When to place in service

7 Replies

Hi everyone! That new podcast got my tax juices flowing. One part that struck me was about capital improvements and placing your property in service. I purchased my first property (duplex - house hack) in mid December. Since then, I've been working on rehabbing the unit that I will rent out. I have all of my receipts so I know what I've spent. I'm not looking for "what should I do?" but I'd like to hear what other investors think or have done in the past. I was planning on waiting until the unit was done being rehabbed to "place it into service" and start advertising. After hearing the podcast, they mentioned placing it into service ASAP, to be able to write off the improvements. That makes sense. I was looking at it from a maximum depreciation standpoint. Wait until its in the best condition, the taxable amount of the structure would be the highest, thus depreciation would be the highest. Does that make any sense? My logic may be flawed. Just wanted other opinions. Thanks in advance!

@Marc Izquierdo

No, your logic is not flawed. But, usually, the repairs that can be deducted have higher tax benefit than from the deduction of the basis depreciation. 

Eg.  5000 basis that is added has to be recovered over 27.5 years, but 5000 expense gives you deduction right away. On top of that, any depreciation you take has to be recaptured when you sell and taxed at 25%.  Repairs are not recaptured. 

So it is always beneficial to make take repairs. The following elements must be proved before it is considered placed in service:

  • 1) Readiness.
  • 2) Availability.
  • 3) Capability to perform its intended function.

Advertising it before actually meeting these do not help you. So do the bare minimum to meet the these and advertise. The expense of the advertisement can be expensed if they are not considered improvements.  BTW, improvements always have to be capitalized so does not matter when you do it. 

Hope that helps. 

@Ashish Acharya  Great information.  Thanks for taking the time to respond.  The recapture piece that you mentioned is great.  Just from that aspect I can see why taking repairs is more beneficial.

This provoked me to do a little more research.  If you could double check my understanding, that would be great.  Like you said, improvements always have to be capitalized and depreciated regardless of when it is "placed in service".  So I could do that now.  They are also subject to recapture though, correct?

Repairs, are what depend on being "placed in service".

So ultimately, (you assume no liability here for tax advice) best practice is to itemize receipts so that at the end of the year, it's easy to determine what was a repair and what was an improvement.

Currently I have a lump sum figure, not itemized.  I should spend the time to do that.

Originally posted by @Marc Izquierdo :

@Ashish Acharya  Great information.  Thanks for taking the time to respond.  The recapture piece that you mentioned is great.  Just from that aspect I can see why taking repairs is more beneficial.

This provoked me to do a little more research.  If you could double check my understanding, that would be great.  Like you said, improvements always have to be capitalized and depreciated regardless of when it is "placed in service".  So I could do that now.  They are also subject to recapture though, correct?

Repairs, are what depend on being "placed in service".

So ultimately, (you assume no liability here for tax advice) best practice is to itemize receipts so that at the end of the year, it's easy to determine what was a repair and what was an improvement.

Currently I have a lump sum figure, not itemized.  I should spend the time to do that.

 Mark, 

Improvements have to be capitalized unless you meet few safe harbors.  And, yes improvements can be depreciated but will be recaptured later when you sell the house and taxed at 25%.

Yes, itemized receipts are must if you want to take full advantage of the deduction. Itemized receipts are also needed when you check if you qualify for the safe harbor I was mentioning above. 

Two of the safe harbors that can help you deduct improvements are below:

1) 2500 de minimis safe harbor.

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)you need to have 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 the invoice
  • Note: The cost for the Unit of Property includes l additional costs (for example, delivery fees, installation services, or similar costs) if these additional costs are included on the same invoice with the property.

2) Small taxpayer safe harbor: To be eligible for the safe harbor, the total amount of improvements for the property for the tax year may not exceed the lesser of

  • $10,000 or
  • 2% of the property's unadjusted basis.

If the total amount paid exceeds the safe harbor threshold, the safe harbor does not apply to any amounts spent during the tax year.

@Ashish Acharya

Awesome.  I didn't know about the safe harbors.  That's great.  I appreciate you sharing all of that.  That led me to researching a bit more.  

In my case, it seems like I won't qualify, as the improvements I'm making are going to be greater than 2% of my unadjusted basis.  However, that is great to know for the future.  

So, when you qualify, you can deduct all of the improvements in that current tax year.  Therefore, there is no recapture, correct?  Once it's done, it's done.

This is probably obvious to people in the tax world but it seems to me that taking a deduction in the tax year is a lot more favorable than depreciating it, from not having to pay a recapture tax standpoint.

@Marc Izquierdo

To put it very simply:

The only recapture will be on the depreciation you take on the house.  Anything that gets added to the basis gets depreciated and later recaptured when you sale. 

And, you might qualify for deduction under de minimis safe harbor. Good luck

Hope that makes sense. 

@Ashish Acharya , you are a machine!  I cannot tell you how awesome it is to have a guy like you on here keeping us oblivious (no offense to you Marc, I speak for myself here!) TAX folks in line!  Thanks Ashish you are a true Champ, appreciate the in-depth information you supply, I have no doubt I speak for a lot more than you know!  Keep up the good work my friend!

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