Depreciation for HVAC in 2020

[WhatsNex]

I purchased two HVAC systems this year for two different rental properties.  One unit was $3,300 the other $2,495.  Both HVAC units are more than 2% of the unadjusted basis for their respective properties.

I would normally depreciate the HVAC unit for 27.5 yrs. However, can I use either section 179 depreciation or the 100% bonus depreciation for either of the units?

[RayW7]

 As for depreciation, if they are part of the central HVAC system you have to depreciate them over 27.5 years.  If they are stand alone units, more like window AC units (i.e. not a part of the structure of the building) then you can depreciate them over a seven year period.

However Landlords may use the De Minimis Safe Harbor to deduct any cost as substantiated by a invoice as long as that cost does not exceed $2,500 ($5,000 if you have applicable financial statements).

This dollar limit is applied to each item on the invoice, not the invoice in the aggregate. As a result, it is critically important to itemize all invoices.

The limit was originally $500 when released in 2013 but the IRS later retroactively applies an increased $2,500 limit.

There is an anti-abuse rule which prevents landlords from breaking down the cost of a component into each of its individual parts on an invoice. For example, you cannot deduct the cost of a new HVAC if the total cost was $4,000 by breaking up that cost into the HVAC’s individual parts on the invoice.

[WhatsNex]

So, to clarify, all 27.5 year property such as HVAC and Water Heaters are eligible to use De Minimis Safe Harbor if the the line item on the invoice identifies them as less than $2,500?

Can you separate the labor to install the new and remove the old item?

[ColeenD3 · Accepted solution]

Yes, the labor can be an expense and yes, as long as each item is $25,00 or less, you can use Safe Harbor.

De Minimis Safe Harbor Election

This election for items $2,500 or less is called the De Minimis Safe Harbor Election. This election is an option you can take each year that lets you write off items $2,500 or less as expenses instead of assets. Expenses typically reduce your income by a larger amount than depreciating an asset over multiple years does. This means you could get a bigger refund.

If you decide to take this option, a form called De Minimis Safe Harbor Election will show up in your tax return. This election will apply to all your businesses, rental properties or farms.

Here are the rules you need to meet to take this election:

• You don't have an applicable financial statement (most people don't).
• You have a consistent process for how you record expenses and assets.
• You record these items as expenses on your books/records.
• The cost of each item as shown on your receipt is $2,500 or less.

[WhatsNex]

Last clarification - the $3,300 HVAC is a 27.5 year item.  Can I use section 179 or bonus depreciation?

Thanks 

[Carl]

SEC179 is not applicable to residential rental real estate. But you can use the SDA (Special Depreciation Allowance) if you want.

It probably won't be beneficial to you, since rental property with a mortgage generally operates at a loss on paper each year anyway.

[WhatsNex]

We do have a profit this year so I'd like to take the special depreciation this year but I'm not able to figure out how to do that in TurboTax?  Here is what I tried:

1. Clicked + to add a new asset
2. Picked "Rental Real Estate Property"
3. Picked "Residential Real Estate"
4. Filled out the next screen "Tell Us about this Rental Asset" - HVAC, cost $3,300, date acquired 8/25/2020 
5. Filled out the next screen "Tell Us more about this Rental Asset" - checked purchased new, %100 business placed in service 8/25/2020 
6. Clicked continue and TurboTax calculated $45 in depreciation. 

I never got a screen with an option to pick bonus depreciation.  If at step c. I pick "Appliances, carpets and furniture" then I can get to the screen that allows me to pick bonus depreciation but "Appliances, carpets and furniture" appears to be for 5 year assets, not 27.5 year assets.

What steps should I be taking to pick bonus deprecation for a 27.5 year asset like an HVAC that costs $3,300?

[Carl]

he HVAC doesn't qualify for bonus depreciation because of it's classification as Residential Rental Real Estate. Since it becomes "a physical part of" the structure, that's the correct classification too.

[WhatsNex]

OK - so  27.5 year property (like HVACs, water heaters, kitchen cabinets) over $2500 are not eligible for section 179, bonus depreciation, or de minimum safe harbor election.  Got it.

What about Paint? Is it a 27.5 yr asset?  I seem to find different answers.

[Carl]

Now you're over thinking this. Check out the below.

RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that “better” the property. Basically, they retain or add value to the property. Expenses for this are entered in the Assets/Depreciation section and depreciated over time. Property improvements can be done at any time after your initial purchase of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.

To be classified as a property improvement, two criteria must be met:

1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.

2) The improvement must retain or add "real" value to the property. In other words, when the property is appraised by a qualified, certified, licensed property appraiser, he will appraise it at a higher value, than he would have without the improvements.

There are rules that allow you to just flat-out expense and deduct some property improvements, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.

Cleaning & Maintenance

Those expenses incurred to maintain the rental property and it's assets in the useable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent are not deductible.

Repair

Those expenses incurred to return the property or it's assets to the same useable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent are not deductible.

Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.

However, when you do something like convert the garage into a 3^rd bedroom for example, making a  2 bedroom house into a 3 bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.

[leeniemela]

I replaced an HVAC for almost $20,000.  Can I claim the 100% Special Allowance under sec 179 for this?

[Carl]

If the HVAC was for residential rental real estate, then no. The new system became "a material part of" the structure. Therefore it's classified as residential rental real estate and depreciated over 27.5 years.

[cndy_orth]

I have read your synopsis of HVAC. When you itemize an invoice, there are two parts in my case, a heater and an AC for a two bedroom apartment. Each apartment has their own units. Each part is under $2500, therefore is this a 27.5 year depreciation or can it be depreciated under the bonus depreciation rules? I would also add that the building is owned by 3 people so my total portion is $1698.

Thank you.

[MarilynG1]

Yes, you can elect the Bonus Depreciation of your portion of the heater and A/C.

Click this link for detailed info on Depreciation of Business Assets. 

[Carl]

From the way I understand IRS publication 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf on page 110, a central air/heat system is classified as residential rental real estate and depreciated over 27.5 years. So it's not eligible for expensing or the SDA if I understand things correctly. On page 110 it states:

Structural components: Parts that together form an entire structure, such as a building. The term includes those parts of a building such as walls, partitions, floors, and ceilings, as well as any permanent coverings such as paneling or tiling, windows and doors, and all components of a central air conditioning or heating system including motors, compressors, pipes, and ducts. It also includes plumbing fixtures such as sinks, bathtubs, electrical wiring and lighting fixtures, and other parts that form the structure.