Repair or Improvement... or Both?

[heimanjj]

Last year (2019) I had repair work done on a rental property I had purchased that year. Wood rot near the foundation was discovered and repaired. Because of the location, two new large windows had to be installed (to replace the older ones that couldn't be put back in). Edit: To be clear, I did not have a choice about the windows, since it was required to be brought up to code the minute the old ones had to be removed, it could be argued that the "improved" windows were a requirement in the repair.

Now the question is, what is this. Will the whole thing go under repair? Will it all go under improvement? Or will just the cost of the windows go under improvement (including or not including the cost of labor for the windows?)? 

Confusing enough yet? There's more.

This was paid for partially in 2019 and partially this year. Do I get to decide which portion I paid for? For example: if part of it is an improvement and part is a repair, can I decide to allocate the amt I paid in 2019 to the repair only?

Thanks in advance

[Critter]

Let us start with the last item ... when you finish paying for anything is immaterial.

Now if these improvements were done after you bought the property but before it was placed in service then all the purchase and improvement costs are combined and become the beginning basis for depreciation purposes. 

[heimanjj]

It is a 4 unit house and the unit that had the repairs was rented at the time and there was no displacement of the renter. 

My understanding of deductible expenses was that the tax year that you pay for the expense is when you deduct it. So I wouldn't be able to deduct something I hadn't paid for yet or deduct something that I had paid for in the previous year. Unless I'm wrong on this?

[Critter]

You are wrong ... you deduct the expense in the year the contractor/store gets paid even if you put it on a payment plan or credit card.  

Now since this was done while the property was being rented and since the corrections   included installing new  windows I would call it all an improvement which is capitalized and depreciated. 

[heimanjj]

Right, I think there might be some confusion here. I never put it on a payment plan or credit card, I just paid half of the bill in 2019 and half in 2020. And since I am directly paying the contractor, that is when they are getting paid. 

Since the window would be an improvement, I'm assuming I can take the cost of the actual wood rot repair (materials and labor) and mark that portion down as a repair expense? Or does the whole bill have to go towards capitalized and depreciated just because a portion of the work ended up being an improvement?

[Carl]

Everything you describe meets the IRS definition of a property improvement and has to be treated as such.

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.

When you paid for the improvement is irrelevant. Depreciation starts on the day that improvement is "available" for rent.  Your improvements are classified as Residential Rental Real Estate and depreciated over 27.5 years.

Be aware that residential rental property improvements do not qualify for the SEC179 deduction.  But there are some improvements that will qualify for the 50% Special Depreciation Allowance. The program has no earthly way of knowing if an improvement you enter qualifies for the allowance or not. You personally are expected to know. That's why the program will ask you if you want to take the allowance.

I can tell you right now that none of your improvements qualify for this, because all of your improvements become "a material part of" the rental structure.

It's when you have other rental assets you are depreciating, such as furniture if you are providing a furnished rental, that you can use the special depreciation allowance.

Overall though, I don't see why anyone would want to use the allowance, since for a vast majority of rental property owners it makes absolutely no difference to your tax liability anyway. It only helps the IRS get more taxes from you if you sell the property prior to passing the assets depreciable half-life.