Accounting Questions

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Accounting Questions

Scott Bartlett
Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes

I've done a few searches here, and I think I have a pretty good idea of what I need to do.

I purchased my first rental property about 45 Days ago and I'm still renovating the property.

I purchased the distressed REO Property for $8,750 with $649.03 in closing costs, bringing total purchase price to $9399.03.

This property was in pretty bad shape and was not rentable. My question was, what can I expense and what do I have to capitalize?

From what I've read here, EVERY PURCHASE/IMPROVEMENT I complete before listing the property to be rent has to be capitalized. I'm assuming this is correct?

Things I've done is rented (2) 10 Cubic Yard Dumpsters, replaced the front porch, gutted the entire upstairs, put drywall throughout 75% of the property, rewired the electrical systems, re-coated the metal roof, landscaping and etc.

So EVERYTHING I purchased for the property such as materials, small tools such as pry-bars, drywall knife and etc must be capitalized or just the MATERIALS used for the improvements? The tools that were purchased were solely used to complete such projects.

The costs I incurred before I purchased the property such as inspections and etc would be expensed since I did not own the property at the time and was a routine business expense while investigating/inspecting properties?

So would the gas that I used to mow the grass be capitalized since the property isn't Rent Ready.

Lastly, do I add a "Capital Improvements" category account to my property under Assets for my accounting?

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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
13y

Hello Scott Bartlett,

This is where tax and accounting get fun. My favorite topics :)

Dawn A. is correct in that your lawn mower and tools etc, would not be added into the home's basis; however, they would have their own that must be depreciated separately. It is distinctly possible these were placed in service before the property was.

Tools such as a lawn mower and snow blower would be 5 year property. Item such as a screw driver and drill bits would be immaterial and deducted as an expense.

Costs for inspections are added to the cost basis of the home.

The fuel to maintain would also be capitalized until the home is "placed in service" (Rent ready and available for rent).

Keep track of your improvements separately. If you replace floors we want to depreciate that over 5 years as opposed to 27.5.

Things I've done is rented (2) 10 Cubic Yard Dumpsters, Add to basis
replaced the front porch, Depreciate separately 27.5 years
gutted the entire upstairs, Depreciate separately 27.5 years/ add to basis.
put drywall throughout 75% of the property, Depreciate separately 27.5 years
rewired the electrical systems, Depreciate separately 27.5 years
re-coated the metal roof, Depreciate separately 27.5 years
landscaping and etc. depreciate separately.

-Steven

[email protected]224-381-2660
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  • Dawn AnastasiPro Member
    Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
    13y

    Everything you do before you put your property into service goes into your basis. This basis is used in the depreciation calculation. Depreciation is calculated at 27.5 years on the house only, not the land.

    I have been told that anything consumable would go into the basis. If you are buying a lawn mower that you use at your own house and for this property, it would not go into the basis. If you are buying tools that you use for this property and the next, etc. then these are not consumables.

    The dumpsters were used just for that property so they are okay to be added to the basis.

    Steven Hamilton is the tax expert on the forums so he'd be the guy to confirm all this (or your own accountant).

    Podcast Guest on Show #29
    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y

    So anything I purchase just for the property would be added to the cost basis and then depreciated over 27.5 years.

    Any tools that could be used on other properties are not consumable and could be expensed or would they have to added to an Equipment asset of some sort. I haven't purchased any tools more then $15-$20 at most. At most, a total of about $100-$150 altogether for tools to complete certain jobs needed.

    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y

    So I assume the costs associated with the inspections and etc before purchase (property was in contract) would be expensed or added to the cost basis?

    0Reply
  • Kyle J.
    Rental Property Investor · Northern, CA · Member since 2012 · 5k+ posts · 5k+ votes
    13y
    Originally posted by Scott Bartlett:
    So anything I purchase just for the property would be added to the cost basis and then depreciated over 27.5 years.

    Not everything is depriciated over 27.5 years. Some things (i.e. appliances, carpet, etc) could be 5 years.

    Here's a link with more info on the subject, but I think it's really best to utilize a tax attorney or CPA who is well-versed in this area:

    http://www.irs.gov/publications/p527/ch02.html

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    I'm not home at the moment. Someone please tag me and ill respond as soon as I'm at a computer.

