Should I advertise a rental that is not ready for tax reasons?

Question

Hello,

I have a rental (in California) that won't be ready for a few months (we have done the rehab ourselves) and have been told by an accountant that I need to advertise it before the end of the year in order to show "intent to rent". I have a few questions that I would love to get some insight on:

1. Is it true that I need to advertise within the calendar year in order to receive the tax benefits?

2. If it is advisable to advertise now - how can I do so and not waste my or the potential residents time if it will be 60-90 days before the house is ready. I don't want to show it until it is appealing and can attract the most desirable residents.

Thanks All!!

Brandon Hall · Answer

@Linda Weygant thanks for the mention!

@Rachael Collins It depends largely on the facts and circumstances surrounding your rental, but I'd argue that advertising it for rent does place the property into service. Sec. 1.179-4(e) explains the placed in service date as:

“the time that property is first placed by the taxpayer in a condition or state of readiness and availability for a specifically assigned function, whether for use in a trade or business, for the production of income, in a tax-exempt activity, or in a personal activity.”

So the question becomes: when you advertise it for rent, is it in a state of readiness and availability? I feel that if you have strategically rehabbed the majority of the inside, you can viably advertise it for rent (placing it into service) and then continue rehabbing the outside. Landlords generally must provide a warranty of habitability, so if the inside is ready to go, wouldn't you say that warranty of habitability is met (differs state-to-state, check with an attorney)?

Once you advertise it for rent, your expenditures are no longer required to be capitalized, meaning, if they qualify for repair treatment, we can currently deduct them.

That said, this is a more aggressive strategy. I certainly would not do it without a CPA and/or an attorney analyzing your set of facts and circumstances and providing advice. I'd also make sure I clearly understand what my accountant needs me to do in order to substantiate the "placed in service" date.

It becomes a riskier strategy the further away you are from completion. I read a case about a guy who advertised his rentals and four years later still hadn't rented them out, but was deducting the expenses all along (can you say AUDIT?). The case name is slipping my mind right now though.

Mike H. · Answer

I'm no cpa but that advice makes a lot of sense.

That being said, I would think you could still get some writeoffs for things like interest expense, utilities, etc.  Because those would have to be taken at the point in time they were incurred. At least in my mind.

But what I really wanted to comment on was the initial thought that you should wait til its completed before you list/show it for rent.

Why would you do that? I only do buy and hold. And now have 45 houses with another 4 more under contract.  After about the 3rd house, I've listed and shown every single one for rent BEFORE the rehab is completed. And I almost always have the houses rented before the rehab is complete.

Here by me, rentals are pretty scarce so people are more than happy to lock in a house before its done. You'd be surprised how many can see the vision - or will at least be willing to risk it to get the house.

That being said, your showings are a little more involved. You can't turn people loose in the house like an open house. You need the one on one to "sell" them the house. Tell em what you're doing and what you're not doing. Paint the picture of what its going to look like.

About house 13 or 14, I started doing before and after videos and posting them on youtube. I then link my ads to the youtube channel.  Allows prospective tenants to see the before and after videos of all our stuff. I've got about 30 or so up there right now I think.

And that helps them overcome the fear of putting money down on a house that isn't done. If they can see the one you did before, it makes it easier to buy in to your vision.

The other interesting benefit to showing the house early is that you get feedback from prospective tenants on "you're not finishing that???". If you get 2 or 3 people saying that about an item, then maybe its a good idea to add it to the list. :-)

But, yes, I would definitely recommend listing the house now so you can get it rented before the rehab is even done. That also gives them time to give their notice so they can be ready to move in as soon as your rehab is completed.

Otherwise, if you wait to show the house after its done, then you're going to have to wait a week or two of showings, and then another month or so for them to give their notice.

You're basically eating an additional 5 to 7 weeks of vacancy on every house. It adds up. My average stuff by me rents for about 1350/mo so that would cost me about 2k on every deal in lost rent if I were to wait for them to be completed before I listed it.

List it on the free sites and do the showings now - even though you're still a couple months away from being done. Best case is you get someone to put a deposit down on it and they're ready to move in right after you get it done.  Worst case is you'll get some free feedback as you walk people thru the house and tell em what you are and aren't doing. :-)

Not knowing your market. But if its anything like mine, you'll have the place rented before you're done.....

