Depreciation & Recapture |
Rental Expenses & Passive Activity Losses (PALs)
Personal Use of Business Property (Condo, Timeshare, etc.) |
Sales, Trades, Exchanges
What kinds of property can be depreciated for tax purposes?
Only property used in a trade or business or in an income production activity can be depreciated. Additionally, the property must be something that wears out or becomes obsolete and it must have a determinable useful life substantially beyond the tax year. The kinds of property that can be depreciated include, but are not limited to, machinery, equipment, buildings, vehicles, and furniture. Depreciation is a complex topic. For more information, refer to Tax Topic 704, Depreciation, or Publication 946, How to Depreciate Property, or Publication 534, Depreciating Property Placed in Service Before 1987.
References:
Can the entire acquisition cost of a computer that I purchased for my business be deducted as a business expense or do I have to use depreciation?
Expense for depreciation of a computer for business use, whether all at once or over a recovery period, generally, would be reported on Form 4562, Depreciation and Amortization, Part V. A computer is, generally, depreciated over a 5-year period. If the computer is used more than 50% for business, then you may also have an option to expense the business portion in as little as one year (a section 179 deduction) using, Form 4562 Part I (as well as part v). Taxable income must be at least as great as the section 179 deduction claimed. Dollar limits and investment limits also apply. For more information on depreciation, refer to Publication 946, How to Depreciate Property.
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I purchased a computer last year to do online day trading part-time from home for additional income. Can I deduct or depreciate the cost of the computer or internet connection from my investment income?
You may deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Form 1040, Schedule A, line 22, Itemized Deductions. These deductions must be reduced by 2% of your adjusted gross income. This would include depreciation on the portion of your computer used for investment purposes, and the portion of your internet access charges used for investment purposes. Use Form 4562, Depreciation and Amortization to compute the depreciation for the portion of your computer used for investment purposes. It may be necessary to use a straight-line Depreciation Method. You cannot claim section 179 expensing of the computer if it is not a business asset. For more information, refer to "Listed Property" in Publication 946, How to Depreciate Property.
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I purchased a computer to support my job-related activities. I understand what percent of the computer I can deduct as an employee, but I do not understand if I can write-off the entire allowed cost or if I have to depreciate it over a few years?
You can claim a depreciation deduction for a computer that you use in your work as an employee if its use is:
- For the convenience of your employer, and
- Required as a condition of your employment.
If you meet the above tests, you generally must depreciate your computer using the straight-line method. You cannot take a section 179 deduction for the item or claim accelerated depreciation unless your use of the computer is more than 50% business or job-related use.
Section 179 deductions and accelerated depreciation methods are explained in Publication 946, How to Depreciate Property.
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I need to know the maximum deduction allowed for depreciation on a passenger vehicle purchased in 2001?
The maximum deduction that can be claimed for a passenger vehicle that was placed in service in 2001 has remained unchanged at $3,060 for the first year, $4,900 for the second year, $2,950 for the third year, and $1,775 for the fourth and following years. For more information, refer to Car Expenses in Chapter 4, Local Transportation Expenses of Publication 463, Travel, Entertainment, Gift, and Car Expenses and Special Rule for Passenger Automobiles in Chapter 4, Listed Property, of Publication 946, How to Depreciate Property.
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What form and line do I deduct the 34.5 cents per mile on for my business travel and do I need to figure depreciation of the vehicle, too?
A Sole Proprietor's busines use of a car or truck is claimed on line 10 of Form 1040, Schedule C, Profit or Loss from a Business or, if eligible, line 2 of schedule C-EZ. You may use either this 2001 standard business mileage rate of 34.5 cents per mile, if eligible, or the actual expense method in calculating your car or truck expense. Depreciation expense has already been included in this standard mileage rate. Depreciation is calculated as a separate expenses, when using the actual expense method. Deductible Employee Business use of a car or truck may be taken on Form 2106, or Form 2106-EZ if eligible, Employee Business Expenses, line 1. These car and truck expenses are then taken with other Employee Business Expenses on line 22, Form 1040, Schedule A, Itemized Deductions. For more information, refer to Publication 463; Travel Entertainment, Gift, and Car Expenses, and Publication 535, Business Expenses.
