Bonus Depreciation vs De Minimis Safe Harbor and North Carolina Rules for Rental Property

[kathryn91]

Hi!   We have just purchased a new rental property under a 2 member LLC.   We have a number of expenses ranging from appliances, capital improvements to repairs.  I would say that a majority of those expenses will be less than $2,500 per item so I'm hoping we can use the de minimis safe harbor rule for some, but there will be a couple capital improvements that will obviously exceed that (i.e. renovation to a bathroom).   Our total expenditures will not exceed $25,000 this year.   (Side note:  we have rented the place and the renovation will be done while occupied so my understanding is that we will be able to expense some of the items that would have normally been considered capital improvements before renting.)  So, I could use some advice on:

1) What is the best way to handle these expenditures?  We had huge capital gains this year from stock we sold to pay for the property so having a large loss with the LLC would certainly be beneficial.   With that in mind, it seems to me what is most beneficial is:

1. For Depreciable Assets like appliances and other improvements under $2,500:  use the de minimis safe harbor election.  Question:  it looks like the maximum election allowed is the lesser of $10,000 or 2% of unadjusted basis of property – we bought the house for $169,050 (this excludes the land) so does that mean the most we can write off with the safe harbor election is $3,381?
2. For Depreciable Assets not eligible for the safe harbor: take Bonus Depreciation (instead of Section 179) because Bonus Depreciation is not limited to taxable income and can create a loss (thus offsetting our capital gains).   So, we would use the Safe Harbor election up to its maximum and then write the rest off with Bonus Depreciation.
3. Can anyone think of a reason that I would not want to use Bonus Depreciation instead of Section 179 or other options?

2)  North Carolina rules – it seems like Bonus Depreciation is the obvious way to go…. but there is the issue of the state taxes.  Apparently North Carolina did not follow the Federal rules with Section 179 or Bonus Depreciation.  (FROM NCDOR website “For tax years 2016 through 2020, individual taxpayers are required to add to federal adjusted gross income and corporate taxpayers are required to add to federal taxable income 85% of the amount allowed as bonus depreciation under section 168(k) or 168(n) of the Code for property placed in service during the tax year. )    From what I can tell It looks like this is still true for 2022 and that if we use the Bonus Depreciation we have to add 85% of that back to Taxable Income/Loss. Then, in the next 5 years we can deduct 20% of the bonus depreciation that was added back to the federal AGI... so at least there's a future deduction allowed.   This seems to be true with Section 179 as well but in that case it looks like you don’t have to add the 85% back until it exceeds $25,000 (not applicable in our case).    So using this example are my calculations correct?:

Federal Taxes

$2,000 rental income

(3,000) de minimis safe harbor expenses (based on 2% unadjusted basis – would love to deduct 10k but looks like we can only do $3,381?)

(4,000) other ordinary expenses

(5,000) net loss before depreciable assets

(15,000) Bonus depreciation for eligible depreciable assets like capital improvements, appliances, etc.

($20,000) LLC’s loss for Federal Tax purposes and which can be used to offset capital gains

North Carolina taxes:

$2,000 rental income

(3,000) de minimis safe harbor expenses

(4,000) other ordinary expenses

(5,000) net loss before depreciable assets

(15,000) Bonus depreciation for eligible depreciable assets like capital improvements, appliances, etc.

+$12,750  Add back 85% of Bonus Depreciation 

($7,250)  LLC’s loss for STATE Tax purposes and which can be used to offset capital gains

Are my assumptions/calculations correct?   And if that’s the case it seems to me that it’s better to use the safe harbor election, and expense as much as I can, instead of using Bonus Depreciation because I lose that benefit on my NC Tax return.   Are there other options I'm missing?

3)  How do I handle cross year capital improvements?   We are planning on remodeling the bathroom – if we pay for half of that in 2022 and the remaining half in 2023 can we use Bonus Depreciation each year for the amount paid that year?   If so.. there is the complicating factor that in 2023 bonus depreciation is reduced to 80% instead of 100%?

Thanks in advance!

Kathryn

[tagteam · Accepted solution]

You sre going to need someone with knowledge of Nort Carolina tax law and regulations to answer your entire question.

However, one critical point of misunderstanding involves the deminimis safe harbor election. You can use Treas. Reg. §1.263(a)-1(f)(1) to expense (immediately deduct) up to $2,500 (per invoice) of tangible personal property.

As a result, the appliances you purchased (and other property costing up to $2,500) can be deducted by making the §1.263(a)-1(f)(1) election. 

See https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations#Ad...

[kathryn91]

Hi, thanks for responding and for the information.   I definitely think the de minimis safe harbor election will be something we will use.  I had read the IRS information you provided but I wasn't sure about the total maximum allowance.  If you look at my first point above:

1. For Depreciable Assets like appliances and other improvements under $2,500:  use the de minimis safe harbor election.  Question:  it looks like the maximum election allowed is the lesser of $10,000 or 2% of unadjusted basis of property – we bought the house for $169,050 (this excludes the land) so does that mean the most we can write off with the safe harbor election is $3,381?

I had read the IRS information you referenced and I took that calculation from the IRS website:

• 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

It sounds like a number of our purchases (such as appliances) will be eligible to be deducted immediately under the safe harbor election.... but based on our specific situation above are we limited to $3,381 total of all the eligible items?   

• So if we bought 4 appliances @ $1,000 apiece are we only able to write off 3 of them for $3,000?  And then use bonus depreciation on the remaining $1,000 ?
• Or.. can we write off up to $10,000?

Thanks.

[tagteam · Accepted solution]

I believe you are conflating the Section 1.263(a)-1(f)(1) deminimis safe harbor election with the safe harbor election for small taxpayers. For your purposes, you would use the former, not the latter.

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@kathryn91 wrote:

It sounds like a number of our purchases (such as appliances) will be eligible to be deducted immediately under the safe harbor election.... but based on our specific situation above are we limited....

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No, you are not limited if you make the Section 1.263(a)-1(f)(1) deminimis safe harbor election. The limitation imposed by that section is $2,500 per invoice (generally item) and there is no total limit provided each invoice is $2,500 or less.