    [email protected]224-381-2660
    0Reply
  • Elizabeth Colegrove
    Hanford, CA · Member since 2013 · 5k+ posts · 1k+ votes
    13y

    Steven Hamilton II

    0Reply
  • James Vermillion
    Lexington, KY · Member since 2009 · 2k+ posts · 1k+ votes
    13y
    Originally posted by Kyle J.:
    Originally posted by Scott Bartlett:
    So anything I purchase just for the property would be added to the cost basis and then depreciated over 27.5 years.

    Not everything is depriciated over 27.5 years. Some things (i.e. appliances, carpet, etc) could be 5 years.

    Here's a link with more info on the subject, but I think it's really best to utilize a tax attorney or CPA who is well-versed in this area:

    http://www.irs.gov/publications/p527/ch02.html

    Kyle J., I thought if the appliances we purchased and installed during the rest of the rehab (prior to the rental going into service) they would be added to the cost basis of the property. However, later, when new appliances / carpet are put in they would be depreciated separately per the regulation.

    I am curious as to what Steven Hamilton II says about this.

    0Reply
  • Elizabeth Colegrove
    Hanford, CA · Member since 2013 · 5k+ posts · 1k+ votes
    13y

    Scott Bartlett I applaud your effort to understanding the tax system. I think it is very important in order to leverage legal tax loop wholes effectively. That being said, I HIGHLY recommend you hire an amazing CPA who specializes in TAXES. A great CPA will make find you more money ten times over there fee.

    This is in addition to the security that you are following the latest tax codes AND have completed your taxes correctly. Many CPA's will go to court with you if there is an IRS issue and they have insurance for the liability issues.

    0Reply
  • Kyle J.
    Rental Property Investor · Northern, CA · Member since 2012 · 5k+ posts · 5k+ votes
    13y
    Originally posted by James Vermillion:
    Originally posted by Kyle J.:
    Originally posted by Scott Bartlett:
    So anything I purchase just for the property would be added to the cost basis and then depreciated over 27.5 years.

    Not everything is depriciated over 27.5 years. Some things (i.e. appliances, carpet, etc) could be 5 years.

    Here's a link with more info on the subject, but I think it's really best to utilize a tax attorney or CPA who is well-versed in this area:

    http://www.irs.gov/publications/p527/ch02.html

    Kyle J., I thought if the appliances we purchased and installed during the rest of the rehab (prior to the rental going into service) they would be added to the cost basis of the property. However, later, when new appliances / carpet are put in they would be depreciated separately per the regulation.

    I am curious as to what Steven Hamilton II says about this.

    It's my understanding that, yes - these items would all be added to the basis if done before the property was placed into service. However, I believe different items can fall under different property classes and may be eligible for accelerated deprecitiation in the early years of the recovery period.

    But I'm no tax expert and I'm sure Steve will correct me if I'm wrong.

    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y

    I have a CPA that does my taxes and I've asked what he would need from me which was more or less a spreadsheet or quickbooks file would be sufficient.

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    Hello Scott Bartlett,

    This is where tax and accounting get fun. My favorite topics :)

    Dawn A. is correct in that your lawn mower and tools etc, would not be added into the home's basis; however, they would have their own that must be depreciated separately. It is distinctly possible these were placed in service before the property was.

    Tools such as a lawn mower and snow blower would be 5 year property. Item such as a screw driver and drill bits would be immaterial and deducted as an expense.

    Costs for inspections are added to the cost basis of the home.

    The fuel to maintain would also be capitalized until the home is "placed in service" (Rent ready and available for rent).

    Keep track of your improvements separately. If you replace floors we want to depreciate that over 5 years as opposed to 27.5.

    Things I've done is rented (2) 10 Cubic Yard Dumpsters, Add to basis
    replaced the front porch, Depreciate separately 27.5 years
    gutted the entire upstairs, Depreciate separately 27.5 years/ add to basis.
    put drywall throughout 75% of the property, Depreciate separately 27.5 years
    rewired the electrical systems, Depreciate separately 27.5 years
    re-coated the metal roof, Depreciate separately 27.5 years
    landscaping and etc. depreciate separately.

