Rental expenses not deductible until rented?

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Bongleur
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Rental expenses not deductible until rented?

Post by Bongleur » Fri Mar 02, 2012 5:10 am

My accountant says that expenses incurred prior to renting a property for the first time are not deductible as rental expenses.

Seems like a Catch-22. Can't rent it to a decent tenant until its fixed up, but can't deduct those expenses unless its ALREADY a rental property. Its not a rental until after a fair-value contract is signed.

What is the solution?

Maybe taking out a loan for the expenses, and not paying it off until after a contract has been written?

Maybe renting it for a month to someone who would otherwise stay at an extended stay business motel?

Not practical to promise to do the upgrades after someone moves in (carpet, plaster, painting...). Might get someone who doesn't want to move in right away, but then if the repairs take too long I am stuck with an unhappy tenant & paying him some penalty.
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Osmund Yep
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Re: Rental expenses not deductible until rented?

Post by Osmund Yep » Fri Mar 02, 2012 7:32 am

Bongleur wrote:My accountant says that expenses incurred prior to renting a property for the first time are not deductible as rental expenses.
Our CPA concurs. She informed us that the last month of two or expenses just prior to renting *may* manage to get deductions applied. Otherwise all that initial rehab expense reduces the cost basis on the property.

For more details, read up on Expenses vs. Capital Expenditures: http://en.wikipedia.org/wiki/Expenses_v ... penditures

OY

pshonore
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Re: Rental expenses not deductible until rented?

Post by pshonore » Fri Mar 02, 2012 7:42 am

Did you mean it increases the cost basis?

imagardener
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Re: Rental expenses not deductible until rented?

Post by imagardener » Fri Mar 02, 2012 8:31 am

I think what your CPA is saying is that rental expenses are maintenance oriented and are only incurred when you have a rental. "Fixing up" expenses generally go into the cost basis such as carpet, fixtures, etc. What you could do is snare a "starter" rental from someone who would pay something less than the going rate so you can start your rental expenses ASAP. Just get someone who won't trash it, maybe a weekend rental. The length of rental shouldn't matter, just the date it's put into service as a legitimate rental.

Maybe you have some family who would come visit and pay rent instead of a motel? Or a good friend?

Muchtolearn
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Re: Rental expenses not deductible until rented?

Post by Muchtolearn » Fri Mar 02, 2012 8:45 am

If cash flow is that much of an issue that you need the tax benefits before renting, why would you bother getting into that situation? Dont do it.

Grt2bOutdoors
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Re: Rental expenses not deductible until rented?

Post by Grt2bOutdoors » Fri Mar 02, 2012 9:19 am

Bongleur wrote:My accountant says that expenses incurred prior to renting a property for the first time are not deductible as rental expenses.

Seems like a Catch-22. Can't rent it to a decent tenant until its fixed up, but can't deduct those expenses unless its ALREADY a rental property. Its not a rental until after a fair-value contract is signed.

What is the solution?

Maybe taking out a loan for the expenses, and not paying it off until after a contract has been written?

Maybe renting it for a month to someone who would otherwise stay at an extended stay business motel?

Not practical to promise to do the upgrades after someone moves in (carpet, plaster, painting...). Might get someone who doesn't want to move in right away, but then if the repairs take too long I am stuck with an unhappy tenant & paying him some penalty.
Let's say you place the property into service on 1/1/2011, not lets say you make repairs on 1/7/11 and then you find someone to rent to on 2/1/11, you can expense the repairs as of 1/1/2011 and depreciate it as of 1/1/2011.
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gkaplan
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Re: Rental expenses not deductible until rented?

Post by gkaplan » Fri Mar 02, 2012 9:24 am

Gordon

sscritic
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Re: Rental expenses not deductible until rented?

Post by sscritic » Fri Mar 02, 2012 9:33 am

GRT2BOUTDOORS wrote: Let's say you place the property into service on 1/1/2011, not lets say you make repairs on 1/7/11 and then you find someone to rent to on 2/1/11, you can expense the repairs as of 1/1/2011 and depreciate it as of 1/1/2011.
Great! Double dipping. Can I both expense and depreciate any expenses from then on? :)

Osmund Yep
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Re: Rental expenses not deductible until rented?

