Taking The Rental Out of Service

By Jason Watson, CPA
Posted Sunday, May 25, 2025

There is a subtle difference between taking a rental property offline versus removing it from service. Renovations, repairs and improvements do not take the rental property out of service- rather it is simply unavailable for occupancy but remains held for the production of income.

Here are some common reasons to no longer hold the property for the production of income and therefore take the rental out of service-

• You want to sell the rental property but it needs renovations first.
• Your mother is aging and you feel she should move into your rental property until she is ready for assisted living accommodations.
• It’s been a good run, and now you are wanting to use the rental property as a second home.

We could go on and on, right?

Another way to look at the in-service versus out-of-service conundrum- once an asset (rental property) is placed into service, it remains in service until the intent to produce income with the asset no longer exists. During renovations or other offline activities, supporting your intent to produce income with the rental property in the future becomes important.

Deductions When Out of Service to Sell

Please recall our discussion regarding expenses between the closing date and available for rent date where most expenses are not deductible. A similar situation exists when the rental property is no longer held as available to rent.

A real estate investor could argue that a rental property that meets the standard of being a trade or business, continues to do so while the property is being held for sale. Recall the definition of a “trade or business” which comes from common law. The Supreme Court has interpreted “trade or business” for purposes of IRC Section 162 to mean an activity conducted with “continuity and regularity” and with the primary purpose of earning income or making a profit.

With respects to depreciation, there is some case law supporting this perspective. In Lenington v. Commissioner, Tax Court Memo. 1966-264, the court answered the question, “can petitioners deduct depreciation on poultry buildings after they ceased operating their poultry business but while the buildings were for sale?” The court reasoned as follows-

Since the poultry buildings were not abandoned or converted to personal use prior to 1962, but were involved in a discontinuance of the active conduct of the poultry business, their previously established character as business property was not changed.

However, IRC Section 62(a)(4) reads-

(4) Deductions attributable to rents and royalties.
The deductions allowed by part VI ( Sec. 161 and following), by section 212 (relating to expenses for production of income), and by section 611 (relating to depletion) which are attributable to property held for the production of rents or royalties.

In a 1944 report from the Committee on Finance, Senate Report 885, 1944 C.B. at 877-878-

Similarly, with respect to the deductions described in clause (4), the term “attributable” shall be taken in its restricted sense; only such deductions as are, in the accounting sense, deemed to be expenses directly incurred in the rental of property or in the production of royalties.

1944 was a zillion years ago, however, in a 2001 Ninth Circuit appeal of Strange v. Commissioner, the court affirmed and referenced IRC Section 62(a)(4) in similar fashion by stating in part-

In this case, our task is to interpret I.R.C. § 62(a)(4), providing for deductions from gross income (“above-the-line deductions”). The Tax Court’s construction of this statute involves a question of law subject to de novo review. See Sliwa v. Commissioner, 839 F.2d 602, 605 (9th Cir.1988). Because tax deductions are a matter of legislative grace, statutes providing for them should be narrowly construed against the taxpayer. Deputy v. du Pont, 308 U.S. 488, 493, 60 S.Ct. 363, 84 L.Ed. 416 (1940).

Section 62(a)(4) provides for above-the-line deductions for expenses “attributable to property held for the production of rents or royalties,”

Matter of legislative grace. Narrowly construed against the taxpayer. Wow! Also, IRS Publication 527 Residential Rental Property reads in part-

Vacant while listed for sale.
If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold. If the property isn’t held out and available for rent while listed for sale, the expenses aren’t deductible rental expenses.

Alrighty then. We really beat that up. There might be wiggle room for mortgage interest as a second home deducted on Schedule A of your individual tax return (Form 1040) along with property taxes.

Ideally, you would keep the rental property occupied while you are wanting to sell. This could be good and bad; it is good if you are selling to another real estate investor, but bad if you are wanting to include families and those who do not want an existing tenant. Also, tenants will not share the same objective or motivation as you. Financial incentives might be required to align everyone’s interests.

Not all is lost on expenses incurred while selling. There might be some expenses directly related to the sale such as real estate commissions, marketing and advertising expenses, repairs or maintenance requested by the buyer, and all the other usual suspects. Some people argue that utilities, such as electricity to keep the rental property in good order for showings, are a selling expense, but this is not definitive.

Deductions When Offline Or Vacant

As just mentioned a bit ago, IRS Publication 527 Residential Rental Property speaks to vacant rental properties-

Vacant rental property.
If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. However, you can’t deduct any loss of rental income for the period the property is vacant.

Additionally, the IRS in their “Tips on Rental Real Estate Income, Deductions and Recordkeeping“ webpage, they expand slightly by stating-

You can deduct the ordinary and necessary expenses for managing, conserving and maintaining your rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance.

You can deduct the costs of certain materials, supplies, repairs, and maintenance that you make to your rental property to keep your property in good operating condition.

The deciding factor is that rental property was placed in service (ready and available for occupancy, and held for rental use through advertising and related efforts), but is now vacant for renovations, repairs or improvements. See our idle property versus vacant rental property section on page 338 for a deep deep give into the nuances in-service, vacancy, and held for producing income.

Keep in mind that renovations or rental property rehabs have some tax deduction opportunities baked into themselves beyond deducting operating expenses during these times. Please refer to our sections on-

• improvements versus repairs,

• partial asset dispositions,

• qualified improvement property (QIP), and

• cost segregation study.

Idle Property

Idle property is mentioned here since there is a subtle difference between idle property and vacant rental property. See our idle property versus vacant rental property section on page 338 for mind-numbing subtleties.

Converted to Personal Use

This is an easy one to tackle since the last day the rental property is occupied or considered to be available to rent marks the end of your related tax deductions except what is customary for primary or additional homes (mortgage interest, property taxes).

Some additional considerations-

• If you want to use the IRC Section 121 capital gains exclusion, there are some rules and math to determine qualified and non-qualified use. You might also have depreciation recapture as well. Please see our section on selling your rental property.

• If the rental property was acquired through a 1031 like-kind exchange, review the rules regarding the 24 months following the purchase (exchange) before converting the rental property to a primary residence or personal use. We discuss this in our section on 1031 exchanges.

Also, if you used IRC Section 179 expensing in the past, you will likely trigger recapture which can be a massive surprise. See our accelerated depreciation and section 179 deduction section on page 287 for less than happy news.