2 rare situations/crazy tax questions for any tax experts

[Mike Palmer]

Hello:

I have 2 situations that I have not been able to find answers to (at least to my satisfaction that they are correct). One is very rare and crazy, but the other I am sure has happened to someone out there. Here goes:

- I live in the upstairs unit of a duplex. The roof is in poor shape and has started leaking, and will need repairs if not full replacement. My tax guy says that I cannot deduct the expense of the new roof. Since the roof covers both units wouldn't I be able to at least write off 1/2 of the cost? I will eventually move out and rent both units. Would I at least then be able to retroactively deduct this cost at that point?

- Now the really crazy situation. I bought this same property as a short sale. The contract stated that the seller would transfer the current tenants deposit and pro-rated rents at closing. Well, the seller is a low-life scum bag and had no intention of doing this. I saw this coming and warned my agent and let the selling agent know, and told them to make sure this was taken care of prior to closing. Well we get to closing and there is nothing (as I expected). In fact, the seller contacted the tenants and tried to get them to pay additional rent in advance so she could skip town with the extra rent. The tenants actually called and told me this (thankfully), and I told them to only pay her the pro-rated portion of the rent before I took ownership. This salvaged half the rent, but the seller says the tenants broke a bunch of rules and that she verbally told them they would not be getting a deposit back. I say this is not for her to decide any more because she will not be the landlord when they move out and that she should have charged them the late fees and other fines at the time they happened. Anyway, since I assume the contract I was then liable to pay the tenants back the deposit, whether I received it or not. I assumed I could write off the loss of deposit, but my tax guy is saying this is just uncollected income and that it is not a direct loss that can be written off. I hear of banks, businesses and hospitals all the time that write off uncollected income as bad debt. Am I just screwed here or should I at least be able to get a tax benefit for not receiving the deposit per the contract?

[Dave Toelkes]

@Mike Palmer

1. Roof

If you repair the roof, then half of the cost of the repair is a personal expense for your residence unit, and the other half of the repair is a deductible rental expense on Schedule E.

You can not write off (deduct) the cost of a new roof. A new roof is a capital expense. Half of the cost of the new roof is an adjustment to basis for your residence unit, and the other half is depreciated on a 27.5 year schedule for your rental unit. If you eventually move out of your residence unit, then the cost basis for your residence unit is used to calculate the depreciation basis when you convert to rental use.

2. Security Deposits.

The best way to handle this would have been to have the seller transfer security deposits and prorated scheduled rents at closing. This could have been deducted from the seller's proceeds of the sale. Rental deposits are really the tenant's money that is held by the landlord against damages you may suffer (when the tenant vacates) due to damage due to tenant abuse, unpaid rent, and even for a broken lease. Since you did not get the deposits from the seller at settlement, you are funding the security deposits yourself. They become a capital contribution to your rental activity, but you do not get to deduct the amount of the deposit that you had to refund out of pocket. Since the tenants did not actually pay rent, you don't get to claim rental income and you don't get a deduction for the security deposit you refunded.