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Question

Rental Property > Personal Residence > Rental Property > Sale

Forum|Forum|3 years ago
March 15, 2023
2 replies
0 views

@Carl11_2or anyone else who cares to tackle this one: After 36 years of ownership (most of it as an investor), I finally sold my co-op apartment. Now I'm a bit confused as to how to enter it into TT 2022 and TT 2023. Here are the key facts:

a) I bought the apartment and put it into service as a rental unit on 9/23/87. In-service date was 9/1/87 and I began taking depreciation, using 27.5 years SL and MM convention. The co-op didn't own the land at the time (it was leased), so I was able to include the full purchase price in my cost basis. The co-op eventually bought the land on 11/9/88.

b) I moved into the unit on 9/1/89 and it became my primary residence. I stopped taking depreciation at that point.

c) After getting married, having a child, and living in the unit for 3 years, we moved out on 8/25/92 and put it into service as a rental unit again. I resumed taking depreciation and rented it continuously for about the next 30 years. I took depreciation until the unit was fully depreciated as of 3/17/15. (I think there were a few years when TT told me to take more than the usual 1/27th depreciation, maybe to make up for the years that I suspended depreciation while using the unit as my primary residence. In any case, every dollar of my original cost basis was depreciated.)

d) My last tenant moved out on 4/9/22, so it was rented for the first 99 days (.27 yr) of 2022 only.

e) After the last tenant moved out on 4/9/22, I remodeled the unit over the remainder (.73 yr) of 2022 and sold it in 2023, closing on 1/10/23. The remodeled unit was never put back into service as a rental.

f) CAPITAL IMPROVEMENTS: I spent $30,390 on capital improvements in 2022, plus $5,882 in 2023, for a total of $36,272. [The amount paid in 2023 occurred AFTER the 1/10/23 sale because this amount is for appliances that I bought on a payment plan that will be paid in full before the end of 2023.)

g) NON-CAPITALIZABLE EXPENSES: I had $19,617 of other expense (non-capitalizable carrying costs) in 2022, but only $6,111 of that was incurred while the unit was still a rental. (The carrying costs were mainly HOA fees, which included my prorata share of real estate taxes and mortgage interest on the building's master loan.) The bulk of those carrying costs ($13,506) was incurred AFTER my last tenant moved out, during the remodeling phase.

So here are my questions for you:

1) On the "Was This Property Rented for All of 2022" screen, I answered "No, this property was not rented all year," and showed Days rented = 99, Personal use = 0. I did NOT check the box that says "I did not rent or attempt to rent this property at all in 2022." Would you agree with those choices?

2) Since the remodeled apartment was never put into service and went straight to sale in 2023, I never depreciated any of the capital improvements (f), but will add them to my cost basis when I do my 2023 taxes and calculate my capital gain on the sale. When I do that, can I include the amount that I spent (on appliances) in 2023, even though I paid for them AFTER the sale occurred?

3) For the $6,111 of non-capitalizable expenses (g) that I incurred while the unit was still rented out in 2022, I'll claim those on my Schedule E for 2022, as usual. But what about the carrying costs that I incurred AFTER 4/9/22, when the tenant moved out, through the end of 2022? Would I claim those expenses on my 2022 Schedule A? Or should I wait until I do my 2023 taxes and claim them as part of my selling expenses, even though I incurred them and paid them in 2022?

4) When I do my 2023 taxes I will state that the property was rented for only 10 days in 2023.

[3/15/23 CORRECTION: I completely misstated this. What I meant to say was: On my 2023 taxes, I will state that the property was OWNED for only 10 days in 2023, and was not rented or offered for rent for ANY days in 2023.] I will include my selling expenses, capital improvements (including those made when I still lived in the unit myself, back in 1989), and any carrying costs incurred after my last tenant moved out. I realize there will also be a ton of recaptured depreciation (27.5 years' worth) working against me in figuring my capital gain. Can you think of anything special that I need to watch for when entering that info into TT 2023?

Rental Property

RobertB4444

1 - You did it right

2 - Yes, it is appropriate to use them in the year for which the money was spent and they are a cost of sale.

3 - What carrying costs are deductible in 2022 should be deducted in 2022 on your schedule A.

