How to classify mixed-use property on Sched. E

Question

I'm wondering how to classify my mixed-use property on schedule E. It has 6 units, 5 residential and 1 commercial and naturally it would be advantageous if I could classify the property as residential and be able to depreciate over 27.5 years vs 39 years.

By unit count the property 83% residential and 17% commercial, by sq footage the property is 67% Residential and 33% commercial. By income, the property is 62% residential and 38% commercial.

So BP how would you classify this? Any creative ideas like splitting the property into 2 separate properties and depreciating them in that manner? Any suggestions or advice is appreciated!

Ashish Acharya · Answer

@Rick Jones,

I agree with @Michael Plaks ,  The instructions to Form 8825 (Used by the entity non-disregarded entities for rental activities)state that each rental property is to be shown separately on the Form 8825. Likewise, Schedule E of Form 1040 indicates that each property is to be shown separately.

The property you have is one property. But when you calculate the depreciation expense on your books,  separate the property into to asset.  Also, in the first year,  you will see that Form 4562 will allow you to show  IRS how you separated the property into two categories for depreciation.

If you depreciate it under 27.5 years but were required to use 39 years, you will end up paying more recapture tax later for the depreciation you didn't take.

Michael Plaks · Answer

@Rick Jones

Definition of residential is 80% of the rents comes from dwelling units - which is not your case.

Splitting it into two properties is an interesting idea, and it may accomplish what you want: depreciate a portion of the building over 27.5 instead of 39 years. However, I'm not sure that the related complexity is worth it. You would have to be allocating all expenses between the two sub-properties, and it's a hassle. More hassle with refinancing, insurance etc.

There is a possibility that such split breaks some IRS rules. I'm not aware of it, but it's conceivable.

I also disagree with @Dave Toelkes regarding 6 properties on tax return. So, if we have a 100-door complex, we should have 100 properties? Pleeeze. The informal definition of one property for tax reporting is something that can be acquired or sold separately. Therefore, a duplex is one property. A 100-door apartment complex consisting of 3 buildings could be one property or 3 properties, but not 100 properties.

Rick Jones · Answer

Some interesting insight here. Really appreciate all the advice. Searching throughout the site and elsewhere I had been having a difficult time finding guidance on  this topic. Sounds like there could be a number of ways to tackle this.

Has anyone one else used any of the above methods?

Chris Mason · Answer

I am not a tax professional and the RE in question is commercial real estate so certainly not my realm of expertise at all, but if OP has residential mortgages in their future (personal residence, etc) this would look highly unusual. It wouldn't be the end of the world, but you'd have a grumpy residential underwriter.

One of the two more commonly seen approaches for mixed use is something like this:

On the "type of property" section, there is no option for "one unit in a multi unit mixed use commercial property," but there is a spot for "multi-family residence" as well as a spot for "commercial."

Again, I'm not a tax professional, the above is simply one of the two approaches that we frequently see for folks with mixed use commercial, that would presumably allow you to depreciate how you like (perhaps this is the very reason people sometimes do it this way? - I've never given it much thought).

The other approach we typically see is all of it lumped together as one property, coin toss if the CPA calls it 2 or 4 when it's majority residential, and I've never checked if they were doing 27.5 or 39.

I don't know the one right answer, because a) I'm not a tax professional and b) the tax professionals themselves are inconsistent and apparently in disagreement. I've not heard horror stories about triggered IRS audits either way, FWIW.

Michael Plaks · Answer

@Ashish Acharya - major improvement! Why did I not think of it?

Treat as single property but depreciate as two assets. Perfect.

Rick Jones · Answer

@Dave Toelkes

Is this something I should be doing with all multifamily properties consistently or just this one since it is split between commercial and residential? Could I split into 2 units one commercial and one residential for ease of bookkeeping? I have another multifamily property that is all residential and I treat it as one. In the past, I have heard that you should use 1 schedule e per parcel number/tax bill. How would this work with a larger multifamily I could see this getting really confusing?

Dave Toelkes · Answer

On your tax return, you do not have one property, you have six individual properties.  Assuming each unit is a separate dwelling unit or commercial unit, you have five separate residential rental units each with a 27.5 year depreciation class life, and, one commercial unit with a 39 year class life (even if they are all under the same roof).

Break out tax bases using square footage then calculate depreciation basis for each individual unit.  Track your income and expenses for each individual unit in your accounting system.  On Schedule E, each unit is a separate property.

How to classify mixed-use property on Sched. E

Most Popular Reply