Depreciating Residential Rental and Commercial Real Property

When you own rental property, depreciation is your best friend.

One reason depreciation is so valuable is that, unlike deductible rental property expenses such as interest and maintenance, you get to claim depreciation year after year without having to pay anything beyond your original investment in the property. Moreover, rental real property owners are entitled to depreciation even if their property goes up in value over time (as it usually does). The basic idea behind depreciation is simple, but applying it in practice can be complex. Indeed, the annual depreciation deductions for two properties that cost the same can be very different.

For example, if you own a motel with a depreciable basis of $1 million, you get to deduct $25,640 each year for depreciation (except the first and last years). If you own an apartment building with a $1 million basis, your depreciation deduction is $36,360.

Why the difference? A motel and apartment building are both rental real estate. Shouldn’t they be depreciated the same way? Not according to the tax law. An apartment building is a residential rental property, while a motel is a commercial rental property. There are different depreciation periods for commercial and residential property: it takes far longer to depreciate commercial property fully. For this reason, you should always make sure you correctly classify your property as commercial or residential. Such classification can be more challenging than you might think, especially for mixed-use properties. If you rent to residential and commercial tenants, the tax code classifies the building as residential only if 80 percent or more of the gross annual rent is from renting dwelling units.

Even properties rented only for residential use may have to be classified as commercial if a majority of the tenants or guests are transients who stay only a short time. This rule can adversely impact the depreciation deductions for property owners who rent their property to short-term guests through Airbnb and other short-term rental platforms. If you’ve been using the wrong depreciation period for your residential or commercial rental property, you should correct the error by filing an amended return or IRS Form 3115 to fix depreciation errors more than two years old.

We are here to help. Call us at 561-995-0064 or email info@lerrosarbey.com

Takeaways

If you keep the property for 40 years, the total depreciation deductions are the same for both residential and non-residential real property. The difference is you get your deductions 42% faster with property classified as residential rental property (39 divided by 27.5). Given the time value of money, this is a valuable benefit of owning residential rental property.

For depreciation, residential property is a building or other structure for which 80% or more of the gross rental income for the tax year is from dwelling units. How much space the dwelling units take up in the building is irrelevant; all that matters is how much money you earn from them. If you live in any part of the building, the gross rental income includes the fair rental value of the part you occupy.

If a building changes from a residential rental property to a non-residential rental property due to the 80% rule, you switch to the non-residential rate of depreciation on the first day of that year.

Likewise, if the non-residential real property becomes residential real property, you switch and depreciate over a 27.5 year recovery period for residential rental property instead of the 39-year period.

The definition of the dwelling unit for purposes of depreciation is more expansive than what you might find with vacation homes. For example, the vacation home rules state that the dwelling unit has basic living accommodations, such as sleeping space, a toilet, and cooking facilities. For 27.5-year residential rental property depreciation, you don’t need the kitchen. The 30-day transient rule applies not only to hotels, motels, and nursing homes but to short-term Airbnb-type rentals as well.

[av_one_full first min_height=” vertical_alignment=” space=” row_boxshadow=” row_boxshadow_color=” row_boxshadow_width=’10’ custom_margin=” margin=’0px’ mobile_breaking=” border=” border_color=” radius=’0px’ padding=’0px’ column_boxshadow=” column_boxshadow_color=” column_boxshadow_width=’10’ background=’bg_color’ background_color=” background_gradient_color1=” background_gradient_color2=” background_gradient_direction=’vertical’ src=” background_position=’top left’ background_repeat=’no-repeat’ highlight=” highlight_size=” animation=” link=” linktarget=” link_hover=” title_attr=” alt_attr=” mobile_display=” id=” custom_class=” aria_label=” av_uid=’av-6gjy1z’] [av_textblock size=” av-medium-font-size=” av-small-font-size=” av-mini-font-size=” font_color=” color=” id=” custom_class=” av_uid=’av-kij8lemh’ admin_preview_bg=”]

