Rental out of service for renovation

[appelman]

A client who is a building contractor also owns a duplex. He has been living in one half and renting the other. Now he has had the rental out of service for over three years while he renovates the entire building into a triplex. How would you treat the rental unit during this period? My inclination would be to consider it a conversion to personal use, followed by a reconversion once it is again available for rental. Capital improvements would be allocated to the rental for depreciation as appropriate once rental service is resumed. Anyone have a different idea?

[taxea]

I would take the rental out of service when the renter moved out. when the restoration is done it and the third unit become rentals again and an adjustment is made on the original rental unit for prior depreciation taken. Unfortunately for the TP no expenses other than mortgage interest and property tax can be taken on Sch A

[Kram BergGold]

Disagree

The part of the building that will eventually be rental, I would continue to treat as rental. It has not been converted to personal use. The part of the building that was rental but will be personal I would treat as personal, as that is what the intent is.
The rules for dealing with a depreciable asset on which depreciation has started are different than the rules for an asset that has not been placed into service.

[mactoolsix]

As Kram Said

The part of the building that will eventually be rental, I would continue to treat as rental. It has not been converted to personal use. The part of the building that was rental but will be personal I would treat as personal, as that is what the intent is.
The rules for dealing with a depreciable asset on which depreciation has started are different than the rules for an asset that has not been placed into service.

From Pub 527: http://www.irs.gov/publications/p527...link1000219035

Idle Property

Continue to claim a deduction for depreciation on property used in your rental activity even if it is temporarily idle (not in use). For example, if you must make repairs after a tenant moves out, you still depreciate the rental property during the time it is not available for rent.

Mike

[taxea]

Mike thanks for the site...I will read it to see whether there is any time limitation placed on it.

[taxea]

Mike..me too...I was not aware that it could be handled this way indefinitely.

[DexEA]

Mike..me too...I was not aware that it could be handled this way indefinitely.

Agree with Kram and Mike, however, I wouldn't agree that temporarily idle equates to indefinitely.

[appelman]

A judgment call.

Three years and counting stretches the credible limits of "temporary."

[mactoolsix]

General Counsel Memorandum

Three years and counting stretches the credible limits of "temporary."

http://www.novoco.com/energy/resource_files/irs_guidance/gcm/gcm_37449.pdf

There are several cases quoted where business property sat "idle" for several years - sometimes 20 years. See Part I on page 2.

Also
Section 23 of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code, § 23, lists the allowable deductions from gross income and includes depreciation in the following terms:

"§ 23(l) Depreciation. A reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) —

"(1) of property used in the trade or business, or

"(2) of property held for the production of income."

I would argue that the property, even though out of service for renovation, is being held for the ultimate production of income.

Mike

[appelman]

Interesting, but perhaps not exactly comparable

The GCM discusses the case of an asset whose use in a business is suspended. In our case, it is the whole business that is suspended, and we are asking whether there should be a Schedule E filed at all. However, I have been thinking about another wrinkle. I perhaps didn't emphasize that this is a building contractor doing the remodel as his own project. So why not simply deduct the carrying costs of the rental half of the remodel (taxes, interest, insurance) on the client's Schedule C? But I'd still be inclined to suspend the depreciation.

[Bees Knees]

I actually had a client with a rental duplex that was idle for 2 years while repairs were being done. He lived in one unit and the other unit had always been rental. The previous renter damaged the property so bad, it took the owner over a year to fix, and then almost a year to find a new renter. The IRS auditor tried to throw out all deductions (utilities, insurance, and depreciation). I had to provide numerous citations to support the idea that rental property can sit idle for a period of time and still produce deductible losses without any income. The issue that won the IRS auditor over was the fact the owner proved he had advertised the property for rent upon immediate completion of the repair project, even though it took almost another year before finally finding a suitable renter.