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AFS
Level 2

100% 1 year Bonus Depreciation

I am looking at my options for handling expenses before I start renting a condo that I am remodeling.  I have AC maintenance fees, HOA fees, new appliances, and various repairs.  I realize that I can't claim them as operating expenses because they occurred before I offered the the unit for rent.  I thought I could use the startup deduction, but I already have one other condo that I am renting in the same area.   I think I have to handle these through depreciation.  Can I use the 100% 1 year Bonus depreciation for these items or do I have to just include these expenses in the overall basis of the condo and depreciate them over the 27.5 years?   Feel free to correct any of my assumptions.      Thank You

6 Replies
Carl
Level 15

100% 1 year Bonus Depreciation

I am looking at my options for handling expenses before I start renting a condo that I am remodeling.

Some of the things you mention while not wrong, lead me to think you may not have a full understanding of "how things work". So I'll cover each, one at a time.

 

I have AC maintenance fees, HOA fees, new appliances, and various repairs. I realize that I can't claim them as operating expenses because they occurred before I offered the the unit for rent.

That is correct. You claim of rental expenses starsts on the first day a renter "COULD" have moved in. Generally, that's the day you put the "for rent" sign in the front yard. It doesn't matter if if took you three months to actually get a renter moved into the property either. Your rental expenses starts on the date a renter "could" have moved in.

 

I thought I could use the startup deduction, but I already have one other condo that I am renting in the same area.

Startup expenses for a rental property ARE NOT deductible and never have been. Any expenses incurred before the property was "available for rent" are just flat out not deductible. Period. DO NOT confuse this with property improvments. That's an entirely different thing from other types of rental expenses.

 

I think I have to handle these through depreciation.

 

Only "qualified" property improvements are depreciated. For example, of the items you mentioned, the new appliances are athe only depreciable assets. But I recommend you "DO NOT" depreciate them if you don't have to. I'll explain later, below.

 

Can I use the 100% 1 year Bonus depreciation for these items

 

For the appliances, you most certainly can if you want to. But again, I don't recommend it.  Before I get into the details of "why", let make sure you know your choices here.

For any appliances (NOT including a hot water heater) that you paid *LESS* than $2,500 for, you can just expense them under the Safe Harbor De-Minimus act. Now for those items, even though you purchased and installed them before the property was available for rent, if they were purchased specifically for the rental and you have *NO* *PERSONAL* *USE* of the asset, then you can just deduct the cost as an expense in the first year you placed the property in service, provided you actually purchased the appliance in the same tax year that the property is placed in service.

 

Therefore, if your appliances cost was under $2,500 and you qualify, I highly recommend you just deduct the item as a rental expense in the rental expenses section and be done with it. The reason I recommend this is because if you elect to depreciate, appliances are depreciated over 5 years. Then when the appliance needs to be replaced you've created a whole bunch of paperwork for yourself, where you have to show your disposition of the old appliance, account for the deprecation and possibly deal with the tax liability on depreciation recapture. (I refer to this as "shooting yourself in the foot on purpose.)  Then it all starts over again with the new replacement appliance.

If you take the Special Depreciation Allowance and deduct the full cost in the first year, then if that appliance breaks next year you "still" have to deal with recapturing that depreciation upon disposition of the broken appliance, and acquisition of the replacement. Again, you're shooting yourself fin the foot on purpose.

 

Another problem with the 100% Special Depreciation Allowance, is that taking it will not make one single penny of difference to your tax liability. Not a single cent.  Remember, rental income is passive income, which means that all rental expenses are passive too. You can only deduct your passive rental expenses from your rental income, and that's it. Once your rental expenses get your taxable rental income to zero, that's it. You can't deduct any more. If you have any left over rental expenses, they just get carried forward to the next year where they can be deducted "IF" you have the taxable rental income to deduct them from.

But I can tell you from experience that you will "never" have the taxable rental income to deduct your carry over expenses from. You'll find that when it comes tax filing time, your rental property will practically "ALWAYS" operate at a loss every year, including the first year. Especially if you have a mortgage on the property.  Your carry over losses will continue to grow larger with each passing year. You can't "realize" those losses until the tax year you actually sell the property.

 

When you add together your deductible rental expenses of mortgage interest, property taxes, insurance and add those to the depreciation you are required to take by law, you'll find those deductions will practically always exceed your total rental income for the year. Add to that other rental expenses you're allowed, such as HOA fees, repair and maintenance costs, and you're practically *guaranteed* to never show a taxable profit "ON PAPER" at tax filing time every year you own and rent out the property.

 

The below information is provided in the hopes it will aid you in figuring out what the different types of incurred costs you have, that you are dealing with so you deal with them correctly on your tax return. Understand that ABSOLUTE PERFECTION on your taxes in your first year of dealing with rental property is not an option; it's an absolute *MUST*. Even the tiniest of mistakes in the first will will grow exponentially as the years pass. Then when you catch it years down the road the cost of fixing it will be $expensive$. So if you have further questions, by all means please ask. No matter how dumb you may think it is. Not asking a question because you think it's dumb, will have the potential to cost you dearly in the long run.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence or 2nd home 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 PROPERTY 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.

