03 Jan My tenant left. Can I still deduct the cost of home improvements?

Q. I live in an owner-occupied two-family home. During the pandemic, I had a tenant who stopped paying rent but continued to live in the apartment for another four months. After the apartment was vacated, I did a total renovation of the apartment before renting it again. I have had no rental income this year, but considerable expenses. How is this situation handled on my income tax return for the current year? Are my expenses deductible with no rental income, or can they be deferred until 2022 when I hopefully have a better tenant?
— Landlord

A. We’re sorry to hear you had trouble with your tenant.

There are several matters to address in your situation.

The renovation would constitute a capital improvement subject to depreciation over the prescribed life for residential real estate, which is 27.5 years, said Neil Becourtney, a certified public accountant and tax partner with CohnReznick in Holmdel.

He said for 2021, there would be partial depreciation based on the month that the construction work concluded.

The depreciation percentages for 2021 can be found in IRS Form 4562.

You refer to having incurred considerable expenses. Presumably these are the normal expenses associated with a rental apartment such as mortgage interest, real estate taxes, insurance, repairs and maintenance.

“If you are continuing to seek a tenant, you can report the rental expenses despite zero rental income,” Becourtney said. “You cannot defer the expenses to 2022. However, you may not be able to utilize the loss for federal purposes that will be reported based on the passive activity rules.”

Unless you are otherwise a materially participating real estate professional, any loss would be disallowed, he said.

However, if your adjusted gross income (AGI) is below $100,000, you can generally deduct rental losses up to $25,000, he said. If your AGI exceeds $150,000, your rental loss is not currently deductible, but it is carried forward to the following year to either offset future net rental income or to be deducted based on your AGI in the subsequent year. For AGIs between $100,000 and $150,000, the $25,000 allowable rental loss gets phased out, he said.

“Under the New Jersey gross income tax, rental losses are offset against rental income,” Becourtney said. “Presumably this is your sole rental property so you will not obtain any current year New Jersey tax benefit. A similar loss carryover is permitted to future years where an offset equal to 50% of rental income can be claimed.”

Good luck to you in 2022.

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This story was originally published on Jan. 3, 2022.

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