Bummed out over Genral Plan of Improvement Rule

Tax, SDIRAs & Cost Segregation
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Bummed out over Genral Plan of Improvement Rule

Shane Moss
Real Estate Investor · Independence, MO · Member since 2010 · 40 posts · 5 votes

I just closed on my first SFR today! I've been feeling good all day until I read more about the difference between repairs and improvements. More specifically, I'm bummed out over the General Plan of Imporvement rule. Here's why:

I purchased a forclosure. It has one huge problem: the foundation needs some major work; about 10K to be exact. I was confident this would be a repair, as the solution will be to restore it back to its original state. Figuring I'd be able to deduct it all in one year as a repair, I thought 10K wasn't too bad since a little over 3K should end back up in my pocket. But then I got to chapter 4 in my book, Every Landlord's Tax Deduction Guide (great book by the way), and read the crap about too many repairs in a short time can constitue a general plan of imporvment, therby classifying your repairs as improvements.

Besides the foundation, I need to make other "repairs" such as, re-glazing the bathtub, re-finishing the wood floors, and completely repainting the interior. These are all fairly large expenses and really need to be done before I rent it out. Of course I have other misc. things that would be classified as an improvement at anytime. That will probably be around 5K for those improvements.

Thank you for hearing my rant. Now if I may, I'd like to ask for advice. Do you guys have any ideas on how to keep these things designated as "repairs" w/o spreading the work out over several years. Is the general plan of improvement subjective enough that I can take some liberties and not worry about it?

I appreciate the help!

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    My first advice is to get a CPA who's knowledgeable about real estate and discuss your situation and plans with them. Real estate taxes are not a DYI project,any more than those foundation repairs.

    If you're doing a fix and flip, all the work you do is either immediately deductible or adds to your basis. In either case, it reduces the gains on the sale and therefore reduces the taxes you owe.

    If you're going to hold this for a rental, anything significant you do prior to having the property rent-ready becomes a depreciable item, and has to be depreciated over several years.

    Not sure what you mean by "putting $3K back in your pocket". If you mean using passive losses to offset ordinary income, be sure you understand those rules. They are complex, and there are significant limitations.

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  • Shane Moss
    OP
    Real Estate Investor · Independence, MO · Member since 2010 · 40 posts · 5 votes
    16y

    Thanks for the reply Jon.

    This will be a rental property. Regarding the 3K back in my pocket comment, I was estimating the amount I'd get back from taxes based on my tax bracket. This was going with the assumption the foundation work was a "repair" and fully tax deductible in the year the work occurs. Sounds like I was wrong though.

    Let me see if I understand you. Are you saying there is no distinction between a repair and improvement when it comes to the work that's done prior to having a property rent-ready? Does that include start-up costs too (legal fees, business cards, etc)?

    You're right, I need to find a CPA. Do you know of one in Kansas City you could recommend? That question goes for anyone on here.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    There is a distinction. Some of the work you do before its rent ready is immediately deductible, some has to be depreciated. I break it out for my accountant and then a miracle happens. It doesn't really matter because you have to do what you have to do to get the property ready.

    When you're talking about getting money back, you almost certainly mean you're using passive losses to offset ordinary income. Its not possible to have a bunch of rentals as your sole source of income, generate a net loss on your taxes and then get a check from Uncle Sam. I'm sure you understand that, which is why I think you must be using those passive losses from this property to offset ordinary income.

    The tax rules say you can't do that. Passive losses can't be used to offset ordinary income. That's a result of abusive tax shelters people set up to use bogus passive losses to shelter all their ordinary income.

    However, there is a "special allowance" that allows up to $25,000 in passive losses to be used to offset ordinary income. For one, you're limited to $25K. For a second, you can only take that $25K if your modified AGI is under $100K. That's for single or married filing jointly filers. If your MAGI is over $150K, you can't take any of this special allowance. In between it phases out.

    The "tax advantages" of rental real estate are often used to put some lipstick on a pig of a deal. In reality, good deals tend not to produce much passive loss, or actually generate a new positive passive income even with depreciation.

    For another gotcha, be aware of depreciation recapture tax that kicks in when you sell.

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