Apartment Building Changed to Mixed Use

[Patrick Michael]

Client owns a building with apartments.  Building was being depreciated over 27.5 years.  In 2020 they converted the first floor apartments into a restaurant and the second floor remained apartments.,  I'm at a lost how to handle the depreciation.  Should I take the original building out of service and set up two new assets, one residential and one business? I How should the prior deprecation be handled?

Thanks.

[BulldogTom]

I don't think you can split the building.   I think there is an 80% test on gross revenue that determines the depreciable character of the building.   If 80% of the gross revenue is not from the apartments, the property is 39 yr commercial.   I think you would have had to segregate it in the year placed in service to get the 2 parts separated and I think that horse has left the barn.  

Not for sure how you calc the depreciation, but I think you just change it to 39 yr property, accumulated stays the same, and the date placed in service stays the same.   You just take the smaller amount in the year of change.

Not researched, please don't rely on just this.   But take a look at §168 code and regulations.   I am sure they will outline how to do this.  It has to have happened before and they would have written rules about it.   I would start with the Master Tax Guide and work from there.

Tom
Modesto, CA

[Lee B]

"Because the gross rental income test is “for the taxable year”, the 80% test needs to be calculated annually. The difference in depreciation rates for residential rental property vs. nonresidential real property can be considerable.

If a change in use results in a shorter recovery period and/or a depreciation method that is more accelerated than the method used before the change in use, the taxpayer has two options:

The taxpayer can compute the depreciation allowance using the shorter and/or more accelerated depreciation method in the year the change in use occurred, or

The taxpayer may elect to continue determining the depreciation allowance as though the change in use had not occurred.

These options provide a planning opportunity to suit a taxpayer’s need for larger or smaller depreciation deductions. For example, a taxpayer with excess net operating loss carryovers might not be able to use the maximum depreciation deductions permitted and may want to use the longer, less accelerated depreciation method.

On the other hand, if a change in use results in a longer recovery period and/or less accelerated depreciation method than before the change in use, the taxpayer must compute the depreciation allowance using the longer and/or less accelerated depreciation method in the year the change in use occurred.

A change in computing the depreciation allowance in the year of change for property subject to Regs. Sec. 1.168(i)-4 is not a change in method of accounting under Sec. 446(e). A taxpayer needs only to complete Form 4562, Depreciation and Amortization, in the year of change. However, the regulations under Secs. 446(e) and 481 apply if the taxpayer does not account for the depreciation allowance in the manner set forth by Regs. Sec. 1.168(i)-4 or revokes the election to disregard the change in use. If Secs. 446(e) and 481 do apply, the taxpayer should file a Form 3115, Application for Change in Account Method, to request an automatic change.

Property affected by the change-in-use regulations is not eligible for bonus depreciation deductions in the year of change, Sec. 179 depreciation (which allows you to expense certain depreciable business assets and is generally not applicable to residential and nonresidential property), or Sec. 1400L (tax benefits for New York Liberty Zone property). Additionally, for purposes of determining whether the mid-quarter convention applies to other MACRS property placed in service during the year, the change-in-use property is not taken into account."

[Patrick Michael]

The apartments do not produce 80% so 39 years it is!  Here's a link to an article I found late last night that discusses the issue https://www.thetaxadviser.com/issues/2012/oct/clinic-story-03.html.

Thanks for educating me. This community is the best!