How do I treat rental property repairs before placing it into service?

[okrandy]

I purchased a property in the fall of 2016.  I made a few repairs and upgrades in 2016.  The property was placed in service in 2017.  Do I capitalize the repairs? If so, over what period do I capitalize them?

[Coleen3 · Accepted solution]

Yes. You would have to capitalize them. You can deduct expenses once the property is placed in service.

Placed in Service

You place property in service in a rental activity when it is ready and available for a specific use in that activity. Even if you aren’t using the property, it is in service when it is ready and available for its specific use.

Example 

On April 6, you purchased a house to use as residential rental property. You made extensive repairs to the house and had it ready for rent on July 5. You began to advertise the house for rent in July and actually rented it beginning September 1. The house is considered placed in service in July when it was ready and available for rent. You can begin to depreciate the house in July.

[okrandy]

So I would capitalize the repairs according to their specific nature just like I do other expenses once the unit is in service.  The capitalization time period would be the same as the depreciation schedule?

[Coleen3]

Yes.

[okrandy]

Got it.  Thank you very much.

[Coleen3]

My pleasure.

[filingsince66]

https://www.irs.gov/faqs/sale-or-trade-of-business-depreciation-rentals/depreciation-recapture/depre...

Question

We have incurred costs for substantial work on our residential rental property. We replaced the roof with all new materials, replaced all the gutters, replaced all the windows and doors, replaced the furnace, and painted the property’s exteriors. What are the IRS rules concerning depreciation?

Answer

Replacements of the entire roof and all the gutters, and all windows and doors of your residential rental property:

• Are generally restorations to your building property because they're replacements of major components or substantial structural parts of the building structure. As a result, these replacements are capital improvements to the residential rental property.
• Are in the same class of property as the residential rental property to which they're attached.
• Are generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention as residential rental property.

Repainting the exterior of your residential rental property:

• By itself, the cost of painting the exterior of a building is generally a currently deductible repair expense because merely painting isn't an improvement under the capitalization rules.
• However, if the painting directly benefits or is incurred as part of a larger project that's a capital improvement to the building structure, then the cost of the painting is considered part of the capital improvement and is subject to capitalization.
• In this case, the painting is incurred as part of the overall restoration of the building structure. Therefore, the repainting costs are part of the capital improvements and should be capitalized and depreciated as the same class of property that was restored, as discussed above.

Replacement of the furnace in your residential rental property:

• Is generally a restoration to your building property because it's for the replacement of a major component or substantial structural part of the building's HVAC system. Therefore, the furnace replacement is a capital improvement to your residential rental property.
• As with the restoration costs discussed above, these costs are in the same class of property as the residential rental property to which the furnace is attached.
• Is generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention as residential rental property.

Note: A taxpayer whose average annual gross receipts is less than or equal to $10,000,000 may elect to not capitalize amounts paid for repairs, maintenance, or improvements of certain eligible building property if the total amounts paid during the taxable year for such activities don't exceed certain dollar limitations. For more information, see Safe Harbor Election for Small Taxpayers in Tangible Property Regulations - Frequently Asked Questions.

[Carl]

We replaced the roof with all new materials, replaced all the gutters, replaced all the windows and doors, replaced the furnace, and painted the property’s exteriors.

Understand that there is a vast difference between a repair and a property improvement. Everything you mentioned is a property improvement, hands down. That includes the painting only if you include it with all the other stuff combined. The painting by itself is not a property improvement, as explained in the definitions below. But it is a property improvement if include as "a part of" any one or more of the other things you did.

Additionally, all of the property improvements you mentioned above are classified as residential rental real estate and depreciated over 27.5 years, starting from the date the property was placed "in service" as defined below.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence before, then this date is the day AFTER you moved out.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter "could" have moved in. That should be your "in service" date if you were asked for that. Vacant periods between renters count also PROVIDED you did not live in the house for one single day during said period of vacancy.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days you lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence or 2nd home, after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.

RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

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.

Cleaning & Maintenance

Those expenses incurred to maintain the rental property and it's assets in the useable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent are not deductible.

Repair

Those expenses incurred to return the property or it's assets to the same useable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent are not deductible.

Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.

However, when you do something like convert the garage into a 3^rd bedroom for example, making a  2 bedroom house into a 3 bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.

[filingsince66]

If by "specific nature" you meant depreciate each repair/replace according to each item's class life, I believe the answer is no. All of the expenses involved with preparing the house, prior to the date the property is ready to place in service, are lumped together into the cost basis of the house and depreciated over 27.5 years. Please note the copy and paste with the link from the IRS FAQs.

Suffice it to say that you would be able to write off expenses over a shorter period, for anything you can put off doing/buying until after the date the house is ready for service. For example you could hold off on painting the exterior until after the date the rental home was considered to be in a state of readiness for service (or even after tenants move in).

[cottagecharm11]

Our situation is similar, we started construction in the spring of 2021, placing the rental in service on Aug 3, 2022, the date  we received the Certificate of Occupancy, it was also rented about the  same time. In 2021 we starting using our previously owned tractor for major work, digging a 700' ditch for electrical and water lines. We plan on using receipts for the diesel fuel, oil, & minor repairs as capital expenses. Our question is do we start depreciating the tractor on the same date the rental was placed in service, Aug. 3, 2022?