ARPA’s Enhancements to The Premium Tax Credit

[/av_textblock] [/av_one_full] [av_one_half first min_height=” vertical_alignment=” space=” row_boxshadow=” row_boxshadow_color=” row_boxshadow_width=’10’ custom_margin=” margin=’0px’ mobile_breaking=” border=” border_color=” radius=’0px’ padding=’0px’ column_boxshadow=” column_boxshadow_color=” column_boxshadow_width=’10’ background=’bg_color’ background_color=” background_gradient_color1=” background_gradient_color2=” background_gradient_direction=’vertical’ src=” background_position=’top left’ background_repeat=’no-repeat’ highlight=” highlight_size=” animation=” link=” linktarget=” link_hover=” title_attr=” alt_attr=” mobile_display=” id=” custom_class=” aria_label=” av_uid=’av-6gjy1z’] [av_textblock size=” av-medium-font-size=” av-small-font-size=” av-mini-font-size=” font_color=” color=” id=” custom_class=” av_uid=’av-kij8lemh’ admin_preview_bg=”] The premium tax credit (PTC) is a refundable credit that assists individuals and families in paying for health insurance obtained through a Marketplace established under the Affordable Care Act. Recent COVID relief legislation (the 2021 American Rescue Plan Act, or ARPA) made several significant enhancements to this credit. Here is an overview of these changes.

Taxpayers with Household Income Over 400% of FPL Made Eligible for PTC

Under pre-ARPA law, individuals with household income above 400% of the federal poverty line (FPL) weren’t eligible for the PTC.

Under ARPA, for 2021 and 2022, the PTC is available to taxpayers with household incomes that exceed 400% of the FPL. This change will have the effect of increasing the number of people who are eligible for the PTC.

Illustration: A 45-year-old single individual with income of $58,000 (450% of FPL) in 2021 wouldn’t have been eligible for the PTC under pre-ARPA law. Under ARPA, that individual is eligible for a PTC of about $1,250.

New Percentage Tables Will Increase PTC for 2021 and 2022

The PTC is computed on a sliding scale based on household income, expressed as a percentage of the federal poverty line (FPL). The amount of the PTC is limited to the excess of the premiums for the applicable benchmark plan over the taxpayer’s required share of those premiums.
[/av_textblock] [/av_one_half] [av_one_half min_height=” vertical_alignment=” space=” row_boxshadow=” row_boxshadow_color=” row_boxshadow_width=’10’ custom_margin=” margin=’0px’ mobile_breaking=” border=” border_color=” radius=’0px’ padding=’0px’ column_boxshadow=” column_boxshadow_color=” column_boxshadow_width=’10’ background=’bg_color’ background_color=” background_gradient_color1=” background_gradient_color2=” background_gradient_direction=’vertical’ src=” background_position=’top left’ background_repeat=’no-repeat’ highlight=” highlight_size=” animation=” link=” linktarget=” link_hover=” title_attr=” alt_attr=” mobile_display=” id=” custom_class=” aria_label=” av_uid=’av-4pizyf’] [av_image src=’https://vcpa.com/wp-content/uploads/2021/03/Web-Post-2-1030×629.jpg’ attachment=’1646′ attachment_size=’large’ copyright=” caption=” styling=” align=’center’ font_size=” overlay_opacity=’0.4′ overlay_color=’#000000′ overlay_text_color=’#ffffff’ animation=’no-animation’ hover=” appearance=” link=” target=” id=” custom_class=” av_element_hidden_in_editor=’0′ av_uid=’av-kij8njkq’ admin_preview_bg=”][/av_image] [/av_one_half] [av_textblock size=” av-medium-font-size=” av-small-font-size=” av-mini-font-size=” font_color=” color=” id=” custom_class=” av_uid=’av-kij8ukp4′ admin_preview_bg=”] The required share comes from a table that is divided into income tiers.

