Vacant Rental Returning to Vacation Rental

[DX-hound]

Back in December 2020 our long term tenants moved out of our out-of-state rental house.  With COVID travel restrictions and the need to do some work on the place, it was not rented (vacant) in 2021 and 2022.   For our 2021 tax return, TurboTax asked how many days it was rented.  I put in zero, so TurboTax erased the rental property.   No Schedule E was filed for 2021.   Maybe that was a mistake.  But assuming we open the house as a vacation rental in 2023, how do we capture the passive activity loss carryover from our 2020 return along with the rental's depreciation records and pick it up again as a rental?   We did incur expenses in 2021 and 2022 like exterior painting, repair of a retaining wall, etc.  Any way to recapture those expenses once the place returns to a rental?  I do not recall telling TurboTax that we converted the property to personal use, just entered zero for the days rented and zero for rental income in 2021.

[Carl]

No Schedule E was filed for 2021. Maybe that was a mistake

Yes. That was a boo-boo. But fairly easy to recover from without having to amend to show a conversion to personal use.

Basically, you will show the property "in service" in 2022 with an in service date of whatever day a renter "could" have moved in. Depreciation will start over from year 1, using a newly established cost basis that takes into account depreciation you have already taken. So the new cost basis on the structure will be lower. The cost basis of the land will be exactly the same, since land can not be depreciated.

First, you need to establish a new, adjusted cost basis for the structure and any other depreciable assets, to be used for depreciation on the 2022 tax return. To do that, you need the two Form 4562's from your 2020 return. (They don't exist on your 2021 return, since you say the property was deleted that year.)

The two 4562's you need are not "official" IRS forms. But thy're in the PDF of your 2020 tax return. Both print in landscape format.  One is titled "Amortization and Depreciation Report" and is the one you will most likely need. The other is titled "Alternative Minimum Tax Depreciation" and it will be needed only if the program asks you for any AMT numbers.

First, determine your new cost basis on the structure. Note that the cost basis of the land will not change, since land is never depreciated.

On the 2021 form 4562, "Depreciation and Amortization Report" look at the asset for the property itself. Now add together the amounts in the "prior year depr" column and the "current year depr" column and write that total down. This is the total amount of depreciation taken on that asset thus far. You have to reduce the cost basis of the structure (not the land) by that amount.

Subtract that total from the amount in the "cost basis (net of land)" column to get your new cost basis for the structure and write that total down.

Now add your new cost basis for the structure to the amount in the "Land" column to get your new total cost basis for the property that you will enter into TurboTax 2022. You'll enter that amount in the COST box, and the amount shown in the "Land" column will be what you will enter for "Cost of Land".

The same process works for any other assets you may have listed on the form 4562 from the 2020 return.

Now, if you have anything entered under a heading of "Amortization", that gets handled in a completely different manner. I'll assume you know that, and stop here.

[Anonymous_]

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@DX-hound wrote:

We did incur expenses in 2021 and 2022 like exterior painting, repair of a retaining wall, etc.  Any way to recapture those expenses once the place returns to a rental? 

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No, not if you took the property out of service for rental use. If the property were not available as a rental, then typical rental maintenance and repair expenses are not deductible.

As an afterthought, you stated the property was not rented due to travel restrictions and the need for some repairs, but did you actually take the property out of service? Merely because you had no renters does not necessarily mean the property was not in service as a rental. Would you have accepted a renter, or renters, during that time period, @DX-hound?

[DX-hound]

If someone had come to us and asked about renting it, yes, we probably would have rented it.  But we were not actively advertising it for rent.  We did contact a property management company in March 2022 about renting it out as a vacation home.  We're continuing to work with that company as we get the house in reasonable order to proceed.  Just takes time when it's far from our primary residence.

[DX-hound]

Thanks!  I'll get the forms from our 2020 return and try to work through your recommendation.  How about the passive activity loss carryover?

[Anonymous_]

Provided the property is available for rent, typical rental expenses can be deducted; active advertising and marketing are not required.

[DX-hound]

Thanks Carl.  I found the 4562 forms from our 2020 return and will work through your recommendation.  When you wrote "On the 2021 form 4562, "Depreciation and Amortization Report" look at the asset for the property itself." did you mean to say "On the 2020 form 4562..."   We don't have a 4562 for 2021 as that was when TurboTax erased the property since I had entered zero for days rented and income.

