repairs or improvements

[bigbunny101]

Hello

The fine line between expenses and improvements probably was discussed countless times. Nethertheless wanted to double check with expert opinions:

-New AC unit due to older units compressor failure and being a fire hazard. Since no more older Freon units are available was forced to buy and replace a new unit with the new refrigerant

-Deck rotten joist and wood repairs. The deck was attached to the house. The deck joists looked rotten and perhaps a hazard to the tenants. Only parts of the original deck was repaired and reinforced. No additions were made.

-French drain redo/repair due to water leaking in the basement during heavy rains. It seemed the older drain failed. Still the new drain needed additional waterproofing inside to completely block the moisture. Do I divide the project into inside and outside waterproofing?

What about the miles traveled for repair, vs improvement purposes? are they treated the same for the year?

[Opus 17]

One definition of an improvement is that it extends the useful life of the property or one of its subsystems.  Replacing the air conditioner extends the life of the HVAC system, and reworking the French drain and foundation waterproofing extends the life of the foundation. I would consider those both to be improvements and I would not think that you should split the interior and exterior waterproofing since they are both part of improving the foundation.   Because the deck work was targeted to specific areas, I would consider that more along the lines of a repair.

If you are traveling to maintain your rental property and to supervise work being done, I would not think you would have to capitalize and depreciate your mileage as part of the cost of an improvement. I think any travel you do to maintain your property is an expense.

[beezer33]

Sorry, I believe those are all maintenance/repair category. Consider that those items could have been counted as CAP IMP one time before, and can't be repeated. Feel free to inquire further.

[AnnetteB6]

I will add one more opinion to the mix.  I agree with Champion Opus 17 that only the deck work would be considered a repair.  Had the entire deck been replaced, then it would have been an improvement.

Additionally, all of your miles related to maintaining the property are treated the same.  

@bigbunny101

[Opus 17]

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@beezer33 wrote:

Sorry, I believe those are all maintenance/repair category. Consider that those items could have been counted as CAP IMP one time before, and can't be repeated. Feel free to inquire further.

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Why can't you make capital improvements more than once?  If you own a property long term, you might well have to replace the roof or air conditioner more than once over 20 or 30 or 40 years.

If you only want to ask someone who will tell you what you want to hear, ask your office or fishing buddies.  Replacing a compressor because it can no longer be repaired is an improvement, since it extends the working life of the HVAC system.  And there's a difference between patching a crack in the foundation and trenching out the whole house to replace a failed French drain. 

[bigbunny101]

Thanks all. It seems to me that any big ticket item can be argued into an improvement by the IRS. Why take chances. Even a 2k deck repair over a relatively large deck, has some bias to it, as it does extend the life of the structure but is rather immaterial to the structure as a whole. 

[Opus 17]

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@bigbunny101 wrote:

Thanks all. It seems to me that any big ticket item can be argued into an improvement by the IRS. Why take chances. Even a 2k deck repair over a relatively large deck, has some bias to it, as it does extend the life of the structure but is rather immaterial to the structure as a whole. 

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Why do you think the IRS wants to drive you into improvements?  So you can deduct a large expense all at once instead of amortizing it?  Doesn't make sense to me.

I think @Carl has real estate expertise.  I've said all I can on this topic. 

[bigbunny101]

I am confused by your reply. Expenses are deducted and improvements - amortized? 

How do you deduct an improvement?

[Carl]

Why do you think the IRS wants to drive you into improvements?

With passive income like rental property, it's simple really. When you take the required depreciation it does not reduce your AGI one penny. It reduces your cost basis basically.

But in the year you sell and have to recapture all that prior year deprecation, it does add to your AGI and therefore has the possibility of pushing you into a higher tax bracket resulting in more tax income for the IRS.

There's two ways to look at recaptured depreciation. One way is to say it reduces your cost basis in the asset. The other way is that the recaptured depreciation is added to your sales price. Either way, your taxable gain on the sale is higher. If sold at a loss, your tax deductible loss you can claim is lower.

The fact that recaptured depreciation is taxed at a maximum of 25% doesn't help many really, as most folks who normally fall into the 12% tax bracket will find the taxable gain on their sale pushes them into the 22% bracket. Those folks who normally fall in the 22% tax bracket will find the taxable gain from the sale will push them into the 24% tax bracket.

Add to that, a vast majority of folks have no understanding at just how tax brackets work. For example, a person in the 22% tax bracket incorrectly and mistakenly believes that all of their income is taxed at the full 22%. That's just not true.

[Opus 17]

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@bigbunny101 wrote:

I am confused by your reply. Expenses are deducted and improvements - amortized? 

How do you deduct an improvement?

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Sorry, I think I was thinking the right thing but wrote the wrong thing, or I read your post wrong.  I also didn't realize that one of the intermediate posts was written by someone else.

My thinking is that the IRS will prefer you to classify things as improvements, since, averaged out over all landlords, it will tend to increase their tax collections.  However, that does not mean you must take a risk avoidance strategy out of fear—you should feel empowered to take every legal deduction you can prove and that is consistent with the law and with financial principles.

"any big ticket item can be argued into an improvement by the IRS"

I would not go that far.  Let's think about the deck, and I will assume that a deck has a 30 year life with proper maintenance. Maintenance includes staining or sealing, to prevent water damage, as well as replacing the occasional nail pop or cracked board.  If you need to replace 20-30% of the surface, including some of the joists, the rest of the deck is still original, and you haven't extended its life, you're still going to have to replace it at 30 years.  And painting is clearly an expense, repainting the entire house every 10 years between tenants does not become an improvement just because it cost 10x more than repainting 1 room per year.  

I've already given my reasons why I think the foundation and AC are improvements but the deck is a repair.  It's ultimately up to you to justify your tax treatment if audited. 

[Carl]

Then there are those who have no conseptual understanding of just what depreciation really is, and an even less understanding of the difference between capitalization/capitalized costs, and amortization/amortized cost. So here's the simplicity of it.

Cost associated with the acquisition of the property are capitalized and depreciated over time. For example, title transfer fees paid at the courthouse to change the title of the property into the buyer's name.

Cost associated with the acquisition of the loan used to purchase the property, are amortized and deducted over time.  As an example, loan application fees and points paid on the loan. (Points are basically pre-paid interest that is paid in advance, but can also include other expenses associated with the loan.)  For rental property, these costs are deducted over the life of the loan.

So depreciation reduces your cost basis in the asset, while amortization reduces the amount of income made with that asset, that is taxable.

It's an odd setup, as if you have a 15 year loan your amortized cost will be completely deducted before the property is completely depreciated. If it's a 30 year loan, the property will be completely depreciated a few years before all of your amortized deductions are realized.

One good thing about the amortized deductions, is that if you sell the property and pay off the loan with the sale proceeds, any remaining amortized amounts left are deducted in the year you sell. Likewise, if you refinance the property to a new loan (so long as it's not with the same lender) then you can deduct the remaining amortized costs on the old loan, and start them anew with your amortized cost incurred in acquiring the new loan.

[bigbunny101]

I came across Bonus Depreciation allowance part of the new tax act. The tricky part is the 20 years rule for the lifetime of the asset.

https://www.fool.com/millionacres/taxes/depreciation/how-bonus-depreciation-affects-rental-propertie...

Does anyone have any more guidelines what would be the depreciation period for french drain , inside water proofing and deck repairs? water pump? do they inherit the 27.5 years or maybe 15 years like landscaping?