Black Friday Appliances for Rental - Best Accounting Method??

14 Replies

I am in the process of renovating a rental property through an insurance claim after a recent fire. Appliances are not included in the insurance claim of what's being covered by insurance since that falls under "personal" items.

I am planning to buy a new kitchen set with the Black Friday deals coming up; however before I did so I wanted to see if anyone had any recommended tax strategies in terms of categorizing them as a repair vs. cap ex, or being able to possible deduct the expense or depreciate them? Any thoughts are greatly appreciated!

@Sean Williams  , 

Good timing to purchase your equipment.  you can use "de minimis safe harbor"  to expense most of the appliance. 

The safe harbor applies to amounts paid during the tax year to acquire or produce what the regs call a “unit of property” (UOP), you must meet these requirements:

  • (1) at the beginning of the tax year, the taxpayer has written accounting procedures treating as an expense for non-tax purposes amounts paid for property costing less than a specified dollar amount (which will be 2500 for you), or with an economic useful life of 12 months or less;.
  • (2) the taxpayer treats the amount paid for the property as an expense on its books and records in accordance with its accounting procedures. ( do this on your bookkeeping software or whatever you utilize)
  • (3) the amount paid for the UOP doesn't exceed $2,500. as substantiated by invoice.
  • Note: The cost for the Unit of Property includes additional costs (for example, delivery fees, installation services, or similar costs) if these additional costs are included on the same invoice with the tangible property.

Eg:

A purchases 100 printers at $500 each for a total cost of $500,000 as indicated by the invoice. Assume that each printer is a unit of property under §1.263(a)-3(e). A has accounting procedures in place at the beginning of Year to expense amounts paid for property costing less than $2500, and A treats the amounts paid for the printers as an expense on its books and records. The amounts paid for the printers meet the requirements for the de minimis safe harbor.

For the tangible property capitalization rules, the UOP for assets generally consists of all the components that are functionally interdependent. 

@Sean Williams How you treat the purchase of appliances can vary based on what will work for you and your business. Individually the appliances will likely fall under $2,500 which is the IRS de minimis threshold which would allow you to expense the entire amount. That being said if you are not a real estate professional and if expensing all of the appliances causes your company to lose money this year you could have passive losses which after a phase out can not be used to reduce income from say a w-2 job if you have one. You could have passive loss carryover's which would have to be carried forward to a year when you have passive income. The alternative argument is that if you capitalize and depreciate you would be subject to depreciation recapture when you sell the property.

@Ashish Acharya and @Brenton Way Really appreciate your alls input on this, this is something I was not aware of that I could potentially utilize. When I mentioned it to my CPA he went more of the route of capitalizing/depreciation so I'll explore both options with him.

I am considering selling the property once this rehab is complete, so depreciating may be useless if a portion of it is going to be recaptured immediately anyways. Would there be a scenario where one strategy makes more sense than the other if selling immediately vs. renting?

Note: mentioning another user on my phone doesn't seem to work so this post was removed and I quoted the original poster.

Originally posted by @Sean Williams :

@Ashish Acharya and @Brenton Way Really appreciate your alls input on this, this is something I was not aware of that I could potentially utilize. When I mentioned it to my CPA he went more of the route of capitalizing/depreciation so I'll explore both options with him.

I am considering selling the property once this rehab is complete, so depreciating may be useless if a portion of it is going to be recaptured immediately anyways. Would there be a scenario where one strategy makes more sense than the other if selling immediately vs. renting?

First off let me start this by saying I am not a tax expert and you should consult with your CPA. That being said, the intent to sell the property could change the circumstances substantially. How long have you owned the property? Are you a real estate professional? What was your intent when you purchased the property (note: you can change your mind from intent to buy and hold to flip)?

If you are a real estate professional and more specifically, if the income generated from selling this property would be classified as ordinary income you would have a completely different treatment. At that point if you purchased the property to flip it the cost of renovations, repairs, apoliances, etc... would be capitalized as WIP inventory and then recognized as cost of sales once the property is sold.

If you are not a real estate professional and you aren't actively flipping multiple properties per year (specific number is a gray area) then you would still have long term or short term capital gains.

I am going to stop short of actually giving you a suggestion because I am not well versed enough to know what to do in certain circumstances. Are you just planning to sell and get out of real estate? Are you looking to do a 1031 exchange? I made some assumptions above but without all of the information I would be speculating as to what makes the most sense for your circumstances.