Because the required share is less under the new tables for 2021 and 2022 than it otherwise would have been, the PTC will be greater. Under pre-ARPA law, a taxpayer might have had to spend as much as 9.83% of household income in 2021 on health insurance premiums. Under ARPA, that amount is capped at 8.5% for 2021 and 2022.

Illustration: Under pre-ARPA law, a 21-year-old with income at 150% of FPL in 2021 would have been eligible for a PTC of about $3,500. Under ARPA, that individual’s PTC will be about $4,300.

Premium Tax Credit Increased for Taxpayers Receiving Unemployment Compensation in 2021

If you receive or are approved to receive, unemployment compensation for as little as one week during 2021, you qualify for special PTC rules for the entire year. Under these rules:

• You are automatically treated as an “applicable taxpayer” who qualifies for the PTC. You still won’t be able to claim the PTC, however, if you are eligible for affordable employer-sponsored insurance.
• Your household income in excess of 133% of the FPL for a family of the size involved isn’t taken into account in figuring your PTC.

As a result of the second rule, if your household income for 2021 exceeds 133% of FPL, your PTC will be calculated as if the income was 133% of FPL. This will increase your PTC, since your required share of the premiums will be lower.

No Repayment of Excess Advance PTC Payments for 2020

Many taxpayers arrange to have advance payments of their PTC made in advance directly to the insurer. The amount of these payments is based on income estimated from tax returns for prior years.

If your actual PTC turns out to be more than the advance payments, you will receive a refundable income tax credit for the excess. But if your advance payments exceed your PTC, you generally must pay back the excess as additional income tax, subject to a repayment cap based on your household income.

However, a special rule applies for 2020 under ARPA. Under that rule, if you file a 2020 return reconciling your advance PTC payments with your actual PTC, no additional income tax will be imposed if the advance payments are greater. You can retain the benefit of the advance payments even though they exceed the PTC to which you are entitled.

Note: Currently, the IRS is telling taxpayers who’ve already filed 2020 returns and paid the excess credit back as an additional tax not to file amended returns to claim a refund. The IRS has said it will provide more details on how to claim a refund of additional tax soon.

Please contact us for more information 561-995-0064
[/av_textblock] [av_one_full first min_height=” vertical_alignment=” space=” row_boxshadow=” row_boxshadow_color=” row_boxshadow_width=’10’ custom_margin=” margin=’0px’ mobile_breaking=” border=” border_color=” radius=’0px’ padding=’0px’ column_boxshadow=” column_boxshadow_color=” column_boxshadow_width=’10’ background=’bg_color’ background_color=” background_gradient_color1=” background_gradient_color2=” background_gradient_direction=’vertical’ src=” background_position=’top left’ background_repeat=’no-repeat’ highlight=” highlight_size=” animation=” link=” linktarget=” link_hover=” title_attr=” alt_attr=” mobile_display=” id=” custom_class=” aria_label=” av_uid=’av-3z7fav’] [av_comments_list av-desktop-hide=” av-medium-hide=” av-small-hide=” av-mini-hide=” alb_description=” id=” custom_class=” av_uid=’av-25giyv’] [/av_one_full]

[av_one_half first min_height=” vertical_alignment=” space=” row_boxshadow=” row_boxshadow_color=” row_boxshadow_width=’10’ custom_margin=” margin=’0px’ mobile_breaking=” border=” border_color=” radius=’0px’ padding=’0px’ column_boxshadow=” column_boxshadow_color=” column_boxshadow_width=’10’ background=’bg_color’ background_color=” background_gradient_color1=” background_gradient_color2=” background_gradient_direction=’vertical’ src=” background_position=’top left’ background_repeat=’no-repeat’ highlight=” highlight_size=” animation=” link=” linktarget=” link_hover=” title_attr=” alt_attr=” mobile_display=” id=” custom_class=” aria_label=” av_uid=’av-6gjy1z’] [av_textblock size=” av-medium-font-size=” av-small-font-size=” av-mini-font-size=” font_color=” color=” id=” custom_class=” av_uid=’av-kij8lemh’ admin_preview_bg=”]

