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Amend TaxAmend tax 4. Amend tax Special Situations Table of Contents Condominiums CooperativesDepreciation Property Changed to Rental UseBasis of Property Changed to Rental Use Figuring the Depreciation Deduction Renting Part of Property Not Rented for ProfitPostponing decision. Amend tax Example—Property Changed to Rental Use This chapter discusses some rental real estate activities that are subject to additional rules. Amend tax Condominiums A condominium is most often a dwelling unit in a multi-unit building, but can also take other forms, such as a townhouse or garden apartment. Amend tax If you own a condominium, you also own a share of the common elements, such as land, lobbies, elevators, and service areas. Amend tax You and the other condominium owners may pay dues or assessments to a special corporation that is organized to take care of the common elements. Amend tax Special rules apply if you rent your condominium to others. Amend tax You can deduct as rental expenses all the expenses discussed in chapters 1 and 2. Amend tax In addition, you can deduct any dues or assessments paid for maintenance of the common elements. Amend tax You cannot deduct special assessments you pay to a condominium management corporation for improvements. Amend tax However, you may be able to recover your share of the cost of any improvement by taking depreciation. Amend tax Cooperatives If you live in a cooperative, you do not own your apartment. Amend tax Instead, a corporation owns the apartments and you are a tenant-stockholder in the cooperative housing corporation. Amend tax If you rent your apartment to others, you usually can deduct, as a rental expense, all the maintenance fees you pay to the cooperative housing corporation. Amend tax In addition to the maintenance fees paid to the cooperative housing corporation, you can deduct your direct payments for repairs, upkeep, and other rental expenses, including interest paid on a loan used to buy your stock in the corporation. Amend tax Depreciation You will be depreciating your stock in the corporation rather than the apartment itself. Amend tax Figure your depreciation deduction as follows. Amend tax Figure the depreciation for all the depreciable real property owned by the corporation. Amend tax (Depreciation methods are discussed in chapter 2 of this publication and Publication 946. Amend tax ) If you bought your cooperative stock after its first offering, figure the depreciable basis of this property as follows. Amend tax Multiply your cost per share by the total number of outstanding shares. Amend tax Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock. Amend tax Subtract from the amount figured in (b) any mortgage debt that is not for the depreciable real property, such as the part for the land. Amend tax Subtract from the amount figured in (1) any depreciation for space owned by the corporation that can be rented but cannot be lived in by tenant-stockholders. Amend tax Divide the number of your shares of stock by the total number of shares outstanding, including any shares held by the corporation. Amend tax Multiply the result of (2) by the percentage you figured in (3). Amend tax This is your depreciation on the stock. Amend tax Your depreciation deduction for the year cannot be more than the part of your adjusted basis (defined in chapter 2) in the stock of the corporation that is allocable to your rental property. Amend tax Payments added to capital account. Amend tax Payments earmarked for a capital asset or improvement, or otherwise charged to the corporation's capital account are added to the basis of your stock in the corporation. Amend tax For example, you cannot deduct a payment used to pave a community parking lot, install a new roof, or pay the principal of the corporation's mortgage. Amend tax Treat as a capital cost the amount you were assessed for capital items. Amend tax This cannot be more than the amount by which your payments to the corporation exceeded your share of the corporation's mortgage interest and real estate taxes. Amend tax Your share of interest and taxes is the amount the corporation elected to allocate to you, if it reasonably reflects those expenses for your apartment. Amend tax Otherwise, figure your share in the following manner. Amend tax Divide the number of your shares of stock by the total number of shares outstanding, including any shares held by the corporation. Amend tax Multiply the corporation's deductible interest by the number you figured in (1). Amend tax This is your share of the interest. Amend tax Multiply the corporation's deductible taxes by the number you figured in (1). Amend tax This is your share of the taxes. Amend tax Property Changed to Rental Use If you change your home or other property (or a