what happens to depreciation if a rental property is taken out of service

[elm100]

I had a rental unit in my two-gamily home with a depreciation schedule on the renovation.  After ~5 years I turned over the apartment to my parents, so for tax purposes it is now personal use.  What becomes of all the remaining depreciation? Thanks!

[Critter-3]

Nothing happens ... the depreciation simply stops since the property was converted to personal use of a familly member since it seems they are not paying a fair market rate.  If the property has a mortgage then you can deduct the interest paid  and the RE taxes on the Sch A if you itemize deductions.

[Anonymous_]

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@elm100 wrote:

What becomes of all the remaining depreciation?

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The accumulated depreciation remains with the property until you dispose of it in a fully taxable transaction to an unrelated party or you die.

If you actually transferred title (gifted the property) to your parents, they will generally take your adjusted basis (which includes all of the depreciation deductions you have taken over the years).

If you still own the property and decide to place it back into service as a rental, then depreciation will start over again (for the 27.5-year recovery period) but with the basis that reflects the previous depreciation deductions (i.e., at the lower adjusted basis).

[Opus 17]

If you resume renting the property at a market rate, you can resume your depreciation. Otherwise, depreciation is not allowed on personal property, whether it is your own home, your car, or anything else you own. Depreciation is only allowed on property used for business purposes to generate income.

As noted, when the property is sold, the depreciation that was previously claimed will have to be re-captured.

[Anonymous_]

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@Opus 17 wrote:

If you resume renting the property at a market rate, you can resume your depreciation.

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Take a look at Treas. Reg. §1.168(i)-4(c). Rental (business) property converted to personal use is treated as a disposition; depreciation is not resumed.

With respect to rental property that is taken out of service and then placed back into service, the recovery period restarts at 27.5 years using the adjusted basis.

@AmeliesUncle had to correct an expert in another thread with respect to this issue.

[Opus 17]

@Anonymous_ 

I was using the word resume in a generic sense. You are correct that the specific method of depreciating property that is placed back into service is to restart the clock.

[Anonymous_]

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@Opus 17 wrote:

@Anonymous_ 

I was using the word resume in a generic sense. You are correct that the specific method of depreciating property that is placed back into service is to restart the clock.

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Understood (now). I thought (mistakenly) that by "resume" you meant restart where the recovery period left off.

[Carl]

Rental Property converted to personal use.

In the tax year you covert the property to personal use, it is important to print out the two form 4562's for that property. The two I'm referring to both print in landscape format. One is titled "Depreciation and Amortization Report" and the other is "Alternative Minimum Tax Depreciation". Print both forms and keep them. You "will" need them at some point in the future. (discussed below)

Rental property converted to personal use, then back to rental.

If you convert the property back to rental property in the future, depreciation will start all over from year one, using the adjusted cost basis of the property. You will "not" change the cost basis of the land since land is not a depreciable asset. You will change the cost basis of the structure only, along with any other listed assets that are "in fact" depreciated. Basically, the adjusted cost basis of the structure is figured by subtracting all prior depreciation taken from the original cost basis that was used in the past when it was a rental. Then you'll use that new cost basis to start depreciation again over the next 27.5 years.

You sell the property.

If you sell the property, if that property was depreciation at any time during your ownership, you are required to recapture all depreciation taken in the year of the sale, and you will pay taxes on that recaptured depreciation. Yes, you have to recapture "ALL" depreciation, which includes depreciation taken during the first period of time it was a rental. Be aware of a few things concerning recaptured depreciation.

 1. Recaptured depreciation is added to your AGI and depending on the numbers, has the potential to bump you into the next higher tax bracket in the tax year you sell the property.

 2. The increased AGI can potentially disqualify you for some tax credits, such as the Earned Income Credit (EIC).

3. Recaptured depreciation is taxed anywhere from 0% to a maximum of 25%. That maximum can matter if the gain on the sale bumps you into the 32% tax bracket. If that happens, then the recaptured depreciation will be taxed at a maximum of 25%.

You gift the property.

Weather you gift the property to your parents or someone else, the recipient's cost basis will be the "lesser" of the adjusted cost basis (subtracting depreciation taken) or the FMV at the time of the gift.  So even if you gift the property, all depreciation taken will still be accounted for and eventually taxed one way or another.

[Anonymous_]

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@Carl wrote:

Weather you gift the property to your parents or someone else, the recipient's cost basis will be the "lesser" of the adjusted cost basis (subtracting depreciation taken) or the FMV at the time of the gift.  

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That would be dependent upon whether there is a gain or loss when the property is sold.

See https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/property-basis-sale-of-home-etc/prope...