Client inherited a rental property with existing tenant

[Just-Lisa-Now-]

The existing tenant paid rent for 4 months but then refused to vacate when given notice so that the property could be fixed up and sold.

They had to hire and attorney to evict the tenant and ended up giving the tenant $12,000 to get out.

The attorney fees and the tenant payout are expenses on Sch E, right?  Its just a huge amount of money for only having 4 months worth of rental income...in my head it makes sense, but when I see that huge loss on the Sch E, it makes me second guess it.

[TaxGuyBill]

Why was the tenant PAID to get out?  Was your client breaking an existing lease with the tenant?

[Just-Lisa-Now-]

Im not sure about the lease, like I said, he inherited it from an elderly sister that passed. 

Down in the SF Bay Area, I believe it was rent controlled, really low rent, but the house was a mess, hadn't been kept up, needed tons of work.

He just wanted to fix it up enough to sell it and move on, had to get an attorney involved and it probably ended up being quicker and cheaper to just pay her to leave than fight it in the courts.

Is there a situation that it wouldn't be a deductible expense?

[TaxGuyBill]

I'm not quite sure, but if the client was breaking the lease to sell, it seems weird to claim a rental expense that was incurred to STOP renting.  It seems like the opposite of a "rental expense".

*IF* that is the case, I would lean towards reporting it as a selling expense (or possibly part of the improvement expense) rather than a Schedule E expense.

But again, I'm not quite sure and that is just my first inclination.

[Just-Lisa-Now-]

That was my first thought too, expense of sale, but it happened when a tenant was still in the building, not when it was in the process of being sold.

Honestly, its not going to make a different taxwise one way or the other....maybe I'll take the attorney fees on Sch E and the tenant buyout as expense of sale, just so it doesn't look like such a big loss on Sch E.

[abctax55]

Sounds similar to "cash for keys" scenario; which I believe, is deductible on Sch E in the year paid.

I'm working at home today, without all my research materials so I'm going on memory ( usually a bad idea, LOL).

[BobKamman]

Does this even belong on Schedule E?  I don't see any business or profit motive.  If the FMV appraisal at date of death was $500K but that did not take into account a $12K de facto lien from the tenant, I think you start with basis of $488K and call the attorney fees a selling expense, reporting it all on Schedule D.  Rental income goes on Schedule 1, Line 8.  

You did send a 1099 to the tenant, right?

[Just-Lisa-Now-]

Im really glad I asked in here, because all these things that have been mentioned have been fighting around in my head!   LOL

It really doesn't matter which way I do it, there wont be any tax consequence, but I wanted it straight in my head...but it looks like everyone sees it from a different perspective.

Originally when he called me about it back in December or January, I figured all of it would be worked into the sale (at that point I didnt realize that any rents had been collected from the tenant, they just had a prior tenant squatting that needed to be ousted in order to sell).

The when he came in a few weeks ago he showed me rental income from this tenant and since the tenant was still in there when the attorney was hired and the payment had been made to them to get out (as  mentioned like a  "cash for keys" type of scenario), it was still technically rental unit when all this occurred, that would be a rental expense.

I think Im going to split it up, adjust basis on the sale for the payout to the tenant, take the attorney fees for the eviction on Sch E.

And no, there wasn't any 1099 issued to the tenant, didnt even cross my mind to be honest.  and theyre long gone now, so if thats something that should have been done, we'll have to take our chances.

[abctax55]

Lisa... WAS it a rental, in his name & he was collecting rent, AFTER inherited?

[TaxGuyBill]

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@BobKamman wrote:

I don't see any business or profit motive ... You did send a 1099 to the tenant, right?

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Huh?  If you don't see a business motive, why would you think a 1099 should be sent out?

[Just-Lisa-Now-]

For 4 months, yes.