New Roof on a Rental property...Expense or capitalize?

[Janitor Bob]

Client had to put a new roof on one of her rental properties....Expense it all in 2012 or capitalize and depreciate?

[michaelmars]

capitalize

[jasdlm]

Ditto

[Elrod]

You-Bet-Cha!

[Guest Taxed]

Does a new roof on a rental property ever get expensed??

[Janitor Bob]

Clearly, I was over-thinking this.....it seemed so obvious, that I started second-guessing.....Thanks everyone!

[jainen]

>>Does a new roof on a rental property ever get expensed??<<

Sure, almost ALWAYS! Does it extend the life of the building? No, it just prevents deterioration. Does it make the building suitable for a new use? No, unless it is an upgrade like steel or something. Usually a new roof just means they repaired the old one.

In order to capitalize it, you must first remove the undepreciated basis of the old roof. Would that make sense? No? Then you aren't really replacing the roof, are you?

[michaelmars]

You are extending the life of the building because with a leaky roof the building won't last too long.

[jasdlm]

Okay . . . because I have never seen Jainen post anything inaccurate, I had to quickly research this just a bit. While Pub 527 states that a new roof is an 'improvement', ergo Capitalize, I just discovered that there is definitely case law supporting expensing.

I withdraw my 'ditto'.

Sheesh . . . I want to download a few of the brains on this board. I will send a thumb drive. Please password protect. You know who you are.

[Guest Taxed]

Can anyone point to a case law or reg. that supports expensing in this example? I must have done hundreds of Sch E over the years and never have I expensed a brand new roof on a rental property. Won't a 10 to 15 thousand expense item stand out like a sore thumb? Those of you who expensed this any of those returns ever get audited?

[Jack from Ohio]

I agree with jainen's thinking, but the regs say differently.

[mcb39]

Jainen does make sense, but I have never expensed a roof on a rental property; right or wrong.

[ILLMAS]

Court case

Northen v. Commissioner, T.C. Summary 2003-113 (8/13/03)

The Tax Court held that the cost of repairing the roof is deductible. She did not intend to prolong the life of the property, increase its value, or make it adaptable to another use.

Expenditures incurred as part of a general plan of reconditioning, renovating, improving, or altering business property are capital expenditures, even though certain portions of the work, considered alone, might be classified as repairs.

Regs. Sec. 1.162-4. Repairs.

[ILLMAS]

Now how many of your clients hire a cost segregation company to know what is the unused basis or know the basis of the roof that came with the house they bought?

[TAXMAN]

ok now confused. The poster said replaced the roof and the court case said repairing the roof. I have in the past expensed repair but not replaced. What say ya?

[SFA]

Ok. I love this topic. I just had the same issue with a client who is sick and dying. She doesn't care about an audit. She wanted me to expense the new roof, but caved when I said capitalize. Bah. Humbug. May be we should amend!?

[jainen]

>>You are extending the life of the building because with a leaky roof the building won't last too long.<<

Same with a busted window! Would you capitalize a termite treatment? Refurbishing something that is worn out or damaged is a repair, not a capital asset. Of course, many a new roof is indeed an upgrade, but I wouldn't assume that on rental property.

And I was serious about reducing basis for a roof that was removed prior to adding new basis. That much IS in the regs, but not that a new roof necessarily adds basis.

[kcjenkins]

I'm with Jainen on this one. Although you might want to ask questions about what 'replace' meant, in most cases it really is just a repair. If they took the old one all the way off, and replaced the boards, the felt, and the shingles, you might have to capitalize. Bit if you just replaced the shingles, I'd expense in a second, and have.

[Jack from Ohio]

I want to hear from someone who had this specific issue in an audit in the last 5 years. You can talk all you want about "I did it this way and it has never been questioned" all day long. But until someone tells me that they won the "Expense vs Capitalize" debate in an audit, I stick with my position.

[kcjenkins]

Jack, as Marco pointed out, you do have at least one cite, Northen v. Commissioner, T.C. Summary 2003-113 (8/13/03)

After all, if XXX told you they won this on audit, you could just as easily say "Just because one auditor gave in does not prove you were right."

[Guest Taxed]

I'm with Jainen on this one. Although you might want to ask questions about what 'replace' meant, in most cases it really is just a repair. If they took the old one all the way off, and replaced the boards, the felt, and the shingles, you might have to capitalize. Bit if you just replaced the shingles, I'd expense in a second, and have.

We are not talking about repalicing a few shingles or caulking or step flashing repair etc. Those i agree are expensed repairs . I think we are talking about removing the old shingles, exposing the deck and then laying tar paper and ice barrier membrame and hammering in brand new shingles. That prolongs the life of the roof and the structure. Otherwise why would they advertise 25/30 year shingles if it did not extend the life???

I am with Jack on this issue. until I see a real case under audit where IRS allowed a complete expensing, i am sticking to the old and tried way of capitalizing. If my client wants to expense a 15k roof let him find another preparer because i am not making a fool of myself upon audit!

[Jack from Ohio]

Jack, as Marco pointed out, you do have at least one cite, Northen v. Commissioner, T.C. Summary 2003-113 (8/13/03)

After all, if XXX told you they won this on audit, you could just as easily say "Just because one auditor gave in does not prove you were right."

