I bought a Rental Property in November 2021. Before the tenant moved in I did repairs, installed new flooring and bought a new washer and dryer. She did not start paying rent until January 1st 2022.
Can I deduct the repairs and treat the flooring as capital expenses? If so what year? If not do I increase the cost basis of the house?
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Repairs done to prepare the property for rent for the very first time are not deductible. But don't confuse repairs with capital improvements. A capital improvement (such as new flooring) adds or maintains the value of the property. Capital improvements get depreciated over time. Regardless of when you may have paid for the improvement, depreciation starts on the date the improvement was placed "in service". In your case, depreciation starts on the date the property was "available for rent", which I'm fairly confident was before Jan 1, 2022. The below guidance should help to clarify quite a bit for you. But still feel free to ask questions if you need additional clarification or help with anything.
Rental Property Dates & Numbers That Matter.
Date of Conversion - If this was your primary residence or 2nd home before, then this date is the day AFTER you moved out, or the date you decided to lease the property – whichever is later.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter was contracted to move in, and/or "could" have moved in. That would be your "in service" date or after if you were asked for that. Vacant periods between renters do not count for actual days rented. Please see IRS Publication927 page 17 at https://www.irs.gov/pub/irs-pdf/p527.pdf#en_US_2020_publink1000219175 Read the “Example” in the third column.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days you lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence, 2nd home, or any other personal use reasons after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.
RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED
Property Improvement.
Property improvements are expenses you incur that Improve, restore, or otherwise “better” the property. Basically, they retain or add value to the property.
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. An example of a pre-existing condition or defect in this context would be something such as foundation repair (slab jacking) or some other, hidden and costly, anomaly.
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. Adding a wheelchair ramp would be an example.
Expenses for these types of costs 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 need to 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 instead of capitalizing and depreciating them, 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 3rd 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.
Carl, thank you very much. I bought this as a rental, so the day I closed it became available for rent. I actually had the renter identified before buying. I see that I can make the flooring and the Washer/Dryer as capital improvements, but I can't deduct the painting as it is not a capitol improvement.
Do I have that correct?
Yes, the painting is a rental expense not an improvement.
Generally, painting is not a property improvement. It's just a maintenance expense. See the "Additional Clarifications" in my earlier post for more insight on that.
But can I deduct painting that was done before I have collected rent?
can I deduct painting that was done before I have collected rent?
The date you are actually paid the rent is not relevant. Understand that the property is "in service" on the first day a renter "could" have moved in. Generally, that is the day you put the "for rent" sign in the front yard. Doesn't matter if it takes you three months to get a renter either.
Expenses incurred while the property is in service are deductible. So if you claim the painting costs, which is a maintenance expense and you get audited on it, all you have to do is prove the property was in service, and you're fine. Generally, your chances of getting audited on something like that are extremely slim. But not zero.
Now here's my opinion on this, and keep in mind we all know what opinions are like in the sense they hold no weight in legal matters.
It's perfectly feasible to paint the outside of a house while it's in service, and even if there's actually a renter living in it at the time.
Whereas if painting the inside of a house, if vacant at the time, if I was an auditing agent for the IRS you'd have to convince me somehow the house was move in ready without painting. Overall, I would not expect that to be to difficult. This would be a hard call for me personally though, because I'm not well versed in the legal arguments if any, the IRS may use to disallow the expense.
For me, (and this is just me personally) if I doubted the legality of my expense and I could not get a firm commitment backed up with something in writing from a tax professional, I would not claim the expense.
Remember the three golden rules when dealing with the IRS:
1) You are guilty until proven innocent.
2) The burden of proof lies on the accused (that would be you!) and not the accuser.
3) If it's not in writing, then it flat out did not occur.
So I currently live in a condo that I owned since 2014, I planned to rent it out in March 2024 since we are going overseas. Would replacing my Fridge and Washer/Dryer in Jan/Feb 2024 be considered a capital improvement since I am getting ready to rent it?
Would replacing my Fridge and Washer/Dryer in Jan/Feb 2024 be considered a capital improvement since I am getting ready to rent it?
Yes. However, if the item(s) cost less than $2,500 you have a choice. You can capitalize it and depreciate it (5 years for appliances I think), or you can just expense it if the asset was purchased new and placed into service with no personal use.
Now for something like a fridge/washer/dryer, you will of course, purchase/install those before you leave. If your use of them will be something reasonable (maybe less than 30 days?) before you depart and convert to a rental, I would treat the asset as "purchased new" so that I could just expense it and not have to deal with the potential issues that can be caused by capitalizing/depreciating it. Especially considering the fact you're going to be "out of area" (overseas) and will most likely be relying (I'm guessing) on a rental management company to manage the property for you.
To be safe, I would go ahead and purchase them, but not install them for use until it was as close to my move out date as reasonably possible, if not on the date of my actual move out. That way, there's no questioning they were purchased as a business asset for the rental since they were not installed and placed in service until I moved out.
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