Terry D EA Posted January 20, 2014 Report Share Posted January 20, 2014 Wroking with a partnership of a few guys that are in the business of buying and renting property. No problem so far. I am of the opinion that amounts spent to renovate and make the property available for rent are capitalized. With that said, the depreciation begins in the month the property became available for rent as well. One of the partners has included the amounts of the renovation in the list of expenses which again I say no. I think he is expecting to see a significant loss on this particular piece of property and I just want to be sure my thinking is correct. Quote Link to comment Share on other sites More sharing options...
Mr. Pencil Posted January 20, 2014 Report Share Posted January 20, 2014 I am of the opinion that amounts spent to renovate and make the property available for rent are capitalized. Is your opinion based on the new taxpayer-friendly regulations effective 20 days ago? Here's a nice summary http://tax.cchgroup.com/downloads/files/pdfs/legislation/repair-capitalization-regulations.pdf And here is an interesting and up-to-date essay by someone who knows the legal issues, Appendix 2 in the Audit Guide http://www.irs.gov/Businesses/Capitalization-v-Repairs-Audit-Technique-Guide#14 1 Quote Link to comment Share on other sites More sharing options...
Terry D EA Posted January 20, 2014 Author Report Share Posted January 20, 2014 Nice read and thank you for the links. While I have not obviously taken the time to read the document at lenght, there is a section regarding capitalized costs for improving the property. As I see it, the changes will allow for the expensing of repairs which in this case there are quite a few. There is still a difference of opinions regarding expensing or depreciating roof replacement which I had intended on depreciating the costs of the roof repair. Renovating the property to make it usable is improving the value of the property and those costs I feel are to be capitalized. Quote Link to comment Share on other sites More sharing options...
jshtax Posted January 20, 2014 Report Share Posted January 20, 2014 Isnt it unless you have audited financials you have to capitalize all expenses over $500 for repairs and maintenance and if supplies are over $200 you must capitalize as well? Quote Link to comment Share on other sites More sharing options...
jshtax Posted January 20, 2014 Report Share Posted January 20, 2014 Isnt it unless you have audited financials you have to capitalize all expenses over $500 for repairs and maintenance and if supplies are over $200 you must capitalize as well? in real world agents are not even aware of this law much less how to enforce on people. i know people that are not going to comply until they are forced to by the IRS Quote Link to comment Share on other sites More sharing options...
Terry D EA Posted January 20, 2014 Author Report Share Posted January 20, 2014 As I read the information provided, your statement doesn't appear to apply. The real question is what do the amounts paid actually do for the property. Do they maintain the original usefulness or do they actually improve the property. That is the question and it appears the documents given by Mr. Pencil back this up. Quote Link to comment Share on other sites More sharing options...
Ranger Posted January 20, 2014 Report Share Posted January 20, 2014 Isnt it unless you have audited financials you have to capitalize all expenses over $500 for repairs and maintenance and if supplies are over $200 you must capitalize as well? It’s much deeper than that. If the renovation took place before property was rented, then the only option is to capitalize. Note the new regs take effect for tax years beginning on or after January 1, 2014, so you follow the "old rules" in this situation. Quote Link to comment Share on other sites More sharing options...
Mr. Pencil Posted January 20, 2014 Report Share Posted January 20, 2014 If the renovation took place before property was rented, then the only option is to capitalize. . Yes, I thought about that. Actually I thought that was the question and that my links were not directly on point. Although a rental shares some characteristics of an "active trade or business," I wouldn't bet a lot of tax that rental start-up expenses can be deducted/amortized under Section 195. There's probably a ruling on that somewhere, limited to specific circumstances. Anyway, "capitalize" in this context does not necessarily mean "depreciate." You still have to determine if they are repairs, which are not MACRS property and can only be recovered when the activity is disposed of. As to the effective date, which I acknowledged, I think in this particular case it is reasonable to rely on the current regs for an original return. These regs interpret existing tax code that is not changing. Quote Link to comment Share on other sites More sharing options...
