Where can I enter the improvements that I made to a rental property in 2018 prior to selling? It should add to cost basis. Do I add the amount to cost basis under asset?

[DanielV01 · Accepted solution]

Yes, you want to have it add to the cost basis.  Where you enter it, however, depends on whether or not you had discontinued your rental activity (and, thus, depreciation on the home) before or after you made the improvements.  If you stopped your depreciation before making the improvements, then enter the information in the Sale of Asset section.  If, instead, you made the improvements before the sale, you will need to report the assets on the Rental Activities Section, Depreciation first.  After your expenses (minus depreciation to be taken this year) from the improvement are calculated, the remaining basis for the improvement is added to your home's remaining basis (after subtracting depreciation taken or allowed to be taken on the home), and that will be your adjusted basis for your sale.

[stevekayak]

DanielV01, I'm a little confused by your response....

You said, "...whether or not you had discontinued your rental activity (and, thus, depreciation on the home) before or after you made the improvements. If you stopped your depreciation (rental activity) before making the improvements, then enter the information in the Sale of Asset section."   This makes sense; rental activity stops, improvements go towards the basis and selling of the property....

Then you replied further and this is what I don't fully understand, "If, instead, you made the improvements before the sale, you will need to report the assets on the Rental Activities Section, Depreciation first."  Did you mean improvements before ending your rental activity? 

Can you clarify?  I see 3 different scenarios:  improvements done before rental activity ceases (must be depreciated and recaptured upon sale); improvements done after rental activity ceases but prior to sale of the house (adjusts basis for capital gains purposes); and, in my case, after rental activity ceases, before the sale of the house, but the end of the tax year intervenes before the sale....  Please clarify as I'm a bit confused.

And, if you'd care to comment further, here is my situation:  What if the improvements were done 1) after the last rental activity 2) improvements were done Nov./Dec. of 2018, when house was empty  3) end of 2018 tax year occurs 4) house sold in March of 2019 with no further rental activity?  (I'm still doing my 2018 taxes.)  Do I put all improvements into their perspective Depreciation Schedules (27.5 for siding, 5 for carpet ((not wall-to-wall)), 27.5 for luxury floating vinyl) for tax year 2018 and worry about the adjusted basis in 2019 when I resolve the sale?

[Carl]

If the last person to move out of the property prior to the sale was a paying rental tenant, you will report the sale in the Rental & Royalty Income (SCH E) section of the program.

If you stopped your depreciation before making the improvements, then enter the information in the Sale of Asset section.

This is not correct. All property improvements will be entered in the Assets/Depreciation section of the program under the Rental & Royalty Income (SCH E) heading. If the property improvement was done after the last renter moved out, then the business use percentage will be ZERO percent. It's in service date will be the date the work was completed and *AVAILABLE* for use. Just because it's available, doesn't mean you actually used it. Hence, the business use percentage is zero percent. This way the asset is not depreciated since it was never actually used, yet it still adds to the cost basis of the property.

[stevekayak]

Carl, thanks for your reply.  "0 business use" makes sense.  TT has record of $$ improvements to add to basis, but never 'used' in the business of producing rent, therefore no depreciation schedule gets started on those items.

What about the other Form 4562 items, from previous years, that are in various stages of their depreciation schedules?   Everything from the house itself, to A/C units, flooring, etc.   Do I try to end their 'business use' in 2018 or just continue all Form 4562 items through year-end 2018 and finalize all depreciation and business use in tax year 2019, when the property sold?  Is there a way to end depreciation (business use) without 'disposing' of the property or converting it to personal use?

  And, if you have any patience left:

What about land improvements (tree removal, distant from the structure)?  How do you add those to the land basis of the property in TT as the IRS says they are not depreciable items?  I certainly want TT to recognize my investment and adjust my land basis to reflect the money spent on those items.  When I add it into TT, it ends up as a 15 year depreciation item despite choosing 'land improvement'.

[Critter]

All of that can be entered as REPAIRS on the Sch E in the year of sale   instead of adding it to the basis.  

