repair vs items that add to the basis of the rental property

[ardi600]

I am a bit confused about how to differentiate between repairs which are expensed and other improvements that add to the basis of the rental property. Also there are other repair/improvements that need to be depreciated like a new water heater(which in that case would an increase to the basis). Could someone give an explanation on this, specially what kind of stuff are added to the basis of the property.

[taxea]

I recently read an article on this issue in the April issue of CPA Journal. Capitalize/Depreciation items that are an structural part of the property or that increase the value. Expense items that are replaced/repaired due to age or condition.

ie your water heater needs to be replaced because it quit working. Definitely an expense. Roof is in bad condition and you are replacing it with a like materials. You would probably be able to justify this as a repair/replacement to maintain the condition of the house. Should you, however, replace it with improved materials such as lifetime roof rather than similar shingles that were on it before then you would capitalize/depreciate it. If you need to replace, say, casement windows due to condition or damage it is a repair if replaced with similar windows. If the windows are replaced with dual-pane vinyl then it is depreciated for the difference in the cost of the upgrade vs the original.

Hope this helps. I would love to post the article for you but can't. Google repair vs. depreciation or search for it on the CPA Journal site. The really interesting thing is that the writer says anything valued over $100. that has a useful life of more than one year has to be depreciated.

[DexEA]

I'd be curious as what others think?

I recently read an article on this issue in the April issue of CPA Journal. Capitalize/Depreciation items that are an structural part of the property or that increase the value. Expense items that are replaced/repaired due to age or condition.

ie your water heater needs to be replaced because it quit working. Definitely an expense.

The really interesting thing is that the writer says anything valued over $100. that has a useful life of more than one year has to be depreciated.

I'm not sure where you'd find a water heater for less than $100, parts maybe which would be a repair. If you replace the water heater whether it is because it quit working or just inefficient I don't believe you could consider it a repair.

[Burke]

Generally, appliances and the like, including a hot water heater, are depreciated over 5 yrs, since you cannot take 179 on rental property (but perhaps bonus depr under the current rules). It would not be expensed as a repair, IMO, nor would it be capitalized and added to basis.

[Burke]

I recently read an article on this issue in the April issue of CPA Journal. Capitalize/Depreciation . The really interesting thing is that the writer says anything valued over $100. that has a useful life of more than one year has to be depreciated.

I think the $100 used to be a rule of thumb used by IRS auditors, but has largely been discarded. The useful life of more than 1 yr is the key. It really is a subjective issue on occasion as to whether it is a repair or improvement, and sometimes you can make a case either way, but the example of the roof is a good one, and the one that seems to come up most often.

[DexEA]

I would not be real comfortable with this scenario either

Roof is in bad condition and you are replacing it with a like materials. You would probably be able to justify this as a repair/replacement to maintain the condition of the house. Should you, however, replace it with improved materials such as lifetime roof rather than similar shingles that were on it before then you would capitalize/depreciate it.

IRS PUB:

How Do You Treat Repairs and Improvements?


If you improve depreciable property, you must treat the improvement as separate depreciable property. Improvement means an addition to or partial replacement of property that adds to its value, appreciably lengthens the time you can use it, or adapts it to a different use.

You generally deduct the cost of repairing business property in the same way as any other business expense. However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it.


Example.

You repair a small section on one corner of the roof of a rental house. You deduct the cost of the repair as a rental expense. However, if you completely replace the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. You depreciate the cost of the new roof.

http://www.irs.gov/publications/p946/ch01.html#en_US_2012_publink1000107378

Generally, appliances and the like, including a hot water heater, are depreciated over 5 yrs, since you cannot take 179 on rental property (but perhaps bonus depr under the current rules). It would not be expensed as a repair, IMO, nor would it be capitalized and added to basis.

That sounds more like it.

[DexEA]

Check out Pub 527

I am a bit confused about how to differentiate between repairs which are expensed and other improvements that add to the basis of the rental property. Also there are other repair/improvements that need to be depreciated like a new water heater(which in that case would an increase to the basis). Could someone give an explanation on this, specially what kind of stuff are added to the basis of the property.

Separate the costs of repairs and improvements, and keep accurate records. You will need to know the cost of improvements when you sell or depreciate your property.

