Example—Property — Publication 527

In January, you bought a condominium apartment to live in. Instead of selling the house you had been living in, you decided to change it to a rental property. You selected a tenant and started renting the house on February 1. You charged $750 a month for rent and collected it yourself. You also received a $750 security deposit from your tenant. Because you plan to return it to your tenant at the end of the lease, you don’t include it in your income. Your rental expenses for the year are as follows.

Mortgage interest . . . . . . . . . . . . . . . . . . . . . . $1,800 Fire insurance (1-year policy) . . . . . . . . . . . . . . . 100 Miscellaneous repairs (after renting) . . . . . . . . . . 297 Real estate taxes imposed and paid . . . . . . . . . . . 1,200

You must divide the real estate taxes, mortgage interest, and fire insurance between the personal use of the property and the rental use of the property. You can deduct eleven-twelfths of these expenses as rental expenses. You can include the balance of the real estate taxes and mortgage interest when figuring the amount you can deduct on Schedule A, if you itemize. You can’t deduct the balance of the fire insurance because it is a personal expense.

You bought this house in 2008 for $35,000. Your property tax was based on assessed values of $10,000 for the land and $25,000 for the house. Before changing it to rental property, you added several improvements to the house. You figure your adjusted basis as follows.

Improvements Cost House . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25,000 Remodeled kitchen . . . . . . . . . . . . . . . . . . . 4,200 Recreation room . . . . . . . . . . . . . . . . . . . . . 5,800 New roof . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600 Patio and deck . . . . . . . . . . . . . . . . . . . . . . 2,400

Adjusted basis . . . . . . . . . . . . . . . . . . . . . . $39,000

On February 1, when you changed your house to rental property, the property had an FMV of $152,000. Of this amount, $35,000 was for the land and $117,000 was for the house.

24 Chapter 4 Special Situations Publication 527 (2025)

Because your adjusted basis is less than the FMV on the date of the change, you use $39,000 as your basis for depreciation.

As specified for residential rental property, you must use the straight line method of depreciation over the GDS or ADS recovery period. You choose the GDS recovery period of 27.5 years.

You use Table 2-2d to find your depreciation percentage. Because you placed the property in service in February, the percentage is 3.182%.

On April 1, you bought a new dishwasher for the rental property at a cost of $425. The dishwasher is personal property used in a rental real estate activity, which has a 5-year recovery period. You use Table 2-2a to find the depreciation percentage for Year 1 under “Half-year convention” (20%) to figure your depreciation deduction.

On May 1, you paid $4,000 to have a furnace installed in the house. The furnace is residential rental property. Because you placed the property in service in May, the depreciation percentage from Table 2-2d is 2.273%.

You figured your net rental income or loss for the house as follows.

Total rental income received

($750 × 11) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,250

Minus: Expenses

Mortgage interest ($1,800 × ¹¹ /12) . . . . . . . . $1,650 Fire insurance ($100 × ¹¹ /12) . . . . . . . . . . . 92 Miscellaneous repairs . . . . . . . . . . . . . . . 297 Real estate taxes ($1,200 × ¹¹ /12) . . . . . . . . 1,100

Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 3,139

Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,111

Minus: Depreciation

House ($39,000 × 0.03182) . . . . . . . . . . . $1,241 Dishwasher ($425 × 0.20) . . . . . . . . . . . . 85 Furnace ($4,000 × 0.02273) . . . . . . . . . . . 91

Total depreciation . . . . . . . . . . . . . . . . . . . . . . . . . 1,417

Net rental income for house . . . . . . . . . . . $3,694

You use Schedule E, Part I, to report your rental income and expenses. You enter your income, expenses, and depreciation for the house in the column for Property A. Because all property was placed in service this year, you must use Form 4562 to figure the depreciation. See the instructions for Form 4562 for more information on preparing the form.