[stevekayak]

@Carl 

Carl, under "Tell Us More About This Rental Asset", "I purchased this asset new", "No, I have not always used this item 100% of the time for this business.", "I first used this item at least part of the time for this business, and also used it for personal purposes.", put in a date (12/1/18)........         I tried plugging in "0" % business use and TT doesn't allow "0" %; must be 1.00% or greater.

It did add all 4 items to Form 4562, increased my basis, etc.  (Concrete siding was so expensive, that it did put in a $2 "current depreciation", even on a 27.5 year schedule.)  So, it had the desired effect. 

Still puzzled by the land improvement designation for the tree removal; why does TT put it on a 15 year depreciation as the IRS clearly states that land improvements cannot be depreciated - just added to the my land basis in the whole property.

[stevekayak]

@Critter 

Even if the money was spent in 2018 and the sale occurred in 2019?

Does the IRS view improvements done between the final tenant and the sale of the property differently than improvements done to 'active' rental property?  If so, that would explain your answer - that all 'improvements', despite cost, or permanence, or classification, or land vs. structure designation - are 'repairs'?  That solution would certainly lower my taxes but how would they increase my basis for avoidance of capital gains taxes?  Or, in the long run, would the 'repair' costs directly offset capital gains, just like increased basis would?

Sorry for my lack of understanding, but this is the first time I've dealt with liquidation of a rental property that incurred such large improvement/repair/maintenance costs at the end of its business cycle.

[Critter]

If the money was spent in 2018 then it will either be an expense on the Sch E  OR  be an asset to be depreciated.  ONLY if the cost is incurred in the same tax year as the sale can it all be expensed. 

[Critter]

If the money was spent in 2018 then it will either be an expense (per the IRS rules on expenses vs assets ) on the Sch E  OR  be an asset to be depreciated.  ONLY if the cost is incurred in the same tax year as the sale can it all be expensed. 

[Carl]

No, I have not always used this item 100% of the time for this business.", "I first used this item at least part of the time for this business, and also used it for personal purposes.", put in a date (12/1/18)........ I tried plugging in "0" % business use and TT doesn't allow "0" %; must be 1.00% or greater.

It did add all 4 items to Form 4562, increased my basis, etc. (Concrete siding was so expensive, that it did put in a $2 "current depreciation", even on a 27.5 year schedule.) So, it had the desired effect.

Actually, I'm fairly certain for business use percentage you can enter less than 1%. Say, 0.1% for example. But overall who cares about $1-2 dollars of depreciation really? 

Still puzzled by the land improvement designation for the tree removal; why does TT put it on a 15 year depreciation

Personally, if the cost of that was less than $2,500 I'd just expense it and call it a day. Remember, in the year you sell the rental property all losses carried forward are not limited to being deducted from rental income. All your losses are deductible in the year you sell, as follows:

 - First, they are deducted from the passive income. Then if there's still losses to deduct;

 - They are deducted from any capital gain realized on the sale. If there's still losses to deduct;

 - They can all be deducted from "other" ordinary income (such as W-2 income) up to a limit.

If after all that you still have losses to deduct, they are carried forward to the next year where they are deducted from ordinary income. If limits are still in place, they just carry forward until all used up.

[stevekayak]

@Critter 

No, money spent / work done and sale of property were different tax years, so I'll have to depreciate all 4 major improvements.

Do you agree with the line of thinking (@Carl) whereby I can claim "0%" business use (TT allows a minimum of 1.00%)  for 2018 (described above)? 

The effects of that are 1) obviously, the improvements are added to the form 4562    2) the total depreciable basis is only 1% of the repairs' total cost.  How does that set me up for 2019 taxes when I show the sale of the property?  Will I recoup the other 99% of the cost of the siding as an increase in my basis when the sale of the property fleshes out?  (They do tally under Cost (net of land) on form 4562.)

My ignorance of depreciation, recapture, depleted assets, etc. and their end affect on basis for capital gains is limited, evident, and frustrating....  Luckily, this was an off year for our other income, so not having higher numbers in Current Depreciation are not affecting my overall bottom (tax) line much.

