Depreciation of rental when increasing business percentage

[mrmoppel]

Say I have a condo with cost basis of $27.5k, if I depreciate it over the regular period of 27.5 years, it's $1k a year. Now let's say for the first 10 years I only use 50% of the property for business use (say I'm renting out one of two bedrooms). After 10 years, I'll have depreciated $5k (so 50% of 10*$1k), with 22.5k remaining value.

Now let's say after 10 years, I'm converting from 50% business use to 100%. I only have 17.5 years of life left, so if I keep depreciating at cost basis / 27.5 rate, I won't be able to fully "use up" it's remaining value, but I'll end up with 22.5-17.5 of "undepreciated value".

Is the personal use "depreciation" is "lost"? Or is there another way to depreciate (for example, Turbotax appears to depreciate based Remaining Basis/Life when increasing in business usage)?

[M-MTax]

Based upon a number of posts on this board and some testing, TurboTax is really not capable of handling rental property with varying degrees of business and personal use.

Regardless, the depreciation deduction that is not allowed for your prior personal use is not recovered (or made up somehow) when you later convert to 100% business use; it was and is simply never allowable as a deduction.

[mrmoppel]

Thanks for the quick response!

In general, how do people deal with rental units with varying degrees of business use (e.g. I would imagine each and every Airbnb host has this problem??). How would I capture this in Turbotax?

Does it change anything if I went from 100% business use to, say, 50% for a few years and then back to 100%? 

Finally, I've stumbled upon 26 CFR § 1.168(i)-4 - Changes in use and found mentions (from chat bots that I don't necessarily trust) that - in case of increases in business use - Per Reg. §1.168(i)-4(d)(4), the depreciation rate must be reset using the "Remaining Basis over Remaining Life" (so this would effectively "catch up" the depreciation).

[M-MTax]

Are you just renting a spare bedroom in your house via AirBnB? 

I believe you can simply input the days of use in TurboTax for the purposes of reporting the income and expenses.

[mrmoppel]

Some years we rented the whole place for part of the year. Yes, Turbotax has a form to separate business days and personal days and correctly calculates the depreciation for those years.

The issue is that now that we've moved out and converted to 100% business, Turbotax calculates the depreciation as "remaining value / remaining life" (cost basis - prior depreciation taken, which was based on less than 100% business use), which is higher than "initial cost basis / 27.5" and I want to make sure it's correct.

It should have all the information of fluctuations in business use from prior years, but don't think it's using it for this calculation.

[M-MTax]

If TurboTax calculated the prior depreciation correctly, then the calculation after conversion to 100% rental use should be correct.

The recovery period would not change.

[mrmoppel]

>  Say I have a condo with cost basis of $27.5k, if I depreciate it over the regular period of 27.5 years, it's $1k a year. Now let's say for the first 10 years I only use 50% of the property for business use (say I'm renting out one of two bedrooms). After 10 years, I'll have depreciated $5k (so 50% of 10*$1k), with 22.5k remaining value. Now let's say after 10 years, I'm converting from 50% business use to 100%. I only have 17.5 years of life left, so if I keep depreciating at cost basis / 27.5 rate, I won't be able to fully "use up" it's remaining value, but I'll end up with 22.5-17.5 of "undepreciated value".

Well, based on my example above, Turbotax would depreciate $22.5k / 17.5 years  = $1.28k (remaining value / remaining life) =  instead of $27.5k / 27.5 years  =$1k from year 11 onwards. This can be interpreted as "catching up" the missed depreciation from personal use. Is your interpretation that this is accurate?

[M-MTax]

I have no idea how TurboTax would actually handle this scenario, but when you convert to 100% rental (business) use, then you would use the adjusted basis of the property for depreciation purposes (or the FMV if that is lower than the adjusted basis).

Again, I believe TurboTax is calculating this correctly as you would not use a new recovery period, but the deduction would increase as a result of the increased business usage.

[AmeliesUncle]

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@mrmoppel wrote:

I've stumbled upon 26 CFR § 1.168(i)-4 - Changes in use and found mentions (from chat bots that I don't necessarily trust)

That Regulation does not apply to your situation.

