Questions about home improvements before placing my rental property in service

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@wleuter wrote:

......things like furniture can be sold at a loss.

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You can separate personal property from real property to get the shorter recovery period on the former (instead of 27.5 years), but within just a few years the basis of your furniture will be reduced to $0.

As a result, if you receive any price higher than $0 for the furniture when you sell, you will have a gain and that would be a Section 1245 gain where the tax rate on recapture is not limited to 25% as it is on Section 1250 property.

The furniture is not what is referred to as improvements - there is no permanent attachment to the land or building. add them separately. furnishings are 5 year property which Turbotax will use when you select rental furnishings or appliances, caroet, furniture (depends on version you using) as the property type.  the basis for depreciation is the lesser of your cost or fair market value when you place it into rental service.  while Tutbotax asks for cost there is a side note that says (this conforms to the tax laws) 

When you convert personal use property to business use (or for the production of income), the basis for depreciation is the LESSER OF:

* the fair market value on the date you placed the property in service (if you are converting your vehicle to business use, you may use the blue book value at the time of conversion to determine its fair market value), OR

* your adjusted basis on the date you placed the converted asset in service.

Understand that depreciation is not a permanent deduction. When you sell rental property (or any other property used for business) you are required to recapture all depreciation taken in the year of the sale, and pay taxes on it. If you do not depreciate the property, then you are still required to recapture and pay tax on the depreciation you should have taken. Two things happen in the year of sale with depreciation recapture.

1) Recaptured depreciation is added to your AGI for that tax year.

2) The recaptured depreciation has the potential to bump your AGI into the next higher tax bracket. Weather it does or not, depends on the numbers.

But the recaptured depreciation itself will be taxed anywhere from 0% to a maximum of 25%. What rate you get, just depends on the numbers.

It may be worth noting that when selling real estate "Like-Kind Exchanges Sec 1031" may be utilized to DEFER tax, but does not eliminate a tax burden which will need to be addressed SOMEDAY. 

If that is something you consider when planning to sell real estate, be sure you use someone that understands how a 1031 exchange works.

Depreciation recapture is more an issue with Real Estate than it is with other assets, such as furniture, because Real Estate tends to INCREASE in value whereas other assets, such as furniture, wear out. 

"I googled and found someone said in this scenario separating the depreciation of personal properties like furnitures will bring tax benefit when selling the house because things like furnitures  can be sold at a loss."

If a rental with furnishings were sold, most likely you would allocate the selling proceeds to eliminate the remaining value of the furniture. For example- if I sell a rental for 100,000 with furniture that has a remaining basis of 5,000, I would allocate 5,000 to the furniture, and split the remaining 95,000 between land and house. If you only allocated 4,000 to the furniture, you would have a 1,000 loss on the furniture, but now 96,000 to split between the house and the land, so the bottom line would be somewhat similar.  Yes, the loss on the furniture could reduce ordinary income, but you would be subject to "Netting and Look-Back". 

If you wanted to go this route, you might want to have a Bill of Sale for the furniture separate from the contract for the real estate.

Depreciation is meant for decreasing the value of an asset over time, allowing a Taxpayer to spread that expense over years to offset the revenue that asset produces. When the asset is disposed of, or sold, any depreciation taken that is realized in the sale is "recaptured".  This philosophy works well with things like furniture and equipment, but sometimes back-fires with real estate and vehicles, especially if the Taxpayer uses Bonus Depreciation and or Section 179 Deduction because the taxpayer takes TOO MUCH depreciation and is "on the hock" to pay some of that back when the asset is sold/disposed of. 

Additionally, be aware that using Bonus Depreciation or Section 179 Deduction may cause a loss for the rental activity and that loss may be limited. 

Any labor you provide is of no monetary value, only work done by a contractor whom you pay qualifies as an expense and if that was done before the house was available for rent, it would need to be added to the basis of the property. 

DON'T FORGET TO VALUE THE LAND AND THAT WILL NEVER BE DEPRECIATED. 

IRS Rental Tips 

IRS Depreciation FAQ

@wleuter 

@delvalle 

@dbovill