rental property depreciation

[Missy008]

on a multi family unit I have one unit that I now use as second home and the other unit is rented.  Do I adjust the asset depreciation that I have been reporting each year.

[Carl]

Under no circumstances and with no exceptions will you ever change anything on any asset that was entered prior to the tax year being reported (which is 2020 at this time). Changing anything on that asset in the assets/depreciation section will totally skew the depreciation history on that asset. How you deal with your specific situation depends on what your specific situation is, and how things were reported in the past.

I need some history here to understand what was done in the past, so we can do things right going forward.

-Were both units rented in the past?

-Did you report each unit as a physically separate property? Or as a single unit multi-family property?

- Assuming both units were rented in the past, on what date in 2020 did you convert one of the units from being a rental property, to being your primary residence? Typically, this is one day after the last renter moved out, or the date you decided to stop trying to rent it - whichever is later.

[Missy008]

Hi Carl

Yes both units were rented in the past we purchased the property in 2014 .  We reported it as a multi family unit. There are two units one is 3 bedroom and the other is 1 bedroom. Due to the problems with COVID when the renters left the 3 bedroom unit in December 2020 we started using that unit as a second home to be near family members. 

[Carl]

There are several ways this can be done. No matter which way you do it, there's going to be some manual math on your part. So I'm going to cover the method that will be easiest with TurboTax. This is going to involve converting the entire property to personal use, effective one day after the renter moved out of the 3-bedroom unit. Then you figure the adjusted cost basis of the 1-bedroom unit and place it in service as a completely new rental property, converting only that one unit back to a rental one day after everything was converted to personal use. For the purpose of detail here, I'm going to assume the renter moved out of the 3-bedroom unit on Jun 31, 2020 since you didn't provide a date. You'll have to adjust the math accordingly.

Step 1 - Convert the entire property to personal use with an effective date of 7/1/2020. As you start working through the rental section, make sure you select the option for "I converted this property from a rental to personal use in 2020".

DO NOT select the option to let the program do the splits for you. You will do all splits manually. If you let the program do the splits for you, then it will split between SCH E for the period of time it was a rental, and SCH A for the period of time it was personal use. Since we're only converting one unit back to a rental, the program just flat out will not be able to figure the math and do the splits correctly for you. Therefore, you must do the splits for Mortgage Interest and property taxes manually, and you will have to pro-rate the property insurance manually.

Next, work through rental income entering only the rental income received up to the date of conversion. (7/1/2020 in my scenario).

Next, work through the rental expenses section and only enter those expenses incurred up to 7/1/2020.This will require you to manually determine the amount of property taxes and mortgage interest to claim in the rental expenses section, as well as the pro-rated portion of the property insurance that you claim. For those three if you figure 1/12 for each month the entire property was classified as a rental in 2020, that should be simple. For example, if you paid $1,200 for insurance and the property was converted to personal use on 7/1/2020, then you get to claim 6/12 of that insurance as a rental expense.

For the math, thats 8.25% per month. So .0825 times 1200 equals 100 per month. For six months (in my scenaro) thats $600 you can claim on the SCH E for property insurance.

Next, work through the assets/deprecation section and you must do the below for each individual asset listed. (Please let me know if you have more than one asset listed)

- As you work through each asset, write down the amount in the "prior depr" box.I am also assuming that the "Asset Type" for all assets listed is "I - Residental Rental Real Estate". If one is different, then I need to know what the asset type is. (May or may not matter when setting up the "new" rental property.)

- Select YES on the screen for "I stopped using this asset in 2020".

- Yes, the property was rented all year. (The program "knows" to stop depreciation on your converstion date, entered later.)

- On the screen that ask for the disposition/sale date, enter a date one day after the last renter moved out of the 3-bedroom (7/1/2020 in my scenario)

- On the "Special Handling Required?" screen you *must* select YES. If you select NO you will be "forced" to enter sales data. You did not sell the property. So select YES.

- On the last screen for this specific asset write down the depreciation for the current (2020) tax year.

- Add that depreciation to the prior depr amount, and that total is the amount of depreciation taken on this specific asset from the date it was placed in service, up to the date you converted it to personal use. You will need this number later.

- Continue working through the asset to the end.

Note you must do all three items above for each and every asset listed. Once all assets have been converted to personal use, click DONE to leave the assets/depreciation section.

If you  claimed any vehicle use for this rental, then you must also work through the "Vehicle Expenses" section, and remove the vehicle from the business. You can show it removed for personal use, and that's fine.

