Returning rental to owner after having made some Leasehold improvements

[pbmunkey]

I rented a home from someone and rented it out on Airbnb. I spent money putting in a new kitchen and driveway and have not fully captured the depreciation on the renovations. I returned the home to the owner in 2021 and walked away from the business. I would like to capture my entire depreciation. Would I dispose of this asset as a sale with a value of $0?

[JillS56]

As a renter of real property, you are not eligible to take depreciation on the renovations you made to this property.  Even if you were the owner of the property, you would not be able to take full depreciation of the renovations in one year. Depreciation is an accounting method that spreads the cost of an asset over its expected useful life.

To take depreciation on property it must meet all the following requirements:

1. It must be property you own.
2. It must be used in a business or income-producing activity.
3. It must have a determinable useful life.
4. It must be expected to last more than one year.
5. It must not be excepted property. Excepted property (as described in Publication 946, How to Depreciate Property) includes certain intangible property, certain term interests, equipment used to build capital improvements, and property placed in service and disposed of in the same year.

Even if you owned the property you could not accelerate the depreciation to take it all in one year unless the property is eligible for Section 179 treatment. Section 179 can only be taken in the taxable year you place the qualifying property in service.  Real Property does not qualify for the Section 179 Deduction. Real Property is typically defined as land, buildings, permanent structures, and the components of the permanent structures (including improvements not specifically covered on the qualifying property page).

Topic 704 Depreciation

Non-Qualifying Property for Section 179

You asked the question:  Would I dispose of this asset as a sale with a value of $0?  You have no asset to dispose of.  

[pbmunkey]

I rented it from the landlord in 2019 and did the renovations then. I returned the house in 2021. If I’m not able to depreciate the renovations, what was the proper way to write it off?

[JillS56]

Since you are not the owner of the property, you cannot write off the cost of the renovations.  You must be the owner of the property in order to depreciate or write off the cost of the renovations.   

[pbmunkey]

Sorry for sounding ignorant but it seems what I’m interpreting is that as a business that put out money for this expense, I have no way of writing it off? 

[ThomasM125]

You are correct, you have no way of writing off the undepreciated cost of the improvements.

You deducted the portion of the cost of the improvements that were applicable to the time you rented the property, for which there is some ambiguity as to whether that was allowable. The rest, or undepreciated, portion of the improvements were then returned to the owner so they are no longer deductible by you since you don't rent the property out anymore.

If you had owned the property you could write off the rest of the cost of the improvements against the sale proceeds when you sold the house. But since you are not the owner, you can't to that.

On a side note, the owner of the property should record the value of the improvements as rent income, but that is not your concern. 

@pbmunkey

[AmeliesUncle · Accepted solution]

The other answers are wrong.

Yes, you were able to depreciate your Leasehold Improvements.

Yes, you can write of the rest of the amount in the year that you abandon them.  

EDIT:  I think this next paragraph is incorrect for this situation; See comment later.

However, if you enter a sale price of $0, the program will treat it as a capital loss.  But in the case of abandoning a Leasehold Improvement like you did, it should be a an "ordinary" loss (which is better for you).  I strongly suspect that TurboTax is not set up for that.  If that is the case, a work-around might be to first go to the rental section and say you converted that "asset" to personal use (that will keep the correct depreciation for the year).  Then enter the sale in the "Sale of Business Property" section, but when you enter the purchase/placed-in-service date, enter a fictitious date that is less than one year before it was sold (which will then treat it as an "ordinary" loss rather than a "capital" loss).

[pbmunkey]

So I have to report a profit even though I'm actually at a loss? One other member posted saying that your answer is incorrect. Is there an article or publication to further explain your answer?

[Carl]

As a renter of real property, you are not eligible to take depreciation on the renovations you made to this property.

That statement as worded is not quite accurate.Leasehold improvements to the structure are generally capitalzed over 15 years. Once the lease  ends, the improvements generally belong to the landlord, unless otherwise specified in the agreement. If the tenant is able to take them, they must remove them without any damage to the property. 

A capitalized leasehold improvement under GAAP is amortized over the lesser of the remaining useful life or the remaining term of the lease if more than 1 year.

[AmeliesUncle]

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After thinking about it, the last section of my last comment about "capital" versus "ordinary" may be wrong in your situation (I shouldn't be answering questions right before going to bed).

Because the improvements are being transferred to the landlord, I don't think that is considered an "abandonment", therefore entering $0 as the sale price for a capital loss would be the correct method.

[pbmunkey]

I tried asking this same question here: https://ttlc.intuit.com/community/self-employed-group/discussion/re-writing-off-leasehold-improvemen... and it seems like every turbotax employee is adamant that I cannot depreciate my leasehold improvements because I dont own the property. Do you have any article/publications to reference your recommendation?

[Carl]

it seems like every turbotax employee is adamant that I cannot depreciate my leasehold improvements

Probably because you're calling them "leasehold improvements" instead of "Qualified Improvement Property (QIP)" which is how it's addressed in the IRS Pubs.

I think your improvements would be more clearly classified as QIP (Qualified Improvement Property) which is depreciated over 15 years, or the terms of the lease to included projected renewals.  The only thing I can find in IRS publication 946 is the definition of leasehold improvements. It says nothing about reporting them. But Qualified Improvement Property is addressed in the pub.

Additionally, the TTX program does have a selection for QIP and the default depreciation on that is 15 years as I would expect.

I suggest you take a l;ook at Pub 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf and read all you can about QIP. Also, quit using the term  "Leasehold Improvements" and start using "Qualified Improvement Property" once you make a determination that's what you have. You need to read the pubs, because not everything we think qualifies as QIP, actually does.

[AmeliesUncle]

While you don't own the original building and land, you DO own the improvements that you made.

I'll point you to the actual law itself - Regulation §1.167(a)-4:

§ 1.167(a)-4 Leased property.

(a) In general. Capital expenditures made by either a lessee or lessor for the erection of a building or for other permanent improvements on leased property are recovered by the lessee or lessor under the provisions of the Internal Revenue Code (Code) applicable to the cost recovery of the building or improvements, if subject to depreciation or amortization, without regard to the period of the lease. For example, if the building or improvement is property to which section 168 applies, the lessee or lessor determines the depreciation deduction for the building or improvement under section 168.

https://www.law.cornell.edu/cfr/text/26/1.167(a)-4

[AmeliesUncle]

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@Carl wrote:

I think your improvements would be more clearly classified as QIP (Qualified Improvement Property) which is depreciated over 15 years

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Carl, it is probably not Qualified Improvement Property.   If this is a Residential Property on Schedule E, it would not be QIP.  And the driveway is not part of the internal part of the building, so that would not be QIP either.

[Carl]

Carl, it is probably not Qualified Improvement Property.

I myself can't rule it out as a possibility, based on the first sentence in the original post. "I rented a home from someone and rented it out on Airbnb." 

At this point, I highly recommend professional help; especially if their state taxes personal income.