part of it) to rental use at any time other than the beginning of your tax year, you must divide yearly expenses, such as taxes and insurance, between rental use and personal use. Amend tax You can deduct as rental expenses only the part of the expense that is for the part of the year the property was used or held for rental purposes. Amend tax You cannot deduct depreciation or insurance for the part of the year the property was held for personal use. Amend tax However, you can include the home mortgage interest, qualified mortgage insurance premiums, and real estate tax expenses for the part of the year the property was held for personal use as an itemized deduction on Schedule A (Form 1040). Amend tax Example. Amend tax Your tax year is the calendar year. Amend tax You moved from your home in May and started renting it out on June 1. Amend tax You can deduct as rental expenses seven-twelfths of your yearly expenses, such as taxes and insurance. Amend tax Starting with June, you can deduct as rental expenses the amounts you pay for items generally billed monthly, such as utilities. Amend tax When figuring depreciation, treat the property as placed in service on June 1. Amend tax Basis of Property Changed to Rental Use When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion. Amend tax Fair market value. Amend tax This is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts. Amend tax Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property. Amend tax Figuring the basis. Amend tax The basis for depreciation is the lesser of: The fair market value of the property on the date you changed it to rental use, or Your adjusted basis on the date of the change—that is, your original cost or other basis of the property, plus the cost of permanent additions or improvements since you acquired it, minus deductions for any casualty or theft losses claimed on earlier years' income tax returns and other decreases to basis. Amend tax For other increases and decreases to basis, see Adjusted Basis in chapter 2. Amend tax Example. Amend tax Several years ago you built your home for $140,000 on a lot that cost you $14,000. Amend tax Before changing the property to rental use this year, you added $28,000 of permanent improvements to the house and claimed a $3,500 casualty loss deduction for damage to the house. Amend tax Part of the improvements qualified for a $500 residential energy credit, which you claimed on your 2010 tax return. Amend tax Because land is not depreciable, you can only include the cost of the house when figuring the basis for depreciation. Amend tax The adjusted basis of the house at the time of the change in its use was $164,000 ($140,000 + $28,000 − $3,500 − $500). Amend tax On the date of the change in use, your property had a fair market value of $168,000, of which $21,000 was for the land and $147,000 was for the house. Amend tax The basis for depreciation on the house is the fair market value on the date of the change ($147,000), because it is less than your adjusted basis ($164,000). Amend tax Cooperatives If you change your cooperative apartment to rental use, figure your allowable depreciation as explained earlier. Amend tax (Depreciation methods are discussed in chapter 2 of this publication and Publication 946. Amend tax ) The basis of all the depreciable real property owned by the cooperative housing corporation is the smaller of the following amounts. Amend tax The fair market value of the property on the date you change your apartment to rental use. Amend tax This is considered to be the same as the corporation's adjusted basis minus straight line depreciation, unless this value is unrealistic. Amend tax The corporation's adjusted basis in the property on that date. Amend tax Do not subtract depreciation when figuring the corporation's adjusted basis. Amend tax If you bought the stock after its first offering, the corporation's adjusted basis in the property is the amount figured in (1) under Depreciation (under Cooperatives, near the beginning of this chapter). Amend tax The fair market value of the property is considered to be the same as the corporation's adjusted basis figured in this way minus straight line depreciation, unless the value is unrealistic. Amend tax Figuring the Depreciation Deduction To figure the deduction, use the depreciation system in effect when you convert your residence to rental use. Amend tax Generally, that will be MACRS for any conversion after 1986. Amend tax Treat the property as placed in service on the conversion date. Amend tax Example. Amend tax Your converted residence (see previous example under Figuring the basis) was available for rent on August 1. Amend tax Using Table 2-2d (see chapter 2), the percentage for Year 1 beginning in August is 1. Amend tax 364% and the depreciation deduction for Year 