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I have a home office. Can I deduct expenses like mortgage, utilities, etc. without deducting depreciation so that when I sell this house, the basis won't be affected?
If you have qualified business use of your home and enough gross income from that business use to that entitle you to a depreciation deduction, you are required to reduce your basis in the home by the amount of depreciation allowed (deducted) or allowable (could have been deducted).
Whether you choose to deduct the depreciation on your current return(s) will not matter. For tax purposes, you will still be treated as if you had taken the allowable deduction, and your basis will have to be reduced. For more information, refer to Publication 946, How to Depreciate Property,Publication 544, Sales and Other Dispositions of Assets, and Publication 587, Business Use of Your Home.
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If I have a rental property. Do I have to take depreciation on it?
You do not have to claim depreciation on your rental property on your tax return. However, when reporting the sale of the rental property you are required to reduce the basis of the property for allowable depreciation regardless of whether the deduction was taken or not. For more information, refer to Publication 544, Sale or Other Dispositions of Assets, the Instructions for Form 4797, Sale of Business Property, and Publication 527, Residental Rental Property (including vacation homes).
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In calculating depreciation on both my rental apartment building and its furniture, what depreciation type, asset class, depreciation method, and recovery period should be used?
An apartment is considered residential rental property. Residential rental property is, generally, depreciated over 27.5 years under the modified accelerated cost recovery system (MACRS) using the general depreciation system (GDS) straight line method with a mid-month convention. Furniture for use in rental property, generally, would be depreciated over 5 years using the MACRS, GDS 200% double declining method with a half-year convention. The convention used will vary depending on when the property was placed in service. Publication 527, Residential Rental Property, contains the appropriate depreciation tables as does Publication 946, How to Depreciate Property. Attach Form 4562, Depreciation and Amortization, to your individual income tax return for the year this property is placed into service to claim the depreciation.
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We replaced the roof on a residential rental property and need to know what to use for the classification and recovery period to calculate depreciation?
Replacement of a roof on a residential rental property is considered to be a capital improvement to the structure. The roof would be in the same class of property as the rental property to which it is attached. Since the rental property is residential rental property, the roof would be, generally, depreciated over a residential recovery period, generally, of 27.5 years using the straight line method of depreciation and a mid-month convention. For more information, refer to Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.
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On residential rental property, would new windows and siding be considered a repair that could be deducted against income, or would they be capitalized as an improvement?
Replacement of windows and siding on a residential rental property is considered to be a capital improvement to the structure, provided the replacement improves the value of this property. The windows and siding, in that event, would be in the same class of property as the rental property to which they are affixed. Since the rental property is residential rental property, the windows and siding would be, generally, depreciated over a recovery period of 27.5 years using the straight line method of depreciation. For more information, refer to Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.
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We have incurred substantial repairs to our rental property: new roof, gutters, windows, furnace, and outside paint. What are the IRS rules concerning depreciation?
Replacement of roof, rain gutters, windows, and furnace on a residential rental property is considered to be a capital improvement to the structure. The items would be in the same class of property as the rental property to which to which they are attached. Since the rental property is residental rental property, the items would be, generally, depreciated over 27.5 years using the straight line method of depreciation and a mid-month convention.
Repairs, such as repainting the house, are current expenses. A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement and able to be depreciated in the same fashion as the rental property that you have restored or remodeled. For more information, refer to Publication 527, Residental Rental Property, and Publication 946, How to Depreciate Property.
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How many years do I depreciate a new furnace installed as an improvement on residential rental property and what method do I use to compute the depreciation?
