Will I get into trouble with the IRS if I had deducted improvements on a rental property but now may be kept for a few years as a second home?

by Scott Rubinsky, CPA | Aug 07, 2018

I purchased an investment property in June 2016 and made capital improvements over the past two years. My intent was to use this as an investment property, but it turns out it may not be possible. I cannot find renters, and I can’t afford to be dumping money into it. My concern is will I get into trouble with the IRS since I deducted home improvements for something that may just be sold or kept for a few years as a second home? I know a second home can have its mortgage interest and taxes written off each year, so I am safe there. But home improvements cannot be deducted for a second home (or even primary home for that matter), so I am worried that if I cannot rent it and have to sell (or if I keep it as a second home) I’ll have to pay what I saved in 2016 and 2017 by taking deductions for the improvements. Please advise.

Improvements are normally capitalized and depreciated depending on the dollar amount. To deduct expenses pertaining to a rental, the property must be available for rent, even if it is not rented. Some questions to consider for your situation are: Was this property being actively advertised and available to rent? Were the deducted costs of the improvements significant? (If so, they should be capitalized, not expensed.) Did you file a Schedule E showing expenses only with a loss?

The prior year’s returns can be amended if the dollar amount deducted is substantial in relation to the initial investment. The IRS could flag the returns, depending on the amount of losses. Either way, penalties and interest will be assessed.
I recommend consulting a CPA, and provide him or her with the answers to the questions I raised. That way you can gain a full understanding of your tax responsibilities.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: Scott Rubinsky, CPA, is a sole practitioner in Huntingdon Valley, Pa.

The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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