Rental property capital improvements

[not_no_cpa]

Hi all,

We have a rental apartment in our home that was first "placed in service" in mid-2020.  Using TurboTax, we have calculated and deducted depreciation on that property for 2020 and 2021.  In 2022, however, the apartment was only rented for 4 months through April.  After that, we did a significant renovation and did not rent it again until this month (Feb 2023).  When do we need to put the 2022 renovation costs "in service"?  2022 or 2023? 

The unit was not in a rentable condition for the remainder of 2022, but does it stay "in service" anyway, so that 2022 improvement costs get added to the cost basis for 2022?  It would be cleaner and easier to lump it all into 2023.

Hope this makes sense. Thanks for your input.

Dave

[JohnB5677]

Your rental property was placed "in service" in mid-2020, it did not lose that status because you did renovations. They will be allocated in 2023, when the renovation was completed.  In most cases improvements will be added to the basis and depreciated over time.  This is as opposed to most repairs that can be expensed in the year they occur.

[not_no_cpa]

Thank you!  Follow-up question about expenses as opposed to improvements:

I am assuming we would only be able to deduct expenses for taxes, utilities, etc. apportioned for the 4 months that we rented in 2022, not whole year amounts.  Correct?

Thanks again.

[GeorgeM777]

Yes, that correct.  To follow-up on the comments from @JohnB5677, deduct only those rental expenses, such as utilities, taxes, that relate to the rental period.   It looks like in 2022 you rented the apartment for four months, and therefore, one-third of your full year expenses can be allocated to your rental property. 

@not_no_cpa

[not_no_cpa]

@JohnB5677 @GeorgeM777 

Thanks!!

[Carl]

The unit was not in a rentable condition for the remainder of 2022, but does it stay "in service" anyway, so that 2022 improvement costs get added to the cost basis for 2022?

No. Nothing changes for your 2022 tax return.  The improvement cost will be added to the SCH E Assets/Depreciation section on your 2023 return you will complete next year. The in service date for that property improvement will be the first day the property was "available for rent" in 2023. Depreciation of the capital improvements will start on that date.

[not_no_cpa]

@Carl @GeorgeM777 @JohnB5677 

Thanks for your responses so far, gentlemen.

I've been going through the steps to enter our income and expenses for 2022 in Turbo Tax Premier.  At the end, it appears that the program is claiming depreciation deduction for the entire 12 months of 2022, even though I entered 120 days of FMV rental (and zero personal use).  Is that correct?  I was assuming depreciation would only be for the months rented, but I can imagine why it would be applicable all year.

In any event, TurboTax did not give me an option to adjust the depreciation expense

Thanks in advance for any additional help!

Dave

[Carl]

I missed something in one of your posts above. So let me recap.

The unit was not in a rentable condition for the remainder of 2022, but does it stay "in service" anyway,

Nothing wrong with that, since your intent is to rent it out once renovations are complete. Therefore, the status does not need to change or be changed. Asset depreciation *will* continue for the entire year, as it should.

I am assuming we would only be able to deduct expenses for taxes, utilities, etc. apportioned for the 4 months that we rented in 2022,

That assumption is incorrect. You can claim/deduct expenses for the entire time the property is classified as a rental. You did not convert the property to personal use at all in 2022. Therefore, all expenses incurred for the entire tax year can be claimed on the 2022 tax return.I'm sure that during renovations, the use of utilities (water for mixing plaster, electricity for the skill saw/power drills, gas for heating so the workers didn't freeze, etc.) was required. Therefore, the cost of those utilities is a valid rental expense.

This is in direct conflict with what @GeorgeM777 says. I suspect he may have mis-read or mis-interpreted something. ( don't think I did, but won't rule it out.)

it appears that the program is claiming depreciation deduction for the entire 12 months of 2022, even though I entered 120 days of FMV rental (and zero personal use). Is that correct?

That is correct. The property is depreciated for the entire time it is classified as a rental.  it does not matter if it was actually rented out or not.

Be aware that vacant periods between renters do not count against you. Only personal use days would count against you, and you don't have any personal use days. Therefore, depreciation is taken for the entire tax year.

For the new asset, (the property improvement you did, whatever that was) depreciation on that will not start until the first day that asset is available to a tenant. So if you put a new roof on and started looking for a renter/advertising in 2022, then that date in 2022 would be the "in service" date. You can also claim it to be "in service" the date the work was actually completed, if you want.

If you did not start looking for a renter until 2023, then you would enter nothing about this property improvement on your 2022 tax return. It would be entered on your 2023 tax return which y ou won't deal with until next year.

Your other option is to convert the entire property and all existing assets to personal use, one day after the last renter moved out. But that means any and all expenses incurred after that date are flat out not deductible at all, in addition to stopping depreciation on the property and all it's assets. But that creates it's own issue when you convert the property  back to a rental, as you have to manually do the math yourself to adjust the cost basis, and depreciation starts all over from year 1, for the next 27.5 years.

In my opinion (and we all know what opinions are like.) you save yourself the headache of converting back and forth, by just leaving the property classified as a rental for the entire tax year. With no personal use of the property, things like utilities remain deductible, as I've no doubt they were required in order to actually complete the renovations. Note your mortgage interest, property insurance and property taxes remain deductible for the entire tax year also.

[GeorgeM777]

No, it is not correct.  You are correct in that you need to enter the number of days the property was rented.  Additionally, you need to enter information regarding the percentage of business use for the property.  Therefore, go back into the Rental Property section, and select Edit next to your property.  On the screen where you can Review Your Rental Summary, select Assets/Depreciation.  

As you work your way through the Asset/Depreciation section, you should see the screen Tells Us More About This Rental Asset.  On that screen you will have the option, among other things,  to enter the percentage of business use for your rental property.  Near the end of this section, on the Asset Summary screen, you can view the details about your rental property.  The correct amount of depreciation should be visible and reported on your return.  

@not_no_cpa

After further review, and in light of the fact that your intention was not to take the rental property out of service, then you can claim depreciation for the entire year of 2022, (not just the four months the property was rented).  

While your property was being renovated, it can be fairly characterized as "idle property," and IRS guidance with regard to idle properties allows depreciation to continue while the property remains idle.  

[Edited 02/17/23 | 4:20pm PST]

@not_no_cpa