Replacement of a furnace in a residential rental property is considered to be a capital improvement to the structure. The furnace would be in the same class of property as the rental property in which it is installed property. Since the rental property is residential rental property, the furnanace would be, generally, depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention. For more information, refer to Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.
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I purchased a snowblower and a lawn mower strictly for use at an apartment building I own. Can I elect section 179 depreciation to fully deduct the costs of the snowblower and lawn mower?
You cannot claim section 179 expense for property held to produce rental income (unless renting property is your trade or business). These assets are classified as 5-year property and must be depreciated as directed in Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.
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I expensed equipment and furniture two years ago under section 179, but stopped doing business last year. Does any of this have to be recaptured and claimed as income, even though the items have not been sold?
If you claim a section 179 deduction for the cost of property and, in a year after you place the property in service, you do not use it moe than 50 percent for business, you may have to recapture part of the section 179 deduction. This can occur in any year during the recovery period for the property even though the items have not been sold. Refer to Publication 946, How to Depreciate Property, on how to calculate the recapture amount. The recapture amount is computed on part IV of Form 4797, Sale of Business Property, and is included as other income on line 6 of Form 1040, Schedule C, Profit or Loss from Business (Sole Proprietorship).
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When an individual sells a rental building, what depreciation is being recaptured? Is it the amount of depreciation taken in the prior years or the depreciation left?
It is the amount of allowed or allowable depreciation which was taken in prior years, and in the current year up to the date of sale or date it is removed from services. But, if you sell a rental building placed in service after 1986 and you used the straight-line method, you would not have any depreciation to recapture. For further information, refer to Publication 544, Sales or Other Disposition of Assets, and Publication 946, Depreciation.
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How do I recapture depreciation on rental property that has been sold?
If you dispose of residential rental property placed in service after 1986 (or after July 31, 1986, if the election to use MACRS was made), you would not have any depreciation to recapture because you used a straight-line method. If you do have depreciation to recapture resulting from a gain on the sale, or because you did not meet the condition above, use Form 4797, Sale of Business Property, to compute the amount of depreciation recapture.
References:
I purchased a rental property last year. What closing costs can I deduct?
The only deductible closing costs are those for interest, and deductible real estate taxes. Other settlement fees and closing costs for buying the property are part of your basis in the property. These basis adjustments include:
- Abstract fees,
- Charges for installing utility services,
- Legal fees,
- Recording fees,
- Surveys,
- Transfer taxes,
- Title insurance, and
- Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. Fees related to obtaining a loan are capital expenses and should be amortized over the life of the loan.
For additional information refer to Publication 527, Residential Rental Property, Publication 17, Your Individual Income Tax Guide, and Publication 535, Business Espenses.
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I own a duplex. I live on one side and rent out the other. Are my mortgage interest and property taxes fully deductible on Schedule E?
No. Assuming that the loan is secured by the duplex, only the mortgage interest and property taxes for the portion you are renting are deductible on Form 1040, Schedule E, Supplemental Income and Loss. If you receive one bill, you should prorate the rental portion based on square footage. Your portion can be deducted on Form 1040, Schedule A, Itemized Deductions, if you can itemize and meet the requirements for Deductible Mortagage Interest. For more infomation, refer to Publication 527, Residential Rental Property (including Vacation Homes), Instructions for Form 1040, Schedule E, Supplemental Income and Loss, and Publication 936, Home Morgage Interest.
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Can you deduct Private Mortgage Insurance (PMI) premiums on rental property? If so, which line item on Schedule E?
Yes. Deduct it on line 9 of Form 1040, Schedule E, Supplemental Income and Loss. Write "PMI" on the dotted line.
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Where on Schedule E do you put costs paid (points, fees, etc.) to refinance a rental property?
Expenses you pay to obtain a mortgage on your rental property cannot be deducted as interest. These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. You may amortize them over the life of the mortgage on line 18 of Form 1040, Schedule E, Supplemental Income and Loss.
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I have losses from a passive rental real estate activity in which I actively participate. Can I offset the losses against my nonpassive income?
