New building on existing lot - special allowance or depreciation?

[NoDisplay]

Hi,

We constructed a new building on an existing lot (primary residence, backyard guest house, detached from the main house). The construction was done in 2017, guest house placed in service (rented 100%) in December 2017, the total cost was $250K.

It seems TurboTax would allow me to take special allowance of 100% and deduct the entire $250K as expense in the same year. If I select this new building to be "land improvement" then it's an expense. If I select "residential rental" then it gets depreciated over 27.5 years.

Does a new building qualify as "land improvement" for the purpose of this qualification? Is this really possible with the new tax law, to deduct as expense what used to be a capital expense that must be depreciated over time?

If it is possible to deduct the whole thing, can I carry the loss to FY2018 and deduct those against rental profits?

Thanks

[Carl]

For starters, real estate and the living structures you may build on real estate is *never* a deduction. Rental property is depreciated over 27.5 years, and you can only depreciate the value of the structure. With rental property, under no circumstances is land depreciated.

"Does a new building qualify as "land improvement" for the purpose of this qualification?"

Never. It's a property improvement. A land improvement (which would not be depreciated) would be something like spending $5000 to re-sod the entire lot. It adds to the value of the land which adds to the total cost basis of the entire property. But that land improvement is not a depreciable asset, ever.

How you deal with this on the SCH E depends on a few factors.

 - Is the building on a separate lot that is billed for property taxes separate from the lot your primary residence is on?

- Does that building have it's own separately metered utilities? (Electric, gas, water, etc.)

I already know the answers to additional questions, based  on  your reference to it as a physically separate structure detached from your main, primary residence.

[NoDisplay]

The building in on the same legal lot as our primary residence, it's in our backyard. All utilities are hooked up from the main house, there are no separate meters for anything.

[Carl]

Thanks for clarifying that. What you have is a property improvement. Basically, here's how you'll treat things in TurboTax.
Your "new" setup for your entire property is different now. You won't enter the new construction as it's own separate entity in TurboTax at all. The basics for working this through the rental section:

- Type of rental is multi-family
 - For "do any of theses situations apply...." select 2017 was the first year I rented this property, and I rent out a unit in a multi unit property where I live.
 - YES, this property was rented all year. (Before you ask, read the "NOTE" on that screen.) then YES, it was rented at FMRV.
 - NO, I do not have a home office.
 - YES, I will enter total amounts and let TurboTax do the math.
 - Enter the percentage of floor space being rented out. For example, if your primary residence is 1000 sq ft of floor space and the MIL house is 500 sq ft, that's a total of 1500 sq ft of floor space. So 33.3% of it is being rented out.
 - No, *you* *did* *not* pay anyone more than $600 that would require you to issue them a 1099-MISC. (Requirement eliminated by congress for rental property owners, years ago.)
 - Enter rental info my self.
 Now on the review screen, what you just completed was the property profile. So that's where you go if you need to change/correct/update anything concerning what you've entered up to this point.
 Work through and enter your rental income and expenses. These are the entries that matter:
Insurance - You will enter the total amount of insurance you paid and if necessary, add together what you paid for your home owners insurance on your residence, and the rental dwelling insurance policy on the MIL house, and enter that total.
For repairs and supplies, not one single penny of your construction cost goes here. Not a one. I am fully expecting those two to be a gif fat zero.
Utilities - enter what you paid for total utilities cost for the entire year. Include only those utilizes you share, which would be electric, gas, water, etc. Cable TV is a utility that you can include *provided* you actually do share it with the MIL house.
Enter the total amount of real estate taxes you paid in 2017. It does not matter if the tax bill for 2017 did not include the MIL house.
For reporting your mortgage interest, enter all 1098-Mortgage Interest Statements you receive on this property, in the exact amounts of each 1098.
Now you start the Assets/Deprecation section to enter/set up the property for depreciation. We'll step through this so I can explain with better clarity. So elect to start/update the Assets/Deprecation section.
- Select YES
- Select NO
- Select YES and on that same screen select NO for the special allowance. (This is not an option in your case, and if you select YES, it will be changed to NO later in the program weather you like it or not.)
- Select NO on improvements, and continue.
- Select Rental Real Estate Property, and continue
- Select Residential Rental Real Estate, and continue.
- On the "Tell us about this rental asset" here's the particulars
   Your "cost" will be at a minimum, what you originally paid for the property when you purchased it all those years ago, "PLUS" what you paid for the MIL house you built out back, "PLUS" the cost of any other property improvements you may have done since you originally purchased the property all them years ago.
   Your "cost of land" is how much of the "COST" entered above, is allocated to the land? Having built the MIL house *does* *not* *change* what you paid for the land when you originally purchased the property all those years ago.
    The date purchased or acquired is the date you "originally" purchased the property all those years ago. Once all data entered, continue.
- Select that you purchased new, and under that select that you did NOT always use this item 100% for business. Then under that select that you used it for personal purposes, before you started using it for business.
    For the date you started using it in the business, enter the earliest date that a renter "could" have moved in. This is generally the date you put the "for rent" sign in the front yard.
Now for that percentage it's asking for, this is based on "TIME" and not use. So if you started using it in your business on July 1st, that percentage would be 50%. If a renter could have moved in on Dec 1st, that percentage would be  8.49%. That would indicate that for all of 2017, the asset was used in the business 8.49% of the year.
After entering all data on this screen, continue.
Now you see the asset summary. If you'll select details and scroll down, you'll see I was telling the truth. Even if you did elect to take the SEC179 or special depreciation allowance, it shows zero for both on the summary detail screen.

