TurboTax Premier Seems to Lead Residential Rental Property Owner to Use Section 179, But It's An Investment

[wildcatgoal]

Transitioned my condo to a rental in Q2-ish of last year.  In Q4 of last year, I replaced the water heater in that property.  The rental property itself is already logged into TurboTax Premier (for Windows).  When adding the water heater, I go through the motions until I get to the 'How Do You Want to Deduct this Item?' page.  

It states 'Since this is the first year of business use for this asset, you may deduct its full value this year or spread the deduction over several years'.  It is my understanding that the IRS generally considers a residential rental property as an INVESTMENT, not a BUSINESS, which would preclude me from Section 179 deductions.

This is my only rental property and I make very little cash flow above mortgage, taxes, insurance, and HOA dues so there is ultimately not a great deal of so called "profit".  Still, I rent "for profit" with a 1-year full-time exclusive lease (I do not use it as an Airbnb, for example).  While I self-manage, I wouldn't think that qualifies as "working at it regularly and continuously" as I do not need to spend a great deal of time specifically with this property.  During 2023, I was on the HOA of the building in which the property was located, though, and as such I did spend, sadly, approximately 300 hours of my time dealing with building-wide HOA matters.

In addition, TurboTax, in an orange pop-up note, seems to imply that if I do the Section 179, I cannot do so in Georgia (my state).  This pop-up says 'State Section 179 (GA) should be blank. Only rental activities identified as commercial property qualify for a Section 179 deduction.  This applies to asset types A, B, D, E, F, G, and H.'  Yet in the instructions above, it states verbatim 'Do not leave this field blank.'  So what do I do here?

Can someone advise as to whether Section 179 is actually viable in my situation?  Where did TurboTax develop the impression that this residential rental is a BUSINESS instead of an INVESTMENT?

[RobertB4444]

Rental real estate is kind of in its own world, tax wise.  It's a business, it's an investment.  In your case you are the property manager and make all of the decisions about the property so you qualify for active participation even if you didn't have the hours.  And you also qualify for the 179 deduction for the new water heater.

You may not want to do it.  It will help this year but not in the next few years.  And if your profit margin on the house is narrow then the water heater may make the difference between making a profit or not.  So leaving it to depreciate over time is fine.  

But the system is correct.  You have the option.

@wildcatgoal 

[Carl]

This is my only rental property and I make very little cash flow above mortgage, taxes, insurance, and HOA dues so there is ultimately not a great deal of so called "profit".

Either your rent is high, or your mortgage, insurance, and/or property taxes are low. It is not common for long term residential rental real estate to show a profit. In fact, it's significantly more common to show a loss each and every year the property is "in service" as a rental.
For the water heater, that's a grey area. Anything that becomes "a material part of" the structure is classified as Residential Rental Real Estate and depreciated over 27.5 years. SEC 179 is not available for that specific MACRS classification.

Yet, one could also say the water heater is an appliance which could be depreciated over 5 years and eligible for SEC 179. This is where it gets grey. There's no question that the plumbing is "a material part of" the structure. The water heater is a part of the plumbing, thus making it "a material part of" the structure.
Now I've not seen or heard of any tax court challenges to this one way or the other. So I would suggest you play it safe, classified it as rental property and depreciate it over 27.5 years.

Where I differentiate is that an appliance can be removed from the property without impacting its value. For example, you can remove the washer, dryer, dishwasher when you sell the property and that really won't have any impact on the value of the structure. But if you remove the hot water heater, that will have an impact on the value of the structure, as in many locales there are rules, laws, regulations or ordinances that require a hot water heater be present before a Certificate of Occupancy will be issued.

But of course, you can do what you want.
Also, there's a difference between material participation, and active participation. One affects deductions while the other affects your qualification for the QBI. You "do" material participate since you are the one who makes all management decisions on the property.

[tagteam]

@wildcatgoal 

You can use the de minimis safe harbor election for the water heater (i.e., expense it) if you would like to do so and the cost was $2500 or less.

See https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations#Ad...

[tagteam]

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@Carl wrote:

You "do" material participate since you are the one who makes all management decisions on the property.

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That is not the test for material participation.