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Updated almost 2 years ago, 02/13/2023

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Nathan Roberts
  • Sarasota, FL
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Converting Primary Residence to Investment Property

Nathan Roberts
  • Sarasota, FL
Posted

I converted a property from a primary residence to a rental located in California in 2022. The date of conversion is 5/29/22 which reflects the first day it was advertised online for rent. After listing for rent, I started work on capital work items such as new exterior paint, replacement shower door, and replacement carpet so I can claim it on my 2022 Tax Return. In addition, I am claiming all typical rental expenses such mortgage, taxes, insurance, maintenance, etc. My understanding is that after I list the property for rent its fair game to claim all capital items and expenses. Is there any thing I am missing?

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Tommy Adeoye
Pro Member
  • Investor
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Tommy Adeoye
Pro Member
  • Investor
Replied

There are lot of CPAs on here that have better answers to ensure that you are complying with all applicable laws and regulations and to maximize your deductions.

Here is my .25c . It sounds like you have a good understanding of the process of converting a primary residence to a rental property in California, and the tax implications associated with it.

In general, once you have listed a property for rent, it is considered a rental property and you can claim all capital expenses and typical rental expenses, such as mortgage, taxes, insurance, and maintenance, on your 2022 tax return.

However, there are a few things to keep in mind:

Capital expenses: Capital expenses are considered improvements to the property, and can be depreciated over a period of time, rather than being deducted in the year they were incurred. The exact depreciation schedule will depend on the type of improvement and the tax laws in effect at the time.

Rental expenses: Rental expenses can be deducted in the year they were incurred, as long as they are considered ordinary and necessary for the operation of the rental property.

Passive activity loss limitation: If you have passive activity losses from the rental property, they may be limited based on your overall income, and you may not be able to fully deduct them in the current year.

California state tax: You should be aware of California state tax laws and regulations, as they may be different from federal tax laws. It's always a good idea to consult with a tax professional who is familiar with California state tax laws to ensure that you are complying with all applicable laws and regulations and to maximize your deductions.

In summary, you are correct that after listing the property for rent, you can claim all capital items and expenses on your 2022 tax return, but you should be aware of the depreciation schedule and passive activity loss limitation and be familiar with the most current California state tax laws. 

  • Tommy Adeoye
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    Patrick Mahoney
    Pro Member
    • Investor
    • Sonoma County, CA
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    Patrick Mahoney
    Pro Member
    • Investor
    • Sonoma County, CA
    Replied

    Hi Nathan,

    That is correct. The time you listed the property is deemed the date your asset has been “placed in service”. From that point the IRS allows you to depreciate the property and claim expenses related to your rental business. Tommy, however, is correct. Capital improvements need to be depreciated over a time period determined by the type of improvement (i.e. building/structural improvements, land improvements, personal property, etc). Some of these improvements depreciate over a 5, 7, 15 or 27.5 year time period for residential buildings. Although this is the case, in 2023, you are allowed to bonus depreciate 80% of any depreciable items in the first year they were placed into service as long as the depreciation time period is 20 years or less for that item/improvement. You should contact a CPA or a Cost Segregation Engineer to consult with about maximizing your ability to recover the cost from improvements made in the year you placed the property in service. Hope this helps. 

  • Patrick Mahoney
  • CLOSED Title logo
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    Linda Weygant
    Pro Member
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    • Arvada, CO
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    Linda Weygant
    Pro Member
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    • Arvada, CO
    Replied

    You're about 90% there.

    The In Service Date is the date the property was ready and available to rent.  So listing it, then beginning an exterior painting project would be acceptable because this project does not affect the availability of the home.  People can live in it and aren't affected by the project.

    A replacement shower door is also likely to be ok because it does not affect the availability of the home - IF THERE IS ANOTHER SHOWER THAT CAN BE USED.  In a one bathroom home, this blocks one of the items of whether a home is livable or not.

    Carpet is the area I'm struggling with.  Could you install the carpet around a tenant's furniture?  Is the home really available for rent if people can't move their items in.  I'd say this project invalidates the declaration that the house is both ready and available to rent.

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    Darius Ogloza
    • Investor
    • Marin County California
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    Darius Ogloza
    • Investor
    • Marin County California
    Replied

    As I understand it (not CPA), you need 2022 income to offset your expenses incurred in the 2022 year.  If you did not receive any rent last year, you should report your expenses in 2023.   

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    Bill B.#2 Buying & Selling Real Estate Contributor
    • Investor
    • Las Vegas, NV
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    Bill B.#2 Buying & Selling Real Estate Contributor
    • Investor
    • Las Vegas, NV
    Replied

    If you’ve owned this property over 2 years as your primary please also tell us you have almost zero appreciation. Otherwise you’re subjecting tax free appreciation to both federal and California income tax. This could take 5-10 years to recapture. 

    It shouldn’t make much of a tax difference if you did cap-ex before it was a rental, added it to your basis to be depreciated over 27.5 years (watch that first year calculation since you’re not using the whole year.) or if you’re spending cap-ex after it became a entail and depreciating it. Especially as you’ll probably be showing a loss with only 6 months of rent for the year. Maybe hire a tax guy, another expense you can deduct from your income. 

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    Julio Gonzalez
    Pro Member
    • Specialist
    • West Palm Beach, FL
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    Julio Gonzalez
    Pro Member
    • Specialist
    • West Palm Beach, FL
    Replied

    @Nathan Roberts 

    Do you have a CPA that specializes in real estate taxation? Real estate has so many tax benefits and credits available, that I always tell people it's crucial to have a CPA that's extremely knowledgeable in this area. This would be an excellent question for them. I have worked with a number of great CPAs over the years and would be more than happy to provide you with recommendations if you'd like?

  • Julio Gonzalez
  • (561) 253-6640