1 is $2,005 ($147,000 × . Amend tax 01364). Amend tax Renting Part of Property If you rent part of your property, you must divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though you actually had two separate pieces of property. Amend tax You can deduct the expenses related to the part of the property used for rental purposes, such as home mortgage interest, qualified mortgage insurance premiums, and real estate taxes, as rental expenses on Schedule E (Form 1040). Amend tax You can also deduct as rental expenses a portion of other expenses that normally are nondeductible personal expenses, such as expenses for electricity, or painting the outside of the house. Amend tax There is no change in the types of expenses deductible for the personal-use part of your property. Amend tax Generally, these expenses may be deducted only if you itemize your deductions on Schedule A (Form 1040). Amend tax You cannot deduct any part of the cost of the first phone line even if your tenants have unlimited use of it. Amend tax You do not have to divide the expenses that belong only to the rental part of your property. Amend tax For example, if you paint a room that you rent, or if you pay premiums for liability insurance in connection with renting a room in your home, your entire cost is a rental expense. Amend tax If you install a second phone line strictly for your tenant's use, all of the cost of the second line is deductible as a rental expense. Amend tax You can deduct depreciation on the part of the house used for rental purposes as well as on the furniture and equipment you use for rental purposes. Amend tax How to divide expenses. Amend tax If an expense is for both rental use and personal use, such as mortgage interest or heat for the entire house, you must divide the expense between rental use and personal use. Amend tax You can use any reasonable method for dividing the expense. Amend tax It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them. Amend tax The two most common methods for dividing an expense are (1) the number of rooms in your home, and (2) the square footage of your home. Amend tax Example. Amend tax You rent a room in your house. Amend tax The room is 12 × 15 feet, or 180 square feet. Amend tax Your entire house has 1,800 square feet of floor space. Amend tax You can deduct as a rental expense 10% of any expense that must be divided between rental use and personal use. Amend tax If your heating bill for the year for the entire house was $600, $60 ($600 × . Amend tax 10) is a rental expense. Amend tax The balance, $540, is a personal expense that you cannot deduct. Amend tax Duplex. Amend tax A common situation is the duplex where you live in one unit and rent out the other. Amend tax Certain expenses apply to the entire property, such as mortgage interest and real estate taxes, and must be split to determine rental and personal expenses. Amend tax Example. Amend tax You own a duplex and live in one half, renting the other half. Amend tax Both units are approximately the same size. Amend tax Last year, you paid a total of $10,000 mortgage interest and $2,000 real estate taxes for the entire property. Amend tax You can deduct $5,000 mortgage interest and $1,000 real estate taxes on Schedule E (Form 1040), and if you itemize your deductions, you can deduct the other $5,000 mortgage interest and $1,000 real estate taxes on Schedule A (Form 1040). Amend tax Not Rented for Profit If you do not rent your property to make a profit, you can deduct your rental expenses only up to the amount of your rental income. Amend tax You cannot deduct a loss or carry forward to the next year any rental expenses that are more than your rental income for the year. Amend tax Where to report. Amend tax Report your not-for-profit rental income on Form 1040 or 1040NR, line 21. Amend tax For example, if you are filing Form 1040, you can include your mortgage interest and any qualified mortgage insurance premiums (if you use the property as your main home or second home), real estate taxes, and casualty losses on the appropriate lines of Schedule A (Form 1040) if you itemize your deductions. Amend tax If you itemize your deductions, claim your other rental expenses, subject to the rules explained in chapter 1 of Publication 535, as miscellaneous itemized deductions on Schedule A (Form 1040), line 23, or Schedule A (Form 1040NR), line 9. Amend tax You can deduct these expenses only if they, together with certain other miscellaneous itemized deductions, total more than 2% of your adjusted gross income. Amend tax Presumption of profit. Amend tax If your rental income is more than your rental expenses for at least 3 years out of a period of 5 consecutive years, you are presumed to be renting your property to make a profit. Amend tax Postponing decision. Amend tax If you