4 - I think you have a remarkably good handle on this stuff. I can't see anything that you've left out except the portion of your property that was reserved for land and non-depreciable over time. If you didn't do that you'll survive but if you did it will help with the gain on the sale.

@Peter_Nemo

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Peter_NemoAuthor

@RobertB4444, thank you for the reply and compliment; you have just reduced my anxiety level and blood pressure by a lot! I have one follow-up question re: 2023 taxes, similar to my original question #1.

In TT 2023, on the "Was This Property Rented for All of 2023" screen, I will answer "No, this property was not rented all year" because it was never rented out for even one day in 2023 (it was sold on 1/10/23).

I will also enter Days rented = 0, Personal use = 0.

And lastly, for the box that says "I did not rent or attempt to rent this property at all in 2023," I will check that box because it's a true statement. Now, as soon as I do that, I'm guessing that TT will delete my Schedule E for this property, which seems OK because the property was never rented in 2023, was sold in 2023, and so I shouldn't worry about Schedule E being deleted.

Does everything that I've stated here seem correct for what I should enter into TT 2023?

Thanks again for your help and expertise.

Carl11_2

Employee

Now, I assume you got the tax year right and we are "in fact" talking about tax year twenty twenty three, for which the TurboTax program for 2023 does not yet exist.

If you don't enter at least 1 day rented, the program will force you to delete the property entirely. There's nothing wrong with entering 1 day rented with no rental income reported for the tax year, as anyone would assume the rent for that 1 day was per-paid before the new year; meaning it was paid last year and included in the 2022 rental income you reported. I just wonder if the IRS computers would flag anything because it was only rented 99 days in 2022. That's why I say just convert it to personal use on the 2022 tax return and be done with it. Otherwise, if you report it on the 2023 tax return, you'll still need to convert it to personal use with a conversion date that is the closing date of the sale so you can get the correct amount of depreciation to recapture when you report the sale in the Sale of Business Property section.

And lastly, for the box that says "I did not rent or attempt to rent this property at all in 2023," I will check that box because it's a true statement.

That will one hundred percent, force you to delete the property from your tax return entirely, and you'll lose everything including all your PAL carryovers and depreciation history. Don't do that.

Does everything that I've stated here seem correct for what I should enter into TT 2023?

Again, this is why you should convert the property to personal use on your 2022 tax return. Even if you want to make the conversion date Dec 31, 2022. Then you'll still have 99 days rented with 0 days personal use. To me, that would be more acceptable a reason why a property improvement that was completed 6 months prior, was never placed in service and depreciated. On top of that, an asset that is placed in service and removed from service in the same tax year, is not required to be depreciated anyway. That's the justification for not entering them on the 2022 return in the assets/depreciation section.

As a reminder (can't recall if I mentioned this earlier in this thread):

Two things about depreciation recapture.

- Recaptured depreciation is added to your AGI in the tax year of the sale. This has the potential to bump you into the next higher tax bracket. So if you're already in the 12% bracket, that jump to the 22% bracket "will" be felt. Weather this happens to you or not, just depends on the numbers. But it's a fair bet that with the realized taxable gain on the sale, chances are good you'll be in the next higher tax bracket for the tax year you close on that sale.

- Recaptured depreciation is taxed at the "ordinary" income tax rate, anywhere from 0% to a maximum of 25% But still, if your "other" ordinary income with the gain bumps you into the 32% bracket, that's what you'll pay on the amount over that threshold.

This is why I prefer to keep my depreciation as low as I legally can.

Carl11_2

Employee

I bought the apartment and put it into service as a rental unit on 9/23/87. In-service date was 9/1/87 and I began taking depreciation, using 27.5 years SL and MM convention.

Think you made a typo there. The unit was either in service on 9/23/87 or 9/1/87. One or the other. Either way, since rental property uses the mid-month convention for depreciation, depreciation started on 9/15/87.

The co-op didn't own the land at the time (it was leased), so I was able to include the full purchase price in my cost basis. The co-op eventually bought the land on 11/9/88.

That just means you would have entered zero in the COST OF LAND box.

The co-op eventually bought the land on 11/9/88.