Post by Osmund Yep » Fri Mar 02, 2012 9:48 am

pshonore wrote:Did you mean it increases the cost basis?
Yes, thanks. :)

travellight
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Re: Rental expenses not deductible until rented?

Post by travellight » Fri Mar 02, 2012 9:57 am

My understanding is that repairs and maintenance are deductible but improvements are not, in general. So, if you replaced the stove and dishwasher it is deductible but if you added a new dishwasher where there was not one before, it is not. I did not know about timing with regard to rentals.

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Sally
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Re: Rental expenses not deductible until rented?

Post by Sally » Fri Mar 02, 2012 10:23 am

IMHO, unless the CPA means that you need rental income (during the tax year) in order to deduct an expense, find a new CPA....

"Pre-rental expenses. You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent."

sscritic
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Re: Rental expenses not deductible until rented?

Post by sscritic » Fri Mar 02, 2012 10:52 am

The key is to advertise before you do the repairs. The day of your first ad is "the time you make it available for rent." When someone comes to look, say, "I am making repairs, but if you need a place right away you can move in and I will coordinate the work around your schedule." If they choose not to move in, that's up to them, but you have met the "the time you make it available for rent" test.

Dougroseville
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Re: Rental expenses not deductible until rented?

Post by Dougroseville » Fri Mar 02, 2012 3:36 pm

Here is another good general reference:
http://www.realtax.com/investors_repairs.html

Bongleur
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Re: Rental expenses not deductible until rented?

Post by Bongleur » Sun Mar 04, 2012 11:03 pm

>The length of rental shouldn't matter, just the date it's put into service as a legitimate rental.

I posed that question and he wasn't sure if it would be acceptable to rent it for a short time since it might appear to be only for the purpose of making the maintenance into an expense.

Increasing the basis is of no use.

The rental management company doesn't know either; but all their owned properties are part of their business as soon as purchased, so don't need to be changed from non-rental to rental.
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Bongleur
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Re: Rental expenses not deductible until rented?

Post by Bongleur » Sun Mar 04, 2012 11:11 pm

Speaking of changes to basis -- how does renting it affect the basis step-up when real property is inherited? Don't want to screw that up. Maybe we should not claim any depreciation...
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Re: Rental expenses not deductible until rented?

Post by Bongleur » Sun Mar 04, 2012 11:17 pm

http://www.irs.gov/pub/irs-pdf/p527.pdf
Pg 6

When Does Depreciation Begin and End?
You begin to depreciate your rental property when you place it in service for the production of income. You stop depreciating it either when you have fully recovered your cost or other ba- sis, or when you retire it from service, whichever happens first.

Placed in Service
You place property in service in a rental activity when it is ready and available for a specific use in that activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

***

This does not address my question. I am not asking when I can begin Depreciation. I need to know when I can deduct maintenance expenses from rental income.
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Re: Rental expenses not deductible until rented?

Post by Bongleur » Sun Mar 04, 2012 11:31 pm

http://www.realtax.com/investors_repairs.html


5. Pre-Rental Expense

Just because a rental unit is vacant, does not mean that you are forced to capitalize your operating expenses. You see, "if you hold your property for rental purposes, you may deduct your ordinary and necessary expenses for managing, conserving, or maintaining the property." The key is to make sure that you hold your property for rental purposes by making it available for rent (by posting a sign, running a newspaper ad, etc.). In the event that your unit remains empty, thus keeping your rental income low, it is important that you keep proof that the unit was available for rent should the deduction be challenged by the IRS.
***

I'd like to find the IRS Pub where that quote is located.

Can I deduct maintenance expenses if I advertise "For rent. Available July 1st" or does it have to be available right now?
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songman52
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Re: Rental expenses not deductible until rented?

Post by songman52 » Sun Mar 04, 2012 11:56 pm

I hope this helps. You need to refer to IRS Publication 527. Any improvements you make to the propery add to the basis, and add to the depreciation amount allowed. Any expenses are deducted in the year in which they occur. There is a chart in the publicatin which lists common improvements, and some explanatory text with examples. For instance, repairing a part of a roof is an expense but replacing the whole roof is an improvement. Also keep in mind that different asset classes have different depreciation schedules. For instance an appliance (unless it's built in) typically has a five-year depreciation period, whereas the rental property itself (house?) has a 27.5 year period.

