Owner-occupied duplex, how to depreciate properly

[Nate Michaels]

Hi all, I'm owner-occupying one unit of a duplex and I'm wondering what is the best to report the depreciation if I convert the owner-occupied unit into a rental at a later date. The challenge I'm having is specifically regarding their depreciation schedule - since they are bought into service at different times, the depreciation schedule are different.

I can see a few options that could achieve this, but none is perfect:

1) treat the two units as two completely different properties with their own Schedule E's (each with half of the cost basis). This way the depreciation can be calculated correct, however, I'm unsure where to put improvements that applies to both units (e.g. a roof replacement).

2) put the duplex in one single Schedule E, with it's full cost basis, however, in the Asset Worksheet, report 50% of "Percentage of business use". then bump it to 100% for the year that the conversion happens. However, the "Percentage of business use" does not seem to apply to "I - Residential Rental" per the instruction on the right.

3) put the duplex in one single Schedule E, with half of its cost basis. In the year of the conversation, change the basis to the full basis.

For #2 and #3, how can I capture the fact that the two units were put into service in different years and thus should be depreciated differently?

Thanks in advance!

[Dave Toelkes]

When you have a multiunit rental property, the IRS requires you to treat each unit as a separate property.  Your option #1, with some refinement, is the only available option to you.  If both sides of your duplex are rentals, then you have two properties, each with a separate address, a separate schedule E, and a separate depreciation schedule.

Repairs that are directly allocated to a specific unit are expensed on the Schedule E for that unit.  Improvements allocated to a specific unit are added to the schedule of depreciable assets for that unit and depreciated as a separate asset from the rest of the dwelling structure.  

Repairs and improvements to the entire building are divided between the two units and treated as separate expense items or separate depreciable assets for each unit. If the two units have the same or nearly the same square footage, then allocate the costs on a 50/50 ratio.

In your case, you are occupying one unit as your primary residence and the other is a rental unit.  Determine the cost basis for the dwelling structure as the purchase price of the property minus the value of the land.  Your depreciation basis for the rental unit is one half of the cost basis for the dwelling structure.  Your initial tax basis for your residence unit is the other half of the basis for the dwelling structure plus one half of the land value.

You still allocate one-half of global property costs (such as property taxes, yard maintenance, exterior painting) to each unit, but you can only expense the rental unit share on your Schedule E.  The portion attributed to your residence unit is a non-deductible personal expense.  Capital improvements that benefit the entire building (e.g., a new roof) are also equally allocated between the rental unit and your residence unit.  The improvement cost for the rental unit is depreciated as a separate asset on a new 27.5 year schedule, while the cost allocated to your residence unit is added to your basis.

When you decide to convert your residence unit to a rental, you need to determine the fair market value of your residence unit. If the fair market value is less than your adjusted cost basis, then the lower FMV becomes the tax basis for your residence unit and that tax basis minus the land value becomes your depreciation basis for your new rental unit. The tax basis and depreciation basis for the original rental unit is unchanged. You will have two separate depreciation schedules, each on a different timeline.

The key point here is that even though you have two units under the same roof, the IRS says you have two separate properties and each has its own tax treatment.  I

[Dave Toelkes]

When you have a multiunit rental property, the IRS requires you to treat each unit as a separate property.  Your option #1, with some refinement, is the only available option to you.  If both sides of your duplex are rentals, then you have two properties, each with a separate address, a separate schedule E, and a separate depreciation schedule.

Repairs that are directly allocated to a specific unit are expensed on the Schedule E for that unit.  Improvements allocated to a specific unit are added to the schedule of depreciable assets for that unit and depreciated as a separate asset from the rest of the dwelling structure.  

Repairs and improvements to the entire building are divided between the two units and treated as separate expense items or separate depreciable assets for each unit. If the two units have the same or nearly the same square footage, then allocate the costs on a 50/50 ratio.

