Investor · Member since 2009 · 132 posts · 30 votes
When rehabbing a property, at what point do the expenses become tax deduction? I realize that it will raise your basis, which will effectively reduce your tax burden when you sell.
Here is an example. I bought a duplex for 8k and spent 12k rehabbing it in October. Can I deduct that 12k against other income since its under the 25k aloowable loss if my AGI is less than 100k? I have a meeting with my accountant this week so in preparation for the year end so I will know more then but wanted to see if I could get any insight on this board.
Here is one last question, lets say I have to replace a toilet next year, is that $100 expense deductable at that point or does it increase the cost basis?
Definitely into CPA territory here. I send mine a stack a receipts and rent data and a tax return comes back. So, take this with a grain of salt and find a good CPA. Taxes aren't a DIY game when you have questions like this.
Any dollar of expenditure either goes into your basis or is deductible or is capitalized. A dollar would never go into both your basis and be deductible. I believe everything you spend before you have it rent ready goes into the basis. Money you spend after its rent ready is either an expenses item (like repairing a toilet) and deductible in the year its incurred or is a capital item (like a roof) and is depreciated over multiple years.
Keep in mind everything that's in the basis is what goes into your 27.5 year depreciation, and the basis goes down by the depreciation each year.
Definitely into CPA territory here. I send mine a stack a receipts and rent data and a tax return comes back. So, take this with a grain of salt and find a good CPA. Taxes aren't a DIY game when you have questions like this.
Any dollar of expenditure either goes into your basis or is deductible or is capitalized. A dollar would never go into both your basis and be deductible. I believe everything you spend before you have it rent ready goes into the basis. Money you spend after its rent ready is either an expenses item (like repairing a toilet) and deductible in the year its incurred or is a capital item (like a roof) and is depreciated over multiple years.
Keep in mind everything that's in the basis is what goes into your 27.5 year depreciation, and the basis goes down by the depreciation each year.
thanks Jon, I was thinking along the same lines, I enter all my expenses into qb for each property but don't distinguish between costs that should increase my basis vs. deductions, that gets pretty hairy. Does anybody have any recommendations on how to keep them seperate in qb 2009? As of now, i am showing a massive loss because I have all of my rehab costs entered in vs just a few months of rent coming back in. I have rehabbed 2 properties in Q4 of this year so I have alot of expenses but not a lot of rental income because of timing in the year, although all units are leased.
I belive a good way to approach it is repairs are tax deductable but improvments increase your basis. I still dont know about "repairs" during rehab though, ex split water lines, reseal roof, etc... I know new flooring, new front porch, etc.. are improvments
The IRS has very specific rules on this. I don't think you have as many choices as you might be thinking. Before its rent ready all these the expenses go into the basis.
Jon is spot on! All of the rehab costs (in the example you gave) are going to have to be classified as capital expenditures and added to the cost basis of your property. That being said, this would be a perfect time to use "cost segregation." You should allocate your costs between the physical structure (Section 1250 property) and items such as appliances, cabinets, toilets, landscaping, shrubs, etc (called Section 1245 property). While the building must be depreciated over a life of 27.5 years, the Section 1245 property can actually be depreciated over a 5 or 15 year time frame depending on the asset. Some of the items may even be written off completely in the first year using Section 179 depreciation.
I do a lot of Repairing, Repainting, Refinishing, Replacing, ect, ect. Whenever you write out a check in the memo line put Re- ... You can deduct the expense if it was to Re-something to the property to make it in the same livable condition again.
If it is adding more value or improving the property, then it needs to be classified as a CapEx and depreciated over 27.5 years.
You replace that $100 toilet, that should be a immediate deduction. Best thing to do is interview some CPA's and it is worth paying extra for an Accountant who knows how the system works and can leverage your business.
Jon is spot on! All of the rehab costs (in the example you gave) are going to have to be classified as capital expenditures and added to the cost basis of your property. That being said, this would be a perfect time to use "cost segregation." You should allocate your costs between the physical structure (Section 1250 property) and items such as appliances, cabinets, toilets, landscaping, shrubs, etc (called Section 1245 property). While the building must be depreciated over a life of 27.5 years, the Section 1245 property can actually be depreciated over a 5 or 15 year time frame depending on the asset. Some of the items may even be written off completely in the first year using Section 179 depreciation.
