Tax question regarding receipt filing and record keeping best practices

4 Replies

Hi BP,  I have 2 rentals that were acquired over the last 6 months... Property #1 closed Dec 2014 and was officially on the market May 1st 2015.  My tenant just moved in.  Property #2 closed mid Feb 2015 and should be on the market Aug 1 2015.  Both have gone through extensive renovations.  My questions are regarding classification of expenses.  I know I need a CPA... its on my list.

Schedule E has a list of expenses... Advertising, cleaning and maint, insurance, legal, repairs, supplies, etc... 

1) Because property #1 wasn't "on market" during the renovation, does everything apply to the basis?  We replaced hot water tank, walls, doors, vanities, fixtures, etc... 

1b) Do I need to break down my pre-market expenses into the Schedule E categories or can I leave them in bulk under "supplies" and "services" like I currently have them?

2) Now that its "on market" I will start detailing my expenses per the Schedule E categories.  If I go to Home Depot and spend $500 on a new bathtub, a door, paper-towels, a new screwdriver set, windex, and valve stems for a faucet; would I break these down into supplies, cleaning and maintenance, and repair with separate entries?

I am using a simple excel spreadsheet that mimics the Schedule E.

Hope this makes sense.  I'm just trying to get my paperwork organized.  

Thanks in advance

So you should be increasing your basis in the property by any capital items (greater than 1 year of life; bathtub, door, faucet, etc.), whether you are 'on the market' or not has no bearing. Make sure you understand the IRS capitalization rules detailed in the link below. Do your best to separate your operating expenses in schedule E, but technically all those expenses you are increasing your basis by should be sepreciated over their useful lives. The annual depreciation expense in included on schedule E. It is really more important to have solid back up files, correctly calculate your basis and not double count opex and capital costs than stress over what line you are putting various expenses into. Let me know if you have any questions on the below link.

http://www.irs.gov/publications/p551/ar02.html

Increases to Basis

Increase the basis of any property by all items properly added to a capital account. These include the cost of any improvements having a useful life of more than 1 year.

Rehabilitation expenses also increase basis. However, you must subtract any rehabilitation credit allowed for these expenses before you add them to your basis. If you have to recapture any of the credit, increase your basis by the recaptured amount.

If you make additions or improvements to business property, keep separate accounts for them. Also, you must depreciate the basis of each according to the depreciation rules that would apply to the underlying property if you had placed it in service at the same time you placed the addition or improvement in service. For more information, see Publication 946.

The following items increase the basis of property.

  • The cost of extending utility service lines to the property;
  • Impact fees;
  • Legal fees, such as the cost of defending and perfecting title;
  • Legal fees for obtaining a decrease in an assessment levied against property to pay for local improvements;
  • Zoning costs; and
  • The capitalized value of a redeemable ground rent.
Deducting vs. Capitalizing Costs

Do not add to your basis costs you can deduct as current expenses. For example, amounts paid for incidental repairs or maintenance that are deductible as business expenses cannot be added to basis. However, you can choose either to deduct or to capitalize certain other costs. If you capitalize these costs, include them in your basis. If you deduct them, do not include them in your basis. See Uniform Capitalization Rules earlier.

The costs you can choose to deduct or to capitalize include the following.

  • Carrying charges, such as interest and taxes, that you pay to own property, except carrying charges that must be capitalized under the uniform capitalization rules;
  • Research and experimentation costs;
  • Intangible drilling and development costs for oil, gas, and geothermal wells;
  • Exploration costs for new mineral deposits;
  • Mining development costs for a new mineral deposit;
  • Costs of establishing, maintaining, or increasing the circulation of a newspaper or other periodical; and
  • Costs of removing architectural and transportation barriers to people with disabilities and the elderly. If you claim the disabled access credit, you must reduce the amount you deduct or capitalize by the amount of the credit.
Originally posted by @Bob Thomas :

Wow!  Great post Bob, thank you very much!  I really need a CPA, lol : )  I will certainly reference this while I'm putting my books together.  I might PM you a few questions if you don't mind.  thanks again


Originally posted by @Bob Thomas :

So you should be increasing your basis in the property by any capital items (greater than 1 year of life; bathtub, door, faucet, etc.), whether you are 'on the market' or not has no bearing. Make sure you understand the IRS capitalization rules detailed in the link below. ...

...Increase the basis of any property by all items properly added to a capital account. These include the cost of any improvements having a useful life of more than 1 year.

Gotta be careful what you tell people here. It's not as simple as saying "anything with a life greater than a year is capitalized" especially with the Final Tangible Property Regs. 

Now everything is broken up into separate units of property, and the plumbing system (or plumbing unit of property) includes pipes, valves, faucets, bathtubs, showers, etc. So if I replace a bathtub and I can support the fact that the bathtub only makes up 10% of the plumbing system as a whole, I can fully deduct the cost in the current year, rather than capitalizing and depreciating as you normally would because the 10% is not a material improvement to the plumbing system as a whole. 

I'd suggest reading through Reg. 1.48-1(e)(1) and Reg. 1.48-1(e)(2).

good point Brandon, I wasn't trying to get into the minutia. 

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