So you would have added the cost of the land to the amount already entered in the COST box, and then entered that amount in the COST OF LAND box. What would happen is the program (not you) would subtract the COST OF LAND amount from the COST amount to determine the depreciation basis. So basically, there would have been no change in the depreciation basis since land is not depreciated. But it would add that cost of the land to your total cost basis of the property.

I moved into the unit on 9/1/89 and it became my primary residence. I stopped taking depreciation at that point.

I assume you correctly worked through all the assets listed in the assets/depreciation section and converted each asset individually to personal use, with a conversion date of 9/1/89 or any date before that, which was after the last tenant moved out.

we moved out on 8/25/92 and put it into service as a rental unit again. I resumed taking depreciation and rented it continuously for about the next 30 years.

Just to clarify, depreciation doesn't "resume". It starts all over from year one using a new adjusted cost basis. The new adjusted cost basis is the original cost basis used for depreciation, minus the total of all depreciation already taken. So the amount in the COST box would have been reduced by the total of all depreciation taken up to 9/1/89. The amount in the COST OF LAND box would remain the same, since land is not depreciated.

I took depreciation until the unit was fully depreciated as of 3/17/15.

From 9//1/89 to 3/17/15 isn't anywhere close to 27.5 years, which indicates you did things wrong.

I think there were a few years when TT told me to take more than the usual 1/27th depreciation, maybe to make up for the years that I suspended depreciation while using the unit as my primary residence.

Your memory is just as rusty as mine can be on some things at times. I'm quite certain that didn't happen. At least, not automatically by the program.

In any case, every dollar of my original cost basis was depreciated.

Because you've sold the property, combined with the fact it's total period of being classified as a rental is in excess of 27.5 years and that the total depreciation taken over the period of time you owned it did not exceed the original cost basis of the structure, there's really no need to fix the boo-boo you made with the cost basis when placing it back in service. You'll still be recapturing the total depreciation taken, which is basically the cost basis of the structure.

My last tenant moved out on 4/9/22, so it was rented for the first 99 days (.27 yr) of 2022 only.

I'm still following you. Keep reading.

After the last tenant moved out on 4/9/22, I remodeled the unit over the remainder (.73 yr) of 2022 and sold it in 2023, closing on 1/10/23. The remodeled unit was never put back into service as a rental.

I suggest you convert the unit back to personal use with a conversion date of 4/10/22. This will stop depreciation on any other assets besides the structure you may be depreciating. Also, since it's clear you had no intent to rent out the unit before you sold it, you would be required/expected to do this from an IRS perspective. There would also be no need for the SCH E to even be included on the 2023 return, as you can't correctly report the sale in the SCH E section of the program anyway.

CAPITAL IMPROVEMENTS: I spent $30,390 on capital improvements in 2022,

Since the improvements were done in 2022 after the last renter moved out, there's no way possible for those improvements to have been placed "in service" as a rental asset, before you sold the property. So absolutely nothing concerning these improvements will be entered anywhere on your 2022 tax return. (you'll deal with it on the 2023 taxes).

plus $5,882 in 2023,

I am assuming this is for the appliances referenced below.

The amount paid in 2023 occurred AFTER the 1/10/23 sale because this amount is for appliances that I bought on a payment plan that will be paid in full before the end of 2023.

Your payment plan is irrelevant and doesn't matter. If that $5,882 is for those appliances, they add to your cost basis "in full" in the tax year you obligated yourself to pay that amount.

I had $19,617 of other expense (non-capitalizable carrying costs) in 2022, but only $6,111 of that was incurred while the unit was still a rental.

Expenses incurred in 2022 while the property was still classified as a rental are deductible as a rental expense on the SCH E. Period. End of story.

Costs incurred after the property was converted to personal use are not deductible anywhere. Just keep in mind that if you paid property taxes and mortgage interest in 2022, that paid for the period of time it was classified as a rental are a SCH E deduction, while that paid for the period of time it was personal use is a SCH A deduction.

Also, when the remodeling was taking place, I'm quite confident it required the use of electricity, water, and maybe other utilities such as gas for heat. Provided you did not live in the property for any personal reasons or purposes, you can include the cost of those utilities in the cost basis of the property improvements done, if the cost was incurred while the work was in progress.