Be sure to keep a record of the basis. If it was inherited then keep a record of the basis of the benefactor as well as the stepped-up basis, usually FMV, on the date you received it. This might come into play years later when you dispose of the property. It's in Pub. 527 (or you might need to consult Pub. 551 as well.)

Why would you NOT want to depreciate the property, if you are depending on it for income? The depreciation will help the current bottom line, and if there is a loss it can offset your other income. Just wondering.

JayRay

Oh, and the answer generally is that you can deduct expenses when the unit is available for rental, as stated previously by others.

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Re: Rental expenses not deductible until rented?

Post by jared » Sun Mar 04, 2012 11:59 pm

Bongleur wrote:Speaking of changes to basis -- how does renting it affect the basis step-up when real property is inherited? Don't want to screw that up. Maybe we should not claim any depreciation...
Depreciation is not optional.

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Re: Rental expenses not deductible until rented?

Post by songman52 » Mon Mar 05, 2012 12:05 am

If you read page 11 of Pub. 527 it states that if you under-depreciated, you can file an amended return. It states that whether or not you claim the depreciation, you must still reduce the basis by the allowable amount.

Bongleur
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Re: Rental expenses not deductible until rented?

Post by Bongleur » Mon Mar 05, 2012 12:31 am

songman52 wrote:If you read page 11 of Pub. 527 it states that if you under-depreciated, you can file an amended return. It states that whether or not you claim the depreciation, you must still reduce the basis by the allowable amount.
As long as I don't screw up the inheritance step-up.

There is no benefit to reducing the basis because what counts is the inheritance step up happening some years from now.

At the moment, I want to expense MAINTENANCE -- new stove, fridge, carpet, repairs to plaster, interior paint. Stuff that makes it rent for more, and which offsets taxes on that rental income.
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Re: Rental expenses not deductible until rented?

Post by songman52 » Mon Mar 05, 2012 12:50 am

New stove, fridge and carpet should be depreciated. Paint and repairs to plaster are expensed. Double check, but the stove and fridge are under the 5 year schedule as appliances, and the carpet is also typically 5 years, using the MACRS.
The benefit is not really in reducing the basis, but in deducting the depreciation as an "expense" against the income. You could have a positive cash flow in your pocket, yet actually show a loss on paper, depending on the rental receipts and the actual depreciation. So it's kind of like a qualified investment - save it now, pay it later.

As for disposal years hence, there could be tax-saving measures such as trade-in-kind, etc. So trade your fully-depreciated property for another property and start the clock ticking again. But if there is still the rule about stepped-up basis on inherited property, what is the concern if you're leaving it to heirs? You don't think congress might somehow change the rules, do you? I wouldn't bet against it, but then I can't plan for it either. Just go with what the law is currently.

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Re: Rental expenses not deductible until rented?

Post by sscritic » Mon Mar 05, 2012 1:06 am

Bongleur wrote: Just because a rental unit is vacant, does not mean that you are forced to capitalize your operating expenses. You see, "if you hold your property for rental purposes, you may deduct your ordinary and necessary expenses for managing, conserving, or maintaining the property." The key is to make sure that you hold your property for rental purposes by making it available for rent (by posting a sign, running a newspaper ad, etc.). In the event that your unit remains empty, thus keeping your rental income low, it is important that you keep proof that the unit was available for rent should the deduction be challenged by the IRS.
***

I'd like to find the IRS Pub where that quote is located.

Can I deduct maintenance expenses if I advertise "For rent. Available July 1st" or does it have to be available right now?
First question: search for what's in the IRS publication, not what's in someone else's summary. Hint: two previous posts mentioned the correct wording.
Second question: If your unit has a sign in the window "Opening, June 2014," does that qualify as "available"? Hint: think about it.

Back to first question: bing "the time you make it available for rent"
http://www.bing.com/search?q=%22the+tim ... or+rent%22

First result: Publication 527 (2011), Residential Rental Property [who'd a thunk it!]
Pre-rental expenses. You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent.
The author you quoted is a plagiarist. But back to the quote from Publication 527. Doesn't that sound familiar? Did someone already post that in this thread? Do we need another hint?
http://www.bogleheads.org/forum/viewtop ... 2#p1323592

And when was that posted? Friday at 7 am by my clock.

