Mental check: repairs vs improvements

[redrocker]

I had a long cleanup process of a rental unit in 2016 after some tenants moved out having been there for at least 3 or 4 years (I owned it for their last two years of tenancy). I did a lot of the work myself and as a consequence I have a huge envelope of receipts and a spreadsheet that has the materials/tools purchases as well as the few times I hired out help.

I'd still consider myself "new" to filing taxes as a landlord so something I hadn't thought about much til lately was distinguishing between repairs and improvements. For one off jobs, maybe that's easier. However I think the line blurred a bit, especially when considering my initial objectives differing from the finished project.

I wanted to gauge opinions on some of the projects that I undertook to see how others would classify them if they were in my shoes:

1. refinished wood floor in one bedroom as well as a flight of stairs - <$400 in materials/tool rentals

2. installed ducting for bathroom and stove since not previously existing (bathroom previously was vented to ceiling space between 1st and 2nd floor) ~$150 in materials

3. shower was falling apart due to being tiled on top of sheetrock that had become water damaged and tub wasn't even attached to the wall anymore - ended up reorienting tub since the necessary demo was extensive. Additionally, sub flooring in half the bathroom was rotted, so flooring had to come up. Retiled the shower, and put vinyl planking down in the bathroom. I hired out the install of tileboard, tile, and flooring. - ~$2200 in material and labor

4. With the bathroom subfloor being addressed, noted that the sewer lines were undersized, in two locations pipe joints were loose/broken, and had alternating mix of pvc/abs as well as being severely undervented. Corrected this, hired plumber. $1100 material & labor

5. replaced tub, shower faucet, tub drain, toilet since I had to pull all fixtures out to demo out the rot anyway $300 in materials (ebay and thrift store for all but the toilet)


6. Sanded, stained, replaced hardware on existing kitchen cabinets ~$100 in materials

7. replaced existing countertop as it was water damaged around the sink and delaminated throughout (w/ in kind formica countertop) ~$450 in material

8. hired electrician to correct several "spiderwebs" as well as install designated line for refrigerator since the whole kitchen was previously on one circuit  - $800 in labor

9. replaced porch railing after historical district cited me for existing railing as being "historically inappropriate." Hired welder to replace. New railing is definitely nicer, old one was painted hollow aluminum, new one is solid metal $1125 material and labor

On projects where it's a judgement call am I correct in assuming that it's more advantageous (or just simpler going forward) to classify as a "repair" instead of an "improvement" or does that depend on my personal tax situation? I intend to hold this property for at least 5 more years but likely no more than 10yrs at this point, and I'm in the 15% tax bracket. Thanks for any comments on classifying this work properly for tax purposes.

[Ocinfo]

You're going to get a lot of different opinions. I am not a lawyer or accountant but I am a landlord. In all likelihood, all of these expenses are improvements. This is partially because of the nature of the items and partially because you undertook multiple projects that materially increased the value of the home. If you had just painted cabinets, that would be a repair but once you start replacing counter tops, adding new circuits , etc... it makes it look much more like an improvement. Again, you're going to get a lot of opinions and it'll be up to you how much you are willing to push the envelope.

There is a lot of discussion and guidance available online so I would suggest reading the IRS guidance at a minimum.

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[CareCPA]

I actually differ in my opinion, I think a lot of these would qualify for repairs. At the end of the day, whoever is signing the return (presumably you) has to be comfortable with how aggressive you're being.

A resource I often use: http://www.kbkg.com/nationwide/brochures/KBKG-repairs-decision-tree.pdf

From the IRS' perspective, the conservative way to treat them would be to capitalize them. This pushes out the expense over a longer period of time, meaning they get their tax money sooner.
It would be more advantageous for you to expense as much as you can.
The answer is likely somewhere between the two.

[SeattleCPA]

I've got a lengthy blog here:

http://evergreensmallbusiness.com/small-businesses-and-the-new-sec-263-repair-regulations/

which pretty completely describes the current regulations for handling repairs and references all the primary sources , but here's a relevant quote:

"...capitalize any repair or maintenance expenditures which “better” or “restore” a property or asset, as well as any expenditures which adapt an asset or property so it’s again “like new” or can be used for something different..."


I think you capitalize most of the stuff... and then probably use the partial disposition rules to remove the costs of the old stuff you're replacing.

[Tiger Stache]

the majority of these are repairs, you're bringing something back to baseline condition. To me, it looks like 2 and 8 could be counted as improvements because you were just making something better, you weren't refinishing or replacing rotted stuff.

[redrocker]

"...capitalize any repair or maintenance expenditures which “better” or “restore” a property or asset, as well as any expenditures which adapt an asset or property so it’s again “like new” or can be used for something different..."

