Reporting assets for depreciation when a new rental property was built on the site of an old rental property

[tracy_roberts]

We had a rental property for 15 years that we demolished and built a new house and ADU on the same site.  So how do I stop the depreciation on the old property and add in the "improvements" which is the new build?

The old property was demolished Jan 2022 and we finished the new house June 2023 and rented it right away (long term rental).  The ADU wasn't finished until 2024 and is operated as a short term rental.

Thanks.

[tagteam]

You can convert the property to personal use to stop depreciation and then add.

I'm going to page @AmeliesUncle for input on the ADU, et al.. Please check back.

[AmeliesUncle]

Do you have separate costs for the construction?  If so, just treat it as a completely separate rental property and use the cost for the construction.

Is the ADU a separate building?   Generally, a short-term term rental is usually depreciated over 39 years (long-term rental buildings are usually depreciated over 27.5 years; you may need to tell TurboTax it is a Commercial property to get it to use 39 years).  If it is the same building as the long-term rental, it gets a bit more tricky and perhaps the entire building may need to be depreciated over 39 years.

[tracy_roberts]

Thanks for your answer.  So basically I convert the existing rental to personal property and then add 2 new rental property assets - the house and the ADU separately using the cost of construction of each unit as the asset cost.

The ADU is separate but it may not always be a short term rental.  What about the scenario that it's sometimes a short term and sometimes a long term rental?  Couldn't I depreciate over 27.5 years in that case?

[tagteam]

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@tracy_roberts wrote:

Couldn't I depreciate over 27.5 years in that case?

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I'm not sure whether @AmeliesUncle and I disagree on this issue, but I would depreciate the building over 27.5 years since it is residential rental real estate. I don't believe the length of the rental period, alone, is controlling for the purposes of the recovery period.

I do believe that providing significant services, such as daily maid services, meals, and the like, is controlling in this instance. In other words, if you're operating like a hotel (e.g., bed & breakfast), then it becomes commercial real estate, and the recovery period is 39 years. In that case, the property is reported on Schedule C.

[AmeliesUncle]

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@tagteam wrote:

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I don't believe the length of the rental period, alone, is controlling for the purposes of the recovery period.

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The definition for a "dwelling unit" for a Residential Rental Property (27.5 years) at §168(e)(2)(A)(ii) includes this requirement:  "does not include a unit in a hotel, motel, or other establishment more than one-half of the units in which are used on a transient basis".  

Rulings say a short-term rental (30 days or less ... or is it "less than 30 days"?) are "transient".  Therefore it is not Residential Rental Property.

EDIT:  But you do have a point:  It needs to meet the 80% rule from "dwelling units".  Hypothetically, the long-term rental could still provide over 80% of the income, which would qualify the entire building as Residential Rental Property.  But if the short-term rental provides over 20%, the entire building would be Nonresidential Real Property.

[tagteam]

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@AmeliesUncle wrote:
....."does not include a unit in a hotel, motel, or other establishment more than one-half of the units in which are used on a transient basis".  

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I understand and we've had this discussion previously (I believe) and I do not disagree with the definition of transient.

I do, however, take issue with the term "other establishment" because it's ambiguous. I believe the intent was to envelop "units" in "commercial" structures of any type that are simply other than "hotels" and "motels". Examples would be something similar to truck stops with rooms for sleeping, boarding houses, and even typical bed and breakfasts run out of single-family homes.

I do not believe that the intent was to include the likes of single-family homes and condos that are rented with absolutely no services provided. "Establishment" smacks of a business enterprise the income from which would properly be reported on Schedule C and the real estate structure using a 39-year recovery period.

[tagteam]

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@AmeliesUncle wrote: 

But if the short-term rental provides over 20%, the entire building would be Nonresidential Real Property.

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I live in SWFL and have for years. I have owned what would be considered short-term rental properties of various types (primarily condos and houses). 

I also know absolutely gobs of lawyers (down here) who are familiar with tax law, CPAs, and just general tax accountants and none of them use a 39-year recovery period for the rentals (theirs or their clients) unless services are provided (and then the rental is reported on Schedule C as a business).

I really doubt whether the IRS would get tweaked about this particular scenario anyway and, apparently, they haven't thus far (i.e., where are the tax court cases, PLRs, etc.?). Let's face it; Section 469 and the Regulations promulgated thereunder are an absolute mess, put together like a patchwork quilt, particularly with regard to this subject and I would bet the IRS doesn't want any part in litigating 27.5 v 39. 

[AmeliesUncle]

Offhand, I don't have any authoritative citations.  But Googling it (something like short-term vacation home 27.5 or 39 years) will show you that MANY places say 39 years, including such websites as AIPCA, NATP, Kiplinger, Forbes and more.  Although admittedly some were just generically taking about short-term rentals, and maybe not specifically referring to a single unit.

I didn't spent much time looking, but at first glance I couldn't find any website that was arguing for a 27.5 year Recovery Period.

[tagteam]

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@AmeliesUncle wrote:

....some were just generically taking about short-term rentals, and maybe not specifically referring to a single unit.

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I suspect that is the difference. There are, in fact, entire buildings with multiple units that are individually owned, but have central management, and do, indeed, provide substantial services (e.g., daily maid service, concierge, staffed front desk, et al).

Also, many offer not just monthly or weekly rentals, but weekend and even daily rentals (so some actually function like a hotel). I believe there is a world of difference between that scenario and an individual owner of a condo or single-family home renting on a short-term basis but providing virtually no services to the renters thereof.