Pre-Rental Expenses Deductible?

Question

I purchased a property this week and immediately advertised it for rent.

I am showing the unit to a prospective tenant today, but we have not yet discussed a lease date.   Have I now met the requirement of making the unit available for rent under the Pre-rental expense provision in Publication 527? Can I now deduct the following expenses which I would like to complete before occupancy? 
 
Painting, carpet cleaning, general cleaning, and door latch replacement?

Has this provision in the Code recently been changed as I see other posts that say a unit must be rented to deduct such expenses?

Thank you.

Steven Hamilton II · Answer

James Farrel,

It has to be available. If work is needed to be done is it available?

Think about this fact.  The person you spoke to: 1. Did not give your their response in writing, 2. Did not provide you with a citation, 3. Gets paid just over minimum wage.

I represent taxpayers like you before the IRS. Majority of my clients are self employed or real estate investors. I too invest in real estate.  This comes into question very often in audit.

Placed in Service
You place property in service in a rental activity when it is ready and available for a specific use in that activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.Example 1. On November 22 of last year, you purchased a dishwasher for your rental property. The appliance was delivered on December 7, but was not installed and ready for use until January 3 of this year. Because the dishwasher was not ready for use last year, it is not considered placed in service until this year.
If the appliance had been installed and ready for use when it was delivered in December of last year, it would have been considered placed in service in December, even if it was not actually used until this year.Example 2. On April 6, you purchased a house to use as residential rental property. You made extensive repairs to the house and had it ready for rent on July 5. You began to advertise the house for rent in July and actually rented it beginning September 1. The house is considered placed in service in July when it was ready and available for rent. You can begin to depreciate the house in July.

http://www.irs.gov/pub/irs-pdf/p527.pdf
http://www.irs.gov/pub/irs-pdf/p946.pdf

-Steven the Tax Guy

Dave Toelkes · Answer

@James Farrel

The dwelling structure is depreciated on a 27.5 year schedule beginning in October.  The cost of the doorway improvement is depreciated as a separate (improvement) asset on a 27.5 year schedule beginning in November.  If the new refrigerator was installed and put in service in November, then the refrigerator is depreciated as a separate asset on a five year schedule beginning in November.  Regardless of the actual day of the month, a tax code uses a mid-month convention to establish the starting day of the month an asset is placed in service.

Derek Johnson · Answer

@Steven Hamilton II I had the same circumstances occur, and wanted to double check that I'm understanding correctly. I lived in my home up until April 2014, and rented the property out starting May 1, 2014. So any painting, fixing windows etc. done prior to being rented cannot be deducted, but I can add the cost to my basis (purchase price) / 27.5 years?

James Farrel · Answer

I purchased another unit on October 20, 2013,     I showed the unit October 25 and signed a lease to start November 15.   However, I decided to replace the refrigerator due to age even though the existing refrigerator did work okay.  I told the prospective tenant I would do this when showing him the unit.  Also, I agreed to add a doorway from the study to the hallway so he could use it as second bedroom.  When the unit had been built this doorway had apparently not been included due to the request of the original buyer but was in place in most if not all similar units in the building.   The doorway project was completed November 12 and the new fridge was delivered the same day.

My question is how to do I report the fridge and doorway on my taxes?    Do they both become part of basis of property or do I amortize or expense either item on a different timetable?   Thank you.

Steven Hamilton II · Answer

@paul C,

Yes, it must be added to basis and depreciated accordingly.  Even if it was a separately listed depreciable item (that is how I prefer to list them).

Much of it depends upon your AGI and whether or not you are active in those investments.

Paul C. · Answer

@Steven Hamilton II , thanks for your explanations.

I purchased my first rental properties last year and hired a CPA because I wanted to make sure the accounting was done right.  Now I'm realizing he may have not treated pre-rental expenses properly.  Instead of capitalizing all expenses prior to the in service date, he categorized them by nature of work.  Based on what I'm reading in this forum, that was a mistake, right?

Also, can passive activity losses from another activity like a restaurant partnership be used to offset passive gains from rental income?  My CPA said no, but the IRS publications I read seemed to say passive losses from one activity can offset gains from another passive activity.  Given my CPA's other mistake, I think I need a second opinion.

Thanks,

Paul

James Farrel · Answer

I called the IRS today, and they said that the Code only requires it be available for rent, and there is no language requiring it be rent ready, rented or occupied.    That is my confusion.

For the sake of argument, what if I rented the unit and then painted it, cleaned it, and replaced the door latch?   Would that make any difference?  Would it matter if the tenant had moved in or agreed to rent reduction until I completed the maintenance and repairs?   I do understand that it would make sense that I  would have implicitly capitalized items as part of the purchase price if the seller had done these things before I made the purchase.

If the expenses are to be capitalized would it be for the life of the building?   It is likely I would have to repaint in a few years so would that affect the depreciation period of the pre-rental painting?

Thank you.

Steven Hamilton II · Answer

James Farrel,

The unit must be available which you have met.  It also must be ready for rent.  Not until it is generally rent ready can it be placed in service. Your expenses would still be capitalized.

Search on BP "placed in service"

-Steven

Pre-Rental Expenses Deductible?

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