Rental property remodeling deductions

[mjbraddy]

A rental property kitchen remodeling project was stopped by contractor due to bankruptcy. I lost a $14,000 deposit. Can this loss be deducted from 2021 rental income? I also purchased new appliances for this project, but they have not been installed yet. Can I deduct their cost or add as an improvement? Have hired another contractor to finish this job in 2022

[Carl]

A rental property kitchen remodeling project was stopped by contractor due to bankruptcy. I lost a $14,000 deposit. Can this loss be deducted from 2021 rental income?

No. But it's not lost. Keep reading. (And keep every single receipt too! That's important!)

I also purchased new appliances for this project, but they have not been installed yet.

If the appliances are "a part of" the remodeling project, they generally are not entered as separate items. But they can be. They're "generally" included in the total cost of the remodel.  More on that below.

Can I deduct their cost or add as an improvement?

What you have here is a property improvement. Your cost of this improvement gets entered in the Assets/Depreciation section, classified as residential rental real estate and depreciated over 27.5 years. You will not enter this on your tax return until the tax year the property improvement is place "in service". It *does* *not* *matter* in what tax year you paid for it either.

So if you paid the contractor in 2021 but the job was not completed and the remodel placed "in service" until 2022, then you will enter absolutely nothing what-so-ever concerning this, on your 2021 tax return. You'll deal with it on your 2022 tax return next year. Again, it's a property improvement, so it gets entered in the assets/depreciation section and depreciated over 27.5 years.

Have hired another contractor to finish this job in 2022

So your total cost for this job will be whatever the new contractor charges you *PLUS* the $14,000 deposit you paid to the now defunct/missing contractor. The total is classified as Residential Rental Real Estate and depreciated over 27.5 years with depreciation starting when the assets are placed "in service". Per your post, that didn't happen in 2021. Therefore nothing concerning this remodel will be entered on y our 2021 tax return. It will be entered on your 2022 tax return, assuming the work is completed and the property is "in service" at some point in 2022.

Now for the appliances. You have several options here.

1. Since the appliances are "a part of" the remodel, you can just include their cost in the total and be done with it.

2. Appliances are depreciated over 5 years. So you can enter the appliances as separate assets on your 2022 tax return next year, classify them as appliances and the program will set it up for 5 years of depreciation.

3. Since the appliances are new and have no "personal use", you also have the option to take a SEC179 deduction on the appliances which allows you to fully depreciate them in the first year they are placed in service.

4. You may also have the option of just expensing and permanently deducting the cost of appliances *IF* the cost for each item is shown on the invoice, and the cost of each item is under $2,500. If you take this route, it's referred to as the "Safe Harbor DeMinimus" election. If you take this election you can't e-file the return. You'll have to print, sign and mail it to the IRS with a signed statement. (This could cause issues with e-filing a state return.)

For the safe harbor election, there are certain very specific tasks and procedures you *must* follow and requirements you "must" meet. See IRS Publication 527 page 5, section titled "Deminimus safe harbor for tangiel property" at https://www.irs.gov/pub/irs-prior/p527--2019.pdf and IRS Publication 535 page 4, starting with section titled, "De minimus Safe Harbor for Tangible Property" at https://www.irs.gov/pub/irs-pdf/p535.pdf

[mjbraddy]

Carl, Thanks so Much! You helped clear up everything for me.

[pnored]

Hi @Carl    Your reply here helped me very much with some issues I needed addressed about remodels I did in 2021. Thank you!  Second, I hope you can help me with some specifics I am thinking about.  I have 7 units in two multi families.  I did 3 units in one multi-family in 20201.   I am thinking about pulling the appliances out and doing the De Minimus Safe Harbor election to deduct as an expense.  Is that all that I can claim under this election when thinking about a remodel? It was extensive in all three...bathroom & kitchen remodels in all three, painted all rooms, added a closet in two units. Also, I replaced HVAC in one. Would it be advantageous to pull that out and put on asset report separate, ie is there a special depreciation I could take for that?

Second, when I do claim the improvements on the asset report, would you claim the entire remodel on all 3 as a total or would you list them out for each unit? Does it matter? I am thinking of doing the latter. 

Thanks in advance!

[DianeW777]

The information about the specifics when deciding about the De Minimis Safe Harbor Election are posted for you below.

Improvements Election

This election is an option you can take each year that lets you write off some building improvements as expenses instead of assets.

