In January, Eileen Johnson bought a condominium apartment to live in. Instead of selling the house she had been living in, she decided to change it to rental property. Eileen selected a tenant and started renting the house on February 1. Eileen charges $750 a month for rent and collects it herself. Eileen also received a $750 security deposit from her tenant. Because she plans to return it to her tenant at the end of the lease, she does not include it in her income. Her rental expenses for the year are as follows.
| ||Mortgage interest||$1,800|| |
| ||Fire insurance (1-year policy)||100|| |
| ||Miscellaneous repairs (after renting)||297|| |
| ||Real estate taxes imposed and paid||1,200|| |
Eileen must divide the real estate taxes, mortgage interest, and fire insurance between the personal use of the property and the rental use of the property. She can deduct eleven-twelfths of these expenses as rental expenses. She can include the balance of the allowable taxes and mortgage interest on Schedule A if she itemizes. She cannot deduct the balance of the fire insurance because it is a personal expense.
Eileen bought this house in 1984 for $35,000. Her property tax was based on assessed values of $10,000 for the land and $25,000 for the house. Before changing it to rental property, Eileen added several improvements to the house. She figures her adjusted basis as follows:
| || Improvements || Cost || |
| ||House||$25,000|| |
| ||Remodeled kitchen||4,200|| |
| ||Recreation room||5,800|| |
| ||New roof||1,600|| |
| ||Patio and deck|| 2,400 || |
| || Adjusted basis || $39,000 || |
On February 1, when Eileen changed her house to rental property, the property had a fair market value of $152,000. Of this amount, $35,000 was for the land and $117,000 was for the house.
Because Eileen's adjusted basis is less than the fair market value on the date of the change, Eileen uses $39,000 as her basis for depreciation.
As specified for residential rental property, Eileen must use the straight line method of depreciation over the GDS or ADS recovery period. She chooses the GDS recovery period of 27.5 years.
She uses Table 2-2d to find her depreciation percentage. Since she placed the property in service in February, the percentage is 3.182%.
On April 1, Eileen bought a new dishwasher for the rental property at a cost of $425. The dishwasher is personal property used in a rental real estate activity, which has a 5-year recovery period. She uses Table 2-2a to find the percentage for Year 1 under "Half-year convention" (20%) to figure her depreciation deduction.
On May 1, Eileen paid $4,000 to have a furnace installed in the house. The furnace is residential rental property. Because she placed the property in service in May, the percentage from Table 2-2d is 2.273%.
Eileen figures her net rental income or loss for the house as follows:
|Total rental income received |
($750 × 11)
|Minus: Expenses|| || |
| Mortgage interest ($1,800 × 11/12)||$1,650|| |
| Fire insurance ($100 × 11/12)||92|| |
| Miscellaneous repairs||297|| |
| Real estate taxes ($1,200 × 11/12)|| 1,100 || |
| Total expenses|| 3,139 |
|Minus: Depreciation|| || |
| House ($39,000 × .03182)||$1,241|| |
| Dishwasher ($425 × .20)||85|| |
| Furnace ($4,000 × .02273)|| 91 || |
| Total depreciation|| 1,417 |
| Net rental income for house || || $3,694 |
| || || |
Eileen uses Schedule E, Part I, to report her rental income and expenses. She enters her income, expenses, and depreciation for the house in the column for Property A. Since all property was placed in service this year, Eileen must use Form 4562 to figure the depreciation. Eileen's Schedule E and Form 4562 are shown next. See the Instructions for Form 4562 for more information on preparing the form.