After I bought a property, I had to replace the water heater right away as the old one was rusty and leaking. Of course I could not rent the property out without water heater being functional. Is it operating expense or capital expense?
Also the property did not have any kitchen appliances. Are they operating or capital expense?
Hi, the question to ask to determine the difference between the two is: Does the expense significantly increase the life of the function of the unit? A hot water heater is an appliance and could go out in less than three years, it's an expense, write it off! A good example of a capital expense is a roof, a remodel. Also you can have a cutoff, like $1,000 or less. If you patched part of the roof and it cost less than a grand write it off. Bill
Updated over 8 years ago
This is under GAAP, Generally Accepted Accounting Principles in the allocation of expenses and is accepted as the basis in accounting for the IRS.
Thank you Bill
Not sure I agree with above 100%, however, I would say that a competant CPA is in order to help you through this.
On a whole, capital expenses improve the value of the asset while operating expenses are those that are needed to keep the business running.
If the old plumbing leaks and you replace it all with a new copper repipe, that is a capital expense, even though you needed to fix it to keep tenants.
One great thing about flipping rather than holding is that every dime you put into the property goes in as part of the acquisition or investment of the property thus raising your basis.
Just as a general clarification for the OP, there are no hard-and-fast rules for determining if something is an operating expense (OpEx) or a capital expense (CapEx).
In general, repairs and maintenance items are considered OpEx, whereas long-term improvements to the property are considered CapEx.
So, things like roof replacement, major remodels, full replumbing, etc, are clearly considered CapEx. And things like repairing a clogged toilet and mowing the lawn are clearly OpEx.
Of course, that leaves a whole lot of stuff in the middle: repainting an exterior, putting in hardwoods, installing new carpet, replacing a toilet, etc.
In fact, you could argue that if you remodel an entire bathroom, it's CapEx, but if you replace the toilet today, the sink next month, the tub the following month, the flooring the following month, and the lighting the following month, each expenditure is OpEx.
So, you can see that determining if something is OpEx or CapEx is not an exact science.
As usual, the IRS has chimed in and tried to clarify things, but they haven't done a very good job of it. Many things are still left up in the air.
So, as Bill suggested, perhaps just set a cut-off point ($1000 might make sense)...everything below is OpEx, everything above is CapEx. Or however you choose to make the determination, try to stay consistent.
Most importantly, talk to your CPA...he or she will likely have their own system that they use, and going by their guidelines will likely make preparing your annual taxes a bit easier.
Great answer Jason.
My CPA could not have said it better.
Thank you guys for all the clarifications and advice.
BTW, read about Section 179 under which you can expense your capital expenses as well, but all in one year, the year when you had those expenses, with some exceptions, but appliances would qualify for Section 179, correct? Improvements to the land and a building would not.
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