Is a CL ad sufficient to prove intent to rent?

Question

Hi everyone,

I own a house that I plan on renting after I make some major repairs. Is a CL ad sufficient proof of intent for the IRS, or should I run a print ad before starting repairs?

Thank you!

Steven Hamilton II · Answer

George  Eliot,

Hire a new accountant.  I deal with the IRS on a daily basis and they do dumb things.

A CL ad could assist in your intent of trying to lease a property; however, as was mentioned below it must be ready to rent.

In determining this:
Are you living in the property?
If so: Do you have another place to stay lined up?
Is the property livable?
Are they repairs that must be done before the property can be leased?

Yes you can be living there and the property be ready to rent; however, you will not be able to deduct anything other than mortgage interest and real estate taxes incurred while living there.

Certain repairs and all capital improvements are added to the basis of your property; which if it was gifted(NOT inherited) means that it is the SAME as it was to the previous owner.  If it was inherited it is the FMV on the date of death.

That is how you would calculate your personal basis.

To calculate your basis as a rental it would be the LOWER of FMV on date placed in service or your basis.

All repairs and updates done before it is place in service are to be added to your basis and then depreciated. That is not to say that you can't do minor things such as fix a light switch; however, if there is drywall to be patched or flooring that needs to be replaced you cannot consider it in service. As David Beard stated you can make some repairs; however, you must be careful that it is not substantial.  He also mentioned that you may not want to show too many current deductions. Yes this can be true for financing purposes; however, just show the property as it should be to give it a true assessment.

So yes, you can be in service before moving out; however, I do not recommend it as it can raise flags in an audit.

George,

You can only deduct deduct 5k in starting costs if you are running a business.  A rental property is a passive activity.  You can't deduct costs before you even start something.  Even a business owner has to have an operating business rental real estate does not apply.

If you have any other tax questions don't hesitate to ask.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Kyle J. · Answer

I know of no requirement to run a print ad.  According to the IRS, a property is considered "placed in service" when it is ready and available for rent, regardless of whether or not it is actually rented at that time.

So, based on that, even if you run an ad prior to doing your "major repairs", if it's not ready and you're still living there it is not available for rent.

David Beard · Answer

Also, the repairs you make prior to renting need to be capitalized (added to the basis of the house), and depreciated, rather than a current year tax deduction.  These various repairs will likely be viewed as a "program of improvement" by the IRS, subject to depreciation.  If some things are just legitimate "repairs" versus upgrades (fixing a leaking toiler), then yes you can deduct that portion.  But reporting huge repair expenses in relation to your rental income is an easily spotted red flag on your return.

Reporting losses by aggressively taking lots of repair deductions (that you might have alternatively capitalized) will also lessen your chances of getting bank loans in the future, as banks like to just take the results off your tax returns, regarless of how much you say, "yeah, but..."

Jon Holdman · Answer

Repairs made prior to having the property rent-ready are added to your basis.  They're not immediately deductible.

When you have a primary residence, repairs aren't deductible at all nor do they add to your basis. Capital improvements get added to your basis.

The rules for handling converting a residence into a rental property are complex, and, having never dealt with them, I don't understand them.

Your situation is further complicated because your father is giving you this house.  I'm not sure how your basis is established.

You're going to need to budget some money for a CPA to help you sort this out and to be sure you get your taxes correct.

Kyle J. · Answer

George  Eliot Listen to Steven Hamilton II as he's the expert and clearly knows his stuff.

Jon Holdman · Answer

George  Eliot, I don't think so.  The rules about rentals are pretty specific.  And while you're living there, I'm sure none of the money you spend is deductible.  At best, some of it will add to the basis.  If you were not living there, the money you spend would largely be added to the basis, but some might be deductible in the year you spend it.  Since you're living there, the rules are very different.

My better answer is that I'm not a CPA.  I rely on my CPA.  I send him all the details about what I spend and let him sort out exactly how things get treated.  Your situation is even more complex than mine.  A good CPA who's really knowledgeable about real estate is going to be essential.

George Eliot · Answer

Jon Holdman Could I not be considered a business owner and thus deduct repairs on the house prior to its being rented out as start up expenses? According to Every Landlord's Tax Deduction Guide, the fact that I'll be actively managing the property and using it to generate most of my income support my being considered a business owner.  So does this mean I can deduct 5k before putting the house up for rent, and then deduct further repairs after the house is "ready and available" (i.e. after I have moved out) for rent?

George Eliot · Answer

Kyle J. and Steve Babiak -- Thanks for the advice.  So, I have to move out of the house, change my address on my DL and establish residency somewhere else before I can consider the place "ready to rent"?  The best strategy then would be to move out first and then do the repairs.  Is that right?  Thanks again.

Mark H. · Answer

Man..

I take it you have never gotten one of "those letters" from the IRS?

You know, "Pay $XXk + fees and interest by Friday, or prove us wrong"...

Seriously, why would you pay a professional that was willing to get you into trouble.  You can get into trouble just fine all by yourself!

My strategy has been to take all the profit I want out of the seller's behind when I buy.  That includes taxes.  Then you can pay whatever the IRS wants with a smile.  This place was a gift, right? Do business the right way, you don't want to deal with the IRS.

Steve Babiak · Answer

If you haven't changed the address on your driver's license, it's not "ready to rent".  Your CPA's advice is "aggressive" (gets you to a lower tax bill), but the challenge is in showing that it is also applicable and accurate to some degree - can you (and the CPA) defend the CPA's position?

Is a CL ad sufficient to prove intent to rent?

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