If I Take Rental Property Out Of Service, Do I Stop Depreciating It?
Technical topics regarding tax preparation.
31-Aug-2016 10:45am
swgordon 
Client took rental out of service in May 2015 to do some upgrades and and then sell. The holding did not sell until tardily 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 recall I should exist doing.
Terminate depreciating the belongings 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 Involvement, Not Home Mortgage Interest)
All other rental deductions deduct for in service period and then ignore for out of service menstruation.
Is that right?
31-Aug-2016 10:57am
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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 bachelor for rent while listed for sale, the expenses are not deductible rental expenses.
31-Aug-2016 11:00am
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If the nature of the "upgrades" is more than similar a renovation or some big kinda project, you may notice 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 information technology is, simply it'south IRS's regulations somewhere that "requires" this. Non actually certain what the requirements are, but if you notice the section on "capitalized repairs" mayhap that'south where information technology tin can be constitute. Or perchance it's the section on "catamenia of reconstruction."
31-Aug-2016 1:45pm
swgordon
Thanks. the upgrades were major improvements (bathroom renovation and new flooring) and then I volition but add those to basis in the auction adding.
1-Sep-2016 11:51am
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Y'know, Harry, the one matter that has e'er bothered me virtually this upshot is whether the rental is in a trade or business. If it is, then the handling is different from the above and it wouldn't end depreciating, etc. Simply if it is merely held for the production of income, so stuff happens under 212.
-Brian
Director of Tax Accounting Methods & Credits
SourceAdvisors.com
Opinions my own.
1-Sep-2016 12:18pm
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Section 167 seems not to discriminate between "used in the trade or business concern" and "held for product of income":
"IRC § 167(a):
General rule
There shall exist allowed equally a depreciation deduction a reasonable allowance for the exhaustion, wearable and tear (including a reasonable allowance for obsolescence)—
(1) of belongings used in the trade or business, or
If you happen to stumble on a definition of "trade or business organisation" please let us know... 
1-Sep-2016 2:30pm
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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 concern keeps depreciating until disposed of or converted to personal utilize. Why the aforementioned dominion doesn't utilize to rentals held solely for the production of income I do not know.
-Brian
Manager of Tax Accounting Methods & Credits
SourceAdvisors.com
Opinions my own.
6-Sep-2016 7:05am
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If they are looking to make a gain on the sale, who cares virtually the depreciation?
six-Sep-2016 eleven:03am
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What about 1231 proceeds vs dealer? I would want to make sure that the propery was still a rental nugget to preserve 1231 gain. The extent and nature of the renovations along with sales endeavor could taint this to exist dealer property. You see something similar to this statement in the condo conversion globe.
6-Sep-2016 11:51am
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Noobie wrote:If they are looking to make a gain on the sale, who cares almost the depreciation?
Depreciation = deduction against ordinary income
Gain on sale = Likely LTCG
Seems similar something to care most to me.
~Captcook
12-Jun-2019 seven:21pm
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Coddington wrote:Y'know, Harry, the one thing that has always bothered me almost this issue is whether the rental is in a merchandise 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.
Allow'due south say the rental is a trade or business that consists entirely of holding out a single belongings for rent. If yous take that belongings off of the market place with the intention to sell information technology, and so follow through, doesn't that mean the trade or business concern was over at the fourth dimension the holding 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-Jun-2019 viii:43pm
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In trying to reply 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 organisation but while the buildings were for auction?" in the affirmative. The court reasoned as follows:
- Since the poultry buildings were not abandoned or converted to personal utilize prior to 1962, but were involved in a discontinuance of the agile conduct of the poultry business, their previously established graphic symbol as business property was not changed.
Can we conclude from the court'southward opinion that an effort to sell the assets formerly used in a business is a continuation of the business activity itself? Is this true fifty-fifty if the taxpayer has no intention to resume operations in the event that the sale is unsuccessful? What virtually the expenses of maintaining the business avails held for sale?
21-Aug-2019 eleven:58pm
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It is surprising that the guidance for such a common state of affairs is not more clear.
I take a client who took a rental out of service that likely will non be treated as a trade or business organisation and then subsequently sold it. As Chay and Brian Coddington have pointed out, there is potency for standing to depreciate property used in a merchandise or business and Brian added the following ascertainment above:
Coddington wrote:That's one of those weird things. Department 167 doesn't discriminate and the example law makes very clear that an nugget used in a merchandise or business keeps depreciating until disposed of or converted to personal use. Why the aforementioned dominion doesn't use to rentals held solely for the production of income I exercise not know.
