Real Estate Converted to Residential Rental Property
If you change your home or other property (or a part of it) to rental use at any time other than the beginning of your tax year, you must divide yearly expenses, such as taxes and insurance, between rental use and personal use.
You can deduct as rental expenses only the part of the expense that is for the part of the year the property was used or held for rental purposes.
You cannot deduct depreciation or insurance for the part of the year the property was held for personal use. However, you can include the home mortgage interest, qualified mortgage insurance premiums, and real estate tax expenses for the part of the year the property was held for personal use as an itemized deduction on Schedule A (Form 1040). If you are unable to itemize your deductions, there is an option for deducting real estate tax (see below).
Example.
Your tax year is the calendar year. You moved from your home in May and started renting it out on June 1. You can deduct as rental expenses seven-twelfths of your yearly expenses, such as taxes and insurance.
Starting with June, you can deduct as rental expenses the amounts you pay for items generally billed monthly, such as utilities.
When figuring depreciation, treat the property as placed in service on June 1.
Adding real estate taxes to standard deduction. If you are not able to itemize your deductions on your 2009 tax return, you may be able to deduct all or part of the real estate tax you paid on property held for personal use. Take the deduction (limited to $500 ($1,000 if married filing jointly)) on Schedule L (Form 1040). See the Schedule L and its instructions for details.
Basis of Property Changed to Rental Use
When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion.
Fair market value. This is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.
Figuring the basis. The basis for depreciation is the lesser of:
- The fair market value of the property on the date you changed it to rental use, or
- Your adjusted basis on the date of the change—that is, your original cost or other basis of the property, plus the cost of permanent additions or improvements since you acquired it, minus deductions for any casualty or theft losses claimed on earlier years’ income tax returns and other decreases to basis. For other increases and decreases to basis, see Adjusted Basis in chapter 1.
Example.
Several years ago you built your home for $140,000 on a lot that cost you $14,000. Before changing the property to rental use this year, you added $28,000 of permanent improvements to the house and claimed a $3,500 casualty loss deduction for damage to the house. Part of the improvements qualified for a $500 residential energy credit, which you claimed on your 2006 tax return. Because land is not depreciable, you can only include the cost of the house when figuring the basis for depreciation.
The adjusted basis of the house at the time of the change in its use was $164,000 ($140,000 + $28,000 − $3,500 − $500).
On the date of the change in use, your property had a fair market value of $168,000, of which $21,000 was for the land and $147,000 was for the house.
The basis for depreciation on the house is the fair market value on the date of the change ($147,000), because it is less than your adjusted basis ($164,000).
Cooperatives
If you change your cooperative apartment to rental use, figure your allowable depreciation as explained earlier. The basis of all the depreciable real property owned by the cooperative housing corporation is the smaller of the following amounts.
- The fair market value of the property on the date you change your apartment to rental use. This is considered to be the same as the corporation’s adjusted basis minus straight line depreciation, unless this value is unrealistic.
- The corporation’s adjusted basis in the property on that date. Do not subtract depreciation when figuring the corporation’s adjusted basis.
If you bought the stock after its first offering, the corporation’s adjusted basis in the property is the amount figured in (1) under Depreciation (under Cooperative, near the beginning of this chapter). The fair market value of the property is considered to be the same as the corporation’s adjusted basis figured in this way minus straight line depreciation, unless the value is unrealistic.
Figuring the Depreciation Deduction
To figure the deduction, use the depreciation system in effect when you convert your residence to rental use. Generally, that will be MACRS for any conversion after 1986. Treat the property as placed in service on the conversion date.
Example.
Your converted residence (see previous example) was available for rent on August 1. Using Table 2-2d (see chapter 2), the percentage for Year 1 beginning in August is 1.364% and the depreciation deduction for Year 1 is $2,005 ($147,000 × .01364).
Illustrated Example— Property Changed to Rental Use
In January, Eileen Johnson bought a condominium apartment to live in. Instead of selling the house she had been living in, she decided to change it to rental property. Eileen selected a tenant and started renting the house on February 1. Eileen charges $750 a month for rent and collects it herself. Eileen also received a $750 security deposit from her tenant. Because she plans to return it to her tenant at the end of the lease, she does not include it in her income. Her rental expenses for the year are as follows.
|
|
Mortgage interest |
$1,800 |
|
|
|
Fire insurance (1-year policy) |
100 |
|
|
|
Miscellaneous repairs (after renting) |
297 |
|
|
|
Real estate taxes imposed and paid |
1,200 |
|
Eileen must divide the real estate taxes, mortgage interest, and fire insurance between the personal use of the property and the rental use of the property. She can deduct eleven-twelfths of these expenses as rental expenses. She can include the balance of the allowable taxes and mortgage interest on Schedule A if she itemizes. She cannot deduct the balance of the fire insurance because it is a personal expense.
