Our primary home became a rental property in 5/21, was rented between 5/21-10/21, and then the decision was made to sell. It was renovated between 10/21-2/22 and then sold 3/22. How do we categorize and assign costs across 2021 and 2022?

[Anonymous]

We incurred startup costs to prepare the property for rent, rental expenses once the property was rented, and various costs while vacant and being remodeled leading up to the sale. Since the property sold in 2022, how do we account for these costs on our 2021 taxes, especially during the vacancy period? 

Our impression is that if we cannot find a way to claim these in 2021, we will not be able to capture the typical benefits associated with sale in 2022 on what amounts to many tens of thousands of dollars of expenses incurred preparing the property for the market. Which are rental expenses? Which are sales expenses? Which should be listed as assets? Which are simply not able to be deducted or capitalized? Thus far all of our attempts to properly categorize the below and account for them between 2021 and 2022 have been fraught and it occurred to us that we mustn’t be the first people to encounter this challenge. There must be a more elegant and appropriate solution than any we’ve come up with. Example costs:

• Improvements, including all new kitchen built-in appliances (purchased 10/21 but arrived and installed 11/21 through 2/22) and upgraded light fixtures (purchased 11/21 and installed in 2022). Are these added as assets and sold with the home? Are they in service and are they depreciated if the property is vacant and the appliances are never used by a tenant?
• Utility costs while vacant.
• Tenant move-out deep cleaning.
• Home insurance bill (paid 5/20) covering period 5/20 - 5/21. Five days of coverage in 5/21 overlap with renter occupancy.
• Home insurance bill (paid 5/21) covering period May 2021 to May 2022
• Property taxes paid October 21, 2021 for tax period 7/21 to 6/22
• Routine gardening and maintenance while vacant
• Non-routine sale-prep gardening and maintenance costs while vacant

Notes: We qualify for the Section 121 exclusion on this sale and the gain will exceed our joint exclusion amount. My wife will qualify as a real estate professional for tax year 2021 (and possibly 2022).

Thank you very much in advance!

[ColeenD3]

• Improvements, including all new kitchen built-in appliances (purchased 10/21 but arrived and installed 11/21 through 2/22) and upgraded light fixtures (purchased 11/21 and installed in 2022). Are these added as assets and sold with the home? Are they in service and are they depreciated if the property is vacant and the appliances are never used by a tenant? These are added to the basis of the home. They were never in service and can't be deducted.
•  
• Utility costs while vacant.
• Tenant move-out deep cleaning.
• Non-routine sale-prep gardening and maintenance costs while vacant

These are personal expenses and are neither deducted nor added to the basis. the property was not available to be rented.

Vacant rental property. If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. However, you cannot deduct any loss of rental income for the period the property is vacant.

Vacant while listed for sale. If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold. If the property is not held out and available for rent while listed for sale, the expenses are not deductible rental expenses.

Any expense that was incurred while the property was rented or placed in service and available to rent is deductible. If you only have one day or one week's worth of expenses, you deduct that amount only.

Placed-in-Service Date An owner can begin to depreciate property when he or she places it in service in his or her trade or business or for the production of income. Property is considered placed in service in a rental activity when it is ready and available for a specific use in that activity.

[Anonymous]

Hi @ColeenD3,

Thank you very much for the quick and detailed reply. If I may ask just a couple of clarifying questions:

(1) Would we treat this as “Vacant rental property” rather than “Vacant while listed for sale”?

The property was first our primary residence, then converted from personal use to rental property (with the express rationale that we wanted the market to recover before selling). The remodel began shortly after the tenants moved out with the aim of improving its resale value. We didn’t live in it, store things in it, or use it for another business during the remodel. The work was completed and we ultimately listed it for sale in early 2022. We did not list it for rent during the remodel or after, but had it not garnered the price we felt it deserved, we would have put it back on the rental market for some period of time before re-attempting to sell.

(2) Am I understanding correctly that regardless of when a bill comes due or is paid during the tax year, only the pro-rated portion of that bill which directly corresponds to the rental period should be deducted (e.g., if it is a rental for 3 months during that year’s property tax period, then ¼ of the property tax can be deducted)? 

(3) How do we accurately enter assets that were paid for in 2021 but put into service in 2022?

With regard to the appliances and other assets, a few challenges have us stumped.

(A) Many of these appliances were purchased in 2021 but not installed until January or February of 2022 and then, I suppose, not placed “in-service” until the property was made available for sale in March of 2022. If I enter an asset, like a new refrigerator, I select “I purchased this asset new” and I am required to choose either: 

• “Yes, I’ve always used this item 100% of the time for business” and then an in-service date, which can’t be in 2022. I assume if I do choose a date in 2021 (the date we bought it? December 31st??), that will start depreciating the asset, which I believe would not be appropriate until it is in-service.

OR I must choose

• “No, I have not always used this item 100% of the time for business”, which seems more likely the correct route for an item in storage or in transit (based on the associated Learn More note that categorizes storage as personal use). I am still required by TurboTax to enter an in-service date in 2021 and also a percentage of time used for business, which must be at least 1%. I could put 12/31/2021 and 1%, which is as close to accurate as I am allowed, but it still doesn’t seem quite right.

Alternately, I could ALSO select 

• “The item was sold, retired, stolen, destroyed, disposed of, converted to personal use, traded in, or given away (or it’s no longer being used in this business for some other reason), with the assumption that a fridge sitting in transit could be considered personal use (storage, as above) or otherwise no longer being used for business. If that is proper, would the date of retirement be the same as the date of purchase? This doesn’t feel quite right, and I wouldn’t want the asset to be deleted because I marked it retired. 

Finally, I suppose I could

• Wait until 2022 to enter these items as assets (though purchased in 2021). However, because the expenses are in the 2021 tax year, I worry that this approach is not appropriate. 

(B) Should assets under $2500 just get expensed under the de minimus safe harbor election (treasury Decision 9636) in 2021? I’ve seen it suggested on this forum to put those items in Schedule E Miscellaneous Expenses with a note mentioning de minimus safe harbor. This won’t help for the larger items but would avoid straddling the 2021/2022 tax year for the smaller stuff. We run our rental properties as a business, but I am not sure that we qualify in this case.

Any thoughts are much appreciated and thank you for your help. We have recently unfortunately had an extremely disappointing experience with our longtime accountant and are thus going it on our own and are so very appreciative of your guidance and this forum.

[ColeenD3]

1) No, this is not a vacation home. Nobody, neither you nor tenants used the property as a residence during the construction period. It was personal property, converted to rental property and then vacant property.

2) Yes, an expense is only a rental expense for the time it was actually rented.

3) You said, ", not placed “in-service” until the property was made available for sale in March of 2022". This property was never placed in service. It was never made available for a tenant's use. You can add the appliances to the basis of the building.

Placed in service:

The term placed in service means the time that property is first placed by the taxpayer in a condition or state of readiness and availability for a specifically assigned function, whether for use in a trade or business, for the production of income, in a tax-exempt activity, or in a personal activity.

4) If the assets you are referring to were placed in service during the rental period, you can take them as expenses under the De minimus Safe Harbor rule.