Linda Weygant · Answer

You want to establish intent to rent if you're in a situation where somebody is offering to buy the property before you have it ready to rent and you're worried about making sure the sale is treated as capital gains rather than ordinary (flipping) income.  In that case, you can establish intent to rent based on documenting conversations you've had with unrelated third parties.  Did you tell your lender it's going to be a rental?  Your contractor?  Your insurance agent?  Better yet, is it insured as a rental?  Financed as a rental?  Do all of your calculations and plans thus far indicate that you intended to buy this to fix and rent?  If so, you have established intent to rent and if you then decide to sell it before putting a tenant in it, you're probably covered.  But @Brandon Hall has discussed this in other areas and could probably comment on it as well.

However, you haven't said anything about that, so I'm assuming you're worried about a more common issue, which is depreciation expenses on the rental.  If that's not the case, you can add a clarifying post below.

You begin depreciating an asset when it is put in service.  Beginning to depreciate it before it's put into service is incorrect tax treatment, plain and simple.  If you're still in the middle of a major remodel, it is not ready for service.  Advertising it as being for rent does not make it ready for service any sooner and does not make it eligible for depreciation.

Rachael Collins · Answer

@Brandon Hall Thanks - that clarifies a bit for me - as clear as tax law can be for those of us not possessing a degree in accounting! I will work on figuring out just what I need to do next.

Thanks again!

Mike H. · Answer

@Rachael Collins, Jennifer T.

Glad to hear it. I hope either of you can shoot out an update on here if you can remember when you get it rented - whether its before or after your rehab is complete.

In terms of the books vs logic, I guess thats about the norm for me. I read a lot of posts and online stuff but not many books. I'm all about the common sense approach to landlording. It serves me well. :-)

But I've read some good stuff over the years and if it makes sense, I'll try it. Showing before makes sense.

I also think that maybe that rule applies to flipping/sales versus buyandhold/rent. It makes sense that you don't want to show a buyer a house for sale before its done. First impressions.  They'll likely still be looking long enough where you aren't risking losing them.

But usually when renters need/want to move, they aren't going to wait a couple months to find something. The chances of a good renter still being there after a two month period isn't very likely in mind. Usually, if they're a good renter, they'll find something pretty quickly.

So, in my mind, you aren't really risking losing them by showing them early. That being said, there will be some people that just don't see it. And they won't take it no matter what you say.  But of the 1 or 2 in 10 that will be an absolutely no, there will be another 4 or 5 in 10 that will have no problem taking the house even in the craziest condition ever.

I've shown houses with no flooring (subfloor only). no cabinets, vanities, light fixtures. And they said they loved it.  It was all about the space and painting the picture of what is going to be done.

You'd be surprised how many people watch these rehab shows and love the idea of getting the "after rehab" house. :-)

Steven Hamilton II · Answer

As @Brandon Hall said it must be both.  If you are still doing repairs and an auditor notices you could lose time being depreciated... Also keep in mind lenders don't like losses.

Rachael Collins · Answer

@Mike H.  It's nice to be reminded to remember common sense. Sometimes I feel like it died many, many years ago - here's to it's return!! I will start looking for my visionary residents, and will try to remember to post my results - thanks again!!

Jennifer T. · Answer

@Mike H., I'm so glad I happened to read your post!  I've been renting the other side of my duplex for a few years, but just bought my first rent/rehab a few months ago.  I was planning to start showings once it was done or almost done, but I'm going to take your advice and start sooner.

I would LOVE to have tenants already lined up to move in as I complete the reno.  It's already gone on twice as long as I expected (sigh).  But its my first swing at a rent/rehab needing substantial work, so I'm trying not to be too down on myself.

Rachael Collins · Answer

@Mike H.

Thanks for this advice. Not a ton of great rentals where this house is, and that strategy may work to our advantage! I will speak to my partner about it definitely. I have read so many posts and books saying to make sure it is rent ready before you show, or you will lose potential residents. I guess that mantra stuck, but your logic makes sense.

Thanks for your help!

Colleen F. · Answer

So the only thing not done is  the bathroom?    If that is the case and the house is not in shambles  I would advertise and post an availability  date and start to show.  You are entering the holiday season  if  you want January 1 it is not too soon to advertise. Tax wise I think you have your answer.

Should I advertise a rental that is not ready for tax reasons?

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