Operation Hidden Treasure’ initiated by the IRS to Root Out Unreported Crypto Income

[/av_textblock] [av_textblock size=” av-medium-font-size=” av-small-font-size=” av-mini-font-size=” font_color=” color=” id=” custom_class=” av_uid=’av-kij8lemh’ admin_preview_bg=”] The U.S. Internal Revenue Service (IRS) appears to be stepping up its enforcement capabilities with a new program dedicated to cryptocurrency tax compliance.
[/av_textblock] [/av_one_half] [av_one_half min_height=” vertical_alignment=” space=” row_boxshadow=” row_boxshadow_color=” row_boxshadow_width=’10’ custom_margin=” margin=’0px’ mobile_breaking=” border=” border_color=” radius=’0px’ padding=’0px’ column_boxshadow=” column_boxshadow_color=” column_boxshadow_width=’10’ background=’bg_color’ background_color=” background_gradient_color1=” background_gradient_color2=” background_gradient_direction=’vertical’ src=” background_position=’top left’ background_repeat=’no-repeat’ highlight=” highlight_size=” animation=” link=” linktarget=” link_hover=” title_attr=” alt_attr=” mobile_display=” id=” custom_class=” aria_label=” av_uid=’av-4pizyf’] [av_image src=’https://vcpa.com/wp-content/uploads/2021/03/IRS-Bitcon.jpg’ attachment=’1626′ attachment_size=’full’ copyright=” caption=” styling=” align=’center’ font_size=” overlay_opacity=’0.4′ overlay_color=’#000000′ overlay_text_color=’#ffffff’ animation=’no-animation’ hover=” appearance=” link=” target=” id=” custom_class=” av_element_hidden_in_editor=’0′ av_uid=’av-kij8njkq’ admin_preview_bg=”][/av_image] [/av_one_half] [av_hr class=’default’ icon_select=’yes’ icon=’ue808′ position=’center’ shadow=’no-shadow’ height=’50’ custom_border=’av-border-thin’ custom_width=’50px’ custom_margin_top=’30px’ custom_margin_bottom=’30px’ custom_border_color=” custom_icon_color=” av-desktop-hide=” av-medium-hide=” av-small-hide=” av-mini-hide=” id=” custom_class=” av_uid=”] [av_textblock size=” av-medium-font-size=” av-small-font-size=” av-mini-font-size=” font_color=” color=” id=” custom_class=” av_uid=’av-kij8ukp4′ admin_preview_bg=”] With “Operation Hidden Treasure,” the IRS will search for unreported crypto-related income, according to the agency’s Director of the Office of Fraud Enforcement, Damon Rowe.

• Speaking at a Federal Bar Association virtual tax conference, Rowe said cryptocurrency fraud will be a priority.
• Operation Hidden Treasure, a joint effort between the IRS’s civil office of fraud enforcement and its criminal investigation unit, will train agents to look at blockchains to root out tax evasion among cryptocurrency users. It will exist as part of the office’s emerging threats mitigation team.
• IRS employees are also reportedly training alongside the European Union Agency for Law Enforcement Cooperation (Europol) as part of the initiative.
  Carolyn Schenck, national fraud counsel in the IRS Office of Chief Counsel, told conference-goers that the agency is working with private contractors and vendors, presumably blockchain analytics firms, to develop “signatures,” or telltale signs of fraudulent activity.

These indicators include looking at those who structure transactions just below reporting requirements (like sending a series of $10,000 transactions), using shell corporations to hide funds as well as “getting on and off the chain,” Schenck reportedly said.

• The IRS has sent conflicting messages to U.S. crypto holders several times in the past. Most recently, an updated FAQ page indicated that investors who simply bought “virtual currency with real currency” would not have to report that transaction on this year’s tax returns.
• Still, cashing out crypto or making every-day purchases is typically seen as a taxable event. Operation Hidden Treasure is designed to find, trace, and attribute such transactions to taxpayers, Schenck said.

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