De minimis safe harbor election with multiple co-owners of rental property

[hativered]

How is the $2,500 limit for the de minimis safe harbor election figured in the case when ownership of a rental property is split between multiple co-owners? 

Example scenario: A new AC + furnace were installed (replaced old AC and furnace) for a total cost of $7,800 at a rental property owned by four people, each of whom shares equally the income and expenses for the rental activity.  If each of the co-owners is responsible for 25% of the cost, that amounts to a $1,950 expense for each co-owner.  For the purposes of any potential safe harbor election, does the IRS view the expense as $7,800 or as $1,950?  Can each co-owner elect to use the de minimis safe harbor to deduct their $1,950 share of the expense on their Schedule E?

[LeonardS]

The De minimis safe harbor election is determined per invoice item.  If the cost exceeds $2,500 per invoice (or item), no part of the cost may be deducted by using the de minimis safe harbor. If you have an applicable financial statement, then you may increase the per item or per invoice amount up to $5,000.

In the example you have given you would not be able to use the safe harbor as the invoice cost for the new AC + furnace exceeded $5000.  If the invoice amount is within the limits allowed then you are correct that each co-owner would receive a percentage.

[pk]

@hativered , you raise an interesting question in that whether the application of the de minimis  election is per unit or per owner.   Please see this ---> https://www.cpapracticeadvisor.com/tax-compliance/article/12372399/the-most-overlooked-tax-deduction...

and

https://www.irs.gov/pub/irs-drop/n-15-82.pdf

Generally it appears to be applicable to the property where an improvement / acquisition is done  and the taxpayer/owner is indirect.  Thus I am of the opinion that this  de minimis  amount is for the whole rental unit   and not per owner ( there just happens to be four owners  at the end of the chain ).

Also I am curious as to why you are treating this "repair/ replacement " that brings the original functionality of the rental unit, as a capital improvement and eligible for depreciation treatment ?   Granted, it is tempting for an auditor to take the position that a non-functioning furnace/ A-C replaced  by anew one is a capital improvement and your argument could be that  1. a functioning   furnace  is a requirement  for  rental and "fit to live" cert by your city; 2.  there is no way to replace a broken furnace/A-C with an equally old but functioning furnace/ A-C unit.  The point I am trying to make is that I would consider this as "repair " since it just maintains  the value  and rentability of the  asset.  If there is an increase in FMV that is only incidental and cannot be measured   ( but yes it probably increases the saleability of the asset).

Is there more I can do for you ?

pk

[Carl]

A new AC + furnace were installed (replaced old AC and furnace) for a total cost of $7,800

The safe harbor election has nothing to do with the amount paid or who paid it. It applies to the total line item cost (which may or may not include labor).

Now even if itemized, I doubt the line-item cost of the AC/Furnace was less than $2,500. I also doubt than an AFS (Applicable Financial Statement) is maintained and filed with any government agency on a recurring basis. So that knocks out the increase to $5K for safe harbor election. An AFS includes a financial statement required to be filed with the Securities and Exchange Commission (“SEC”) or a certified audited financial statement accompanied by the report of an independent certified public accountant for credit purposes, reporting to shareholders, or for other non-tax purposes. An AFS also includes a financial statement required to be provided to a federal or state government or agency other than the IRS or the SEC. This is not all that common for a rental property owner, partnership or multi-member LLC that deals in real estate rental property.

However, a new furnace/AC does meet the requirements of a property improvement since it meets the two basic criteria.

 - It becomes "a material part of" the main structure.

 - It adds "real value" to the property; i.e.: when appraised by a qualified, certified, licensed property appraiser they will appraise the value of the property at a higher value than they would have without the new furnace/AC

The asset should be classified as Residential Rental Real Estate under MACRS and depreciated over 27.5 years. Others will say classify as an appliance and depreciate over 5 years. An "appliance" doesn't become a material part of the structure. So the furnace/AC is not an appliance. (This is a "really" grey area for a hot water heater, but that's another story.)

The point I am trying to make is that I would consider this as "repair " since it just maintains the value and rentability of the asset.

Respectfully disagree based on my above, based on my experience. A few years ago the cooling fan motor on the outside compressor unit quit working. Thankfully, I caught it soon enough before the compressor overheated to self-destruction. Called a repair tech and they were able to replace just the motor at a cost of less than $500 including labor. This was a repair expense.

Just last year in another rental property, the compressor motor outside, and the blower unit inside were both fried by a massive power surge. Replacement was the only option, since when the compressor motor flew apart it took out the cooling coils with it. I was only 6 years into the depreciation of this unit.

Entered the new unit (about $7500) as a separate asset.

I also deducted the remaining depreciation not yet taken on the old unit as a casualty loss.

[tagteam]

---

@Carl wrote:

So the furnace/AC is not an appliance. (This is a "really" grey area for a hot water heater, but that's another story.)

---

There is no "grey area" since the IRS clearly considers a new water heater to be an improvement.

See https://www.irs.gov/publications/p527#en_US_2020_publink100071091

Regardless, a new water heater (as is the case with all improvements) would qualify for the de minimis safe harbor election provided the invoice was $2,500 or less.

[magiklamp]

@pk , thank you.  As much as I'd love to count it as a "repair" I think the IRS is very clear that this should be treated as a "capital improvement."  From the IRS website:

Replacement of the furnace in your residential rental property:

Is generally a restoration to your building property because it's for the replacement of a major component or substantial structural part of the building's HVAC system. Therefore, the furnace replacement is a capital improvement to your residential rental property.
As with the restoration costs discussed above, these costs are a separate asset with a new placed-in-service date and are in the same class of property as the residential rental property to which the furnace is attached.
Is generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention as residential rental property.

https://www.irs.gov/faqs/sale-or-trade-of-business-depreciation-rentals/depreciation-recapture/depre....

[pk]

@magiklamp , I know that IRS would definitely like to have as much of the repair / replacement  considered as capital improvement -- I think @Carl  also has the same position. However , in my rental properties  ( had six at one time and now down to zilch ) I  treated such repairs  as "repairs ", was prepared for a challenge with documentation showing that  (a) city required  functioning furnace  for  occupancy cert.   ( in Michigan );  (b) there was no change in FMV with this repair and hence did not qualify as "capital improvement " and (c) the replacement was with similar equipment and not an  improvement.  Never got a challenge.   However,  in case of adding furnace and A/C to a house where only furnace existed , I did  like up with the capital improvement , because it did increase  the FMV.

I do understand your position though

pk