In your case, you are occupying one unit as your primary residence and the other is a rental unit.  Determine the cost basis for the dwelling structure as the purchase price of the property minus the value of the land.  Your depreciation basis for the rental unit is one half of the cost basis for the dwelling structure.  Your initial tax basis for your residence unit is the other half of the basis for the dwelling structure plus one half of the land value.

You still allocate one-half of global property costs (such as property taxes, yard maintenance, exterior painting) to each unit, but you can only expense the rental unit share on your Schedule E.  The portion attributed to your residence unit is a non-deductible personal expense.  Capital improvements that benefit the entire building (e.g., a new roof) are also equally allocated between the rental unit and your residence unit.  The improvement cost for the rental unit is depreciated as a separate asset on a new 27.5 year schedule, while the cost allocated to your residence unit is added to your basis.

When you decide to convert your residence unit to a rental, you need to determine the fair market value of your residence unit. If the fair market value is less than your adjusted cost basis, then the lower FMV becomes the tax basis for your residence unit and that tax basis minus the land value becomes your depreciation basis for your new rental unit. The tax basis and depreciation basis for the original rental unit is unchanged. You will have two separate depreciation schedules, each on a different timeline.

The key point here is that even though you have two units under the same roof, the IRS says you have two separate properties and each has its own tax treatment.  I

[Lori Williams]

Quote from @Dave Toelkes:

When you have a multiunit rental property, the IRS requires you to treat each unit as a separate property.  Your option #1, with some refinement, is the only available option to you.  If both sides of your duplex are rentals, then you have two properties, each with a separate address, a separate schedule E, and a separate depreciation schedule.

Repairs that are directly allocated to a specific unit are expensed on the Schedule E for that unit.  Improvements allocated to a specific unit are added to the schedule of depreciable assets for that unit and depreciated as a separate asset from the rest of the dwelling structure.  

Repairs and improvements to the entire building are divided between the two units and treated as separate expense items or separate depreciable assets for each unit. If the two units have the same or nearly the same square footage, then allocate the costs on a 50/50 ratio.

In your case, you are occupying one unit as your primary residence and the other is a rental unit.  Determine the cost basis for the dwelling structure as the purchase price of the property minus the value of the land.  Your depreciation basis for the rental unit is one half of the cost basis for the dwelling structure.  Your initial tax basis for your residence unit is the other half of the basis for the dwelling structure plus one half of the land value.

You still allocate one-half of global property costs (such as property taxes, yard maintenance, exterior painting) to each unit, but you can only expense the rental unit share on your Schedule E.  The portion attributed to your residence unit is a non-deductible personal expense.  Capital improvements that benefit the entire building (e.g., a new roof) are also equally allocated between the rental unit and your residence unit.  The improvement cost for the rental unit is depreciated as a separate asset on a new 27.5 year schedule, while the cost allocated to your residence unit is added to your basis.

When you decide to convert your residence unit to a rental, you need to determine the fair market value of your residence unit. If the fair market value is less than your adjusted cost basis, then the lower FMV becomes the tax basis for your residence unit and that tax basis minus the land value becomes your depreciation basis for your new rental unit. The tax basis and depreciation basis for the original rental unit is unchanged. You will have two separate depreciation schedules, each on a different timeline.

The key point here is that even though you have two units under the same roof, the IRS says you have two separate properties and each has its own tax treatment.  I

 Dave, thanks for the explanation.

I have a similar situation. I have a SFH that has always had a separate living area in the basement. It has been rented out for a couple years as a SFH (so it's been depreciated as a SFH since we bought it), but we want to move into the basement and use what amounts to less than 1/3 of the total available square footage (including the basement).

Basically, the renters get the actual house, we would be living in a small basement apartment. It is not formally duplexed, but there is a separate entrance to the basement.

So how would I go from SFH rental to SFH with personal use of 1/3 of the house and rental use of 2/3 of the house?

We probably won't live in the basement apt forever, so this would be temporary.

Thanks for any insight you can offer, bc the tax software is not helping me at all with this.

[Chris McCormack]

Work with a real estate specific tax advisor. They'll walk you through it