It always helps to read your own thread. The answers might be sitting there staring you in the face. :)

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Re: Rental expenses not deductible until rented?

Post by Bongleur » Mon Mar 05, 2012 1:28 am

I've been reading 527.

>Second question: If your unit has a sign in the window "Opening, June 2014," does that qualify as "available"? Hint: think about it.

Dunno. They could sign a contract, but my accountant seems to be saying that isn't sufficient since it has never been rented before. Maybe I have to collect some rent $$ before I can expense anything ??? Need the IRS to tell me (while waiting for the accountant to figure it out...)

This is my parents house, and eventually I will inherit, so I need the stepped-up basis. Don't want to do anything to screw that up. Its worth 10-20 times their purchase price in the '60s.
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Re: Rental expenses not deductible until rented?

Post by tadamsmar » Mon Mar 05, 2012 4:03 pm

Muchtolearn wrote:If cash flow is that much of an issue that you need the tax benefits before renting, why would you bother getting into that situation? Dont do it.
He did not say that. The obvious interpretation is that he wants to avoid taxes regardless of whether cash flow is an issue.

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damjam
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Re: Rental expenses not deductible until rented?

Post by damjam » Mon Mar 05, 2012 4:51 pm

>Second question: If your unit has a sign in the window "Opening, June 2014," does that qualify as "available"? Hint: think about it.

Dunno. They could sign a contract, but my accountant seems to be saying that isn't sufficient since it has never been rented before. Maybe I have to collect some rent $$ before I can expense anything ??? Need the IRS to tell me (while waiting for the accountant to figure it out...)
I'm not an expert, but it sounds to me like the apartment is available to place into service June 2014.

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damjam
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Re: Rental expenses not deductible until rented?

Post by damjam » Mon Mar 05, 2012 6:02 pm

Bongleur wrote:This is my parents house, and eventually I will inherit, so I need the stepped-up basis. Don't want to do anything to screw that up. Its worth 10-20 times their purchase price in the '60s.
The basis in a property you inherit from a decedent is generally one of the following:
IRS Pub 17 wrote: The FMV of the property at the date of the decedent's death.

The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate valuation.

The value under the special-use valuation method for real property used in farming or a closely held business if elected for estate tax purposes.

The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation easement.
So it appears the basis in the property is unchanged by any depreciation taken prior to inheritance.

If I've misinterpreted the IRS or have the wrong Publication someone please correct me.
Last edited by damjam on Tue Mar 06, 2012 4:13 pm, edited 1 time in total.

Bongleur
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Re: Rental expenses not deductible until rented?

Post by Bongleur » Mon Mar 05, 2012 6:14 pm

>I'm not an expert, but it sounds to me like the apartment is available to place into service June 2014.

What I need to know is: does "not available for move-in until June" count as "currently in service" or "will be in service in June?"

If I am currently offering to write a rental contract that starts in the future, is it in service?
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Re: Rental expenses not deductible until rented?

Post by imagardener » Tue Mar 06, 2012 4:05 pm

If I am currently offering to write a rental contract that starts in the future, is it in service?

No, unless it is available to rent now and ongoing. It will be in service exactly when it is in service, not before.

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Re: Rental expenses not deductible until rented?

Post by Bongleur » Tue Mar 06, 2012 6:53 pm

My accountant says that having a contract might be sufficient; having a contract with a security deposit ought to be sufficient.
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Muchtolearn
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Re: Rental expenses not deductible until rented?

Post by Muchtolearn » Tue Mar 06, 2012 7:08 pm

I just figured out, at least to my satisfaction, why the IRS would not permit it to be deductible. A person contemplating placing a property for rental or prepping it for rental or anything like that is not objective in that it could simply be their own property that they never rent. So I assume they want to see some real proof like a rent payment to show that you have truly rented the place.

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Re: Rental expenses not deductible until rented?

Post by Bongleur » Wed Mar 07, 2012 1:18 am

Well if you never rent it then obviously there would be no rental income to offset by the maintenance expense. The Catch-22 is that you can't do repairs until AFTER it is "in service" when logically you should be able to repair the place FIRST in order to attract a higher rent. Then the Govt would make more taxes.
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