How to switch from TurboTax Online to TurboTax Desktop?