Terry D EA Posted January 21, 2014 Author Report Share Posted January 21, 2014 I agree with both of you. I just wanted to confirm my own thinking. I guess the statement that I made regarding when the depreciation begins implied the expenses were incurred to make the property available for rent. Thus the need to capitalize. Quote Link to comment Share on other sites More sharing options...
jshtax Posted January 21, 2014 Report Share Posted January 21, 2014 It’s much deeper than that. If the renovation took place before property was rented, then the only option is to capitalize. Note the new regs take effect for tax years beginning on or after January 1, 2014, so you follow the "old rules" in this situation. You could expense this before? I always thought it had to be capitalized if it was not available for rent. Quote Link to comment Share on other sites More sharing options...
Ranger Posted January 21, 2014 Report Share Posted January 21, 2014 I don’t think I said it could be expensed. (?) Quote Link to comment Share on other sites More sharing options...
Ranger Posted January 21, 2014 Report Share Posted January 21, 2014 As to the effective date, which I acknowledged, I think in this particular case it is reasonable to rely on the current regs for an original return. These regs interpret existing tax code that is not changing. I am not sure about that last sentence. For example I believe the “Small Taxpayer Exemption” comes out of the new regs and would not be available before 1/1/14. In many cases it looks like the new regs will result in capitalization where expense could have allowed before. I agree with you that with the information given in this case the results would likely be the same. Quote Link to comment Share on other sites More sharing options...
DANRVAN Posted January 21, 2014 Report Share Posted January 21, 2014 Anyway, "capitalize" in this context does not necessarily mean "depreciate." You still have to determine if they are repairs, which are not MACRS property and can only be recovered when the activity is disposed of. I don’t follow what you are saying about repairs. “if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. Example. You repair a small section on one corner of the roof of a rental house. You deduct the cost of the re-pair as a rental expense. However, if you completely re-place the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. You depreciate the cost of the new roof.” Quote Link to comment Share on other sites More sharing options...
Mr. Pencil Posted January 21, 2014 Report Share Posted January 21, 2014 Example. You repair a small section on one corner of the roof of a rental house. You deduct the cost of the re-pair as a rental expense. However, if you completely re-place the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. You depreciate the cost of the new roof.” Yes, but what if you repair a small section on one corner of the roof of a house that is not yet in service as a rental? You can't deduct it currently because the activity is not being operated for profit at the time. When rental does start, you still can't depreciate it because it was not a capital improvement. Only if the rental (a passive activity) can be considered "active conduct of a trade or business," and if repairs can be considered start-up expenses, would a Section 195 election apply. I don't know of any actual regs or rulings allowing a rental to use Section 195, so that's an aggressive (though reasonable) position. It would be safer to treat a series of such repairs as an overall remodel adding to the acquisition basis. Quote Link to comment Share on other sites More sharing options...
clay Posted January 21, 2014 Report Share Posted January 21, 2014 I don’t follow what you are saying about repairs. “if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. Example. You repair a small section on one corner of the roof of a rental house. You deduct the cost of the re-pair as a rental expense. However, if you completely re-place the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. You depreciate the cost of the new roof.” If you did not remove the plywood under the shingles, this might be a repair. At least that is what they told us at a tax update class. Quote Link to comment Share on other sites More sharing options...
Terry D EA Posted January 22, 2014 Author Report Share Posted January 22, 2014 I guess we can drill as far down on this subject as we like. Most of my property owners do not give me the details of the "roof replacement" just the cost involved. I don't see how a roof replacement is a capital improvement. It is a repair to maintain the integrity of the structure. I do agree with Mr. Pencil again that you cannot begin depreciation until the property iks rented. Then you can determine whether there is a capital improvment or repair. Quote Link to comment Share on other sites More sharing options...
Mr. Pencil Posted January 22, 2014 Report Share Posted January 22, 2014 I don't see how a roof replacement is a capital improvement. It is a repair to maintain the integrity of the structure. Structural integrity is not the only issue. These days a new roof is often an upgrade with steel or hi-tech materials for fire proofing or energy efficiency. The new regs call that a "betterment" and require capitalization. Quote Link to comment Share on other sites More sharing options...
