Sale of vacant rental property

[dndltax]

Rented property for 10 years. 

• Ended lease September 2021
• Property vacant while being renovated from October 2021 to April 2022, when it was sold.
• Questions
  • Should I consider it converted for personal use starting January 1, 2022?  
  • OR can I still call it rental property for 2022 but note that there was no rental income, no rental expenses and include the renovation costs in the cost basis calculation?
  • Where do I include the renovation costs to the cost basis for the sold property?

[KrisD15]

No, from your explanation, the property was not converted to personal use. 

No, you can't include the renovation costs in the basis because those costs were not depreciated. 

You can report this a couple ways, as selling costs and/or separate rental assets.

The complication is this-

When you sell the rental there will most likely be two kinds of income for you to report:

"Depreciation Recapture" which is Ordinary Income

Gain (purchase price versus selling proceeds) which is capital gain. 

If the "Renovations" include things like painting, enter that amount as a "selling costs".

If there was more, such as a new roof, you may need to enter that expense as an additional asset, HOWEVER you need to do it in a way so that there is no depreciation taken on those additional assets since it wasn't an active rental at that time. 

To do that, you might need to enter it as purchased and  placed in service, on the same date as sold. (so there is no depreciation computed) 

Then allocate the sale proceeds to those assets so that there is no Capital Gain/Loss for those particular assets and you get them off the books.  

For Example, 

House purchased 300,000

Depreciation taken 100,000

Roof cost 15,000

Sold 425,000

Allocate 15,000 to the roof, leaves 410,000

Adjusted basis for depreciation recapture is 200,000, since you "expensed" 100,000, so 100,000 is Depreciation Recapture and Ordinary Income since the house did not loose value (you are paying the 100,000 back)

410,000 is applied to the original basis (300,000), so 110,000 Capital gain 

Here is a link for further discussion. 

[Carl]

No, you can't include the renovation costs in the basis because those costs were not depreciated.

That statement is a bit misleading. The cost of your property improvements does get included in the overall cost basis. However, since those improvements were never placed "in service" as a rental asset, you need to include the cost in your cost basis in a way so they will not be depreciated. Or if they are depreciated, the depreciation amount will be so minimal it won't matter.

Doing as @KrisD15 suggests and adding those property improvements to the assets/depreciation section with an "in service" date of the closing date of the sale will work just fine. With only one day in service, it's likely no depreciation will be taken. But if it is, then it will be so minimal that it really won't matter and won't make any difference to your overall bottom line tax liability.

One thing I've never checked out, is that if you place the asset in service on the closing date of the sale, and then declare 1 day of personal use on that asset, will that guarantee no depreciation is taken? I would expect it to, but don't know that for a fact.

[dndltax]

Thank you...helpful!