How to deduct expenses related to a vacation home not yet listed for rental

Forum|Forum|4 years ago
April 11, 2022
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We bought a home last year and began spending money to update and renovate it, but didn't get it listed for rental until this year. I understand that all the improvements must be rolled into the value of the home that will be depreciated, and that depreciation cannot begin until the home is listed. But what about the expenses? Utilities for example. When I try to put this into TurboTax Premier, it tells me to "delete it as a rental" because I didn't rent it in 2021. So how do I enter my expenses? Thanks.

DavidD66

You can't take any deductions in the year before your rental is operational. You have to wait until the first year you are "in business".

Costs you incur before you are actually in business (have listed your property for rent) are start-up expenses. Start-up expenses are costs you incur to get your rental business up and running. Any expense that would be deductible as an operating expense by an ongoing rental business is a start-up expense when it's incurred the property is available for rent. Common start-up expenses for landlords include:

minor or incidental repairs to get a rental property ready to rent
outside office expenses paid for before a rental business begins, such as office rent, telephone service, utilities, office supplies, and office equipment rental
home office expenses
the cost of investigating what it will take to create a successful residential rental business, including research on potential real estate markets
attending real estate seminars or conferences or other educational programs or classes
insurance premiums (but not title insurance)
maintenance costs for a rental property paid for before the property is offered for rent—for example, landscaping and utilities (but not the cost of connecting utilities)
costs for recruiting and training employees before the business opens—for example, hiring and training an apartment manager
fees paid to a market research firm to analyze the demographics, traffic patterns, and general economic conditions of a neighborhood
business licenses, permits, and other fees, and
fees paid to lawyers, accountants, consultants, and others for professional services; however, legal and other fees paid to purchase a rental property are not start-up expenses.

There is a limit on the amount of start-up expenses you are allowed to deduct the first year you are in business of $5,000. You have to capitalize any amount of over $5,000. If you have more than $50,000 in start-up expenses, your deduction is limited or even eliminated.

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Carl11_2

Employee

@DavidD66

Common start-up expenses for landlords include:

Can you show me where in IRS Publication 527 that it says start up expenses are deductible for SCH E rental property? I've asked 3 others this question and have yet to receive a response one way or the other.

Start up expenses for SCH E rental property are not deductible, and for the 30 years I've been a landlord they never have been to the best of my knowledge.

Now do not confuse "expenses" with "property improvements". Those are two completely separate beasts.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence or 2^nd home before, then this date is the day AFTER you moved out, or the date you decided to lease the property – whichever is later.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter was contracted to move in, and/or "could" have moved in. That would be your "in service" date or after if you were asked for that. Vacant periods between renters do not count for actual days rented. Please see IRS Publication927 page 17 at https://www.irs.gov/pub/irs-pdf/p527.pdf#en_US_2020_publink1000219175 Read the “Example” in the third column.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days you lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence, 2nd home, or any other personal use reasons after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.

RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that Improve, restore, or otherwise “better” the property. Basically, they retain or add value to the property.

Betterments:
Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. An example of a pre-existing condition or defect in this context would be something such as foundation repair (slab jacking) or some other, hidden and costly, anomaly.
Restoration:
Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.
Adaptation:
Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property. Adding a wheelchair ramp would be an example.

Expenses for these types of costs are entered in the Assets/Depreciation section and depreciated over time. Property improvements can be done at any time after your initial purchase of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.

To be classified as a property improvement, two criteria need to be met:

1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.

2) The improvement must retain or add "real" value to the property. In other words, when the property is appraised by a qualified, certified, licensed property appraiser, he will appraise it at a higher value, than he would have without the improvements.

There are rules that allow you to just flat-out expense and deduct some property improvements instead of capitalizing and depreciating them, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.

Cleaning & Maintenance

Those expenses incurred to maintain the rental property and its assets in the usable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent for the very first time are not deductible.

Repair

Those expenses incurred to return the property or its assets to the same usable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent for the very first time are not deductible.

Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.

However, when you do something like convert the garage into a 3^rd bedroom for example, making a 2-bedroom house into a 3-bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.