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Rental Taken out of Service To Sell

Technical topics regarding tax preparation.
#1
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Client took rental out of service in May 2015 to do some upgrades and then sell. The property did not sell until late 2016 due to a bad market. I just want to make sure that I am reporting the Rental correctly in 2015. Here is what I think I should be doing.

Stop depreciating the property as of date out of service.
Allocate R/E taxes between in service and out of service periods and put out of service on Schedule A.
Allocate Mort Int between in service and out of service periods and put out of service on Schedule A (Investment Interest, Not Home Mortgage Interest)
All other rental deductions deduct for in service period and then ignore for out of service period.

Is that right?
 

#2
WEISSEA  
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"Is that right?"
Yes, Pub 527: Vacant while listed for sale.   If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold. If the property is not held out and available for rent while listed for sale, the expenses are not deductible rental expenses.
 

#3
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If the nature of the "upgrades" is more like a renovation or some big kinda project, you may find that some of the expenses during the upgrade may be able to be capitalized into the tax cost of the upgraded stuff. I forget where it is, but it's IRS's regulations somewhere that "requires" this. Not really sure what the requirements are, but if you find the section on "capitalized repairs" maybe that's where it can be found. Or maybe it's the section on "period of reconstruction."
 

#4
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Thanks. the upgrades were major improvements (bathroom renovation and new flooring) so I will just add those to basis in the sale calculation.
 

#5
Coddington  
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Y'know, Harry, the one thing that has always bothered me about this issue is whether the rental is in a trade or business. If it is, then the treatment is different from the above and it wouldn't stop depreciating, etc. But if it is merely held for the production of income, then stuff happens under 212.
-Brian
Tax accounting methods and credits consultant for hire.

http://www.coddingtontax.com
 

#6
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Section 167 seems not to discriminate between "used in the trade or business" and "held for production of income":

"IRC § 167(a):
General rule
There shall be allowed as a depreciation deduction 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."


If you happen to stumble on a definition of "trade or business" please let us know... 8-) 8-) 8-)
 

#7
Coddington  
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That's one of those weird things. Section 167 doesn't discriminate and the case law makes very clear that an asset used in a trade or business keeps depreciating until disposed of or converted to personal use. Why the same rule doesn't apply to rentals held solely for the production of income I do not know.
-Brian
Tax accounting methods and credits consultant for hire.

http://www.coddingtontax.com
 

#8
Noobie  
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If they are looking to make a gain on the sale, who cares about the depreciation?
 

#9
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What about 1231 gain vs dealer? I would want to make sure that the propery was still a rental asset to preserve 1231 gain. The extent and nature of the renovations along with sales effort could taint this to be dealer property. You see something similar to this argument in the condo conversion world.
 

#10
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Noobie wrote:If they are looking to make a gain on the sale, who cares about the depreciation?


Depreciation = deduction against ordinary income

Gain on sale = Likely LTCG

Seems like something to care about to me.
~Captcook
 

#11
Chay  
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Coddington wrote:Y'know, Harry, the one thing that has always bothered me about this issue is whether the rental is in a trade or business. If it is, then the treatment is different from the above and it wouldn't stop depreciating, etc. But if it is merely held for the production of income, then stuff happens under 212.

Let's say the rental is a trade or business that consists entirely of holding out a single property for rent. If you take that property off of the market with the intention to sell it, and then follow through, doesn't that mean the trade or business was over at the time the property was taken off the market? And doesn't that mean there is no longer a case for any further business deductions, since there is no longer any income expected?
 

#12
Chay  
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In trying to answer my own question, I've located Lenington v. Commissioner (T.C. Memo. 1966-264). In this case, the court answered the question "[c]an petitioners deduct depreciation on poultry buildings after they ceased operating their poultry business but while the buildings were for sale?" in the affirmative. The court reasoned as follows:

    Since the poultry buildings were not abandoned or converted to personal use prior to 1962, but were involved in a discontinuance of the active conduct of the poultry business, their previously established character as business property was not changed.
Can we conclude from the court's opinion that an effort to sell the assets formerly used in a business is a continuation of the business activity itself? Is this true even if the taxpayer has no intention to resume operations in the event that the sale is unsuccessful? What about the expenses of maintaining the business assets held for sale?
 


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