Thanks for the link. That was definitely an informative post. It sounds like the IRS would prefer to distinguish between repair/improvement simply in terms of an arbitrary number (be it $500 with applicable accounting policy or lesser of $10k/2% of building cost). And when using the latter criteria it still leaves a lot of room to game the rules if you stretch a big project over the last months of a year into the next.

I guess what I struggle with is the emboldened part of the above quote. Because technically any repair makes something "better" or "restores" it to functional use. So even with the guidance, there is inherent subjectivity.

[SeattleCPA]

I think the phrases can be used to gain insight into what should be capitalized.

E.g., adapt... if you adapt something to a new use--the attic or the basement is now a heated room--that's capitalized.

Another example... better... if you make something better--the bedrooms now all have another window or a fireplace--that's capitalized.

A final example... restore... if you take a beat up house and restore it to like-new condition--that's again capitalized.

In that blog post I referenced, you can get to relevant treasury regulations that give examples of betterments or adaptions. Those examples can provide more help too.

Also, as you noticed, the safe harbor rules provide some "loopholes" you can use to expense lots of stuff.

P.S. I think the $500 limit in the post is now a $2500 limit... The regs changed shortly after they were published.

[redrocker]

P.S. I think the $500 limit in the post is now a $2500 limit... The regs changed shortly after they were published.

Yep, I was just about to come ask about that. I was trying to capitalize some of the above expenses in TurboTax by adding an asset to the property and I when I submitted a question about which category of asset to use, the response I got (from either TT or a fellow user, not sure which) said I should just use the de minimis Safe Harbor exemption since the expense is under $2500.

IRS Notice 2015-82 seems to suggest I can expense items under $2500. Which would cover all of the above mentioned items. Unless I'm overlooking a restriction.

[nawhite]

I definitely fall on the "deduct all the things aggressively" side of things but I wouldn't feel bad about justifying things as follows

1. Refinishing is expected maintenance. Not a repair or an improvement. It's like calking windows.
2. It wasn't up to code and was hitting the house as is so it's a repair not an improvement.
3. Assuming it is approximately the same quality as it was before it became water damaged, it's a repair.
4. Replacing the broken pipe is 100% repair. Upgrading the size of the pipes I could see as maybe being an improvement but if have to re read the rules.
5. Improvement. You decided to upgrade them because it was convenient.
6. Maintenance. Again, wood needs to be refinished periodically.
7. "Damaged" means it's a repair if replaced with something similar.
8. Code/fire issues are repairs. Adding a circuit is probably an improvement though.
9. Definitely just an improvement.

[jwright]

I would expense everything less than $2,500 under the de minimis safe harbor rules.  Which sounds like it is almost everything on your list.

[MustacheAndaHalf]

Think of how you'll explain each item to the IRS.  For all those items where you start by explaining what was broken, the IRS will want to say you fixed something that was broken.  Maybe you aren't likely to be talking to an IRS agent about it, but it's one way to come up with a conservative approach.

I actually view venting into the attic as a code violation that was corrected - so I'd say #2 was a repair.  An inspection should have revealed something like that, especially since it can lead to rot in the attic from the venting of moist air.  But other opinions may vary, and I'm just a layperson.

Maybe again showing my layperson, but #9 sounds like the strongest candidate as an improvement.  You had a fully functioning railing, and the City forced you to replace it with something else.  The fact you can even document this demand reinforces it as an improvement in my mind.

[redrocker]

Maybe again showing my layperson, but #9 sounds like the strongest candidate as an improvement.  You had a fully functioning railing, and the City forced you to replace it with something else.  The fact you can even document this demand reinforces it as an improvement in my mind.

Agreed. That was actually the specific item I asked for assistance from TurboTax in categorizing as an improvement, since it seemed like it might be a land improvement (since fencing was one of the examples) but then it tried to get me to take a special depreciation deduction that sounded farm related. TT responded back it should be deducted under the de minimis safe harbor.

[KeithTax]

Redrocker, everything you list is a deductible repair since you are restoring the property to its original value, not improving it. Also, the repair regs allow a deduction on any expense $2,500 or less with a simple election. (Sec. 1.263(a)-1(f) de minimis election) There should be an election screen in your software where you can make the election.

For improvements up to $10,000 per project you can classify the improvement as a deductible repair by make a Section 1.263(a)-3(h) election. This election is per project and is made on the 4562 screen of most software.

My credentials: I write The Wealthy Accountant blog and have over 30 experience in the industry. I also advise/prepare taxes for MMM.

[redrocker]

My credentials: I also advise/prepare taxes for MMM.

That's pretty legit!

Thanks for the details!