If your rental of real estate is a passive activity, you may, generally, offset a loss of up to $25,000 against your nonpassive income if you actively participate in the activity. However, married persons filing separate returns who lived together at any time during the year may not claim this offset. Married persons filing separate returns who lived apart at all times during the year are each allowed a $12,500 maximum offset for passive real estate activities. For additional information on limits on rental losses, refer to Chapter 10 of Publication 17, Your Federal Income Tax, and Tax Topic 425, Passive Activities - Losses and Credits, as well as, the Instructions for Form 1040, Schedule E, Supplemental Income and Loss.
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I received income for renting out my timeshare for a week. I understand that I don't have to report income from any rental less than 15 days, but the property management company reported that income to the IRS. Do I have to report it when I file?
If you use the dwelling unit as a home (based on degree of personal use) and you rent it for fewer than 15 days during the year, do not include any of the rent in your income and do not deduct any of the rental expenses. If you do not meet the tests for using your timeshare as your home, the income is reportable on Form 1040, Schedule E, Supplemental Income and Loss.
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I rent my home out for two weeks each year. Do I have to show the income on my return?
If you use a dwelling as a home and rent it for fewer than 15 days during the year, do not report any of the rental income and do not deduct any expenses as rental expenses. In this case, you may deduct some expenses on Form 1040, Schedule A, such as mortgage interest, property taxes, and any casualty losses. For additional information, refer to Tax Topic 415, Renting Vacation Property/Renting to Relatives.
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I am renting a house to my son and daughter-in-law. Can I claim rental expenses?
In general, if you receive income from the rental of a dwelling unit, such as a house, apartment, or duplex, there are certain expenses you may deduct. Besides knowing which expenses may be deducible, it is important to understand potential limitations on the amounts of rental expenses that may be deducted in a tax year. Whatever expenses you are allowed to deduct will reduce the amount of taxable rental income. For example, if you have no significant personal use, but rent the dwelling unit to your son and daughter-in-law at less than fair market rental value, then you may only deduct rental expenses up to the amount of actual rental income (received). If you do not have signicant personal use and rent to your son and daughter-in-law for more than 14 days per year, then the expenses will also be limited to the amount of rental income, but the excess expenses may be "carried over" to a future year.
For more information on which expenses to deduct, as well as limitations, refer to Tax Topic 414, Rental Income and Expenses, Tax Topic 415, Renting Vacation Property and Renting to Relatives, and Publication 527, Residential Rental Property (including vacation homes).
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What form(s) do we need to fill out to report the sale of rental property?
The gain or loss on the sale of rental property is reported on Form 4797, Sale of Business Property.Form 1040, Schedule D, Capital Gains and Losses, is often used in conjunction with Form 4797. For further information, refer to Publication 544, Sale on Other Disposition of Assets, Publication 550, Investment Income and Expense, the Instructions to Form 4797, Sale of Business Property, and the Instructions to Form 1040, Schedule D, Capital Gain and Losses.
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We are selling rental property and have never claimed depreciation. What do we do about this when we file our taxes?
When reporting the sale of or computing gain or loss on rental property, you are required to make an adjustment to your basis for allowable depreciation regardless of whether the deduction was taken. For more information refer to Publication 544, Sale or Other Dispositions of Assets, and the Instructions for Form 4797, Sales of Business Property.
To take deductions for some of this unclaimed depreciation, you may amend your income tax returns using Form 1040X, Amended U.S. Individual Income Tax Return. Generally, however, you may only amend your return, for refund or credit, for three years from the the due date of the return, or two years from the date you paid your tax, whichever is later.
References:
I am selling my rental property and was asked to pay the buyer's closing costs. Is all or part of the costs deductible for me?
In computing your gain or loss on the sale, reduce your proceeds from the sale by your selling expenses, including the buyer's closing costs that you agree to pay. Refer to Publication 544, Sales and Other Dispositions of Assets, for additional information.