Eileen bought this house in 1984 for $35,000. Her property tax was based on assessed values of $10,000 for the land and $25,000 for the house. Before changing it to rental property, Eileen added several improvements to the house. She figures her adjusted basis as follows:
|
|
Improvements |
Cost |
|
|
|
House |
$25,000 |
|
|
|
Remodeled kitchen |
4,200 |
|
|
|
Recreation room |
5,800 |
|
|
|
New roof |
1,600 |
|
|
|
Patio and deck |
2,400 |
|
|
|
Adjusted basis |
$39,000 |
|
On February 1, when Eileen changed her house to rental property, the property had a fair market value of $152,000. Of this amount, $35,000 was for the land and $117,000 was for the house.
Because Eileen’s adjusted basis is less than the fair market value on the date of the change, Eileen uses $39,000 as her basis for depreciation.
As specified for residential rental property, Eileen must use the straight line method of depreciation over the GDS or ADS recovery period. She chooses the GDS recovery period of 27.5 years.
She uses Table 2-2d to find her depreciation percentage. Since she placed the property in service in February, the percentage is 3.182%.
On April 1, Eileen bought a new dishwasher for the rental property at a cost of $425. The dishwasher is personal property used in a rental real estate activity, which has a 5-year recovery period. She uses Table 2-2a to find the percentage for Year 1 under “Half-year convention” (20%) to figure her depreciation deduction.
On May 1, Eileen paid $4,000 to have a furnace installed in the house. The furnace is residential rental property. Because she placed the property in service in May, the percentage from Table 2-2d is 2.273%.
Eileen figures her net rental income or loss for the house as follows:
| Total rental income received ($750 × 11) |
$8,250 |
|
| Minus: Expenses |
|
|
| Mortgage interest ($1,800 × 11/12) |
$1,650 |
|
| Fire insurance ($100 × 11/12) |
92 |
|
| Miscellaneous repairs |
297 |
|
| Real estate taxes ($1,200 × 11/12) |
1,100 |
|
| Total expenses |
3,139 |
|
| Balance |
$5,111 |
|
| Minus: Depreciation |
|
|
| House ($39,000 × .03182) |
$1,241 |
|
| Dishwasher ($425 × .20) |
85 |
|
| Furnace ($4,000 × .02273) |
91 |
|
| Total depreciation |
1,417 |
|
| Net rental income for house |
|
$3,694 |
|
|
|
|
Eileen uses Schedule E, Part I, to report her rental income and expenses. She enters her income, expenses, and depreciation for the house in the column for Property A. Since all property was placed in service this year, Eileen must use Form 4562 to figure the depreciation.
Source: IRS Publication 527
This is a blog post for Real Estate Professionals, Investors, Landlord, Property Manager, and Property Management Companies. 2010 Tax Tips for Accidental Landlords, Real Estate Investors who converted property to rental is brought to you by SimplifyEm Pay Rent Online and Property Management Software
|
Welcome back! What did you think of our Property Management Software?
Are you subscribed to our feed and receiving email updates? |
You might also want to read:
- 2010 Tax Tips for Landlords, Real Estate Investors for personal use of Rental Property We are looking at rental activities where the same dwelling unit is used both as your home (or is considered to be your home) and as a rental. This might be a vacation home or......
- 2010 Tax Tips for Accidental Landlords, Real Estate Investors who rent a room If you rent part of your property, you must divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though you......
- 2010 Cooperatives Rental Property Tax Tips for Landlords, Real Estate Investors If you live in a cooperative, you do not own your apartment. Instead, a corporation owns the apartments and you are a tenant-stockholder in the cooperative housing corporation. If you rent your apartment to others,......
- 2010 Vacation Rental Property Tax Deduction Tips for Landlords, Real Estate Investors If you receive rental income from renting to others, a dwelling unit, such as a house or an apartment, you may deduct certain expenses. These expenses, which may include interest, taxes, casualty losses, maintenance, utilities,......
- 2010 Rental Property Income Reporting Tax Tips from IRS for Landlords, Real Estate Investors Generally, cash or the fair market value of property you receive for the use of real estate or personal property is taxable to you as rental income. You can generally deduct expenses of renting property......