Ok, your reply (@carl) hit a second before I posted above so I'll edit it...   Tree work was 2700, so I tried the Land Improvement treatment, and it ended up on a 15 yr schedule.  Oh well.

A little box pops up in TT if you try to enter anything less than 1.00% business use.  It won't allow you to continue.  Oh well.

Unfortunately, I can't see the entire thread while editing, but thank you for that explanation of how the carryover will occur.

[Critter]

The non-deducted basis is recouped in the year of sale ... and you should use the same business % as the other assets. 

[Carl]

No, money spent / work done and sale of property were different tax years, so I'll have to depreciate all 4 major improvements.

If it is true that your property improvements were done "AFTER" the last renter moved out, and before the sale, then wait and enter the property improvements on the tax return for the tax year you actually sell/sold the property with an "in service" date of Jan 1 of that year. Then declare 1% business use. Then, there will be no depreciation since you don't depreciate assets held less than a year. The program "knows" this.

Do you agree with the line of thinking (@Carl) whereby I can claim "0%" business use (TT allows a minimum of 1.00%)  for 2018 (described above)? 

My testing with TTX 2018 shows that the program will not accept 0% business use when you have an "in service" date - a date that must be entered for a rental asset, no matter what.

The effects of that are 1) obviously, the improvements are added to the form 4562    2) the total depreciable basis is only 1% of the repairs' total cost.  How does that set me up for 2019 taxes when I show the sale of the property? 

Like I said, wait and enter the property improvements on the 2019 tax return. Then it really doesn't matter what percentage of busines use you show. If you sell the asset within the same tax year it's placed in service, it's not depreciated. But of course, you want to be as honest as you can on your tax return too. Since the program will not accept 0% business use, enter the lowest number it will accept. It won't be depreciated anyway provided the "in service" date and the sale date are in the same tax year.

Will I recoup the other 99% of the cost of the siding as an increase in my basis when the sale of the property fleshes out?  (They do tally under Cost (net of land) on form 4562.)

You'll see it listed as a separate item on the 4562 titled "Depreciation & Amortization Report" for that specific property. You'll also note there will be zero depreciation on it if the in service date and sale date are both in 2019.

My ignorance of depreciation, recapture, depleted assets, etc. and their end affect on basis for capital gains is limited, evident, and frustrating....  Luckily, this was an off year for our other income, so not having higher numbers in Current Depreciation are not affecting my overall bottom (tax) line much.

It took me a few year's of tax returns to get the hang of it and understand depreciation myself. The IRS rules on depreciation are convoluted at best. One would think that for an asset placed in service on a specific date, that the depreciation for that first year would be a percentage of the total days in the year the asset was in service. But that's not how it works. That first year of depreciation is based on what the IRS calls a "convention", and what convention is used depends on the date placed in service. Here's a few of the conventions used with rental property assets. You'll see these on the 4562 under the Method/Convention column. Under that column are two letters, a slash and two more letters. The convention is the letters to the right of the slash.

MM - Mid-Month

MQ - Mid-Quarter

HY - Half Year

A mid-month convention is used for all residential rental property and nonresidential real property. Under this convention, you treat all property placed in service, or disposed of, during any month as placed in service, or disposed of, at the midpoint of that month.

A mid-quarter convention must be used if the mid-month convention doesn’t apply and the total depreciable basis of MACRS property placed in service in the last 3 months of a tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) is more than 40% of the total basis of all such property you place in service during the year. Under this convention, you treat all property placed in service, or disposed of, during any quarter of a tax year as placed in service, or disposed of, at the midpoint of the quarter.

The half-year convention is used if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, you treat all property placed in service, or disposed of, during a tax year as placed in service, or disposed of, at the midpoint of that tax year. If this convention applies, you deduct a half year of depreciation for the first year and the last year that you depreciate the property. You deduct a full year of depreciation for any other year during the recovery period.