    -Steven

    [email protected]224-381-2660
    2Reply
  • Dawn AnastasiPro Member
    Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
    13y
    Originally posted by Kyle J.:
    Originally posted by James Vermillion:
    Originally posted by Kyle J.:
    Originally posted by Scott Bartlett:
    So anything I purchase just for the property would be added to the cost basis and then depreciated over 27.5 years.

    Not everything is depriciated over 27.5 years. Some things (i.e. appliances, carpet, etc) could be 5 years.

    Here's a link with more info on the subject, but I think it's really best to utilize a tax attorney or CPA who is well-versed in this area:

    http://www.irs.gov/publications/p527/ch02.html

    Kyle J., I thought if the appliances we purchased and installed during the rest of the rehab (prior to the rental going into service) they would be added to the cost basis of the property. However, later, when new appliances / carpet are put in they would be depreciated separately per the regulation.

    I am curious as to what Steven Hamilton II says about this.

    It's my understanding that, yes - these items would all be added to the basis if done before the property was placed into service. However, I believe different items can fall under different property classes and may be eligible for accelerated deprecitiation in the early years of the recovery period.

    But I'm no tax expert and I'm sure Steve will correct me if I'm wrong.

    It's my understanding that appliances such as a range are depreciated separately under a 5-year schedule. That is what I have done.

    Podcast Guest on Show #29
    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    James Vermillion,

    You may depreciate the separate costs if you can show the separate acquisitions. If you purchase a property and install new flooring, appliances, landscape, etc. You Want to depreciate each item over its property class life. You are not forced to 27.5 years.

    It is not quite cost segregation it is adequately documenting what items were placed in service when.

    Scott Bartlett, Under capital improvements, I recommend that you make sub categories for each depreciation class life.

    [email protected]224-381-2660
    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y
    Originally posted by Steven Hamilton II:

    Scott Bartlett, Under capital improvements, I recommend that you make sub categories for each depreciation class life.

    Steven Hamilton II,

    I was planning on doing something very similar to this, but for each sub category as areas that I improved with total costs for each category and then figuring out what the depreciation class each one fits into.

    So each of my subcategories would be "Porch", "Electrical", "Roof Repairs" and etc.

    Is there a website that would explain what improvements would qualify for each class of depreciation?

    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y

    Sorry, answered my own question:

    1Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y

    So the inspection costs associated with the property would be added to the cost basis even though it was done before the actual purchase?

    What about Cashier Check Fees from the bank used for the EDM and Purchase? Expensed or added to Cost Basis?

    0Reply
  • Jacob A.
    Investor · Raleigh, NC · Member since 2013 · 348 posts · 128 votes
    13y

    Steven Hamilton II Holy crap a tax guy said the word immaterial!!!! I work in audit Steven and it's my favorite word but to hear a tax guy say it is like seeing a unicorn!

    0Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    13y

    And I use "irrelevant" as well, LOL

    As to the chart of accounts, you don't break down accounts by the section or part of a property like porch or bedroom, but by it's depreciation schedule for materials, like carpet, appliances or roofing.

    As to permits, inspections and other soft costs, you may need to take those out when presenting your basis for financing, depends on what the significance of such fees might be so I suggest you break them down by hard and soft costs (hard costs add value and extend the life of usefulness), but for taxes Steve is correct so you'll need that with each property. :)

    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y

    Hate to admit this, but it appears I'm getting lost here...

    To figure out cost basis, I need to split the cost between the building and land according to the tax assessment or what some figures say in my closing paperwork?

    Then, all costs that were used to IMPROVE the property before being put in services needs to be added to the cost basis except those that did not add any value to the property such as the small immaterial items such as small tools and etc?

    So all items that were added to the cost basis needs to be depreciated along with the building according to it's depreciation class.

    I'm just curious accounting list would look something like this?

