Tax Guru – Ker$tetter Letter

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Depreciating converted property

Posted by taxguru on January 5, 2008

Q:

Subject: Depreciation Question

Hi Guru, Have been reading you for a long time but never have seen a question like this.  From 1999 to 2006, I ran a B&B and depreciated the business portion of my property as a commercial business.  On Jan 1, 2007, I converted this property to a single family rental.  Do I use the residential depreciation schedule this year?  Also, would I continue to use the old basis or create a new basis when the property was converted.  The property has appreciated almost double in value from 1999 to 2006.

 

Thanks for your advice and hopefully this might be helpful to some other loyal readers

Thanks

 

A:

If you have been reading my stuff for any length of time, you should know that you need to be working directly with a professional tax advisor to ensure that you do things properly.

This is a perfect example of a very common way in which people accidentally commit tax fraud; by setting up assets converted from personal to business use at a much higher cost basis than is appropriate.  The tax law is very specific in the fact that converted assets are to be set up at the lower of their original cost or their current fair market value as of the date of conversion.  Under no circumstances could you increase the depreciable value above what your actual cost was.  To do so would essentially be giving you tax deductions on values to which you are not entitled.

That is the case for assets converted from purely personal usage to a new business usage.  In your case, you were already using the property in a business, so you have no justification whatsoever for modifying the cost basis for depreciation purposes in its new use.  You need to keep track of the original cost, along with the deprecation you had already claimed. 

If you were depreciating the structure over the 39 years required for nonresidential real estate, you can change the appropriate life to the 27.5 years used for residential rental property as of the date of the new use.  Again, you should have an experienced professional tax preparer do those calculations for you.

I hope this isn’t too confusing and properly stresses how dangerous it is for you to continue to try to negotiate the  treacherous tax waters on your own.

Good luck.

Kerry Kerstetter


Follow-Up:

Thanks!! I appreciate your swift reply

 

 

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