Renting out old personal res - can I deduct repairs on taxes?

Question

Hey Bigger Pockets, new landlord-to-be here.

We close on a new personal residence in March and will be keeping our current home as a rental. We will be doing some rehab work to our current home such as replacing some of the carpets, refinishing the floors, painting, etc. This work will be done after we move into our new home. For tax purposes, if the repairs & maintenance take place after we move are we allowed to count those as expenses of our old home which would then be considered a rental property? It’s not a deal breaker either way but I would like to report those if allowed.

Thank you in advance.

Matt Galbraith · Answer

Thank you gentlemen for your time and thorough answers on this.

Jon Holdman · Answer

All the money you spend getting the property ready to rent adds to its basis.  The basis is what you use to determine depreciation.  Items that would normally be treated as expenses (e.g., repairing a toilet) instead add to the basis when they are done while preparing the property to rent.  Once its rent ready, repairs like this are deductible in the year you incur them, but not if they're done before the place is rent ready.

Other items, like carpets, are always capital items and are always depreciated.  In the case of carpets (flooring, in general), the period is five years rather than 27.5 years for the improvements as a whole.  So, you want to track each item separately.  Your account will depreciate these items separately.

Don't fool yourself.  Depreciation is sometimes considered a "free deduction" because its not tied to cash you actually spend.  But it very much is.  If you spend $2500 on carpets, you get to take a $500 depreciation deduction for that carpet for each of the next five years.  If very likely you'll end up replacing that carpet in about that five year time frame, so you're lay out another chunk of cash all at once, but deduct it over the coming five years.  If you end up replacing is sooner (judges around here only allow deductions for security deposits for carpets less than three years old), you can take any remaining depreciation on the old carpet in the year when you replace it.

As always, consult with your accountant.  If your accountant gives you deer-in-the-headlights looks when you ask these questions, time for a new accountant.  This is complex stuff.  I send the details to my CPA and he sorts out all the specifics.

Joe Splitrock · Answer

The point is that if you increase value with the improvements, it will increase your basis value for depreciation. Depreciation is a tax deduction the same and capital improvements. You will not lost out either way. It comes down to the right way to claim it. Talk to your accountant right away so they can tell you what types of things you should track and deduct.

Matt Galbraith · Answer

Ok thanks for this thought as well Joe. I will be sure to have everything documented very well. The management company said they would start advertising it and we would have a specific move in ready date so if it was being advertised by the management company maybe that would satisfy the IRS obligation. As mentioned, I'm ok doing it either way so I will keep everything very detailed for when I meet with the accountant to keep from getting into any trouble. In the end if I can't deduct those then it won't affect me but your post is very appreciated so that I'm aware of what I need to be checking with an accountant. Thanks!

Luc Boiron · Answer

You are right Joe, my mistake.

We treat repairs and capital expenses the same way otherwise, so I would assume this would be the same again. I have been shown wrong, thank you for correcting me.

Joe Splitrock · Answer

Is this the standard in Canada or are you citing US IRS definition?

Joe Splitrock · Answer

The IRS defines this based on when the house was placed in service as a rental. That is not the day you buy a new primary residence. It is the day your old property is ready to rent and being advertised as a rental. My interpretation from reading IRS documents on this is that you can only start depreciating the home and declaring expenses when the house is rent ready. That would generally mean after updates are completed and you place the property for rent. Here is a specific example the IRS gives that I copied and pasted from an IRS website publication:

"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."

What you will need to do is talk to an accountant. Depreciation and capturing expenses will begin on the day the house is ready to rent. They will work with you to establish a depreciation value. The depreciation value is not what you paid for the house. There are a couple methods to establish current depreciation value and let your accountant decide what is best.

I am not sure I would worry about claiming the improvement expenses. Any major improvement expense would be depreciated. Since you are establishing your depreciation value after improvements, your improvements will increase value and therefore increase the amount you can depreciate. I guess the point is you cannot double dip. For example if you put the house in service as a rental March 1, then spend $10,000 replacing flooring in April, you would depreciate the flooring expense. If you spend $10,000 on flooring in March and then put the property in service as a rental in April, your depreciation value will most likely be $10,000 higher to account for the improvements. In either example you get benefit from the improvements. Technically you are not supposed to put the property in service until the updates are ready. Basically this means the day you start advertising it for rent is the day it is put in service.

Some accountants may claim your property went in service before the updates, but I would be careful because the IRS is pretty specific on this. Would you get audited and caught, probably not.

https://www.irs.gov/publications/p527/ch02.html#en...

Please talk to an accountant. I am not one, so my input here is just based on my lay understanding.

Matt Galbraith · Answer

Great, thank you Luc!

I figured I could deduct the expenses but just wanted to be sure of the timing of everything. I have my budget, contractor quotes, type of carpet, etc. and everything ready to purchase but I was waiting until right after we moved out. Just wanted to make sure I was correct in my assumption in that I would be allowed to deduct the expenses. If I wasn't going to be able to for some odd reason then I was just going to go ahead and get started now on fixing it up but since I can deduct those expenses I will wait until it's "officially" not my primary residence anymore.  I've already had a property management company come out and look at the property, go over the rehab that will be done, and they are working with me to get it rented with a specified ready date for the property. So by waiting to make the repairs it shouldn't delay getting a tenant in much but will definitely make a difference in taxes.

Thanks again!

Luc Boiron · Answer

Yes.

If you had just bought the property and were going to rent it out, could you expense the replacement of carpets?

Treat it as if you bought it as of the day you move out and it becomes a rental.