Rental Property - New Construction with Existing Building - Tracking expenses & depreciation strategies.

[Waterl]

We have a rental property with a single family house. We are adding two additional duplexes to the same property. (which will make a total of 5 'units').

A couple notes that are probably important:

- Property is in NY

- Property is in an LLC (Partnership) - it is the only property owned by the LLC

- We still have depreciation available in the original house.

- The original house is likely going to be demolished and replaced or significantly renovated in the near future (not this year.).

- We have no reason to separate out expenses from a business side of the equation - so any complexity here would just be for tax purposes either for tax benefit or tax necessity.

- The entire project is based upon a cost per square foot, but also includes work related to the entire site that will benefit even the existing house.

- These are long term holdings and not a 'flip'.

- We use turbotax business as our tax platform.

QUESTION 1: Do I need to split out expenses during construction and/or operating expenses going forward, or can I just lump them together. Again, only would be doing this for tax purposes if necessary or beneficial. I'm thinking like do I need to track basis separately or something - particularly if I end up doing a substantial renovation or demolition/replacement of the existing house in the near future.

QUESTION 2: I use de minimis safe harbor election (1.263(a)-1(f)) on this property. I do not believe I can use this on the new construction even though my contract breaks the costs down to below $2500 / item, or am I incorrect? Is there another recommended method of advancing depreciation? Should I be looking into cost segregation (I'm an architect so we've prepared these for clients before - but never understood how they affected their taxes) or something else? I'm looking for some direction so I can do my owner deep dive into it.

Note: We've done our own taxes for years due to our complete dissatisfaction with local CPA's - so 'hiring a tax professional' hasn't worked out in the past. I'm more than comfortable doing the research & even calling the IRS with questions - I just need some general direction for now. If it's too complicated - I'm not opposed to hiring someone actually knowledgeable on these topics and would probably be reaching out to this community for recommendations.

[DianeW777 · Accepted solution]

The answers to your questions are shown below.

QUESTION 1: Do I need to split out expenses during construction and/or operating expenses going forward, or can I just lump them together. Again, only would be doing this for tax purposes if necessary or beneficial. I'm thinking like do I need to track basis separately or something - particularly if I end up doing a substantial renovation or demolition/replacement of the existing house in the near future.

1. Operating expenses do not necessarily need to be broken down if you are treating this as or want to aggregate the activity.
2. Basis should definitely be tracked separately for each building.  When you sell a building down the road you want to have each asset listed separately for each one even if aggregating as one rental activity with several assets.
3. Capital improvements and/or renovations will be a separate asset but will also belong to one building. Think about that when you name the assets as you enter them.

QUESTION 2: I use de minimis safe harbor election (1.263(a)-1(f)) on this property. I do not believe I can use this on the new construction even though my contract breaks the costs down to below $2500 / item, or am I incorrect? Is there another recommended method of advancing depreciation? Should I be looking into cost segregation (I'm an architect so we've prepared these for clients before - but never understood how they affected their taxes) or something else? I'm looking for some direction so I can do my owner deep dive into it.

1. Yes, you are incorrect.  There are two types of safe harbor: 
   1. $2,500 DeMinimis Safe Harbor for equipment - This election is an option you can take each year that lets you write off/deduct items $2,500 or less as expenses instead of assets.
   2. Safe harbor Election Small Taxpayers: Here are the rules you need to meet to take this election:
      1. Your gross receipts, including all your other income, are $10,000,000 or less.
      2. Your eligible building has an unadjusted basis of $1,000,000 or less.
      3. The cost of all repairs, maintenance and improvements is less than or equal to the smallest of these limits:
         • 2% of the unadjusted basis of your building or
         • $10,000
   3. What can I depreciate or expense with the business safe harbor method?
2. Simply, cost segregation is a tax deferral strategy that identifies assets within a building that can be depreciated over a shorter period.  The building itself and the capital improvements such as a roof, a room addition, siding, or other attachments to the building itself will be depreciated over the usual 27.5 year for residential rental property. 

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