Converting rental property to personal residence and back to rental property.

[RESIPSA123]

Client/single tax payer purchased a home in Nevada while a resident of California in 2001.  Client rented the home from 2001 to 2011 and no longer has any of the tax returns from those years.  Next client moved to Nevada and out of CA into the Nevada rental home, converting it to her personal residence from 2011 to 2021.  Client did not make enough income to warrant filing tax returns during those years.  Finally, client made substantial improvements to the property during 2022 in anticipation of renting it again (client inherited money and paid off a 2019 reverse mortgage on this property in 2022 as well) and found a tenant in February of 2023.  Here's what I'm thinking... 1. When I start up depreciation again, I will include the improvements made to increase the basis for depreciation.  2. I will show the prior depreciation taken on the property from 2001 to 2011 (I know original purchase price and how long the property was a rental) .  I will start the 27.5 yr clock on depreciation for the 2022 improvements and continue the depreciation on the original cost basis (17.5 years left).  My understanding is that to the extent the reverse mortgage was used to improve the property, I can deduct the interest proportionally (not exceeding the $750K maximum).   Am I thinking about all of this correctly?  Am I forgetting anything?  There is no intent to sell the property at the moment.   Thanks in advance for any assistance.

[BobKamman]

Well, that's certainly not from a take-home final exam.  If the client has not been filing tax returns, are interest deductions even needed?  I wouldn't worry too much about the reverse payoff.  Were the 2001-2011 returns self-prepared, or is there a paid preparer who might still have copies.  (I could come up with a pdf for most of my clients back then.)  

[TaxGuyBill]

You don't pick up where you left off for depreciation.  You restart the 27.5 years anew, using the lower of (a) Adjusted Basis or (b) FMV on conversion to a rental. 

The Adjusted Basis is likely (1) original purchase price (including certain closing costs), minus (2) depreciation allowed/allowable, plus (3) cost of improvements.

Make a note of the prior depreciation allowed/allowable for whenever the property is sold, because that will be factored into things.

[RESIPSA123]

Bob-  Thanks for your reply.  The reason for the concern over the reverse mortgage interest is that she inherited a substantial sum of money in 2022 and about 100K of it is taxable.  So, I'm looking to offset her tax liability with allowable deductions.  Since I know her original purchase price, the percentage of land to improvement of the rental property, the precise date it was first rented and the last day it was rented, with no other improvements during that period, I can figure out pretty closely what the prior depreciation must have been.  Certainly I feel comfortable that it's a reasonable number and fair to the gov't and to the client.  

During the time it was a rental, there was a CPA handling her returns.  He is no longer in business.  No forwarding address or number.   Thanks, again...

[RESIPSA123]

Bill-  Thanks for this response.  Very helpful.  

[BobKamman]

I would say that you pick up where you left off on the original depreciation calculation started in 2001, except in the rare case where the FMV in 2023 is less than what it was in 2001.  (That just didn't happen in Las Vegas real estate market.)  That calculation runs only another 17.5 years and should be kept separate from the improvements from 2012 through 2022, which can run 27.5 years.  In other words, you'll be tracking two assets, not just one with combined amounts.  But maybe there is a special rule for property that goes from business to personal and back to business.  If so, where did you find it?

[qbteachmt]

This seems contradictory and/or unlikely: "made substantial improvements to the property during 2022 in anticipation of renting it again (client inherited money and paid off a 2019 reverse mortgage on this property in 2022 as well)"

"The reason for the concern over the reverse mortgage interest is that she inherited a substantial sum of money in 2022 and about 100K of it is taxable."

But you are implying a reverse mortgage was used, similar to real mortgage or HELOC, to improve the property. That narrative and timeline imply otherwise. You don't take out a reverse mortgage in 2019 to improve a property when you didn't inherit money to be able to take any of these actions until 2022.

You seem to be relating two things that are not related, and I like to use the word "discoverable" as in, anyone, including the IRS, can look at the date of the events and the disbursement of the reverse mortgage to see, oh, for instance, did your client live in those payouts in that time period in Nevada where there seemed to be no reason to file income taxes?

Make sure the story makes sense.

[RESIPSA123]

Contradictory?   I do things by the book, which is why I’m asking for opinions on whether to restart the depreciation from 2011 or start anew.  I’ve never encountered a rental property converted to a personal residence, converted back to a rental property.  The reverse mortgage is typically only deductible when the funds were applied to the betterment of the property and definitely not deductible if used as funds to live on.  I get that.  Some of the reverse money was spent on the 2022 improvements..  but I do not think deducting the interest or any portion of it is worth the trouble.  So, at this point, looks like I will restart the 2011 depreciation with 17.5 years remaining and separately account for improvements made during the personal residency years.  Thank you all!  

