almost 3 years ago we rented out our house and rented a bigger one for ourselves as we needed more space. Around 8 months ago our tenant moved out and the place was left with lot of damage to the carpet, walls/stucco and the plumbing was falling apart ( though no fault of tenants). We fixed up the property spent around 14 thousand dollars. While we were at it we also got the house painted from outside and made it attractive for new prospects. However, I had been out of job almost 10 months, the outlook was not too encouraging, also our landlord had increased our rent to 3000/- per month ( from 2600/-). Given the circumstances, it made sense for us to move back to our own house, which we did in September 2008.

My first question is that can we still deduct the cost of fixing up the house as a rental expense? Also, if the deductible part of mortgage payments, taxes and repairs are more than the rental income, can it be carried over to next year, though the house is no longer a rental property? I am back in the job and have purchased additional property so we will have future rental income but from a different property.

Thank you.

It seems that your property was a rental property for part of tax year 2008 up until September 2008, and thereafter it become a personal residence. So, the issue of being able to deduct the cost of fixing the home becomes one of a timing issue! Did you initiate the work whilst the property was not occupied by you and if so, CPA's may choose to deduct these so called repair expenses on Schedule E.

But, if these expenses were incurred whilst you occupied the home, then they are not deductible on Schedule E and instead are to be capitalized and added to the basis of your home. In other words, they would not get expensed in 2008.

If the mortgage expense and property taxes are more than the rental income during the period Jan 08 thru to Sept 08, the excess of expenses over the rental income will generate rental real estate losses. These rental real losses are subject to passive activity loss limitations, namely if your adjusted gross income exceeds $150,000 they are not deductible.

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