are starting your rental activity and do not have 3 years showing a profit, you can elect to have the presumption made after you have the 5 years of experience required by the test. Amend tax You may choose to postpone the decision of whether the rental is for profit by filing Form 5213. Amend tax You must file Form 5213 within 3 years after the due date of your return (determined without extensions) for the year in which you first carried on the activity or, if earlier, within 60 days after receiving written notice from the Internal Revenue Service proposing to disallow deductions attributable to the activity. Amend tax More information. Amend tax For more information about the rules for an activity not engaged in for profit, see Not-for-Profit Activities in chapter 1 of Publication 535. Amend tax Example—Property Changed to Rental Use In January, Eileen Johnson bought a condominium apartment to live in. Amend tax Instead of selling the house she had been living in, she decided to change it to rental property. Amend tax Eileen selected a tenant and started renting the house on February 1. Amend tax Eileen charges $750 a month for rent and collects it herself. Amend tax Eileen also received a $750 security deposit from her tenant. Amend tax Because she plans to return it to her tenant at the end of the lease, she does not include it in her income. Amend tax Her rental expenses for the year are as follows. Amend tax Mortgage interest $1,800 Fire insurance (1-year policy) 100 Miscellaneous repairs (after renting) 297 Real estate taxes imposed and paid 1,200 Eileen must divide the real estate taxes, mortgage interest, and fire insurance between the personal use of the property and the rental use of the property. Amend tax She can deduct eleven-twelfths of these expenses as rental expenses. Amend tax She can include the balance of the allowable taxes and mortgage interest on Schedule A (Form 1040) if she itemizes. Amend tax She cannot deduct the balance of the fire insurance because it is a personal expense. Amend tax Eileen bought this house in 1984 for $35,000. Amend tax Her property tax was based on assessed values of $10,000 for the land and $25,000 for the house. Amend tax Before changing it to rental property, Eileen added several improvements to the house. Amend tax She figures her adjusted basis as follows: Improvements Cost House $25,000 Remodeled kitchen 4,200 Recreation room 5,800 New roof 1,600 Patio and deck 2,400 Adjusted basis $39,000 On February 1, when Eileen changed her house to rental property, the property had a fair market value of $152,000. Amend tax Of this amount, $35,000 was for the land and $117,000 was for the house. Amend tax Because Eileen's adjusted basis is less than the fair market value on the date of the change, Eileen uses $39,000 as her basis for depreciation. Amend tax As specified for residential rental property, Eileen must use the straight line method of depreciation over the GDS or ADS recovery period. Amend tax She chooses the GDS recovery period of 27. Amend tax 5 years. Amend tax She uses Table 2-2d to find her depreciation percentage. Amend tax Since she placed the property in service in February, the percentage is 3. Amend tax 182%. Amend tax On April 1, Eileen bought a new dishwasher for the rental property at a cost of $425. Amend tax The dishwasher is personal property used in a rental real estate activity, which has a 5-year recovery period. Amend tax She uses Table 2-2a to find the percentage for Year 1 under “Half-year convention” (20%) to figure her depreciation deduction. Amend tax On May 1, Eileen paid $4,000 to have a furnace installed in the house. Amend tax The furnace is residential rental property. Amend tax Because she placed the property in service in May, the percentage from Table 2-2d is 2. Amend tax 273%. Amend tax Eileen figures her net rental income or loss for the house as follows: Total rental income received ($750 × 11) $8,250 Minus: Expenses Mortgage interest ($1,800 × 11/12) $1,650 Fire insurance ($100 × 11/12) 92 Miscellaneous repairs 297 Real estate taxes ($1,200 × 11/12) 1,100 Total expenses 3,139 Balance $5,111 Minus: Depreciation House ($39,000 × . Amend tax 03182) $1,241 Dishwasher ($425 × . Amend tax 20) 85 Furnace ($4,000 × . Amend tax 02273) 91 Total depreciation 1,417 Net rental income for house $3,694 Eileen uses Schedule E, Part I, to report her rental income and expenses. Amend tax She enters her income, expenses, and depreciation for the house in the column for Property A. Amend tax Since all property was placed in service this year, Eileen must use Form 4562 to figure the depreciation. Amend tax See the Instructions for Form 4562 for more information on preparing the form. Amend tax Prev Up Next Home More Online Publications
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