Ok, then define for me the parameters for "repair" vs "replace" and give me the cite where that information is found?

[Slippery Pencil]

I had a client replace siding that was expensed. About 40% of the siding was stolen off the house while it was vacant between tenants. The auditor claimed ripping off the rest and replacing it was an improvement, thus a capital expenditure. If he had left the remaining siding and replaced only the stolen stuff it would have been a repair. The auditor said if I found some court cases she'd change her mind.

I came up w/ Oberman Manufacturing Co. v. Commissioner, Northern & Cox vs Commissioner, & Illinois Merchants Trust Co.

In Oberman, the Court held that the cost of replacing a roof as well as the cost of inserting an expansion joint in the roof was a deductible expense ($20,791 in 1961 or 159,000 in 2012 dollars according to the federal govt’s online CPI calculator). The Court observed that "it is necessary to take into consideration the purpose for which an expenditure is made in order to determine whether such expenditure is capital in nature or constitutes a current expense." Since Oberman's "only purpose in having the work done was to prevent leakage and keep the leased property in an operating condition over its probable useful life and not to prolong the life of the property, increase its value, or make it adaptable to another use. There was no replacement or substitution of the roof." The Court allowed a deduction.

In Northern, the Court held that the cost ($49,308 in 1998, equal to $69,000 in 2012) of replacing roof covering was a deductible repair expense. The repairs were done to maintain normal operating condition.

In Illinois Merchants Trust the court allowed deductions for repairs to the foundation ($46,562 in 1920 or $469,000 in 2012) stating the amount was not required to be capitalized.

I also relied upon temp reg 1.263(a)-1

1.263(a)-1. Capital expenditures; in general

(f) CAPITALIZATION OF BETTERMENTS--

(1) IN GENERAL. A taxpayer must capitalize amounts paid that result in the betterment of a unit of property. An amount paid results in the betterment of a unit of property only if it--

(i) Ameliorates a material condition or defect that either existed prior to the taxpayer's acquisition of the unit of property or arose during the production of the unit of property, whether or not the taxpayer was aware of the condition or defect at the time of acquisition or production;

(ii) Results in a material addition (including a physical enlargement, expansion, or extension) to the unit of property; or

(iii) Results in a material increase in capacity (including additional cubic or square space), productivity, efficiency, strength, or quality of the unit of property or the output of the unit of property.

Numerous examples are included in the reg. I pointed out three of them.

EXAMPLE 9. Not a betterment; replacement with same part. X owns a small retail shop. In 2008, a storm damages the roof of X's shop by displacing numerous wooden shingles. X decides to replace all the wooden shingles on the roof and hires a contractor to replace all the shingles on the roof with new wooden shingles. Assume the shop building and its structural components are the unit of property. The event necessitating the expenditure was the storm. Prior to the storm, the retail shop was functioning for its intended use. The expenditure did not result in a material addition, or material increase in the capacity, productivity, efficiency, strength or quality of the shop or the output of the shop compared to the condition of the shop prior to the storm. Therefore, the amounts paid by X to reshingle the roof with wooden shingles do not result in betterment to the shop building. X is not required to capitalize as an improvement under this paragraph (f) amounts paid to replace the shingles.

EXAMPLE 10. Not a betterment; replacement with comparable part. Assume the same facts as in Example 9, except that wooden shingles are not available on the market. X decides to replace all the wooden shingles with comparable asphalt shingles. The amounts paid by X to reshingle the roof with asphalt shingles do not result in a betterment to the shop, even though the asphalt shingles may be stronger than the wooden shingles. Because the wooden shingles could not practicably be replaced with new wooden shingles, the replacement of the old shingles with comparable asphalt shingles does not, by itself, result in an improvement to the shop. X is not required to capitalize as an improvement under this paragraph (f) amounts paid to replace the shingles.

EXAMPLE 11. Betterment; replacement with improved parts. Assume the same facts as in Example 9, except that, instead of replacing the wooden shingles with asphalt shingles, X decides to replace all the wooden shingles with shingles made of lightweight composite materials that are maintenance-free and do not absorb moisture. The new shingles have a 50-year warranty and a Class A fire rating. The expenditure for these shingles resulted in a material increase in the quality of the shop building as compared to the condition of the shop building prior to the storm. X must capitalize amounts paid to reshingle the roof as an improvement under this paragraph (f) because they result in a betterment to the shop.

The auditor denied the deduction.

The auditor's decision was overturned on appeal. The appeals conference consisted of a five minute phone call where the appeals officer stated I presented a pretty solid case and she was allowing the deduction.

[joanmcq]

I've expensed adding another layer of asphalt shingles, but capitalized ripping off three layers, repairing the substructure and reroofing. This year I'm redoing my roof, a flat roof, but instead of tarpaper & gravel, I'm going with a lifetime new membrane. That's a capitalize. So like so many things in tax & accounting, it's an 'it depends' facts & circumstances answer.

[kcjenkins]

Great post, Slippery. I knew I'd found a number of good cites, back a year or so, but was feeling lazy tonight. You saved me a lot of digging.