How do I report expenses related to fixing up my property to rent?

[californiakk]

We purchased a single unit rental property in November 2017. 
We made repairs, painted it, installed window coverings, put in washer/dryer, and paid utilities while preparing it to be rented. We began advertising the unit for rent in April 2018. 
How do I properly categorize the expenses we incurred while preparing our unit to rent?
Also, we did not rent the unit until September 2018. How do I categorize expenses incurred while advertising the property for rent, but while it was still vacant.
Thank you!

[Carl]

You can't. Startup expenses for a rental property are never deductible. But please read all of the below to understand the difference between "expenses" and "property improvements". I get the impression that 2018 was your first year as a landlord. So all of the below is important to you. Please do ask questions if you still have questions after reading all this.

• Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence before, then this date is the day AFTER  you moved out.
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 "could" have moved in. That should be your "in service" date if you were asked for that. Vacant periods between renters count also PROVIDED you did not live in the house for one single day during said period of vacancy.
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 or 2nd home, 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 POPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that add value to the property. Expenses for this 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 must 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 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.

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.

[californiakk]

The window coverings we installed are a lot nicer than the ones that were there originally. Could those be counted as an improvement?

[Carl]

What are you calling "coverings"? If you mean shutters or awnings that are physically attached to the outside of the windows, then I see that as "a material part of" the property, unless you intend to remove them if you sell the property. If you're talking about curtains or window blinds inside, then no.
Keep in mind that since you're setting this up for the first time in TurboTax, you don't need to list each property improvement separately. (Unless you want to.) Here's an example:
Purchased house for $100,000 on Jan 1, 2018.
Paid $10,000 for a new roof in Feb of 2018.
When entering the house in the SCH E section of the program I'll work it through as the program is designed for me to work it through. Then when I'm done with that, I'll go into the Assets/Depreciation section of the program, elect to EDIT the rental property asset and start working it through. On the screen titled "Review Information" you see several boxes for data there. One is "Cost" which is what you paid for the property after all your deductible sales expenses were taken off. So for me it may show a cost of $95,000. Since I paid $10K for a new roof after I purchased the property and before I placed the property "in service", I can just add my $10K paid for the roof to the total "Cost". So I'll change the $95K to be $105,000. Any property improvements done prior to you placing the property "in service" can be added to that "Cost" total. But under no circumstances will you change the "Cost of Land" amount.
Why can you do it this way? Because, the rental property and all of it's improvements are placed "in service" at the same time, regardless of when you actually paid for that property improvement.
Now any property improvements I do "after" the property has been placed in service, must be entered separately in the assets/depreciation section and those improvements will stand on their own, since their "in service" date would be after the property itself was originally placed in service.

[californiakk]

Thank you, Carl. We did not make any improvements to the property in that case. TurboTax asks for the value of the land separate from the value of the property. The property is a condo. We don't own the land. I have looked at the property tax bill and our insurance policy as suggested, but I don't see the value of the land listed in either one of these places.

[Carl]

Understand what goes in the two boxes.
COST - What you paid for the property in it's entirety.
Cost of Land - The portion of COST that is for the land.
Now even with a condo you need to allocate "something" to the land. As an example, if it's a permanent structure then you do "in fact" own the land that the building foundation physically sits on. If a 2nd floor condo, then you still own a percentage of the land that the building physically sits on. So if you allocate 10-15% of your total cost to the land, you'll be fine. Remember, this is for depreciation purposes mainly, and the value of the land the building sits on in your case, is not depreciable.
If you indicate a land value of zero, that has the potential to raise flags. See IRS Publication 527 at <a rel="nofollow" target="_blank" href="https://www.irs.gov/pub/irs-pdf/p527.pdf">https://www.irs.gov/pub/irs-pdf/p527.pdf</a> and check out chapter 4. It clearly states: "If you own a condominium, you also own a share of the common elements, such as land, lobbies, elevators, and service areas."
So your share of the land and all common areas are not depreciable, and if you enter "at least" 10% of your cost in the Land value box, you'll be fine.

[californiakk]

For the cost I have added the total of the following items: sales price of condo, escrow fees, deed recording fee, fee to transfer to management company, interior painting, interior solar shades, front door replacement costs, solar fan in the roof, and the washer/dryer. Is this correct? Thank you.

[californiakk]

What about the HOA fees that I paid while preparing the unit to be rented?