[BobKamman]

If your home needs a new roof or air conditioner and you don't anticipate inheriting enough to pay for it when someone dies in three years, how in H are you going to stay in it without a reverse mortgage?

[qbteachmt]

If you don't have enough income to need to file an income tax return (considering this time frame included years of stimulus moneys as well as refundable credits) and unless you anticipate someone dying any day now, over those three years, how likely is it a person takes a reverse mortgage to live on? Because if it was only for improvements, a HELOC avoids the fees incurred when using reverse mortgage. But reverse mortgage is a tactic for covering living expenses. I'm just pointing out that the story as presented doesn't meet the strategy being proposed.

[BobKamman]

@RESIPSA123  "The reverse mortgage is typically only deductible when the funds were applied to the betterment of the property and definitely not deductible if used as funds to live on."

Was there an existing mortgage on the home, that was refinanced with the reverse mortgage?  Would the interest on that part be grandfathered?  Were the "improvements" needed for the property to even qualify for the reverse mortgage?  

I'm amazed that this client's decisions in 2019 are being questioned three years later.  Sometimes a HELOC is a better idea, and sometimes it is not.  Rather than meandering off on that tangent, check out Matthew 7:1-2

[qbteachmt]

Bob, I don't see where someone questioned the client's decisions?

I described that the timeline doesn't match the scenario. The 2019 reverse mortgage doesn't jibe with 2022 improvements.

[TaxGuyBill]

---

@BobKamman wrote:

But maybe there is a special rule for property that goes from business to personal and back to business.  If so, where did you find it?

---

§1.168i-4(c) says conversion to personal use is treated as a disposition for depreciation purposes (but no gain or loss is reported).

So if it was treated as disposed for depreciation purposes, then placing it in service again would start everything anew.

[BobKamman]

@qbteachmt The word you want is jibe, not jive.  The facts you need about reverse mortgages are as follows.  She may have known in early 2022 that the inheritance was coming later in the year, and used her line of credit to get the improvements started sooner.  Or she may have made some of the improvements in 2019 -- none of the facts posted suggest otherwise.

"In 2023, the reverse mortgage line of credit continues to be the most popular option for homeowners to access their funds.  According to an article by AARP, borrowers recognized this choice about 66% of the time when obtaining a reverse mortgage as being the right choice for them.

The credit line option allows borrowers a great deal of freedom when planning their finances.  Homeowners like the fact that they can take as much as they want when the loan originally closes up to the maximum allowed by HUD in the first 12 months and then can take the funds as needed from there."

https://reverse.mortgage/line-of-credit 

[BobKamman]

@TaxGuyBill   I don't read that as saying that the depreciation starts with a new useful life, but I don't read it as saying otherwise, either.  And it's an important issue for people in a situation with which I'm familiar.  State Department employees often serve one assignment in Washington DC, then one or two assignments at a foreign post.  To avoid being priced out of the DC real estate market, they keep their home there and rent it out while away.  Using your method, the annual depreciation of the original cost would be less every time they converted it back to rental use.  I don't think that's what most people do, but maybe they should.  

[qbteachmt]

"The word you want is jibe, not jive."

Thanks; edited my reply. That's what you get from someone married to a jazz musician...Jive on the mind.

"The facts you need"

We were told the reverse mortgage was from 2019.

[BobKamman]

Not to belabor the point, but a reverse mortgage in 2019 could allow for draws up to and including 2022.  In that way, it's much like the HELOC that you accuse the indigent taxpayer of not choosing instead.  And not to keep repeating myself, but it could have been used in 2019 for improvements also.  Nothing posted indicates that is not the case.  

Don't get hurt jumping to conclusions.  

[qbteachmt]

Geez, Bob. You are doing a lot of overreaching. I've never understood where you bring your assumptions from. I never accused anyone of anything. I also didn't consider the person might be indigent; that's a bit rude, don't you think? I pointed out that if they didn't file taxes in the years as described, they might have missed out on money they were entitled to, and the reason to take out a reverse mortgage is not typically to make improvements. I was reading between the lines to figure out if the timeframe matches the tax strategy proposed. There is nothing wrong with taking a second look at something. I would never demean the taxpayer like you did.

"Not to belabor the point"

Well, you've pretty much hammered it into the ground. The point is gone.