It looks to me like the difference betwixt a merchandise or business organisation deduction for depreciation and a deduction for depreciation or other expenses related to rental property that is non a trade or business organisation is that the erstwhile is allowed as a deduction past IRC 62(a)(ane), only the latter must pass through IRC 62(a)(4).
IRC Section 62(a)(4) allows the following:
The deductions immune by part Vi (Sec. 161 and following), by department 212 (relating to expenses for production of income), and by department 611 (relating to depletion) which are attributable to holding held for the production of rents or royalties.
Although Department 167 does non discriminate between belongings held in a merchandise or business or held for the production of income, Section 62(a)(4) in a higher place attaches the additional condition that the deduction must exist "owing to property held of the product of rents or royalties" in guild for the Section 212 amount to be deductible against AGI.
One could debate that property that was at whatsoever time in the by "held for the production of rents or royalties" would autumn nether a literal reading of this section, and therefore the deduction of costs afterward the property is taken of the rental marketplace and listed for sale should exist allowed, merely the legislative history construes the meaning of this department narrowly:
The deductions described in clause (ane) to a higher place are limited to those which fall within the category of expenses directly incurred in the conveying on of a trade or business. The connection contemplated by the statute is a direct one rather than a remote 1. for example, property taxes paid or incurred on existent belongings used in the trade or business volition be deductible, whereas state income taxes, incurred on concern profits, would conspicuously not be deductible for the purpose of computing adapted gross income. Similarly, with respect to the deductions described in clause (4), the term "attributable" shall be taken in its restricted sense; only such deductions every bit are, in the bookkeeping sense, deemed to exist expenses directly incurred in the rental of property or in the product of royalties . *** (Due south. REPT. 885, 1944 C.B. AT 877-878)
This linguistic communication was relied upon by the court in applying this section in the Strange case which dealt with whether an income tax levied upon royalty income was deductible under IRC 62(a)(4), as follows:
The language and structure of section 62(a) reveal Congress's intent that state income taxes levied on net royalty income (gross royalty minus production taxes, overhead, operating expenses, and depletion) are not deductible higher up-the-line. Such income taxes are not expenses incurred in the production of the royalty. See Accountants' Cost Handbook, 1.9 (James Bulloch et al. eds., 3d ed. 1983) (defining expenses as "expired costs ...used to produce revenue"). Above-the-line deductions must be attributable to "property held for the production of ...royalties" — non owing to the royalties derived therefrom. I.R.C. department 62(a)(four) (accent added). The linguistic communication and sentence structure evidently separate the "holding" from the derived "royalties."
Then if the costs deductible under 62(a)(4) for a rental that is not a trade or business must be "expired costs ...used to produce revenue," and must be "expenses direct incurred in the rental of holding or in the production of royalties," then information technology seems that a more stringent standard may exist for these costs than for merchandise or business costs and that the IRS position in Publication 527 quoted higher up may accept some weight.
This is non the conclusion I wanted to come to, so hopefully someone will exist able to point out a flaw in this assay.
22-Aug-2019 six:29am
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TrueTax, I agree with your conclusion. I'd also like to add is that although your client tin't do good from any depreciation, the house isn't actually retired from service for depreciation services. If we yet had 2% miscellaneous deductions, that'south where the depreciation would show upward forth with whatever "expired costs used to produce revenue". Because nosotros don't, the depreciation attributable to the time later which the house is no longer "property held for the production of rents" is disallowed. I would take the depreciation expense for a total year and prorate it by the number of days in the yr that the belongings was held for rents to get the depreciation expense for that year.
When Congress decided to allow deductions above the line for rents, royalties, and capital letter losses, they were trying to make the various types of income "every bit nearly equivalent as practicable" to other types of income, such as interest and dividends, for the purpose of "equitable awarding of a mechanical taxation table or a standard deduction" (S. Rept. 885, 1944). Expenses for the maintenance of tangible property employed in a productive apply are to be expected; not so with intangible property similar stocks and bonds. I retrieve this is the reason why Congress would view the expenses incurred when the property is no longer held for hire in the aforementioned light equally portfolio management expenses.
22-Aug-2019 7:56am
dave829
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Chay wrote:Can nosotros conclude from the courtroom'southward stance that an effort to sell the assets formerly used in a business is a continuation of the business activeness itself? Is this true even if the taxpayer has no intention to resume operations in the event that the auction is unsuccessful? What about the expenses of maintaining the business assets held for sale?
You might want to look at Carter-Colton Cigar Co., 9 T.C. 219 (1947).
If I Take Rental Property Out Of Service, Do I Stop Depreciating It?,
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