Jack from Ohio Posted January 22, 2014 Report Share Posted January 22, 2014 I guess we can drill as far down on this subject as we like. Most of my property owners do not give me the details of the "roof replacement" just the cost involved. I don't see how a roof replacement is a capital improvement. It is a repair to maintain the integrity of the structure. I do agree with Mr. Pencil again that you cannot begin depreciation until the property iks rented. Then you can determine whether there is a capital improvment or repair. Whether you see it or not, the IRS has determined that replacement of the roof is a capital improvement and must be depreciated 27 1/2 years. The latest "clarification" makes that abundantly clear. When you replace the roof, you expense the unused depreciation on the old roof, then capitalize and depreciate the new one. The clarification leaves no room for doubt as to how the IRS treats it. 1 Quote Link to comment Share on other sites More sharing options...
Mr. Pencil Posted January 22, 2014 Report Share Posted January 22, 2014 When you replace the roof, you expense the unused depreciation on the old roof Nope, that was outlawed way back in 1981 by the change to ACRS. You can no longer use component depreciation like that--when a structural component of a building is removed, it is not treated as a disposition until the entire building is disposed of. There is no adjustment to basis, no gain/loss, no recovery of cost allocated to the removed component. The building as a whole continues on the same depreciation schedule, even though a new schedule is started for the replacement component. Quote Link to comment Share on other sites More sharing options...
jshtax Posted January 22, 2014 Report Share Posted January 22, 2014 Nope, that was outlawed way back in 1981 by the change to ACRS. You can no longer use component depreciation like that--when a structural component of a building is removed, it is not treated as a disposition until the entire building is disposed of. There is no adjustment to basis, no gain/loss, no recovery of cost allocated to the removed component. The building as a whole continues on the same depreciation schedule, even though a new schedule is started for the replacement component. If you did a cost segregation analysis on the property I guess this still would not work. Is that because you cant break the roof out from the rest of the structure? Quote Link to comment Share on other sites More sharing options...
Mr. Pencil Posted January 22, 2014 Report Share Posted January 22, 2014 If you did a cost segregation analysis on the property I guess this still would not work. Is that because you cant break the roof out from the rest of the structure? Cost segregation is theoretically possible, but not practical for a residential rental house. First, literally first, you have to identify separate assets before you start depreciation. You need an engineering study to do that, and nobody wants to bother for less than $100,000. Then you have to get IRS agreement for a change in accounting method, and they don't like those very much unless there is real solid business (non-tax) purpose for it. So just include the cost of removal in the basis of the new roof, and let the old depreciation schedule run its course. Quote Link to comment Share on other sites More sharing options...
Ranger Posted January 22, 2014 Report Share Posted January 22, 2014 Yes, but what if you repair a small section on one corner of the roof of a house that is not yet in service as a rental? Now I see, you are talking about repairs before placing in service. They are treated as cost of placing the building in service and depreciated as such. Or as the new regs read “The amounts paid must be capitalized as amounts to acquire the building unit of property…” Quote Link to comment Share on other sites More sharing options...
Mr. Pencil Posted January 22, 2014 Report Share Posted January 22, 2014 talking about repairs before placing in service. They are treated as cost of placing the building in service and depreciated as such. After further research, I agree. Quote Link to comment Share on other sites More sharing options...
michaelmars Posted January 22, 2014 Report Share Posted January 22, 2014 Cost segregation is theoretically possible, but not practical for a residential rental house. First, literally first, you have to identify separate assets before you start depreciation. You need an engineering study to do that, and nobody wants to bother for less than $100,000. Then you have to get IRS agreement for a change in accounting method, and they don't like those very much unless there is real solid business (non-tax) purpose for it. So just include the cost of removal in the basis of the new roof, and let the old depreciation schedule run its course. Many companies specialize in doing cost seg engineering studies. The one I use charges around $7000 for a residential property of 60-80 units, elevators etc. This makes it very cost effective. And you don't need IRS approval, correcting depreciation is an automatically allowed chance since it is considered a correction in lives not a change in accounting methods. I recently did a few for a client that sold his buildings. You get the catch up depreciation at ordinary rates and pick up the extra gain due to reduced basis at capital gain rates. It saves 10% for those in the highest brackets. 1 Quote Link to comment Share on other sites More sharing options...
kcjenkins Posted January 22, 2014 Report Share Posted January 22, 2014 Agreed, Michael. In fairness, tho, while in Long Island, NY you can find such a company, in many parts of the country they are few and far between, and thus much more expensive. Also, lots of difference in a 60-80 unit building vs a single family rental house. Quote Link to comment Share on other sites More sharing options...
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