Where do I put deductions for improvements made to a room I rented on Airbnb?

[devinher]

I've seen another answer that says it goes in schedule E, under rental income but it doesn't seem to appear in my Home and Business edition.

[Carl]

You don't "deduct" property improvements per-se. They are capitalized and depreciated over time. You'll enter it in the Assets/Depreciation section on the rental summary screen. That's the same screen where you click the buttons to enter your rental income and rental expenses. The 3rd button down is for assets/depreciation.

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 classified as cleaning/maintenance costs. They are instead classified as startup costs, amortized as such and depreciated over time.

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 classified as startup costs, amortized as such and depreciated over time.

Startup Costs

Please note that if residential rental income is not your PRIMARY business, and your PRIMARY source of income, then your rental business is considered to be passive, and you flat out, no way, no how , are not allowed to deduct your startup costs. Period. The IRS says so. See https://www.irs.gov/pub/irs-drop/rr-99-23.pdf and please take note that rental property produces “passive” income, while other types of businesses produce “active” income. Your rental property is not classified as your “active” business, unless you are a real estate professional, an active participant in the management of the property, and it provides a substantial (more than half) amount of your taxable income for the year. All three requirements must be met. There are no exceptions

Start up costs are expenses incurred while preparing the property for rent, with the express purpose being to prepare it for rent, before it is available for rent. These costs do include repair, cleaning and non-recurring maintenance cost. It does NOT include property improvements. With a normal business that produces active income (rental income is passive) you would amortize these costs over 15 years. But you can’t do that with a rental property. However, you can deduct a maximum of $5000 in startup costs in the first year the rental is available for rent, PROVIDED your total startup costs do not exeed $50,000. This is reported on line 18, “Other Expenses” of SCH E, and should be labeled “start up expenses”.

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.

[devinher]

This is great, Carl. Thank you. I thought I read somewhere that the room changes, if substantial and directly related to the room that would be rented, could be fully deducted as an expense. Does that not matter? I paid a lot of money to make a basement room water tight and made other serious revisions so it could be comfortable.

[Carl]

You're confusing that with safe harbor. The safe harbor act says that some (I reiterate *some*) types of things that would qualify as property improvements, can be expensed if they cost less than $2500. For the most part, if it meets the first requirement above, it's a good bet it doesn't qualify for safe harbor. For example, appliances replaced in a rental are considered rental assets. But if that appliance is less than $2500 and does not become "a material part of" the property, then you have the choice to capitalize it, or expense it. That would be something like a new refrigerator.
But lets take a new under the counter built-in dishwasher. Depending on how you look at it, that could go both ways. Technically, since it's an under the counter model, it becomes "a material part of" the property. but hey, what if before I sell the property I remove the dishwasher and turn that space into a cabinet? See the ambiguity there?
For me, technically, since a dishwasher cost less than $400 now-a-days, it's not worth capitalizing over 5 or 7 years, and I'd just expense it. Capitalizing $400 over 5 years just isn't going to have any appreciable affect on my tax liability. So it's not worth it to me to capitalize it.
But lets say I am renting an empty room and when the renter moves out, I decide to furnish the room for the next tenant. I can do that easily for under $2500. I'd have the choice in that scenario to capitalize or expense the furniture. I'd choose to expense it myself. But that's me.

[devinher]

Great answer. Thank you.