How to account for Cap- Ex

Question

I am looking for guidance on how to account for the Cap-Ex on my rental properties. Unlike the rental deposit that is required to be on a separate account, I am not sure what to do with the cap-ex. I know I should account for this, but do I actually pull it out of the account and hold it separately? How does it, if at all, show up on taxes: is this part of profit, expenditure, or can it go unrecorded just like the rental deposit? I will greatly appreciate if someone can share best practice with the money I am saving for capital expenditure.

Julius Vincent · Answer

Hey @Patience Echem - Capex is different from deposits because it’s not something you set aside in a separate account...it’s a tax/accounting treatment issue. Best practice is usually to keep a reserve account for Capex so you’re financially prepared for big-ticket repairs or improvements (roof, HVAC, renovations), but from a tax standpoint, you don’t expense those savings when you set them aside.

On your taxes, Capex only comes into play when you actually spend the money on an improvement. At that point, it gets capitalized and added to your property’s basis (rather than deducted all at once like a repair). Then you recover it through depreciation over time.

Most tax accountants handle this really smoothly. They just add the Capex to your basis and depreciation schedules. So the “holding” of the money is really just an internal reserve for you; the IRS only cares when you actually spend it.

If you’re working with a tax professional, they’ll likely have systems already set up to track this for you, so you don’t have to worry about misclassifying it.

Gregory Schwartz · Answer

We keep a CapEx cushion of about $5k per unit in our operating account. It’s not an interest-bearing account, so technically that money could be put to better use in a high-yield savings account earning 3–4%. But either way, when a CapEx project comes up—like replacing stairs at a fourplex—we just redirect what would have been an owner draw back into the business until the cushion is replenished.

The bookkeeper/CPA handle the rest, haha.

Arn Cenedella · Answer

@Patience Echem

Cap ex costs get added to your basis in the property.

Investors or their tax professionals should keep a chart updated annually with current basis for each property.

Purchase price plus non recurring closings costs is original basis.

Each year basis is adjusted.

Original basis less depreciation plus cap ex items equals new basis.

Aaron Zimmerman · Answer

If you do incur capex, this is not an expense. You get to recover that cost over time. Generally, anything over $2,500 per invoice or per item should be expensed. In  addition, any costs incurred before the property was placed into service (hard and soft costs) should be capitalized and the cost recovered over time.

as for holding a bank account, separately for capex, it may be overkill. Generally you want to keep 5-10% per year budgeted for capex.

William Whitley · Answer

So rereading your question, you are saving a portion for future capital expenditures, if I am understanding it correctly. So you are setting aside reserves for replacement. You can have an account in your books for reserves for replacement, but it might be a good idea to have a bank account that is specifically for reserves for replacement. That reserves account would be an asset bank account in that scenario. You would simply transfer money from your operating bank account to a bank account that is designated for you reserves for replacement.

Feel free to reach out if you have any other questions.

William Whitley · Answer

Hello,

I actually operate a bookkeeping company just for real estate investors. CapEx is not expensed out in one year like general repairs and maintenance is expensed out.

For my clients' books, I have 4 asset categories for rental properties...5 actually but one is a contra account.

1. Land, 2. Building 3. Closing Costs (for purchase and refinances), and 4. CapEx. The 5th is Accrued Depreciation.

When you spend money on CapEx it goes in that asset account and adjusts your basis.

Your CPA or tax professional would then have a depreciation schedule based on your adjusted basis (buildings and capex), which becomes a depreciation expense to you for the tax year. Each year's depreciation expense goes into the accrued depreciation account.

If/when you sell the property, the total sale price less selling expenses is part of the equation in factoring your capital gains. From that you deduct your adjusted basis (land, building, closing costs, and CapEx). The difference between your sale price less selling expenses and your adjusted basis is your total capital gain, but you have to account for recapture of depreciation. The total capital gain less accumulated depreciation is your capital gain. There is a tax for the capital gain and a tax for the recapture of depreciation.

I hope that is helpful.

All the best!

Michael Murphy · Answer

If you are talking about your capex reserves (i.e. the cash you have set aside to handle future capex) you can hold them in whatever account you want.

For the accounting, you would just show the cash balance that you have set aside on your balance sheet.  Nothing would happen prior to the funds actually getting spent when needed for capex.  If it is true "capital expenditures" then it gets capitalized and added to your balance sheet.  You have to determine the useful life of the capital asset and then depreciate it over time.  If it is a "repair" then it gets expensed.  The IRS has rules on when to classify it as a capital expenditure versus a repair.