Writing off Leasehold Improvements

[pbmunkey]

I asked this question and got an answer saying that I CANNOT write it off since I do not own the house and another answer saying that the first answer is WRONG. I'm more confused than ever. Here's the question:

I rented a home from someone 2 years ago and rented it out on Airbnb. I spent money putting in a new kitchen and driveway and have not fully captured the depreciation on the renovations. I returned the home to the owner in 2021 and walked away from the business. I would like to capture the rest of my depreciation. Would I dispose of this asset as a sale with a value of $0?

[ColeenD3]

You can't take depreciation for property you do not own.

From Tax Topic 704 from the IRS.

You may depreciate property that meets all the following requirements:

1. It must be property you own.

Depreciation

[pbmunkey]

Just making sure we’re on the same page:

number 1 says it must be property that I own. Though I don’t own the house, the kitchen renovation and driveway was paid for by me. The cabinets and countertops can be removed if need be but I chose to leave it in the house when I returned the home to the owner.

is it still not depreciable? If not, what other options do I have to in order to write off this expenditure?

[JillS56]

That is correct, if you do not own the property you cannot write off any of the expenditures.  There are no other options for you to write off these expenditures.

[pbmunkey]

When you say “you do not own the property” are you referring to the house, not the items I put in as improvements to the house?

lastly, during the years I had the house, I shouldn’t have been depreciating my leasehold improvements either?

[LudwigVan_fan]

Question...is this house where you live, and thus the improvements are for personal use?   If so, there is no write off of the improvements.

However, if this house is used by you for a business, you do not live there,  and you have a lease, then leasehold improvements paid by you can be amortized over the course of the lease.  This applies to property that you paid for and should be capitalized.  If the property would be left behind when you terminate the lease, then if business property, it would be amortized either under the life of the property or the terms  (including automatic renewals) of the lease.  If the property would be taken with you, such business property would be depreciated by you and you would own such property.

It comes down to what are you renting the house for and the use of the house in your hands.  For example, if you were renting space in a mall, strip mall, etc., etc., and you did improvements to the space.  Those improvement would be leasehold improvements for a business and would be amortized over the lease or if expected to be renewed, the lease plus expected renewals.

Personal use of leasehold improvements are basically lost to you.  The same as the rent can't be deducted for personal use.

[DaveF1006]

To answer this question, I reviewed the IRS link that ColeenD3 mentioned in her previous post. In the post, it mentions that you cannot depreciate property that you don't own.

Your argument is that even though you do not own the property, you own the leasehold improvements, which should be independent from the property. This argument cannot be made because you would need to own the property to claim those leasehold improvements that are attached to that property. Those leasehold improvements become part of the property which you do not own, thus cannot be claimed as depreciable assets.

@pbmunkey

[pbmunkey]

Thank you for your explanation. Some people are saying that I can't depreciate it since I've already returned the house, but I have depreciated a little on these improvements while my lease was active. I'm assuming that was the wrong thing to do as well?

[ColeenD3]

Yes, it was. You will have to amend your return and delete those entries.

[AmeliesUncle]

While you don't own the original building and land, you DO own the improvements that you made.

I'll point you to the actual law itself - Regulation §1.167(a)-4:

§ 1.167(a)-4 Leased property.

(a) In general. Capital expenditures made by either a lessee or lessor for the erection of a building or for other permanent improvements on leased property are recovered by the lessee or lessor under the provisions of the Internal Revenue Code (Code) applicable to the cost recovery of the building or improvements, if subject to depreciation or amortization, without regard to the period of the lease. For example, if the building or improvement is property to which section 168 applies, the lessee or lessor determines the depreciation deduction for the building or improvement under section 168.

https://www.law.cornell.edu/cfr/text/26/1.167(a)-4

[DianeW777]

The qualified leasehold improvements apply only to nonresidential real property according to the IRS. If you reported this as business income as indicated below, there may be a possibility but continue to review your specific situation.

• IRS Publication 956 (page 30) Printed below for your convenience.
  • Qualified improvement property. Generally, this is any improvement to an interior part of a building that is nonresidential real property, and the improvement is section 1250 property, is made by you, and is placed in service by you after 2017 and after the date the building was first placed in service by any person.
    • However, a qualified improvement does not include any improvement for which the expenditure is attributable to any of the following.
      • • The enlargement of the building.
      • • Any elevator or escalator.
      • • The internal structural framework of the building.

It's unclear how you treated your Airbnb income but here are some key components. Most people who use Airbnb are running a business and by default are required to file under Schedule C if there is "substantial services".

If you’re providing hotel-like perks such as regular cleaning or maid service (in excess of 10% of the rental cost), fresh linens or towels, in-room coffee, transportation, or sight-seeing, you’re providing substantial services, and that means you'd file Schedule C.

• If you provide substantial services that are primarily for your tenant's convenience, report your income and expenses on Schedule C. If this is the case, then you use the nonresidential real estate like a hotel and/or bed-and-breakfast.  This will be the 39 year recovery.
  • Should I Report My Rental on Schedule E or Schedule C
  • Where do I enter Schedule C?

If you did report the income as rental on Schedule E, then there is nothing you can use for depreciation that you did not own as indicated by our awesome tax experts @ColeenD3, @JillS56 and @DaveF1006.

Please update if you need further clarification.

@pbmunkey

[AmeliesUncle]

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@DianeW777 wrote:

If you did report the income as rental on Schedule E, then there is nothing you can use for depreciation that you did not own as indicated by our awesome tax experts @ColeenD3, @JillS56 and @DaveF1006.

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Did you not read the law that I posted?

Perhaps it would be clearer if the OP asked "can I depreciate capital improvements I made to the property I rented from somebody".  But just because the improvements don't qualify under the category of "Qualified Improvement Property" (or the former "Leasehold Improvement Property") does NOT mean the capital improvements can't be depreciated.  They are just depreciated under the 'normal' categories for real estate.

[pbmunkey]

Yes it was strictly for business use. I didn’t live there. 

[DaveF1006]

I do see where AmeliesUncle has posted an IRS - Regulation §1.167(a)-4 where you could depreciate these assets. To claim, you will need to report the Airbnb like it was a business. 

1. Go to federal>income and expenses>
2. Self-Employment>Self-employment income and expenses
3. Complete the profile that asks about your business
4. Then there will be a screen where you will enter your self-employment income.
5. After entering, you will start entering expenses into your program.
6. If using Turbo Tax online, there is an asset section in the expense category. This is where you can enter your improvements as depreciable assets.
7. if using the Turbo Tax Home and Business Software, There is a separate Business Asset section where you will enter this information. 
8. Interviews from both products will reference improvements made, which will lead through the sections.

@pbmunkey

[AmeliesUncle]

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@DaveF1006 wrote:

I do see where AmeliesUncle has posted an IRS - Regulation §1.167(a)-4 where you could depreciate these assets. To claim, you will need to report the Airbnb like it was a business. 

No, it does not need to be a business on Schedule C.  A rental on Schedule E would qualify as well.