Converting rental property to personal residence and back to rental property.

Forum|Forum|3 years ago
July 8, 2023
2 replies
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Client/single tax payer purchased a home in Nevada while a resident of California in 2001. Client rented the home from 2001 to 2011 and no longer has any of the tax returns from those years. Next client moved to Nevada and out of CA into the Nevada rental home, converting it to her personal residence from 2011 to 2021. Client did not make enough income to warrant filing tax returns during those years. Finally, client made substantial improvements to the property during 2022 in anticipation of renting it again (client inherited money and paid off a 2019 reverse mortgage on this property in 2022 as well) and found a tenant in February of 2023. Here's what I'm thinking... 1. When I start up depreciation again, I will include the improvements made to increase the basis for depreciation. 2. I will show the prior depreciation taken on the property from 2001 to 2011 (I know original purchase price and how long the property was a rental) . I will start the 27.5 yr clock on depreciation for the 2022 improvements and continue the depreciation on the original cost basis (17.5 years left). My understanding is that to the extent the reverse mortgage was used to improve the property, I can deduct the interest proportionally (not exceeding the $750K maximum). Am I thinking about all of this correctly? Am I forgetting anything? There is no intent to sell the property at the moment. Thanks in advance for any assistance.

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BobKamman

Level 15

Well, that's certainly not from a take-home final exam. If the client has not been filing tax returns, are interest deductions even needed? I wouldn't worry too much about the reverse payoff. Were the 2001-2011 returns self-prepared, or is there a paid preparer who might still have copies. (I could come up with a pdf for most of my clients back then.)

R

RESIPSA123Author

Level 3

Bob- Thanks for your reply. The reason for the concern over the reverse mortgage interest is that she inherited a substantial sum of money in 2022 and about 100K of it is taxable. So, I'm looking to offset her tax liability with allowable deductions. Since I know her original purchase price, the percentage of land to improvement of the rental property, the precise date it was first rented and the last day it was rented, with no other improvements during that period, I can figure out pretty closely what the prior depreciation must have been. Certainly I feel comfortable that it's a reasonable number and fair to the gov't and to the client.

During the time it was a rental, there was a CPA handling her returns. He is no longer in business. No forwarding address or number. Thanks, again...

qbteachmt

Level 15

This seems contradictory and/or unlikely: "made substantial improvements to the property during 2022 in anticipation of renting it again (client inherited money and paid off a 2019 reverse mortgage on this property in 2022 as well)"

"The reason for the concern over the reverse mortgage interest is that she inherited a substantial sum of money in 2022 and about 100K of it is taxable."

But you are implying a reverse mortgage was used, similar to real mortgage or HELOC, to improve the property. That narrative and timeline imply otherwise. You don't take out a reverse mortgage in 2019 to improve a property when you didn't inherit money to be able to take any of these actions until 2022.

You seem to be relating two things that are not related, and I like to use the word "discoverable" as in, anyone, including the IRS, can look at the date of the events and the disbursement of the reverse mortgage to see, oh, for instance, did your client live in those payouts in that time period in Nevada where there seemed to be no reason to file income taxes?

Make sure the story makes sense.

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T

TaxGuyBill

Level 15

You don't pick up where you left off for depreciation. You restart the 27.5 years anew, using the lower of (a) Adjusted Basis or (b) FMV on conversion to a rental.

The Adjusted Basis is likely (1) original purchase price (including certain closing costs), minus (2) depreciation allowed/allowable, plus (3) cost of improvements.

Make a note of the prior depreciation allowed/allowable for whenever the property is sold, because that will be factored into things.