[Carl]

Painting is not a property improvement by itself. Under no circumstances do you list painting as a property improvement by itself. See the "Additional clarifications" above. You would "include" the cost of painting as a part of a property improvement that required it. (such as putting new sheetrock on an entire wall.)
"deed recording fee" adds to the cost basis of the property.
"fee to transfer to management company," Nope. That does not add to the cost basis and is not deductible as a sales expense. That has nothing what-so-ever to do with the loan or with your ownership of the property. If this is for a 3rd party company that you are paying to manage the rental for you, then that will be a valid expense claimed as a management fee in the rental expenses section.
"interior painting"
Nope. If that's all you did, that is in no way a property improvement. You have to look at it from the perspective of a property appraiser. Painting alone flat out does not add value to the property, because you have no way of knowing the buyer will even like the color. See "Additional clarifications" above for details about including painting cost as a part of a property improvement such as building a wall or replacing the sheetrock on a wall.
"front door replacement costs, solar fan in the roof," For the front door, definitely adds to cost basis. For the fan, if you're referring to an attic fan then that too adds to the cost basis.
"Washer/Dryer" If you provided that washer/dryer after the purchase then I would not include it in the cost basis at all. Since appliances are depreciated over 5 years, you're creating a future nightmare when the washer/dryer has to be replaced. I can 100% guarantee it. Since the washer/dryer cost less than $2500 you should just expense those items and be done with it. If you purchased them new after you purchased the property, then you can expense your purchase price. Otherwise, you expense the FMV of those items on the date placed in service.
"What about the HOA fees that I paid while preparing the unit to be rented? "  Not deductible anywhere. Period. Remember, cost incurred preparing the property to rent are just flat out not deductible. But once the unit is placed in service, your HOA fees are deductible as a rental expense from that point forward. There is no specific place for HOA fees in the rental expenses section. But the very, very, very last thing you're asked for in that section is "other expenses not already reported" and that's where you would enter the HOA fees paid.
Since the property was not available for rent until April 2018, that means this property is not reported on your 2017 return on SCH E at all. But that doesn't matter really. Having placed it in service in 2018 makes all the above we've talked about, true for your 2018 return.
Here's a bit more clarity.
 - Expenses incurred that are related to the acquisition of the property are added to the cost basis of the property. (painting costs are not acquisition costs)
 - Expenses incurred related to the acquisition of the mortgage loan are amortized (not capitalized) and deducted over 15 years or the life of the loan, whichever is greater.
So title transfer fees are related to acquisition of the property, while points and credit check costs (only if you actually paid for them as indicated on your closing documents) are related to acquisition of the loan.

[californiakk]

Thank you. This is very helpful.

[californiakk]

So we paid $1700 for the washer and dryer, but we bought it and had it installed before April 1st. I assume we can't include it as an expense in the Schedule E because be bought it before April 1st. Is that correct?

[Carl]

Technically yes. But your only other choice (which you can do) is to list it as a separate asset. You'd have to do that because a washer and dryer is not "a physical part of" the structure. It's an appliance. Additionally, appliances are depreciated over 5 years, whereas your rental property is depreciated over 27.5 years.
But a new law was enacted a few years ago referred to as "de-minimus safe harbor" which allows you to expense certain qualified assets (such as appliances) that cost under $2500. A washer/dryer qualifies for this expense since you purchased it specifically and only for the rental. The fact you purchased it before the property was placed in service is fine since there's no "personal use" of the appliance.
By expensing it, when you need to replace it down the road you just dispose of the old one, buy/install the new one and expense the new one too. It's a given that you will get "at least" 5 years out of it. More than likely it will last double that, depending on the kind of tenants you have.
Remember the oxy-moron rule set of the IRS?
1) For every rule their is an exception.
2) There are no exceptions for rule number 1.

[californiakk]

Very cool. I don't think a washer/dryer will last 27.5 years, so this makes sense.

[californiakk]

How do I enter the asset (washer/dryer) into TurboTax?

[Carl]

Just work it through the assets/depreciation section and follow the prompts making sure you read the entire screen first, so you make the correct selections.
If you are offered the 50% special depreciation allowance, I suggest you take it. That way, you can depreciate up to $850 the first year. Otherwise, on a $1700 cost you'll be depreciating $340 a year over 5 years, and that's just not worth the time to me. (It may be okay with you however.)