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

• Your gross receipts, including all your other income, are $10,000,000 or less.
• Your eligible building has an unadjusted basis of $1,000,000 or less.
• 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

This election for building improvements is called the Safe Harbor Election for Small Taxpayers. If you decide to take this option, a form called Safe Harbor Election for Small Taxpayers will show up in your tax return. This election will apply to all your businesses, rental properties or farms. (IRS Tangible Property FAQs)

De Minimis Safe Harbor Election - Personal Property (not personal use):

You expense the furniture in the year they are placed in service, based on your comments that will be 2021.  The rental unit is rented or available for rent and advertised as such.

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/deduct 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.
• Rental Property select Edit > Other expenses > Other Miscellaneous Expenses
• Enter Description (Safe Harbor ...) and amount (not entered as assets under this election)

Note:  Because you are under the $2,500 threshold, you are not required to used section 179.  You can list these expenses under Miscellaneous.  If the amount was over 2,500, then you would enter these as assets and then would be able to choose the 179 option.

• Maintain a complete record with your tax return should you need to verify these items at a later time.

[Carl]

I am thinking about pulling the appliances out and doing the De Minimus Safe Harbor election to deduct as an expense.

What do you mean "pulling the appliances out"? If those appliances are what came with the property when your originally purchased it, those appliances are already included in the cost basis of the property as a total and are being depreciated as "a part of" the structure depreciation over 27.5 years. YOu can't "pull them out" and then deduct them.

Safe harbor is for "new" purchases. For example, if you remove the old appliances and then go out and purchase new appliances, you have two choices with the new appliances.

1) Take the safe harbor and deduct the cost of the new appliance in the tax year purchased/placed in service, as an expense.

2) Treat the new appliance as an asset which is classified an an appliance and depreciated over 5 years. This option is available only in the tax year the asset/appliance is purchased/placed in service.

Is that all that I can claim under this election when thinking about a remodel?

Simply put, most likely, yes. Personally, (and this is just me) I'm not dealing with the PITA of separating things out on a remodel for safe harbor just to reduce my depreciation by a mere few bucks a year.

It was extensive in all three...bathroom & kitchen remodels in all three, painted all rooms, added a closet in two units.

I'd just total the cost of everything and if it was all placed in service on the same date, enter it as a single asset, classify it a residental rental real estate and depreciate over 27.5 years.

Also, I replaced HVAC in one. Would it be advantageous to pull that out and put on asset report separate, ie is there a special depreciation I could take for that?

You can if you want. But I wouldn't bother. Generally, I've never seen an HVAC system that was under $2,500. So that has to be capitalized/depreciated anyway. You can do it separately over 5 years if you want. But if it was a part of the remodel I wouldn't bother. Just include it in the grand total that gets depreciated over 27.5 years and be done with it.

Second, when I do claim the improvements on the asset report, would you claim the entire remodel on all 3 as a total or would you list them out for each unit? Does it matter? I am thinking of doing the latter.

That depends on how you've set things up in TurboTax. If you're reporting  the rentals as 7 physically separate structures, then all costs directly associated with a specific unit get reported on SCH E for that specific unit. Even then, there are some things that would need to be split between the units. For example, say you have a structure that has 4 units in it and you're reporting each unit as a separate property. If you put a new roof on the structure you'd have to split that property improvement across all four units. Not all that difficult really.

Whereas if you elected to treat that 4-unit structure as a combined single unit by setting it up in TTX as a "multi-family structure", then there's nothing to split up and divide between those units.

Personally, I think it better to treat each unit in a multi-unit structure as it's own physically separate unit. Makes things easier and simpler under certain scenarios. For example, if things get bad and you have to move into one of the units as your primary residence, conversion from rental property to personal use is a breeze. Whereas if you're reporting income from the 4 units as a "multi-family" structure, converting 1 of the 4 units to personal use is a nightmare on the tax front.

Always look ahead at worst case possibilities and keep all your options open and as easy as you possibly and feasibly can. You've heard the saying, "Hope for the best, plan for the worst."  I've altered it a bit for my needs.

Hope for the best, ***PREPARE*** for the worst.

Planning and preparing are not the same.

[pnored]

Thank you for your comments I really appreciate it! It was very helpful to me!!!

Pulling out the appliance was a figure of speech.... claiming them separate on the asset report is what I was referring too.....