Property Converted to Rental

[Terry D EA]

Have a client who owns a second home with a 16 x 30 out building. The out building has been modified as an apartment and is now for rent. Here are my questions:

1. The outbuilding cost was included in the total cost of the home, lot and outbuilding. My client has no idea what the building would have cost. What is the easiest way to determine the cost basis?

2. Renovations or upgrades cost 8k. The builiding is now rented as of Feb 1, 2011, all expenses incurred were in 2010. Are they expensed, or should they fall under depreciation and be depreciated appropriately?

3. What affect does all of this have on the re-sale of the original home as they do have it listed.

Thanks

[Margaret CPA in OH]

You might try to see a property tax bill whether it is taxed separately. Most that I see at least have the land value listed separately. Also on our county website improvements are listed and valued when they occur even if prior to the current ownership. It is not too hard to make a rational decision as to relative values. Perhaps the outbuilding was added later. Did the buyers pay extra for the property because of this building? What about comparable sales for homes in the area that do not have such a building? And don't forget the depreciation would be lower of fmv or purchase.

Renovations and upgrades would be depreciated as of the date of availability depending on whether remodeling or appliances, etc. Look at the class.

The resale issue may be trickier but I would think it would be treated as a recapture of depreciation. The problem I see is that, as an outbuilding, it was not part of the principal residence. Hmmm, have to ponder that one. At least it will be a 2011 issue. Just be sure to collect all data possible in the interim.

[Achmid]

the absolute answer is common sense, intelligence, and knowledge of your work!

[ed_accountant]

Have your client give you an estimate of what the fmv of the out building was at the time of purchase. Depreciate the estimated value subracted from cost of cost basis of entire home.

Also depreciate any renovations related to the apartment as improvements.

The portion allocated to the out-building would be treated as a rental property if sold in the future. Recapture of depreciation in the future if sold.

[Terry D EA]

This was exactly my position on this and I do appreciate you backing me up here. Now getting the client to estimate the outbuilding might be a little difficult. However, would it be unethical for me to estimate the possible cost based on my knowledge of what a 16 x 30 building would cost?

[Julie]

I don't see any issue with that, if your knowledge is reasonably current and local. Keep a note of your calculations so you can make the correct basis adjustments, just in case they rent out their house in the future.

Another possible method: Since the space is fitted out as an an apartment, its value per square foot is comparable to the house. So you could take the total structure value off the property tax bill and take the apartment portion.