2 rare situations/crazy tax questions for any tax experts

7 Replies


I have 2 situations that I have not been able to find answers to (at least to my satisfaction that they are correct). One is very rare and crazy, but the other I am sure has happened to someone out there. Here goes:

- I live in the upstairs unit of a duplex. The roof is in poor shape and has started leaking, and will need repairs if not full replacement. My tax guy says that I cannot deduct the expense of the new roof. Since the roof covers both units wouldn't I be able to at least write off 1/2 of the cost? I will eventually move out and rent both units. Would I at least then be able to retroactively deduct this cost at that point?

- Now the really crazy situation. I bought this same property as a short sale. The contract stated that the seller would transfer the current tenants deposit and pro-rated rents at closing. Well, the seller is a low-life scum bag and had no intention of doing this. I saw this coming and warned my agent and let the selling agent know, and told them to make sure this was taken care of prior to closing. Well we get to closing and there is nothing (as I expected). In fact, the seller contacted the tenants and tried to get them to pay additional rent in advance so she could skip town with the extra rent. The tenants actually called and told me this (thankfully), and I told them to only pay her the pro-rated portion of the rent before I took ownership. This salvaged half the rent, but the seller says the tenants broke a bunch of rules and that she verbally told them they would not be getting a deposit back. I say this is not for her to decide any more because she will not be the landlord when they move out and that she should have charged them the late fees and other fines at the time they happened. Anyway, since I assume the contract I was then liable to pay the tenants back the deposit, whether I received it or not. I assumed I could write off the loss of deposit, but my tax guy is saying this is just uncollected income and that it is not a direct loss that can be written off. I hear of banks, businesses and hospitals all the time that write off uncollected income as bad debt. Am I just screwed here or should I at least be able to get a tax benefit for not receiving the deposit per the contract?

For the roof, it might be a big enough repair that you have to depreciate the roof expense.

For the security deposit, you did not have to pay it yet I'm guessing - so nothing lost as an expense that you can deduct. Once you return the deposit at move out, that is when you will have a hit. Now, that assumes you did not have to deposit the security deposit into a bank account to hold it due to local law requiring that to happen; if you did that, then you have turned some of your money over and you should explain better to your tax guy.

Yes, I figure I will have to depreciate it (if it needs full replacement), but he is saying that I cannot do that either because I live under the roof. That is really my question is whether I can write off any of the costs at all on my taxes. I just changed to this tax guy 2 years ago, and he has saved me tons more money than my last guy, but I would think there has got to be some way to get some tax advantage of the roof, even though I live under it and the other unit is below me.

On the deposit those tenants are gone and I did already have to pay it. Since they took care of things while I was there and cleaned fairly well I felt they deserved it back, and I didn't want to screw them just because I was getting screwed. Since I didn't want to come out of pocket for it, I just had them not pay the last month's (or few weeks or whatever it was) rent. But I can easily change that to show they paid me rent and I had to pay them back the deposit. However, my tax guy is saying that there again is not tax situation where this can be used to offset income or be counted as an expense...

@Mike Palmer

1. Roof

If you repair the roof, then half of the cost of the repair is a personal expense for your residence unit, and the other half of the repair is a deductible rental expense on Schedule E.

You can not write off (deduct) the cost of a new roof. A new roof is a capital expense. Half of the cost of the new roof is an adjustment to basis for your residence unit, and the other half is depreciated on a 27.5 year schedule for your rental unit. If you eventually move out of your residence unit, then the cost basis for your residence unit is used to calculate the depreciation basis when you convert to rental use.

2. Security Deposits.

The best way to handle this would have been to have the seller transfer security deposits and prorated scheduled rents at closing. This could have been deducted from the seller's proceeds of the sale. Rental deposits are really the tenant's money that is held by the landlord against damages you may suffer (when the tenant vacates) due to damage due to tenant abuse, unpaid rent, and even for a broken lease. Since you did not get the deposits from the seller at settlement, you are funding the security deposits yourself. They become a capital contribution to your rental activity, but you do not get to deduct the amount of the deposit that you had to refund out of pocket. Since the tenants did not actually pay rent, you don't get to claim rental income and you don't get a deduction for the security deposit you refunded.

If you collected last month's rent, then returned the deposit (which you never received) you would deduct that deposit. In effect, this cancels the last month's rent.

Your tax guy is right, if you collected the deposit, and didn't claim it as income (which, if you put it in an escrow account, you don't add it a income) then upon returning it, there's no tax event, no deduction. But here you 'paid back' something you didn't collect in the first place.

Originally posted by @Frank M. :
...But here you 'paid back' something you didn't collect in the first place.

That was my point. This was money out of my pocket. It seems there is usually a beneficial tax advantage for this type of scenario. Why is it that hospitals are able to 'write off' the cost of services they don't collect for, and that banks can write off the bad debt they take off the books when they sell short or lose money on a foreclosure? Is this any different in theory?

So it sounds like the deposit issue is a wash, and I can depreciate half the roof now (even though I live upstairs in an up/down unit where the roof fully covers my residence), and the other half if/when I move out and rent the top unit out?

You did essentially "write off" the "returned" deposit, as you didn't collect "rent" for that last month, so you didn't report any income for that rent--a straight wash, just as if you collected $500, then paid it back out. Hospitals and others get to "write off" bad debts, because they are on an accrual basis and they reported that debt as income the moment it was earned. The write off just "washes out" the uncollected income that was previously reported. You didn't previously report the deposits as income, so that's the difference. It's not a surprise you didn't get the deposits off set at the closing, since the bank had a required Net to them from the HUD. Any deduct would be coming from the bank's Net, and returning deposits is not an expense they will pay.

I guess where I am confused is that a deposit is not income, where the rent would have been. So rather than receive a deposit that I basically hold in escrow and give back, I had to put up the deposit myself, creating an expense. Since I did not want to come up with the funds for this expense, I had them not pay rent. This cancelled out the income, but rather than receiving the income, paying taxes on it, and keeping what is left, there was no income due to the expense. Maybe I am just going in circles, it just seems that there would be a tax angle on this. I got screwed either way, but if there was a tax benefit I guess I would just feel better about it:).

The problem is the seller (and their agent) hid the fact that they were renting out the house and receiving income from it. The bank requirements also stated that the seller could not receive any proceeds from the home, of which they received the deposit and a partial month's rent outside of settlement. The seller was also sent a 1099 or something from the bank after settlement, but it did not show any of the rental income. I kind of want to report it to the IRS as tax fraud and evasion, but I don't have faith they would actually pursue it (when they can just audit those of us trying to do things right) and have come to grips that it is probably better to just let it go and move on.

Thanks for all the input everyone. I still don't think I get it, but everyone is in agreement and I am not a tax professional so I am probably in the wrong. It was an expensive lesson, but I am learning new things all the time.

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