    Assets
    - Property (Adams St)
    - Cost Basis
    -- Hard Costs
    ---- 27.5 Year Depreciation Class
    ---- 15 Year Depreciation Class
    ---- 5 Year Depreciation Class
    -- Soft Costs

    - Bank Accounts
    -- Checking
    -- Savings

    Equity
    - Owner's Equity
    - Personal Draws

    Expenses
    - Expenses list according to Schedule E Form

    Income
    - Rent
    - Late Fees
    - Interest

    Liabilities
    - Credit Cards
    -- Credit Card 1
    -- Credit Card 2
    - Personal Loan
    - Security Deposit for Property (Adams St)
    - Accounts Payable

    0Reply
  • Dawn AnastasiPro Member
    Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
    13y

    I usually see it like this:

    ASSETS
    - Land
    - Building
    - Accumulated Depreciation - Building
    - Other Assets
    - Accumulated Depreciation - Other Assets

    EXPENSES
    - Depreciation Expense

    Each year you make an entry to credit accumulated depreciation and debit depreciation expense.

    Podcast Guest on Show #29
    0Reply
  • Jacob A.
    Investor · Raleigh, NC · Member since 2013 · 348 posts · 128 votes
    13y

    Scott Bartlett Sounds like you have a pretty good hold on things. One thing I would say though is that I wouldn't use the tax records to record the cost of your building. Your cost is whatever you paid for it at closing.

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    Jacob Allen,

    Yes, it is not worth dealing with depreciating it.

    Scott Bartlett,

    The tools are not 100% specific to that property however, they are being used for business purposes, therefore you can deduct the cost if it is immaterial (I've said it twice in this thread) meaning that it is typically under $100 and not worth keeping on the books. Dawn A. is correct, that is how it should look like.

    Consider using a free bookkeeping program like Wave accounting.

    -Steven

    [email protected]224-381-2660
    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y
    Originally posted by Dawn A.:
    I usually see it like this:

    ASSETS
    - Land
    - Building
    - Accumulated Depreciation - Building
    - Other Assets
    - Accumulated Depreciation - Other Assets

    EXPENSES
    - Depreciation Expense

    Each year you make an entry to credit accumulated depreciation and debit depreciation expense.

    Dawn A.,

    I forgot the "land" on my list. Accumulated Depreciation (Building) is where I would be putting my improvements that need to be depreciated (adding to my cost basis?)

    I'm assuming Other Assets are for such as equipment and etc. Then each month I'll apply the depreciation as an expense based on the depreciation class (I'm assuming straight line depreciation?)

    I guess I'm getting hung up on understanding the Cost Basis and etc.

    Steven Hamilton II,

    I am using GNUCash, but I am considering using Quickbooks since my CPA uses this also.

    0Reply
  • Dawn AnastasiPro Member
    Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
    13y
    Originally posted by Scott Bartlett:
    I forgot the "land" on my list. Accumulated Depreciation (Building) is where I would be putting my improvements that need to be depreciated (adding to my cost basis?)

    I'm assuming Other Assets are for such as equipment and etc. Then each month I'll apply the depreciation as an expense based on the depreciation class (I'm assuming straight line depreciation?)

    I guess I'm getting hung up on understanding the Cost Basis and etc.

    Scott,

    You need to separate the land from the building because you're only allowed to take depreciation on the building, not on the land. Land doesn't depreciate. There was another post on BP about how to calculate the split between land/building. Basically you take your FMV (fair market value) from the tax bill and you can use this percentage to split.

    The cost basis is the % of your purchase price based on the allocation I described above + your improvements as described in the prior posts.

    Each year, you calculate the depreciation using the cost basis for the asset only using the IRS schedule. Let's pretend your depreciation for building was $500.

    So your journal entry for 12/31/13 would be a debit to depreciation expense and a credit to accumulated depreciation building. Repeat for each other asset.

    Podcast Guest on Show #29
    0Reply
  • Scott Bartlett
    OP
    Investor · Fremont, OH · Member since 2013 · 137 posts · 12 votes
    13y

    Dawn A.,

    I understand what you've posted about making a debit to depreciation expense and credit to accumulated depreciation.

    But my question is this:

    Lets say I spent $2,000 for materials to build a new porch.

    Where do I debit this on my Assets since this would be capitalized (improving the porch adds value and prolongs its life, and the property has not been placed in service)?

    This is where I'm getting lost at the moment. Looks like I'll need to take another accounting class at the local community college. I've taken Financial Accounting and Managerial Accounting.

    0Reply
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