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How do I file the gain on an installment sale of business property in each year? What form do I use?
Use Form 6252, Installment Sale Income, to figure your installment sale income each year. This form also identifies and quanitifies taxable interest income from the sale that needs to be reported each year by the seller, usually on Form 1040, Schedule B, Interest and Ordinary Dividends.
You may also need Form 1040, Schedule D, Capital Gains and Losses, and Form 4797, Sales of Business Property. For additional information including forms and instructions, refer to Publication 537, Installment Sales
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What forms do we file to report a loss on the sale of a rental property?
The gain or loss on the sale of rental property is reported on Form 4797, Sale of Business Property.
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I sold a rental property in which I had previous years' loss carryovers due to the loss limitation rules. Can I recover the total carryover since the property has been disposed of?
Yes. Claim the expenses limited for that property in prior years on Form 1040, Schedule E, Supplemental Income and Loss.
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Can you sell rental property and reinvest it into rental property without paying capital gains tax?
Unless you exchange properties in one of several types of a qualifying like-kind exchanges, you may not defer the gain on the sale of your rental property by purchasing replacement property. For additional information on like-kind exchanges, refer to Publication 544, Sales and Other Dispositions of Assets.
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I have heard that I can sell my rental property and use the proceeds to purchase rental property of equal or greater value and the transaction is viewed just like an exchange in that the tax is deferred until the new property is sold. Is this true?
What you have heard about is a qualifying like-kind exchange. A qualifying like-kind exchange, when properly executed, represents a way to postpone the recognition (taxation) of gain by allowing for a basis reduction in the new property, equal to the amount of the postponed gain. There are several rules and restrictions that must be strictly adhered to, in order for a successful exchange to take place. For more information refer to Publication 544, Sales and Other Disposition of Assets, and Form 8824, Like-Kind Exchanges.
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We sold a rental property last year and used the 1031 Tax Deferred Exchange law to defer the gain into another like-kind property. How do I report this transaction on my tax return?
Report the exchange of like-kind property on Form 8824, Like-Kind Exchanges. The instructions for the form explain how to report the details of the exchange. Report the exchange even though no gain or loss is recognized.
If you have any taxable gain, resulting from the transaction, because you had a partially deferred exchange or otherwise received money or unlike property, report it on Form 4797, Sale of Business Property, and Form 1040, Schedule D, Capital Gains and Losses. Refer to Publication 544, Sales and Other Dispositions of Assets, which has a detailed section on qualifying like-kind exchanges.
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Can we move into our rental property, live there as our main home for two years, and sell it without having to pay capital gains tax?
You may be able to exclude your gain from the sale of your main home that you have also used for business or to produce rental income if you meet the ownership and use tests, detailed in Publication 523, Sale of Your Home.
However, if you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. (Note: If you can show by adequate records or other evidence that the depreciation deduction allowed (did deduct) was less than the amount allowable (could have deducted), the amount you cannot exclude is the smaller of those two figures.)
The gain, exclusion, and depreciation recapture should be reported on Form 1040, Schedule D, Capital Gains and Losses, as described in Publication 523, Selling Your Home.
References:
I just sold a commercial rental property my wife and I had purchased thirty years ago (before she passed away) and I want to know how to figure my cost basis. Is it the full appraised value at the time of her death, or is it just half?
The answer depends on in which state you live in. Generally, the basis of property you inherit is its Fair Market Value (FMV) at the date of the decedent's death. If you inherit your spouse's interest in a property for jointly owned, and live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), then the basis for the entire property becomes the FMV at the date you spouse's death. This also assumes that at least half the value of the community propert interest is included in the deceased spouse's gross estate. In other states, the basis of the one-half that your spouse owned would be increaswd to one-half of the FMV of the property at the date of death. The basis in the one-half that you owned would remain at the one-half of the pre-death adjusted basis. The new adjusted basis is, naturally, subject to all future routine basis adjustments until the property is either sold or other disposed of.
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