The expenses you capitalize for improving your property can generally be depreciated as if the improvement were separate property.

Table 1-1.Examples of Improvements

Additions:
Bedroom
Bathroom
Deck
Garage
Porch
Patio

Lawn & Grounds:
Landscaping
Driveway
Walkway
Fence
Retaining wall
Sprinkler system
Swimming pool

Miscellaneous:
Storm windows, doors
New roof
Central vacuum
Wiring upgrades
Satellite dish
Security system

Heating & Air Conditioning:
Heating system
Central air conditioning
Furnace
Duct work
Central humidifier
Filtration system

Plumbing:
Septic system
Water heater
Soft water system
Filtration system

Interior Improvements:
Built-in appliances
Kitchen modernization
Flooring
Wall-to-wall carpeting

Insulation:
Attic
Walls, floor
Pipes, duct work

http://www.irs.gov/publications/p527/ch01.html#en_US_2012_publink1000218979

[Bees Knees]

I think the $100 used to be a rule of thumb used by IRS auditors, but has largely been discarded.

No, its actually in the regs. See the chart in TTB on page 1-12.

[Burke]

Wow. How old is that? I think we have had a bit o' inflation since that was established.

[Black Bart]

Repair vs. depreciation

Interesting take on the subject:

Fully deductible in the current year?

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:

§ 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:

§ 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.

Last edited by Koss; 04-03-2008 at 09:19 PM. Burton M. Koss
koss@usakoss.net

[Bees Knees]

Wow. How old is that? I think we have had a bit o' inflation since that was established.

The temporary regs were issued the last week of 2011, and were supposed to take affect on January 1, 2012. All of the tax seminars I attended last year made a big deal about this. Then IRS got a bunch of complaints and delayed their effective date until January 1, 2014. In the mean time, IRS says they will re-issue them sometime this year (prior to January 1, 2014) as final regs with some modifications. The $100 threshold is expected to remain as is.

[Bees Knees]

I disagree

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.

Last edited by Koss; 04-03-2008 at 09:19 PM. Burton M. Koss
koss@usakoss.net

That line of thinking has actually been overturned by the recent temporary regs IRS issued in 2011, and the new final regs are due to be issued soon.

From TTB page 1-12:

Footnote #4. Something that improves a unit of property is something that
results in a betterment to the unit of property, restores the unit of property, or
adapts the unit of property to a new or different use. See Regulation section
1.263(a)-3T for rules on how to determine if a repair must be capitalized as
an improvement to tangible property.

The point being, if a unit of property has reached the end of its useful life and needs to be repaired or replaced due to its age, then the cost to repair or replace it is a betterment, something that extends the useful life of the property.

It only makes sense. The original kitchen sink has a useful life of so many years. No sink has a useful life of forever. Thus, when the sink gets too old and needs to be replaced, then replacing it means you are extending the life of the building by replacing the sink.

A repair, on the other hand, is fixing something that still has a useful life. You are not extending the useful life because the repair merely puts the asset back into working order so that it can live out the rest of its useful life. Thus, if the sink was supposed to last 10 years and needed fixing after 5, the cost to repair it in year 5 is a repair. If the sink that was supposed to last 10 years needs replacing at year 12, then it is a capital improvement because the thing replaced has reached the end of its useful life.

[Black Bart]

Spoilsport

Repair vs. depreciation

Interesting take on the subject:

...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...

Last edited by Koss; 04-03-2008 at 09:19 PM. Burton M. Koss

I disagree

That line of thinking has actually been overturned by the recent temporary regs IRS issued in 2011, and the new final regs are due to be issued soon. From TTB page 1-12:The point being, if a unit of property has reached the end of its useful life and needs to be repaired or replaced due to its age, then the cost to repair or replace it is a betterment, something that extends the useful life of the property.

It only makes sense...

Just when I find some good, solid, unfortunately outdated information that's favorable to taxpayers, you've gotta come along and deep-six it with late-model stuff that ratchets everything up from 5-7 to 27-39 years.

Okay smart guy; I just noticed a useful post (hmmm...surprised it wasn't me) -- let's see you rebut this:

Separate the costs of repairs and improvements, and keep accurate records. You will need to know the cost of improvements when you sell or depreciate your property.