Safe Harbor for Small Taxpayers for repairs and improvements

[MarkAU]

I started renting out my house mid lasty year. After a month some sewer piping below the house began leaking. The cost to repair the piping whici included replacing a portion of the piping that went from under the house (crawlspace) to being buried (under the house footing) cost $9,500. This falls under the $10,000 allowance. However I had some additional repair expenses that would put the total costs over $10,000 for the year. Can I still use the Safe Harbor in this case? If I cannot, is replacing half of the sanitary plumbing below a house an improvement to an UOP that then must be capitalized?

[Carl]

The sewer pipe replacement is not a "repair" by any stretch of the imagination. It's a property improvement since it clearly meets the IRS definition of a property improvement.

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Property Improvement.

Property improvements are expenses you incur that 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 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.

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I had some additional repair expenses

Any other work done that you may be thinking of classifying as a repair, is included in the cost of the property improvement if the work was done "because of" or "in relation to" the property improvement.

Therefore, your property improvement is entered in the Assets/Depreciation section of the SCH E and depreciated over 27.5 years.

Besides, since rental property almost always operates at a loss on paper every year at tax filing time, you'll find the safe harbor rules may not change your tax liability for that year by one single penny. Especially if the property has a mortgage on it.

Generally, when you add up the deductible mortgage interest, property taxes, property insurance and the depreciation you are required to take by law, it's common for those four deductions alone to exceed the total rental income received for the year. Add to that any of the other common expenses allowed and you're practically guaranteed to have no taxable income on the SCH E.

[MarkAU]

Thanks for the clarification, but the way I was reading it, or at least hoping to interpret this SHST was that you could treat an improvement as a repair provided the property was not pricey, your income is low, and the repair/improvement was $10,000 or less. Unfortunately, because I am in California the rent income still exceeds all the deductions you listed by a fair amount.

The reference I was looking at states (bold is by me): 

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Safe Harbor for Small Taxpayers

The Safe Harbor for Small Taxpayers (SHST) is one of three safe harbors enacted due to the IRS repair regulation issued in 2013.

See the Routine Maintenance Safe Harbor and the De Minimis Safe Harbor.

The SHST allows landlords to currently deduct on Schedule E all annual expenses for repairs, maintenance, improvements, and other costs for a rental building (IRS Reg. § 1.263(a)-3h).

There are restrictions to qualify (listed below) but landlords need to ensure they keep careful track of all their annual expenses for repairs, maintenance, and improvements to justify the use of the safe harbor.

Rental Business Size Limitations

Landlords cannot use this SHST in any year that the following limitations are exceeded:

• $1 Million limit on unadjusted basis – note that unadjusted excludes land, land improvements, and personal property identified through a cost segregation study
• Annual expenses for repairs, maintenance, and improvements, cannot exceed the lesser of $10,000 or 2% of the building’s unadjusted basis
• Annual gross income for the landlord must be less than $10MM for the three preceding tax years.

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And then from the IRS directly (bold by me again):

https://www.irs.gov/businesses/small-businesses-self-employed/tangible-prop[product key removed]atio...

What are the simplifying alternatives to the facts and circumstances analysis?

• Safe Harbor Election for Small Taxpayers;
• Safe Harbor for Routine Maintenance; and
• Election to Capitalize Repair and Maintenance Costs.

Safe Harbor Election for Small Taxpayers

You are not required to capitalize as an improvement, and therefore may be permitted to deduct, the costs of work performed on owned or leased buildings, e.g., repairs, maintenance, improvements or similar costs, that fall into the safe harbor election for small taxpayers. The requirements of the safe harbor election for small taxpayers are:

• Average annual gross receipts of $10 million or less; and
• Owns or leases building property with an unadjusted basis of less than $1 million or less; and
• The total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property doesn't exceed the lesser of-
  • Two percent of the unadjusted basis of the eligible building property; or
  • $10,000 (for questions about how to calculate the unadjusted basis, refer to "Figuring the Unadjusted Basis of Your Property" in Publication 946
• You make the election to use the safe harbor for each taxable year in which qualifying amounts are incurred.

[AmeliesUncle]

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@MarkAU wrote:

• The total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property doesn't exceed the lesser of-
  • Two percent of the unadjusted basis of the eligible building property; or
  • $10,000 (for questions about how to calculate the unadjusted basis, refer to "Figuring the Unadjusted Basis of Your Property" in Publication 946
• You make the election to use the safe harbor for each taxable year in which qualifying amounts are incurred.

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I highlighted a couple of important aspects of that election.  The TOTAL repairs, maintence, and improvements need to be under that threshold.  So if the total of any other repairs, maintenance and improvements were over $500, that puts you over the $10,000 limit.

Also, it is the LOWER of 2% of the Unadjusted Basis or $10,000.  So in the event the Unadjusted Basis of the home is under $500,000, the threshold is less than $10,000.  I realize that if you are in California that may not be an issue.   🙂

[MarkAU]

@AmeliesUncle 

Thanks for the clarification. So it seems that if you have had a light year in terms of repairs and maintenance, then it can makes sense to do a (small) improvement that will not put you over the $10k (or 2%) limit and use this SHST election.

This board is a great resource.