On the "Was This Property Rented for All of 2022" screen, I answered "No, this property was not rented all year," and showed Days rented = 99, Personal use = 0. I did NOT check the box that says "I did not rent or attempt to rent this property at all in 2022." Would you agree with those choices?

I agree only if the property was classified as a rental for the entire tax year, which you most certainly can do. But I wouldn't recommend it since you clearly stated you did not rent it out once the work was done, thus insinuating you had no intention of renting it out after the work was done. In that case, you would not have any "carrying costs", as they would be SCH E rental expenses if incurred while the property is still classified as a rental.

Since the remodeled apartment was never put into service and went straight to sale in 2023, I never depreciated any of the capital improvements

...and you would not depreciate them. In fact, you won't enter your property improvements anywhere on the SCH E (i.e.; you will not enter them in the assets/depreciation section.)

(f), but will add them to my cost basis when I do my 2023 taxes

Correct. Do do that, you can't report the sale in the Rental & Royalty Income (SCH E) section of the program. You would instead report the sale in the "Sale of Business Property" section. Thats how you increase your cost basis without having to depreciate the improvements for even 1 day, since they were never placed in service.

When I do that, can I include the amount that I spent (on appliances) in 2023, even though I paid for them AFTER the sale occurred?

If the appliances were included in the sale, then you most certainly would include what you paid for those appliances in your total cost basis.

But what about the carrying costs that I incurred AFTER 4/9/22, when the tenant moved out,

You don't specify what those carrying costs are. So I can only assume. I've already covered the three basics of property taxes, mortgage interest and property insurance, along with a possible way to handle utilities costs as part of the property improvements costs. Typically, once a property is converted to personal use, that's what it is and there are no "carrying costs" associated with it, just like there would be no such thing as carrying costs if you sold your primary residence.

When I do my 2023 taxes I will state that the property was rented for only 10 days in 2023.

That would mean you would have to place your property improvements "in service" at some point; typically no later than the day after the work was completed. You'd really have to. For example, if you put on a new roof in 2022, there's no way you can rent out the property without including the roof as an "in service" asset.

If you're going to leave the property classified as a rental for the entire 2022 tax year, yet not place your property improvements in service (assuming they were completed in 2022 and you can prove it (or prove otherwise) if audited, I would think that has a risk of at least "raising eyebrows" with the IRS. But I really don't know if it would or not. I myself would not risk it and would just convert the property to personal use the day after the last tenant moved out. Otherwise, you would only need to report the property as rented in 2023 for 1 day. Then it would be "known" and expected that the rental income for that one day was paid prior to that one day; which would have been on Dec 31 of the prior year or before. But it would really look funny for a property rented for only 99 days in 2022 and 1-10 days in 2023.

I will include my selling expenses, capital improvements (including those made when I still lived in the unit myself, back in 1989),

The improvements made in 1989 should already have been included in the adjusted cost basis used for depreciation when you converted the property back to a rental on 8/25/92. If you did not do that, then you need to figure the depreciation you "should" have taken on those improvements starting 8/25/92 and recapture it. Remember, when you sell the property you are required to recapture the "higher" of the depreciation actually taken, or the depreciation you "should" have taken. So if you didn't depreciate your property improvements done in 1989, you have unreported depreciation to recapture.Yet another reason why you can't report the sale in the rental section of the program, and need to report it in the "Sale of Business Property" section.

and any carrying costs incurred after my last tenant moved out.

Can't comment on that really, as if you left the property classified as a rental for all of 2022, you don't have any "carrying costs"; only SCH E rental expenses.

I realize there will also be a ton of recaptured depreciation (27.5 years' worth) working against me in figuring my capital gain.

You may end up recapturing more depreciation than y ou actually took, if you didn't include the 1989 property improvements in the adjusted cost basis when you converted to rental for a 2nd time.

Can you think of anything special that I need to watch for when entering that info into TT 2023?

Three things to keep in mind at all times when dealing with taxes and the IRS.

1) You are guilty until proven innocent.

2) The burden of proof is in the accused (that would be you) and not the accuser.

3) If it's not in writing, then it did not occur. (i.e.; do you have a rental contract that covers the 1-10 days rented in 2023?)

