New Tax Laws: Expenses or Capital Improvements?

Question

I am trying to get a handle on the new taxes codes in regards to expensing versus capitalizing and depreciating. I have heard that the new laws basically state that "replacing" something such as a roof, AC unit, etc is now expensed (written off 100% in the year it was done) versus the old way, which was to add the amount paid for the replacement to your cost basis and depreciate the improvement over time.

From what I understand, the IRS is saying that since you already bought the roof when you purchased the home replacing the roof isn't really considered an improvement anymore - and it is written off like you'd write off something cosmetic like paint. I suppose the gist of it is that if it's a replacement of something its an expense, and if its an addition its a capital improvement - like putting a deck on where one didn't previously exist.

Is this accurate? If it is, the impact this has on our cost basis is significant. We could no longer increase our cost basis by doing basic renovations when we buy and this will lead to less that we can write off in depreciation, which translates to more taxes we'll pay on our cashflow. On the positive side, we'll be able to take 100% of the losses/expenses as they happen, which would even things out if we are continually buying and renovating properties. I am thinking correctly on this? Thanks in advance for the feedback!

Steven Hamilton II · Answer

No, that is not correct. There is a $500 threshold to start to determine repair vs expense. What you are thinking of is the Tangible Property Regulations allowing the ability to subtract out what would be apportioned to the roof in your purchase cost.

Brandon Hall · Answer

@Jerry Kisasonak Under the final tangible property regulations, the key is to perform repairs rather than a large overhaul or completely replace the Unit of Property (UOP).

A roof for example is evaluated separately from all other components of the building structure because it is a discrete and critical function within the "Building Structure" UOP. If you spend $100k replacing a portion of the roof that amounts to say 20% of the entire roof, the costs are not required to be capitalized because the 20% doesn't represent a major component nor a significant portion of the roof itself.

You also have the benefit of claiming the remaining basis of a replaced asset as a current year deduction. This is called claiming a disposition.

@Steven Hamilton II The $500 threshold was a general rule of thumb but is now essentially eliminated with the more specific final regs. Unless of course you are referencing the De Minimis Safe Harbor or the rules on materials and supplies ($200), in which case you are correct.

Chris Martin · Answer

I'm trying to figure out where you saw this new guideline. From what I see in http://www.irs.gov/publications/p535/ch07.html#en_US_2014_publink100026600 I get the opposite opinion, that you can elect to capitalize expenses. @Steven Hamilton II may have some insight into this...

From Publication 535 (2014) Costs You Can Deduct or Capitalize:

Repair and Maintenance Costs

Generally, you can deduct amounts paid for repairs and maintenance to tangible property if the amounts paid are not otherwise required to be capitalized. However, you may elect to capitalize amounts paid for repair and maintenance consistent with the treatment on your books and records. If you make this election, it applies to all amounts paid for repair and maintenance to tangible property that you treat as capital expenditures on your books and records for the tax year.

How to make the election. To make the election to treat repairs and maintenance as capital expenditures, attach a statement titled

New Tax Laws: Expenses or Capital Improvements?

New Tax Laws: Expenses or Capital Improvements?

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