Also, where/how do I recapture the passive activity loss on the property for our 2022 return?

[Carl]

did you mean to say "On the 2020 form 4562..."

Yes.

where/how do I recapture the passive activity loss on the property for our 2022 return?

I can't recall the details exactly. But as you're working through the property in the program, you're asked if you have any PALs on the property. Or maybe it's a checkbox you have to select to indicate that. (????) But I do know you'll be able to "bring it forward" one way or the other.

Just make sure you read the small proint on "every" "single" "screen" before you move on. Also, pay attention to the wording on each screen. There is a difference beteween "select the ONE the applies" and "select ALL that apply". So watch out for that.

[Anonymous_]

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@DX-hound wrote:

Also, where/how do I recapture the passive activity loss on the property for our 2022 return?

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You will come across the screen in the screenshot below in the Property Profile subsection. Make sure to check the box.

[DX-hound]

Carl,

One clarification on what date to enter at the bottom of the relevant TurboTax page asking for Cost, Cost of Land and Date Purchased or Acquired.  You stated:

"Basically, you will show the property "in service" in 2022 with an in service date of whatever day a renter "could" have moved in. Depreciation will start over from year 1, using a newly established cost basis that takes into account depreciation you have already taken."

So do I enter the date we originally place the house into rental (back in the fall of 2007) or some date in 2022?  My confusion comes from "depreciation will start over from year 1."

Also, just to confirm, the entry in the COST block should be the sum of the new cost basis of the structure and the land, not just the cost basis of the structure.

Thanks!

[Carl]

So do I enter the date we originally place the house into rental (back in the fall of 2007

No. You enter the date in 2022 when you converted it from personal use, back to residential rental real estate.

the entry in the COST block should be the sum of the new cost basis of the structure and the land

Correct. Take note that the amount in the COST box will be different from what it was before, since it includes the added cost of your improvements to the structure, and you had to subtract the total amount of depreciation taken on it in past years. But the amount in the COST OF LAND box will be exactly the same as it was before, since you did not do anything to the land to add any value to the land, and land is never depreciated.

When the program (not you) subtracts the "cost of land" from "cost", that will be the amount that gets depreciated over the next 27.5 years. TurboTax will show you what's being depreciated on that final screen where you can select the "review" box to see it.

Outside of TurboTax, it's up to you to keep track of that prior year's depreciation total, as you will be required to recapture it if/when you sell the property in the future. That means when/if you sell it in the future, you won't be able to report it in the SCH E section of the program. You'll have to report it in the "Sale of Business Property" section instead. But deal with than when and if it happens in the future.

Also note that the first year of depreciation (which will be 2022) will be pro-rated, depending on what month you converted it back to a rental and placed it back "in service".

[DX-hound]

OK, but perhaps I was not clear enough in my first post.   We never converted the property to personal use.  It was available for rent in 2021 since out tenants moved out in late December 2020, but we had no renters in 2021 due to our inability to travel out of state to deal with the property (COVID restrictions) and COVID issues in general.  When I made the mistake of entering zero in days rented for 2021, TurboTax erased the Schedule E stuff for 2021's return.  That said, is the only remedy (without filing an amended return) the method you describe and start the depreciation clock over again in 2022, beginning with the new cost basis?

Thanks again!

[Carl]

is the only remedy (without filing an amended return) the method you describe and start the depreciation clock over again in 2022, beginning with the new cost basis?

It's not the only remedy. But it's the best remedy that is the simplest without you amending either the 2020 or the 2021 tax return. You will need the landscape printouts of both 4562's for that rental property from your 2020 tax return, in order to "do the math" to get the correct new cost basis for the 2022 return. You'll also have to keep track of that prior depreciation yourself, outside of TurboTax, since you will be required to recapture it when/if you sell the property in the future.

If you're going to amend, I would suggest you amend the 2021 tax return. But if you do that, then you can't even start your 2022 tax return until you complete the amended return. That's the only way to ensure the correct (amended) values from 2021 are imported into the 2022 tax return, and assuming the property remains "in service" for the entire 2021 tax year, even if it did sit empty because of COVID. (That happened to a lot of landlords that year. So it's not a red flag or anything.)