By default, TurboTax calculates depreciation using the 'mathematical' method, rather than using the "tables". If I remember correctly, the ORDER of the math calculations are bit unclear for how to do that.  The order that TurboTax (and several other brands of software) use results in those weird depreciation amounts when the business percentage changes.  I really don't know if that is a correct way or not due to the unclarity of how the order of math calculations should be done.

You aren't supposed to change things mid-stride like this, but if you have the CD/downloaded desktop version of TurboTax, you can go into the "Forms" mode to access the Asset Entry Wks.  When you are on that worksheet, you can scroll WAY down to the bottom and there should be a checkbox to 'Use the Tables'.  That could result in more traditional depreciation, rather than the weird results that you are seeing.  But as I said before, you are not supposed to change things after you have already been depreciating it for a while.

[mrmoppel]

> "'Use the Tables'"

OK great, this seems to work - this gives me a 2024 depreciation of "initial cost basis" / 27.5 instead of (remaining value / remaining life), so this should work (assuming it's the right thing to do!).

AmeliesUncle (or anyone else on this thread), do you know what the correct method (per Tax code, never mind Turbotax's implementation) is:

From year 11 onwards, is it:

1) (remaining value / remaining life) $22.5k / 17.5 years  = $1.28k OR

2) (initial cost basis / total life) $27.5k / 27.5 years  =$1k ?

[Mike9241]

this might work cut the cost in half and continue to use the original in-service date, etc but 100% business use for 2024. if needed change prior depreciation to what it would be if you depreciated $13750 100% for the old rental period which would come from last year's depreciation history or report. the current year should compute at $500. create a new asset with an in-service date of when the new rental starts with a life of 27.5 years 100% business use.  (assumes cost is less than fair market value)

[AmeliesUncle]

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@mrmoppel wrote:

If you get rid of your numbers, BOTH methods are acceptable (but see later comment about the first one).   The first one is the mathematical method and the second one is essentially what the "tables" do.  But as I said before, you aren't supposed to start mid-stream (once you start using one method, you are supposed to keep using it).

The unclear part about the mathematical method (the first option you asked about) is how/where the percentage is applied.

• Should it be remaining value IF it had been depreciated at 100%, then divided by 17.5, then multiple by the business percentage?
• Or is it the remaining value factoring in the ACTUAL percentage changes each year (which is what TurboTax does), then apply the current year percentage?
  • The IRS Publication about this does not discuss if an asset changes percentage, so a literal reading of the Publication would say this is correct.  But Publications are often incomplete and don't cover every matter.  I don't remember if the Regulations or other official guidance has address if the percentage is less than 100%.

You've got me curious now; it has been MANY years since I looked into it so I'm going to have to research it to see if there is a clearer answer anywhere.

[mrmoppel]

> The unclear part about the mathematical method (the first option you asked about) is how/where the percentage is applied.

Exactly.

> You've got me curious now; it has been MANY years since I looked into it so I'm going to have to research it to see if there is a clearer answer anywhere.

Appreciate it, let me know what you find (I spent hours researching this and 1) couldn't find an example for this exact case and 2) every chat bot gives you a different answer and rationale, 3) I tried calling the IRS to ask about this, but they said they can't help with "advanced tax questions...").

[mrmoppel]

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@Mike9241 wrote:

this might work cut the cost in half and continue to use the original in-service date, etc but 100% business use for 2024. if needed change prior depreciation to what it would be if you depreciated $13750 100% for the old rental period which would come from last year's depreciation history or report. the current year should compute at $500. create a new asset with an in-service date of when the new rental starts with a life of 27.5 years 100% business use.  (assumes cost is less than fair market value)

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Yeah, this is probably a "clean" way of doing it (two schedule solution). That said, unfortunately for me, my actual numbers are even more complicated because the business % was different every year for a few years (so I'd need to keep track of 5 or so "property parts" which would get really unwieldy - and can't be how people do it in practice, say if they are renting out a bedroom).