tax deduction for for items brought separately from renovation

14 Replies

I purchased a multi unit property ,the  renovation was included in the mortgage my question is ,when it is asked on the tax for depreciation the purchase price do i use the sale price of the property or do i use the sale price and add the renovation price , also in addition to that I brought kitchen cabinets and counter tops and had them installed by the contractor who was doing the scope of work in the renovation loan , are the cabinets and counter tops an improvement or are those items supplies, because they were not a part of the scope of work and were purchased separately on my credit card

@Linda M.

Your basis is all the cost that is associated with acquiring the property. Your purchase price plus the costs of acquiring the property  that may include appraisal fees (initiated BY YOU not the bank), title insurance, survey costs, legal fees, inspection cost, and similar closing costs. They are added to the purchase price of the home to determine its tax basis for depreciation 

.

Whats not included in these basis of the property:

a) Fire insurance premiums

b) charges connected to getting a loan: (these costs can be deducted over the term of the loan) 

  • 1) Points (discount points, loan origination fees) - This is amortized
  • 2) Mortgage insurance premiums,
  • 3) Loan assumption fees,
  • 4) Cost of a credit report, and
  • 5) Fees for an appraisal required by a lender.

Every work that was done before you rented the place out is added to the basis of the property. Even if you paid it via your card, that is added to the basis of the property for depreciation. 

@Linda M.

@Ashish Acharya has an excellent answer which stopped short of explaining some important details. 

For example, kitchen cabinets and possibly even counter tops could be considered "personal property" and, as such, could be written off completely if installed after Sept 27 2017. If they were installed before that date, they could still be eligible for a massive write-off, but not 100%. Similar rules exist for appliances,  carpets, fences, and various other items. 

Trying to learn these details on your own is tough. I highly recommend finding a competent REI accountant (there're a lot of us right here on BP) and discussing what you can do with him or her. It depends on your situation and your property, not just on the law.

If the property is big enough, your accountant can even recommend a professional study called cost segregation study - the best, albeit not cheap, method to maximize your deductions for property acquisition.

Thank you Ashish and Michael for your response and at this time I think it would be wise to look for the assistance of an accountant as recommended.This being my first time doing taxes with a renovation price fixed into the loan.I am just getting started in the real estate investment and starting a relationship with a REI accountant right now would be advantageous to my future in Real Estate, THANKS

@Michael Plaks , as always, thanks for your valuable input but I please correct me if I am wrong. The property is usually considered a building structure based on the degree of attachment and the extent of the damage caused if removed. 

That is the principal determinants of whether an item is a structural component fof the building.  Also, the property related to the operation of the building is a factor too. 

Wouldnt the kitchen cabinets and countertop considered Building Structure  and not eligible for bonus depreciation. 

There are multiple cases regarding this such as, Morrison Inc, (1986), where Vanity Cabinets and Counters. were ruled not personal property because they were required for the operation of the building.

Maybe you have seen others where they were. I would love to know them. 

That's a very interesting topic, @Ashish Acharya , which I have not extensively researched. So I really appreciate you citing Morrison.

I have always been of an opinion (keyword!) that removable kitchen cabinets are personal property, while those that are permanently attached are structural. Morrison case does not contradict my view. They dealt with vanity cabinets, and it was specifically noted by the court that they were bolted to the wall, indicating permanence. Also, the TP did not really argue the removable aspect. They chose to argue "accessory to business" - a very different concept.

I found a relevant recent case for an apartment complex, Amerisouth (2012). The Court rejected cabinets as personal property, despite cost segregation study(!), under a curios argument that, while movable, there was no indication the TP actually planned to move them. Hmm. I find it encouraging that the court, while discussing several earlier cases, did mention being movable as a favorable factor to TP, seemingly leaving the door open.

Finally, most important to me, the IRS ATG on Cost Seg for restaurants explicitly permits cabinets and counters as 5-yr property, except in the restrooms - apparently a fallout from Morrison. A very similar approach is prescribed in the ATG for auto dealerships. By extension, I assume that it is allowed for SFHs. 

Until I'm faced with a definitive prohibition, I stand by my opinion.

Would love some input from @Yonah Weiss and @Paul Caputo , as well as from our CPA/EA peers.

@Michael Plaks and @Ashish Acharya Thanks for pointing this out. We regularly treat capinets and counters as 5-year 'personal property'. Below is a direct citation from one of our recent reports on a strip-mall with office suites. Important to note, in all of the 10,000+ studies my company has conducted, there have been a handful of clients who have been audited (for other reasons) and ALL of our studies have been no-change.