[Carl]

Our question is do we start depreciating the tractor on the same date the rental was placed in service, Aug. 3, 2022?

Is the tractor a permanent rental asset? I ask, because I seriously doubt the only thing you will use the tractor for is "that" specific rental property. Therefore it would not be a rental asset. So the tractor would not be classified as a rental asset of any type in any way, shape or form.  However, you can claim the "actual expenses" incurred using the tractor, such as fuel costs.

We plan on using receipts for the diesel fuel, oil, & minor repairs as capital expenses.

That's what I would do, and if the expenses section has no category for those, I'd list/itemize them in the Miscellaneous Expenses section.

As I understand/interpret your post, the tractor "is not" a rental property asset, and "is not" something that you plan to be utilized on a routine/regular/recurring basis for the production of income. So I would not list it as a rental asset. However, I see no issue with actual costs incurred to operate the tractor *for maintaining/repairing/improving" the rental property.

[cottagecharm11]

This house does sit on a 35 acre tax lot of sage brush covered range land.  There will be barbed wire cross fencing installed eventually, and some of the existing fencing replaced. The landscaping for the portion of land that would reasonably be considered the actual yard still needs to be done. Since we live in an area with snow,  there will also be snow removal for the 200' driveway to this house, plus the 1/3 of a mile roadway that runs across county owned land to access the nearest road. We are responsible to keep it cleared and maintained, we live next door. Our 50 acres adjoins the 35 acres, so the maintenance of the 1/3 mile roadway benefits us too. We are conservative when doing our taxes and don't want to try to get away with anything. Does this added information make a difference for placing the tractor in service? Thanks so much for answering our question, we really appreciate your help!

[Carl]

Does this added information make a difference for placing the tractor in service? Thanks so much for answering our question, we really appreciate your help!

Yes and no. Unfortunately, with my three rentals I don't have an experience of my own to draw from and relate to your situation with. But I'll do my best based on my own "line of thinking" as I make what will probably be a futile attempt to imagine such a situation.

First let me start by stating the obvious. Understand that depreciation is not a permanent deduction. At some point in your life there will come a time when you will no longer have that tractor for whatever reason. Believe it not, there are those who do not realize that depreciation is not a permanent deduction. So at some point in the future when you sell or otherwise dispose of that tractor, all depreciation taken on it has to be accounted for. Typically, when you sell an asset, you are required to recapture all depreciation taken on that asset and pay taxes on it in the year you sell or otherwise dispose of it. Two things about that.

1. Recaptured depreciation is taxed anywhere from 0% to a maximum of 25%. It just depends on the numbers.

2. Recaptured depreciation is added to your AGI in the year of recapture. Depending on the numbers, that could bump you into the next higher tax bracket.

Now when it comes to selling used motorized equipment, (particularly cars) even with depreciation recapture taken into account, it's not common to show a taxable gain on such an asset anyway. But you still have to account for that depreciation even though it may not be taxed.

One thing for you, is that the tractor is not a 100% business asset. Since it's used for both personal use on your 50 acres and business use on the rental 35 acres, that means "at best", you have 35/80 or 43% business use. But that's assuming you will use it "exactly" 43% of the time for the rental, every single year.  On a realistic front, you'd have some years where it might be less than 43%, and other years where it's more than 43%.  I'm sure the business use percentage will change every year, and the TTX program can not deal with that in a way that would allow the program to track the year to year depreciation correctly. In my opinion (and we all know what opinions are like!) that would complicate the manual book keeping required on your part, to keep things straight. You'd also most likely have to perform "over-rides" in the program every year, to keep things straight in the program. Two things happen when you do an over-ride.

1. You can not e-file the tax return. You have to print, sign and mail it to the IRS. Same holds true for the state return, if your state taxes personal income.

2. A program over-ride will void the TurboTax 100% Accuracy Guarantee.

So if I were in your shoes, I would just go with actual costs. For example, since the driveway is shared by you and the tenant, you can claim 43% of the cost of fuel used to clear snow off the driveway as a maintenance expense. Whereas if you use the tractor to dig a hole for a new septic tank for the rental property, then 100% of the fuel costs for that would be a valid rental expense.

I'm confident others will drop in here with more information, and suggest you consider all avenues before making a final decision. Generally, (not always) once a path is chosen on the tax front, it's either impossible or extremely difficult, time consuming and costly to "change your mind" later.

In my own experience, what may be easy and cost saving on the tax front today, has a decent potential to "bite you in wallet" later.

[cottagecharm11]

It sounds like a big headache, and not worth the bother to depreciate the tractor considering what you have said. Thank you so much for your well thought out answer. 

[Carl]

I agree on the big headache, as that's exactly why I don't claim any vehicle expenses on any of the three rental properties I have. The so-called "savings" is just not worth all the time and effort. Especially since you have to recapture vehicle depreciation *and* pay taxes on it later. Save a little now, just so you can pay a lot more later.