Rental expense deductions

[alien3]

This is a two part question;

1)  We live in a federal declared disaster area (Dallas) due to the freeze in January 2021.

We own two rental houses that sustained major freeze damage to the pool equipment that cost approximately $10,000 each to repair.

Do I list these expenses on Schedule E as a repair expense, or somewhere else?

2)  One of the rental houses central air conditioning unit went out and required replacement.

Do I list these expenses on Schedule E as a repair expense, or somewhere else?

[Critter-3]

10K for a repair is expensive ... sounds like you replaced the system and not just repaired a leak.  

If you did replace the system with a new unit  then that and the new AC are both new assets to be depreciated and not expenses to be deducted.  

[alien3]

The entire pool equipment plumbing froze and burst due to the sudden and unexpected deep freeze.  That's why our area was declared a federal disaster area.  Not "just a leak".

[Critter-3]

If you did replace the system with a new unit  then that and the new AC are both new assets to be depreciated and not expenses to be deducted.  

[alien3]

Even though in a federal declared disaster area?  Don't different rules apply to the frozen pool equipment?

[Critter-3]

The property was not totally destroyed ... so you don't have a casualty loss to report.  If you did get some insurance money for the damage then it is either reported as income on the Sch E and the repairs it paid for entered as repair expenses on the Sch E  or  neither is entered ... your choice.  

Deducting the Cost of Cleanup and Repairs

The cost of repairing or replacing business property damaged or destroyed in a casualty event is not part of a casualty loss; neither are cleanup costs. The cost of restoring property destroyed or damaged due to a casualty event ordinarily must be capitalized (depreciated) and added to the property's basis.

https://www.nolo.com/legal-encyclopedia/how-landlords-can-deduct-casualty-theft-losses-their-taxes.h...

[Critter-3]

What’s the Difference? Capital Improvements vs Repairs

When thinking about capital improvements vs repairs you need to have a clear understanding of the definitions of each.

A capital improvement is a durable lasting upgrade, adaptation, or enhancement of the property which significantly increases the value of the property. Often this involves structural work or restoration.

A repair on the other hand includes both routine and preventative maintenance, ie. work carried out when an asset “breaks” or before, so long as the work is carried out to restore the asset to the original condition. This includes action taken to prevent further deterioration and to replace or substitute a component at the end of its “useful life”. A maintenance task cannot be deemed a repair if it improves upon that original condition.

The reason knowing what a capital improvement is vs a repair is that the expenses need to be treated differently. The cost of capital improvements cannot be deducted at the end of the tax year like regular repair expenses. Instead, the cost needs to be added to the cost basis of the property and depreciated. The benefit of this is that it can reduce the tax hit associated with capital gains and depreciation recapture when the property is sold.

A capital improvement would include major work such as refurbishing the kitchen converting a room or attaching a conservatory. A repair on the other hand is general maintenance, for example, repairing a tap, repainting surfaces, fixing the air conditioning, or maintenance on appliances. The cost of repairs and maintenance can be deducted at the end of the tax year.

https://www.landlordstudio.com/blog/capital-improvements-vs-repairs/

[Opus 17]

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@alien3 wrote:

This is a two part question;

1)  We live in a federal declared disaster area (Dallas) due to the freeze in January 2021.

We own two rental houses that sustained major freeze damage to the pool equipment that cost approximately $10,000 each to repair.

Do I list these expenses on Schedule E as a repair expense, or somewhere else?

2)  One of the rental houses central air conditioning unit went out and required replacement.

Do I list these expenses on Schedule E as a repair expense, or somewhere else?

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You first have to understand the difference between a repair and an improvement.  An improvement adds value or extends the useful life of the property, while a repair restores the property to as-was condition.  A new AC condenser sounds definitely like an improvement because it extends the life of the cooling system.  For the pool, it depends on what was actually done.  A replacement of major components would probably be considered to extend the useful life, but only you know what was done.

Second, did you have insurance coverage?  You can only declare a casualty loss for the amount not covered by insurance--if you have insurance but don't make a claim, you can still only deduct the amount that you would have paid after making a claim.  

Next, let's think about a casualty loss.  The amount of the casualty loss is not necessarily the cost of repair, the amount of the loss is the loss in property value (determined by an appraisal) considered before and after the storm.  If you restore the property to its previous condition, the cost of restoration will usually be accepted as the amount of the loss.   If you restore the property to better condition, then cost of restoration is not a fair estimate of the loss in value. Your property doesn't have to be completely destroyed to have a casualty loss, it just has to lose value.  

https://www.irs.gov/pub/irs-pdf/p547.pdf

Next, you have the option to deduct a 2021 casualty loss on your 2020 tax return, if that would create some advantage for you.  See the instructions to form 4684, and you would have to file an amended 2020 tax return to do this.   Or you can take the loss on your 2021 tax return.  The amount of deduction is the loss in fair market value due to the disaster, which might be the cost of restoration. 

https://www.irs.gov/forms-pubs/about-form-4684 

Deducting the casualty loss also subtracts that amount from your property's adjusted cost basis, which will affect future depreciation calculations.

Then separately, the cost of restoration improvements are added to the property's cost basis as an asset or improvement and you begin taking depreciation.  The cost of restoration repairs are a rental expense on the tax return for the year in which they were actually paid. 

[alien3]

TurboTax walked me through this and a lot more convoluted than one would think. 
Offers a lot more insight than comments here, but I appreciate the input.
Issue resolved.