Capital Gains and Expenses

[Robert Littke]

Can someone give me some clarity on what is deductible against capital gains in commercial real estate? I was under the impression that maintenance costs and general repairs were not, but capital improvements to the property were. Is this correct?

[Jon Holdman]

Not a CPA, and this would be a good topic for a discussion with your CPA. That said...

A capital improvement is not deductible. It does, however, increase your basis. That has the effect of reducing capital gains when you sell.

A capital improvement becomes depreciable, once its put in service. The length of the depreciation period will depend on the item. There's a schedule in the IRS documents. The amount of depreciation each year is a deduction against the income for the year.

When you sell, you're subject to depreciation recapture tax, which is based on the amount of depreciation taken or that could have been taken, whichever is larger. Also, depreciation (taken or allowed) decreases your basis. The capital improvement adds to your basis, then depreciation reduces it and subjects you to depreciation recapture tax, which is at a higher rate (25%, currently) than capital gains tax (15%, though it will be interesting to see how long that survives.) So, you really do want to take those depreciation deductions.