 

Anonymous
Not applicable

100% 1 year Bonus Depreciation

@Carl.  there is an exception to what you posted. "Once your rental expenses get your taxable rental income to zero, that's it. You can't deduct any more. If you have any left over rental expenses, they just get carried forward to the next year where they can be deducted "IF" you have the taxable rental income to deduct them from."

the special allowance for real estate losses when there is active participation. From form 8582 instructions

Special Allowance for Rental Real Estate Activities 
Active participation. If you actively participated in a passive rental real estate activity, you may be able to
deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities.The special allowance isn’t available if you were married, are filing a separate return for the year, and lived with your
spouse at any time during the year. Only an individual, a qualifying estate, or a qualified revocable trust that
made an election to treat the trust as part of the decedent's estate may actively participate in a rental real estate activity. Unless future regulations provide an exception, limited partners are not treated as actively participating in a partnership's rental real estate activity.

Active participation is a less stringent requirement than material participation
You may be treated as actively participating if, for example, you participated in making management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include:
• Approving new tenants,
• Deciding on rental terms,
• Approving capital or repair expenditures, and
• Other similar decisions.
The maximum special allowance is:
• $25,000 for single individuals and married individuals filing a joint return for the tax year.
• $12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year.

Carl
Level 15

100% 1 year Bonus Depreciation

@Anonymous For "about" half the folks, and it depends on when the property was placed in service for most, even after that $25K exception against other ordinary income they will still have carry over in that first year. So that's why I don't bring it up unless it's posted back that they don't have any carry over. Then I'll go into the details of the exception. I think I've only dealt with that maybe 5 times for the 2019 tax year.

The reason I don't bring it up (especially for a first time landlord) is because it has to much potential to add to their confusion and/or understanding of all the data I provide them already. In other words, it's an attempt to avoid as much information overload as possible.

 

tagteam
Level 15

100% 1 year Bonus Depreciation

@Carl With all due respect, what you wrote in your post, as pointed out by @Anonymous, is still erroneous. Beyond the special allowance, however, the two criteria you posted that must be met to be "classified as an improvement" are not incorporated into the Code, Regs, Rulings, Publications, case law, or any source that could be considered even remotely authoritative.

 

If you do not want to mention the $25,000 special allowance (for whatever reason), then you should also not flatly state, "Once your rental expenses get your taxable rental income to zero, that's it. You can't deduct any more.", because that is simply inaccurate depending upon the individual taxpayer's circumstances. 

 

Further, it needs to be pointed out (although it should not need to be pointed out) that virtually none of us have even a rough idea as to how many taxpayers will "still have carry over", much less do we know that "about half the folks" will have carryover. Frankly, if a qualifying rental owner continually sustained more than $25,000 in net losses, I would advise that owner to consider selling the rental property.

Carl
Level 15

100% 1 year Bonus Depreciation

The best plain english information I can find today is at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. It's actually a link that is referenced from https://www.irs.gov/businesses/small-businesses-self-employed/tips-on-rental-real-estate-income-dedu...

Everything they talk about they refer to as a "betterment", and in all the examples used, it does one of two things.

 - Adds real value to the property, or;

 - Maintains a value that could potentially be lost.

So to keep it as simple as possible, a property improvement adds real value to the property.

As an example, cleaning carpets does not add value, or even maintain the value all that much really.If anything, it slows the loss in value. So it's a maintenance expense. When you clean a 3 year old carpet, it's still 3 years old. Whereas when you replace that 3 year old carpet with new carpet, you are adding value or at a minimum, regaining what was lost on the 3-year old carpet that's been in there for 3 years already.  Now this is a really bad example. But it's best I can come up with.

I guess another would be wood floors. Lets say "real" pine wood floors that have been there for about 30 years. Waxing the floors maintains it. It doesn't add value or any "betterment". It's a maintenance expense. However, if you have those floors sanded, treated and resealed with something like polyurethane, that's definitely a betterment, and it definitely adds value. But weather you paid more or less than $2,500 for it, you could probably go either way. Either expense it (under safe harbor just be be safe) or depreciate it.

I found it interesting on the website (because I didn't know this before) that there are some things that can be safe harbored if over $2,500 and less than $5,000. Something to do with having an "Active Financial Statement". But from what I see that applies more to a SCH C or corporate business, than it would to a SCH E rental property. (That's not to say it could never apply to a SCH E property though. I just didn't read much beyond the AFS requirement on that specific item.)

 

Since the $25K thing seems to be getting under your skin, I've added it to the boilerplate.

BTW - have you ever heard of the "Oxy-Moronic Rule Set"?

tagteam
Level 15

100% 1 year Bonus Depreciation


@Carl wrote:

Everything they talk about they refer to as a "betterment", and in all the examples used, it does one of two things.

 - Adds real value to the property, or;

 - Maintains a value that could potentially be lost.

So to keep it as simple as possible, a property improvement adds real value to the property.


Yet, nowhere in the link you provided is "real value" nor "become a material part of" mentioned.

 

In fact, "material" is used consistently in a totally different context than you use that word in your post; it refers to "significant" or "substantial".

 

"Real value" is a completely ambiguous term. There are a plethora of "improvements" that various real estate owners make that either add no value or actually lower the value of the property. To take that to the extreme, adding a walk-in closet in the master bedroom is definitely an improvement but probably does not add any "real value" if the space converted to the closet was the master bathroom. 

 

The point is you are the one who put those words together, not any governmental authority.

 

 


@Carl wrote:

Since the $25K thing seems to be getting under your skin, I've added it to the boilerplate.

BTW - have you ever heard of the "Oxy-Moronic Rule Set"?


If you are going to insert a bunch of boilerplate, then I suppose it is a good idea to get the law correct for the sake of completeness and accuracy. 

 

On a final note, I am aware (a) that the word "oxymoron" is not hyphenated and (b) when to use the words "weather" and "whether" (hint: default to "whether" unless you are posting on Intuit's TurboWeather Community).

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