Ok, your reply (@carl) hit a second before I posted above so I'll edit it...   Tree work was 2700, so I tried the Land Improvement treatment, and it ended up on a 15 yr schedule.  Oh well.

If I recall (without having to re-read this whole thread) the tree removal was actually more of a safety/security issue, than a property improvement. If so, I'd still expense it and label it something like "dead tree removal" to indicate that it is "in fact" an expense, and not an improvement to anything. Maybe you can come up with a better, more descriptive label fo the expense.

Keep in mind that it doesn't make any difference in your taxable gain if you list this as an asset, or claim it as an exepense. Either way it reduces your taxable gain on the sale. So use the KISS method. 🙂

[Carl]

What about the other Form 4562 items, from previous years, that are in various stages of their depreciation schedules? Everything from the house itself, to A/C units,

If you just follow the guidance at the end of this post, it all gets accounted for.  But one thing I want to point out concerning my comment of "zero percent business use" above. Depending on your specific and explicit situation, the program may not accept zero percent, and will "insist" on 1%. If this happens to you, then make the business use percentage 1% and the in service date the same date that you close on the sale. Then if any depreication is taken (it probably won't) it will be extremely minimal.

Is there a way to end depreciation (business use) without 'disposing' of the property or converting it to personal use?

Nope. If you convert it to personal use before the sale date, then you have no choice but to report the sale in the Sale of Business Property section. That could hurt, because all rental expenses incurred after you convert it to personal use are not deductible. Period. Some of those expenses "might" be deductible as sales expenses. But it's really more of a PITA to do it that way and increases the possibility of human error on your part.

Besides, for the bit of additional depreciation you'll be recapturing for 2019, it's gonna be taxed at your "ordinary" tax rate anyway, up to a maximum of 25%. So if you're in the 12% or 22% tax bracket already, it's not gonna make any difference.

What about land improvements (tree removal, distant from the structure)? How do you add those to the land basis of the property in TT as the IRS says they are not depreciable items?

Simple enter it for what it is ---- land improvement. If that don't work, then enter it as a normal rental property improvement. The only thing is, the COST and COST OF LAND will be exactly the same. That way, nothing is depreciated as it should not be for your specific land improvements.

Now course, you want to work through the SCH E section to get all your pertinent data entered. Then when you get to the screen with the "Done with Rental Property" button, click that button to exit and save all your changes and additions.

Then work through the rental section again to report the sale using the guidance below.

Reporting the Sale of Rental Property

If you qualify for the "lived in 2 of last 5 years" capital gains exclusion, then when prompted you WILL indicate that this sale DOES INCLUDE the sale of your main home. For AD MIL personnel who don't qualify because of PCS orders, select this option anyway, because you "MIGHT" qualify for at last a partial exclusion.

Start working through Rental & Royalty Income (SCH E) "AS IF" you did not sell the property. One of the screens near the start will have a selection on it for "I sold or otherwise disposed of this property in  2019". Select it. After you select the "I sold or otherwise disposed of this property in 2019" you continue working it through "as if" you still own it. When you come to the summary screen you will enter all of your rental income and expenses, even it it's zero. Then you MUST work through the "Sale of Assets/Depreciation" section. You must work through each individual asset one at a time to report its disposition (in your case, all your rental assets were sold).

Understand that if more than the property itself is listed in your assets list, then you need to allocate your sales price across all of your assets.  You will only allocate the structure sales price; you will NOT allocate the land sales price, since the land is not a depreciable asset.  Then if you sold this rental at a gain, you must show a gain on all assets, even if that gain is $1. Likewise, if you sold at a loss then you must show a loss on all assets, even if that loss is $1

Basically, when working through an asset you select the option for "I stopped using this asset in 2019" and go from there. Note that you MUST do this for EACH AND EVERY asset listed.

When you finish working through everything listed in the assets section, if you ever at any time you owned this rental you claimed vehicle expenses, then you must also work through the vehicle section and show the disposition of the vehicle. Most likely, your vehicle disposition will be "removed for personal use", as I seriously doubt you sold your vehicle as a part of this rental sale.