OK, that makes sense, but what falls under operating expenses? Obviously the formation of my LLC is not capitalized.
What about milage to and from the property for repair work? Also, what about utilities, prop taxes, insurance and interest payments during the rehab period. Aren't all those still operating expenses even before the property is rent ready?
Calling @Steven Hamilton II for accounting expertise here, along with @Dave Toelkes who also knows IRS code much better than I do.
For rental property, all of that mileage and repair expense that occurs prior to being "placed in service for rent" is not deductible in the (fiscal) year incurred; it is added to basis and it increases the depreciation deduction. Once a tenant is in there, repairs and the mileage do become deductible expenses in the (fiscal) year incurred - even if the unit is going through a vacancy.
For flip properties, there is no depreciation, and accounting is different because you have goods (a house) being sold. The repairs and renovations become part of the costs of those goods. @J Scott has posted elsewhere how to handle this for tax purposes, so unless he chimes in here, do a search of the forums.
Jon is spot on! All of the rehab costs (in the example you gave) are going to have to be classified as capital expenditures and added to the cost basis of your property. That being said, this would be a perfect time to use "cost segregation." You should allocate your costs between the physical structure (Section 1250 property) and items such as appliances, cabinets, toilets, landscaping, shrubs, etc (called Section 1245 property). While the building must be depreciated over a life of 27.5 years, the Section 1245 property can actually be depreciated over a 5 or 15 year time frame depending on the asset. Some of the items may even be written off completely in the first year using Section 179 depreciation.
OK, that makes sense, but what falls under operating expenses? Obviously the formation of my LLC is not capitalized.
What about milage to and from the property for repair work? Also, what about utilities, prop taxes, insurance and interest payments during the rehab period. Aren't all those still operating expenses even before the property is rent ready?
Actually,
Your formation of the LLC IS capitalized. The mileage before it is placed in service is added to basis as well as the other expenses except property taxes. Property taxes before the property is placed in service is deducted on Schedule A.
Hi Jon, My partner and I invest in Chicago IL and are currently rehabbing a 4-flat. We have 2 units rented and the other 2 are still to be renovated.
I learned a lot from your post. What do you mean about baseline, does it apply only when you first purchase the property, or every time you have a vacancy where repairs are required in order to rent the unit?
I'm trying to gain some understanding on this. I bought a rental property in Nov and spent $10K rehabbing and keeping track of all my mileage and receipts for 2014. It is not rented, I'm still working on it, no LLC, or business of any kind. Where does the $10K get applied to when my CPA does my taxes this year? This is my first year using a CPA.
Even though the property is not rented, is it ready and available for occupancy? Have you begun advertising the property for rent?
If the answer is no, then all the costs you incurred to make your property rent-ready are added to your cost basis for the property. None of the costs are expensed on your tax return, so, the CPA that does your tax return for this year will most likely ignore the $10K for this year. Keep all the receipts and records of your mileage. The CPA will need those next year when you have placed the property in service as a rental.
If the answer is yes, then the CPA that does your tax return will add the make ready costs to your cost basis and then use that cost basis to determine your depreciation schedule. You will get a depreciation expense prorated to the month you placed the property in service.
So quick question - I just bought a single family home I intend on using as a rental but....I'm going to live in it for about a year before I rent it out. It needs about 10-13K in rehab cost to bring it up to my rental standards. Can I track the expenditures and add them to my cost basis in a year once I advertise the property for rent? Basically is there a timeframe on the work done being added to the cost basis?
No time limit. Yes, both the purchase and capital improvements should go into your depreciable cost basis.
However, there may be a lower of cost or market test. If someone were to drastically over improve a personal residence, I'm not sure they could roll all their expenditures into the basis of the property to be used for rental.
For example - suppose you bought an estate for $750K as a personal residence and it had a pool and pool house with a value of $150K - and the rest of the house/property was worth $600K. If you tore down the pool house and pool and built a garage with apartment above (at a cost of $150K), still to be used as part of your personal residence for guests, and the new value of the property was still $750K, then I don't think you could roll all $900K you had spent to date into the basis once you converted the estate to a rental.
The principle is that you disposed of a personal asset- the pool/pool house, with a basis of $150K, for a loss. But losses on personal assets are never deductible or depreciable. So to the extent that your renovations are replacing personal assets that still have residual value and therefore may not be increasing the market value of the property by the entire cost of the renovation, your basis increase may be limited.