Once all the above is done, then we need to enter a completely new rental property that consists of only the 1-bedroom unit, with an in-service date of one day after you converted it to personal use. We'll get into those details once you've done the above, any questions you may have are answered, and you're comfort level is such that you're ready to move on.

[Missy008]

Hello Carl 

I apologize I have not gotten back to you.  I am having difficulty signing in. 

What is my next step 

Have a question why on the 2021 turbo tax software shows you can indicate you are living in one of the multi units

Thank you for your help

Missy08

[Carl]

why on the 2021 turbo tax software shows you can indicate you are living in one of the multi units

Clarification: You are not using TurboTax 2021. That software does not yet exist and will not be released until Dec 2021 at the earliest. You are using TurboTax 2020.

That's one way you can enter this as an entirely new property. You can enter it as a multi-family unit where you are living in one of the units. But your in service date would be one day after you converted the entire property to personal use. However, I don't recommend you do it this way, because if you later convert the 3-bedroom back to a rental in the future, you'll have to jump through the same hoops you're jumping through right now.

-First, you need to figure what percentage of the total depreciation taken on the property applies to the 1-bedroom that was still rented out. So figure what percentage of the total floor space of the entire structure is the 1-bedroom unit. For the sake of making the math simple, I"m going to pick a percentage out of thin air, and say that the 1-bedroom unit occupies 35% of the total floor space of the structure.

- Next, multiply the total depreciation taken (which you totaled up and wrote down earlier) by the percentage of floor space the 1-bedroom occupies, to get the total amount of prior depreciation that applies to the 1-bedroom. Write that figure down and label it "1-bedroom depreciation taken".

- Next, look at your cost basis in the entire structure, and multiply that by by the percentage of floor space the 1-bedroom occupies. This gives you your "temporary" cost basis of the 1-bedroom unit.

- Subtract the amount labeled "1-bedroom depreciation taken" from this temporary cost basis for the 1-bedroom unit. This is your new cost basis for the one bedroom unit. Write that down and label it "1-bedroom cost".

- Now multiply the "cost of land" by that same percentage. Write down the answer and label it "cost of land 1-bedroom unit"

- Now in the Rental & Royalty Income (SCH E) section of the program elect to add another rental and fill in the details for that specific unit. The in service date for the 1-bedroom unit will be one day "AFTER" you converted the entire structure to personal use.

- Your COST will be the amount you wrote down and labeled "1-bedroom cost".

- Your COST OF LAND will be the amount you wrote down and labeled "cost of land 1-bedroom unit"

- Day rented: THE WHOLE YEAR

- Days of personal use:  **********ZERO*********** (if asked for that, I expect you won't be asked this.)

For the property taxes and mortgage interest amounts you can claim, the math will be as follows:

- Total paid in property taxes, divided by 12.

- Multiply that answer by the number of months the 1-bedroom is in service. Since you placed this asset in service in Dec (I assume) you'll only be multiplying by the digit one.

- Now multiply that answer by the percentage of floor space occupied by the 1-bedroom unit. The answer is the amount of property taxes you can claim on this 1-bedroom for the month of December. 

- Subtract that amount from the amount of property taxes reported on the SCH A.

Do the above for mortgage interest, by simply replacing the word "tax" in all it's forms, with "mortgage interest".

For rental expenses, you only claim those expenses incurred for the 1-bedroom in the month of December.

For rental income, you only report the amount of rental income received in December.

Finally, keep the paperwork with all your math. *YOU WILL NEED IT* in the future when any one of three things happens in your lfe.

1) You sell the property

2) You convert the 3-bedroom back to a rental

3) You die. (Your heirs will need this information for proper tax reporting on your final tax return and/or estate tax return.)

[Anonymous]

According to Carl, will the new basis for the unit that continues to be rented will start over at 27.5 years? Also will the acquired/purchase date for this "new" property start on the day you make the conversion?

[Carl]

will start over at 27.5 years?

Absolutely. It's starts over with the new adjusted cost basis with 2020 being year 1 of the next 27.5 years.

Also will the acquired/purchase date for this "new" property start on the day you make the conversion?

The acquisition date and the conversion date are two completely separate things. Your acquisition/purchase date will never change for any reason. Not ever. The date you convert it from personal use back to a rental will be the date in 2020 that is the first day a rental "could" have moved in. Depreciation starts on the date of conversion, and has nothing to do with the date of purchase/acquisition.