@Brenton Way I've owned the property for 2 years now. I am a practicing licensed broker with a decent size business (LLC #1), however this rental property is within (LLC #2) which has a couple other rentals in it as well...so when you say "real estate professional" I am a little unclear if my "day job" as a broker would give me this title since this property pertains to LLC #2 and is my "rental job" which is passive income, not active.

We've rented the property for 2 years as originally intended, but do the fire and renovations, plus the market being higher than I ever anticipated in this area, I want to get out what I can and roll the money into a better location via a 1031 tax exchange.

Thanks again for all your input!!

@Sean Williams You definitely qualify as a real estate professional but based on the information you provided you should still be able to do a 1031 exchange. 

I am not very familiar with 1031 exchanges so you would be better off reaching out to someone that has experience. I have seen Dave Foster comment a lot of threads relating to 1031 exchanges so he might be able to answer you questions either in this thread or via private message. 

Hey Newbie question... I'm noticing a lot of these answers start out with: "if you're a real estate professional"... so what classifies someone as a real estate professional? @Brenton Way

Originally posted by @Thea Linkfield :

Hey Newbie question... I'm noticing a lot of these answers start out with: "if you're a real estate professional"... so what classifies someone as a real estate professional? @Brenton Way

 Here is a link with an explanation and some examples. I didn't read this to ensure its accuracy but it certainly looks to be from a credible source. 

https://www.irs.gov/pub/irs-utl/33-Real%20Estate%2...

Cliff Notes:

Real Estate Professional Qualification • Material participation in each specific rental • Material participation in separate Real Property Trade or business • 50% rule • 750 hours rule • 5% ownership rule

Real Estate Trade or Business Defined IRC Sec. 469(c)(7)(C) Any Real Property: • Development or redevelopment; • Construction or reconstruction; • Acquisition and/or conversion; • Rental Activity that is not a Passive Activity; • Property management; • Brokerage activities.

Example 1: Laura owns 5% or more of a real estate sales office • Works full time as a broker • She owns 3 rental properties and: • She finds the tenants; • Approves tenants and leases; • Approves and oversees repairs & improvements • Net rental losses are $31,000 and her modified AGI is $160,000 before the losses • Deduct the full $31,000 in the current tax year

Example 2: John acquires old homes and contracts 3rd parties to renovate and ready for resale. John is a single member LLC and files a Schedule C as a real estate trade or business. This is his main source of income. • He owns 2 rental properties that generate ($28,000) of losses in which he materially participates in the management: his modified AGI is $175,000 before the losses. Since he is a real estate professional the $25,000 limitation and modified AGI tests do not apply.

@Thea Linkfield The alternative is someone like myself. I work a W-2 job and I have a property manager for my two rental properties. Because I am not a real estate professional, losses from my rental business would be considered passive losses. What that means is that if my modified adjusted gross income (AGI) on my tax return is less than $150k I can deduct some or all of the losses up to $25k. There is a phase out that starts at $100k in modified AGI. If I am unable to deduct some or all of the losses then they are carried forward to future tax years when I have passive income.

Brenton,

Be careful,  if you materially do NOT participate in your rental activities you cannot deduct standard 25k passive losses. I saw you mentioned you employ a management company for your holdings so that being said it may disqualify you from taking those losses from the IRS's standpoint....

 You actively participate if you are involved in meaningful management decisions regarding the rental property.

I guess you can still have Management in place and still participate but I'd double check with your accountant

thx,

Chris

Originally posted by @Chris Masons :

Brenton,

Be careful,  if you materially do NOT participate in your rental activities you cannot deduct standard 25k passive losses. I saw you mentioned you employ a management company for your holdings so that being said it may disqualify you from taking those losses from the IRS's standpoint....

 You actively participate if you are involved in meaningful management decisions regarding the rental property.

I guess you can still have Management in place and still participate but I'd double check with your accountant

thx,

Chris

 Thanks Chris! You make an excellent point. I had talked to my accountant about it and he had mentioned that it could be difficult to take the passive losses since I have a property management company depending on how involved I am in the business. I will have the discussion again during tax season if I end up with passive losses.

Edit: 

Active participation means making significant management decisions, such as approving rental terms, repairs, expenditures, and new tenants. Taxpayers who use a leasing agent or property manager are still considered active participants if they retain final management rights.

source: https://apps.irs.gov/app/vita/content/12/12_05_005.jsp

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