Siding on commercial building

[Gretel]

Would you treat this as repair or a new asset?

[JG EA]

Would you treat this as repair or a new asset?

Does it add to the value of the house? Would one call it extensive remodeling or restoration? Or does it just fix part of the house that was damaged?

If it is the whole house - all new siding - I would view like a roof and call it an improvement.

You can sell that to your client by pointing out that at some point they may be very happy to have some basis left in the property.

[Gretel]

Does it add to the value of the house? Would one call it extensive remodeling or restoration? Or does it just fix part of the house that was damaged?

If it is the whole house - all new siding - I would view like a roof and call it an improvement.

You can sell that to your client by pointing out that at some point they may be very happy to have some basis left in the property.

Thanks, JG. These are good clients and do whatever I advise them to do, so no convincing problem.

I need to get more info from them. I know it is a very small building with wood siding, very simple, costs under $4,000 for the whole building. I tend to expense the costs if they replaced rotten wood, since it does not really add value and doesn't make the building last longer, or does it?

[kpangelinan]

Capital Improvement

I agree with JG, if it's the whole house, capitalize. it.

[Matt Sova]

Difficult answer

There is some case law on this issue as it pertains to a roof on a residential rental. I do not remember 100% of the details, but the TP expensed out the cost of reshingling the entire roof. I believe that the argument was that the property could not be rented without doing this, therefore, it was an ordinary and necessary expense in the current year. I would look to that case with regards to the siding. Did they have to re-side the entire building to bring it to code? Was it necessary to make it rentable according to local law? If not, then it would be capitalized.

[Gretel]

Thanks, in my small, rural town there not many codes to comply with and it definitely was rentable as it was, before the new siding was put on it. But then again, you should see the condition of places that are rented out.

I guess I rather capitalize then.

[Black Bart]

Repair or capitalize?

Would you treat this as repair or a new asset?

Gretel,

Here's an interesting and informative post by Burton Koss from a couple of years back in which he replied to a similar question:

Originally posted by NotEasy 04-03-2008

Depreciation question: A stairway of a rental property is broken and hazardous. So a new stairway is installed to replace it. Does the taxpayer have to depreciate it? Fully deductible in the current year?

Originally posted by Burton Koss 04-03-2008

An accountant I know recently made me rethink this particular question, i.e., whether something is a capital expenditure that must be depreciated or whether it is actually an ordinary business expense.

The underlying purpose of the expense, as well as the question of whether the expense was necessary to properly operate and maintain the business activity are the key factors.

On your fact pattern, my colleague would probably take the position that the replacement of the stairwell was an ordinary and necessary business expense, and classify it as repair or maintenance.

The text of the Internal Revenue Code that requires depreciation, and disallows a full current-year deduction, reads as follows:

Quote:

§ 263. Capital expenditures

(a) General rule

No deduction shall be allowed for—

(1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate.

In contrast, the section that authorizes ordinary deductions reads as follows:

Quote:

§ 212. Expenses for production of income

In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year—

(1) for the production or collection of income;
(2) for the management, conservation, or maintenance of property held for the production of income; or
(3) in connection with the determination, collection, or refund of any tax.

So the issue here is whether the stairway had to be replaced. If replacing it was the only reasonable way to eliminate the hazard, or if replacing it was effectively cheaper than repairing it, then the building owner did not pay for the work to increase the value of the property; rather, he paid for the work to maintain the property.

It may be the case that the value of the building increased a bit when the work was completed. But the text of the law can be read in a way that hinges heavily on the intent of the taxpayer.

When you add a deck or a swimming pool, you are not maintaining something that was already there, and I think it's a bit more cut-and-dried.

But my colleague argues that something like replacing a garage door or a kitchen sink, if that particular fixture has reached the end of its useful life, is not a capital improvement. It is simply maintaining the property. If you don't replace it, the property becomes uninhabitable, and may even violate building or housing codes. Correcting that kind of problem is remedial. You are not adding value to the property in a meaningful way. To the extent that the value may increase a little, that is incidental to the real underlying purpose of the work.

I'll concede that this is a gray area, that is highly dependent on individual facts and circumstances. If you tear up an old linoleum floor and put down expensive marble tile that is worth five times what the linoleum was worth when it was new, then perhaps you've made a capital improvement. But if you replace the floor with something comparable, and it had to be replaced, then you're just maintaining the property.

I think maybe some of us have a knee-jerk reaction that anything with a useful life of more than one year must be depreciated. I certainly thought that was how it worked most of the time. But now I've started looking at this from a different perspective. The useful life does not appear to be the only factor...

By the way: there are many areas of the tax law in which the IRS recognizes that the taxpayer's intent can have a significant impact on the tax treatment of an item. See, for example, the IRS discussion of the bona fide residence test for purposes of qualifying for the Foreign Earned Income Exclusion. You'll find this in the instructions for Form 2555, or in Publication 54.
__________________
Burton M. Koss
koss@usakoss.net

[Gretel]

Bart, thank you so much for digging this out. Good, old Koss. Sorry, Koss.