"Cabinets, Counters and Shelving - These items qualify as tangible personal property because they meet the definition in Reg. Sec. 1.48-1(c). The Senate Finance Committee Report on the Revenue Act of 1978 identified similar items, such as booths for seating and beverage bars, as tangible personal property. In Metro National Corp. v. Commissioner, No. 33279-84, TCM 1987-38, cabinets were found to be tangible personal property. The cabinets were easily movable and there was no damage to the cabinets or to the building structure. In Morrison Inc. v. Commissioner, No. 34300-83, TCM 1986-129, March 31, 1986, the court disallowed vanity cabinets and counters in public restrooms. However, these items were disallowed because they were considered a necessary part of the public restrooms and thus, necessary in the operation and maintenance of the building. Also, the record noted that the vanity cabinets and counters were attached in such a manner that removal would damage the underlying walls. The subject cabinets, counters, and shelving are not permanently attached to the walls and are not necessary in the operation and maintenance of the building. Rev. Rul. 75-178, 1975-1, C.B. 9 Tax Justifications 1 of 8 SECTION 1245 PROPERTY JUSTIFICATIONS for (this property) concludes tangible personal property based on (1) the manner of attachment and (2) the degree of permanence. As discussed in Hospital Corporation of America v. Commissioner, 109 T.C. No. 2 (1997) and Rev. Rul. 67-349, 1967-2 C.B. 48, floor and wall coverings installed in a manner so as not to be a permanent covering of the floor or wall qualify as tangible personal property. These rulings held that if the floor or wall coverings are not an integral part of the floor or wall, they could not be considered a structural component of the building. Similarly, the cabinets, counters, and shelving items reflected in this report are not integral parts, nor permanent coverings, of the structural components of the building. Rather, all of these items can be easily removed without sustaining damage and without affecting the structural integrity of the building."

@Yonah Weiss , I am in the process of purchasing an old Elementary School and converting it into apartments. this was some good information, thank you@Linda M. for bringing the subject up. I also know in Europe their kitchen cabinets are all removable so that they can take them with them if they move, i installed a kitchen like that in Norway for a relative, if they ever move they can be taken down and reused elsewhere, that's why you see the cabinets from Ikea get installed on metal tracks.

Yonah, how does that relate to carpets and light fixtures then? would that be the same? ( i am not putting carpet in any in my units but just curious ). and is there a place to get a "List" of items used in construction and how they can be treated?

@Patrick Liska The subtle point I was bringing about was that this work really must be conducted by experts, who specialize not only in the engineering of buildings, but also the specialized tax code. Carpets and light fixtures can have their place as 5-year 'personal property', but sometimes depends on how they are installed. There is not any list that I am aware of. 

Bottom line, segregation out assets for faster depreciation without proper citation of the tax code, and rulings, is a surefire way to fail an audit. There is a reason why experts in this field are used.

@Yonah Weiss thank you for the response, I wasn't attempting to do this myself, I know that there is a lot to it, it was more of a guidance request and for my own knowledge as a guide to know what to look for or expect. Is there some references I can read that you would recommend for ( law sections or books) further understanding? 

Originally posted by @Patrick Liska :

@Yonah Weiss thank you for the response, I wasn't attempting to do this myself, I know that there is a lot to it, it was more of a guidance request and for my own knowledge as a guide to know what to look for or expect. Is there some references I can read that you would recommend for ( law sections or books) further understanding? 

The only thing I could suggest is The CS Audit Techniques Guide, very technical. 

@Yonah Weiss thank you for that reference, believe it or not, i have already read that. that is more of a guide on how to go about the segregation, but does have some helpful links in it too to laws that i will investigate further to learn, but will hire someone to handle it. thank you!

Thanks for the mention @Michael Plaks ! A few things I'd like to add here. Whether something qualifies as 5 year personal property or a long life asset that is either a structural component or necessary for the general operation and maintenance of the building relies on the "facts and circumstances" of the particular asset. There are 6 "tests" known as the WhiteCo factors that are used to determine if an asset is personal property or structural/necessary to the building. So for everything that could qualify it can really go either way depending on the circumstances. That's why its so important to have a qualified construction engineer who also knows the tax code looking at assets to classify them properly as @Yonah Weiss pointed out.

@Patrick Liska There isn't a real "list" of what qualifies and what doesn't because in different situations the same asset could go either way. With your school to apartment conversion I'd recommend getting out in front of it and getting preliminary cost seg consulting to maximize 5 year assets and be able to expense out all the retired assets. We get the best results when we can say "do this, don't do that" before you start the conversion or construction.

On the cabinets most of the time they'll qualify as personal property in the kitchen, but not in the bathroom. This isn't necessarily because of the Morrison case it's because bathrooms are considered necessary for the operation of a building since they provide "human comfort". Even though you can easily remove a toilet and will surely have to replace it before it's 27.5 or 39 year life expires that doesn't matter because it has to be there. 

The Amerisouth case is a great example of what NOT to do with cost seg. Many assets incorrectly classified and even assets they didn't own put on the depreciation schedule on top of Amerisouth stopping correspondence to the Tax Court. This is a pretty obvious case of trying to bend the rules to your favor which is a big no no. 

As with everything with the IRS make sure you can back it up!

@Paul Caputo thank you for that input, that helps. I will start looking for cost segregation experts in central PA. Closing on the property the end of March and hoping to have a contractor hired and started as soon as possible ( out for estimates right now) I will want someone soon then.

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