[NoDisplay]

Hi, thank you for a very detailed instructions, I greatly appreciate the effort. The situation is a bit more complex, here is how : The main house is a 1,366 sqft 4 bedroom house, bought and moved into in 2015. In the same year we started doing AirBNB vacation rentals out of 2 spare bedrooms, and have reported all income and claimed relevant maintenance, utilities, repair costs at 50% since then. We've had a few major improvements in 2016 (patio covers, concrete walkways, fire pit etc.) which were claimed on tax return and are being depreciated as per whatever rules Turbotax applies to that.

In Dec 2017, we closed the main house and opened the guest house for vacation rentals. The guest house is large, 1,500 sqft 2 story house and is divided into 4 completely separate studio apartments. Each comes with its own private entrance, full kitchen and full bathroom, and sleeps up to 4 people.
Up to Dec 2017, we are claiming relevant income made at the main house and deducting 50% of costs. From Dec 2017, I planned to deduct 80% of costs, based on number of units (guest house is 4 units and main house 1 unit) and number of people (up to 16 in the guest house and 4 in the main house). To make things a bit more separate, I created a new rental property entry in TurboTax for the guest house, thinking I'd phase out the main house entry in FY2018 as there would be no income and no 50/50 costs to split. Only the guest house would remain from FY2018 onward, and costs claimed at 20/80.

Does this make sense, and does it change the process you described above?

Many thanks!

[Carl]

You can disregard everything in this thread. "opened the guest house for vacation rentals" means that more than likely, this is a SCH C business the same as your AirB&B rental is. We have both wasted an inordinate amount of time now, because of the lack of clarity and the omission of relative facts from the start.
Basically, you will indicate that you stopped using your existing assets and removed them from service entirely, at least one day before the new building became available. Then you will enter a completely new asset that goes "in service" at least one day after you removed the old assets from use, and the new asset entry will include both physical structures and the major changes there are you have more total square footage to deal with on all fronts. That will of course, change the percentage of floor space used for business.

[NoDisplay]

Hi,
I've found a couple of sources advising Airbnb income is Sch E activity provided no other services are offered (which is the case here - we rent space only, no breakfast, cleaning during stays etc.) :

Having trouble pasting links here for some reason, maybe not allowed: please search online for:
"ernst young guidance airbnb us" - Airbnb commissioned paper on US based tax filing, and
"h&r block Airbnb"

Does this puts us back on track with the original advice?
Thanks!

[Carl]

Yes, it's perfectly possible for what you have to be a SCH E business. Most who get into the AirB&B thing do it with the full intention of it being a SCH C business so they can benefit from it with increased contributions to their social security and Medicare accounts (which helps them at retirement age), as well as being able to include that income when figuring their maximum allowed IRA contribution for the year.
So are you going to stick with SCH E? If so, we just need to modify a few things. There is more than one way to deal with this in TurboTax and the end result will still be the same. If you've been reporting it on SCH E in the past and intend to continue that into the future, then we just need to make a few modifications to my above guidance.

[NoDisplay]

Hi, Yes, I've done Sch E in the years past and it seems we can continue that way. I've been thinking, I probably need to add the new building as an improvement to existing rental property entry, instead of making a new one. If I do a new one, then all remaining depreciation under the old one (from 2016) is sort of lost when I "stop using it for business" and gets added to base value? This being our primary residence, when we sell it we're tax free for gains up to $500K, provided we remain below that depreciation is truly lost?

[Carl]

When you sell rental property at a gain, you *WILL* pay tax on the recaptured depreciation no matter what. There's no way out of that. Recaptured depreciation is not included in the "lived in 2 of last 5" exception. Additionally, you won't qualify for any exception anyway, unless you stop renting the space and convert it back to personal use at least 2 years before you sell the property.
" I probably need to add the new building as an improvement to existing rental property entry, instead of making a new one."
Yes, that would most likely be the easiest way to go. Then you declare the new building as 100% business use, provided of course you do not utilize it for one single day for personal use of any type. I believe that by adding it as an asset/property improvement, the program will have no issues dealing with the splits for all the allowed/deductible expenses that way.
Of course, for the 2018 program you want to check absolutely everything. With the massive tax law changes, there's no way to say for sure what won't be touched, and what won't turn into a nightmare. 🙂

[TaxGuyBill]

You need to add a new "asset" for the new building.  You will keep the old "asset" (your house) and if you stopped using it as a rental, you will tell the program you converted it to personal use.  DON'T just add the new building information to the old "asset" for depreciation.

As Carl pointed out, you will need to keep track of the depreciation that you were eligible to take on your old building (your home) for whenever you sell it or start using it as a rental (or business) again.

[NoDisplay]

Carl, could we go with Bill's plan on separate entry? Create a new rental asset entry for the guest house, add the new building under that ($250K building value, land value is zero since it's on the same lot as the main house which already has land value added to it from previous years?), placed into service Dec 15 2017. On my FY2018 return I can set the main house rental entry as "converted to personal use" Dec 31 2017 or Jan 1 2018 (just to keep clean cut off date, we did have a few bookings for the main house in December that we couldn't move to the guest house).
Anything I'm missing from above?

Thanks!

[Carl]

That's something that we discussed and agreed was best, in our comments just above Bill's. You can leave the existing asset just as it is. Then add your MIL house as a new asset, and that new asset will be 100% business use. Like TGBill said, you'll only have a structure value on the new asset, with a land value of zero. That will give you two assets in the assets/depreciation section. One your main house with less than 100% business use, and the 2nd one the new contruction with 100% business use.

[NoDisplay]

Thanks you both very much for your detailed explanation and consideration of all aspects of this situation. I'm sure there are others in the same boat that will find this info to be of great value.

[Carl]

What we finally agreed on should have been the first thing I considered. I'm sure TaxGuyBill was banging his head on the keyboard, and that's why it took him awhile to jump in here. 🙂