Peter_NemoAuthor

@Carl11_2, thank you for the detailed reply. As you noted, I made some mistakes in how I handled depreciation when I converted the property from rental to personal use in 1989, and again when I converted it back to a rental in 1992. In hindsight, I now realize that I should have started with a new adjusted cost basis in 1992, when we moved out of the property and it became a rental for the second time.

I also made a big typo in my original post, where I wrote:

When I do my 2023 taxes I will state that the property was rented for only 10 days in 2023.

That was entirely wrong. What I meant to say was: On my 2023 taxes, I will state that the property was OWNED for only 10 days in 2023, and was not rented or offered for rent for ANY days in 2023. So at no point am I going to state that the property was ever placed back in service as a rental unit after my last tenant moved out on 4/9/22.

I will take your advice to convert the unit back to personal use with a conversion date of 4/10/22. When I do that and get to the "Was This Property Rented for All of 2022" screen, I will answer "No, this property was not rented all year," and will show Days rented = 99, Personal use = 266 (rather than 0). Is there anything else I need to do in the TT 2022 program in order to convert the property back to personal use?

Re: "carrying costs" that I referred to when I said:

But what about the carrying costs that I incurred AFTER 4/9/22, when the tenant moved out,

These expenses were partly comprised of property tax and mortgage interest , so I will list those on my 2022 Schedule A, as you advised. But I also paid about $8,000 worth of other co-op fees (HOA fees) during the 2022 remodeling phase -- none of which were property taxes, mortgage interest, or insurance. Will I be able to claim that $8,000 portion as a "carrying cost", or deduct it in any other way, when I enter the sale of the property on my 2023 taxes?

Carl11_2

Employee

and will show Days rented = 99, Personal use = 266 (rather than 0)

No. Days of personal use is days you lived in the property as your primary residence, 2nd home or vacation home *while the property was classified as a rental*. With a conversion date of 4/10/2022 you'll have ZERO days of personal use, because you did not live in the property as your primary residence, 2nd home, vacation home, or any other "personal pleasure" type of use at any time during the tax year. EVen if you lived in the property during the upgrades/work being done so that you could either do the work, supervise or manage it, that does not count as personal use days because "personal use" was not your primary reason for being there.

I also paid about $8,000 worth of other co-op fees (HOA fees) during the 2022 remodeling phase.

Typically, HOA fees are just flat out not deductible for the period of time the property is classified personal use. Just like the pro-rated amount of property insurance is not deductible for the period of time it's classified as personal use. Never has been to my knowledge. But I do hear of people that add it to their cost basis at the time of sale. Weather they get called out on it or not, I don't know because it's not like they brag about it. Your call.

I wonder if you'd be better off including at least some of it in the improvement costs for the months the work was on-going. Either way, it's adding to the cost basis.

On a side note, $8000 for HOA fees in a year? That's so far beyond what I would consider acceptable for any HOA. For two of my rentals. For me, the HOA fee is $30/mo for each rental. For the house I live in it's $50/year.

I can see a significantly higher amount for a multi-unit condo association type of HOA though, as the HOA would most likely be maintaining the outside of the structure, and a new roof isn't cheap.

For my rentals HOA I've gone down a few times over the last 25 years to look at the books. They take in close to $1M a year in fees. Of that, per the HOA bylaws they're required to set aside about 10% for "unexpected situations" and the rest is used for office fees (which are meager in comparison) and common area maintenance. About 20 years ago there was an "unexpected situation" when the entire filtration system in the community pool had to be replaced. Covered from the set-aside account with no assessments necessary.

There was one year where the set-aside account exceeded the maximum allowed by the by-laws. Per the by-laws, the excess is to either be credited or refunded. But that year the membership voted to allow the excess to be invested in the market somewhere for one year. The return was so good, HOA fees were cut in half the next year and those W-2 employees in the office (less than 10) all still got their yearly cost of living raise.

Now while I'm still "in" that HOA, I'm not as active with it as I was when I lived in the community (before moving and converting the property to rental). But when I moved out back around 2003 monthly dues were $20/mo, whereas now they're $30/mo and have stayed there for the last few years. One of the better HOAs I've ever dealt with or heard of.