When claiming capital gains tax on the sale of a property, how recently do improvements have to be made in order to qualify as deductions?

[add11601]

I have to claim capital gains for this house because I claimed the 2-year primary residence capital gains exemption last year. Improvements on this house were made about 2 and a half years ago. Can I still deduct the improvements (did a full remodel) from the capital gains that I will have to claim?

[MinhT1 · Accepted solution]

Improvements made on a property are always added to the cost basis of the property, no matter when they were paid for during your ownership of the property. Adding these improvements to your cost basis will reduce any capital gains you may have on the sale of the property.

[bigsteve1037]

So I think this answers my question as well, however we lived in a house for 5 years, made a bunch of upgrades, then turned it into a rental property and sold it 10 years later (last year). it sounds like I can deduct the improvements made on the property when we lived there. Can this be confirmed? Also the follow on question is more specific about turbo tax. where do I put this in turbo tax? Just in the repairs section of the rental property?

[JohnB5677]

You didn't quite use the correct term.  The improvements to the house that you made before it was a rental can be added to the cost basis to reduce the capital gain on the house.  This is not a deduction in the traditional sense.

However, this should have been done back when you turned it into the rental and it would have been depreciated annually.

Depreciation.

Depreciation is a capital expense. It is the mechanism for recovering your cost in an income-producing property and must be taken over the expected life of the property.  You can begin to depreciate rental property when it is ready and available for rent. See Placed in Service under When Does Depreciation Begin and End? in chapter 2.

See IRS Publication 527 (2020), Residential Rental Property

[bigsteve1037]

So, if i understand this correctly, things we did when we lived in the property, new cabinets should have been added to depreciate them when we turned it into a rental property which would have lowered our cost basis. Since this was not done, is there anything i can do now to lower the amount of capital gains tax based on these improvements?

[DianeW777]

It depends.  The IRS language for the depreciation you did not claim is allowed or allowable which means use it or lose it. The capital improvements can be added to the cost basis but the depreciation on these improvements must also be accounted for to reduce the cost basis. This means the gain would increase by the depreciation that would have been used had you entered this improvement when it became a rental property. 

Add the improvements as an asset with the original date as if you had put it in service like the house. Then prorate the selling price and expenses for each asset for the sale.  See the example below.

To take the deduction for the depreciation that you never utilized over the 10 years, on your 2021 tax return, you can use the procedure below.

• Form 3115 Instruction: By including this with the current year tax return, you can complete everything on the 2021 tax return.

1. Adopt a change in accounting method: This option allows you to go back as far as you need. Make the adjustment on your current year tax return to expense the missing depreciation.
   • Why am I adopting a change in accounting method? Not claiming depreciation in two or more years indicates that you've chosen an accounting method without depreciation. In this case, you must now elect to change your accounting method to include depreciation.
2. You must use the TurboTax CD/Download version to complete this form. TurboTax does not help you with this form. And your return must be mailed because this form is not supported through e-file.
   1. This must be completed and filed with the return on time. 
   2. How do I switch from TurboTax Online to TurboTax CD/Download?

Use the original cost of each asset listed on depreciation, add those together then divide each one by the combined total to find the percentage of the cost for each asset.  Use that percentage times the sales price and sales expenses to find the selling price/sales expenses for each asset.

Example:  Original Cost (of each asset on your depreciation schedule)

$10,000 Land                = 13.33% 

$50,000 House              = 66.67%

$15,000 Improvements  = 20%

$75,000 Total                 = 100%

Multiply each percentage times the sales price/sales expenses to arrive at each individual sales price/sales expense.

I hope this example provides clarification to enter your sale.

You need to dispose of the property by telling TurboTax how and when it was disposed of.  Follow the instructions below.

1. Click on Income & Expenses
2. Under Your income and expenses, scroll down to
3. Rental properties and royalties, click Edit/Add
4. Do you want to review your rental?, click Yes
5. Under Rent and Royalty Summary, click Edit
6. Click Update to the right of Assets/Depreciation.
7. Do you want to go directly to your asset summary?, click Yes and Continue
8. Click Edit to the right of each asset to be disposed
9. Go through several screens until you get to Tell Us More About This Rental Asset
10. Click on This item was sold…….   And continue to answer the questions

You might also review information here.

@bigsteve1037