Looking for a Second Opinion from Tax Pros

[Kate McClinton]

I'm second guessing some answers my CPA gave me recently and wanted to run the following questions by others who specialize in real estate accounting.  Thanks so much for your time!

We purchased a house, listed it for rent a few days after closing, and had the following work done:

Painting (interior of house) - $4,220
Plumbing and electrical work - $1,603
Countertops - $2,130
Flooring - $5,800
Garage Door - $850

1.)  Is it permissible to use the de minimis safe harbor election and expense the renovation costs that fall below $2,500 instead of capitalize them?

2.)  Is the house considered “placed in service” on the day it was listed for rent?

3.)  When calculating the cost basis of a home, is it permissible to use the allocation of building to land from the county property tax assessment instead of an appraisal?  Our CPA said we had to use the appraisal as it is more accurate.

4.)  Our CPA has been depreciating new appliance purchases from all of our rental properties instead of expensing them in the current year using the de minimis safe harbor election.  When asked, she said she didn’t think it would make much of a difference and would likely cost us more in professional fees for her to use that election.  Does this sound right to you?

Thanks so much for your input!

[Carl Fischer]

@Kate McClinton

I let my accountants figure out the answers for the most part. We discuss the issues and make decisions. 

I don’t I don’t necessarily agree with his premise that the appraiser is more accurate either

[Michael Plaks]

@Kate McClinton

1. Yes, that's what the de minimis is for.

2. Yes, assuming it was actually available and in rentable condition.

3. Yes.

4. Does not sound right. Also, besides the de minimis, there's the new 100% bonus depreciation, allowing another way to expense appliances.

[Justin Freeman]

Hi Kate,

Congratulations on the purchase. I'm a CPA who does a fair amount of work in the real estate industry and owns multiple residential rental properties as well. It's kind of cool as I get to see accounting in real life.

In regards to your questions l, the IRS issued new regulations about capitalization of assets, and capitalization falls into four categories, Betterment, Improvement, Adaptation or Restoration. But my thought on this and same with many of my peers is this falls after the available for rent moment. Generally if you have to fix up a product after you buy it but before it's available to be put to use you would capitalize those items. So those expenses would you listed would depend on when it the cylcle they occurred. After the property is available to rent, i.e. in between tenants or during occupancy a lot of those expenses can get their own safe harbors, not necessarily the deck minimus safe harbor.

When the building could be moved into is when it's available for rent. I've seen a lot of people list it and then make the updates trying to avoid capitalization. I'm not sure that actually works, but I've never been tested on it either with the IRS. I think it's a common sense thing. The IRS has rules written about it as well which provide good examples.

Unless I have an appraisal I almost always use the town/county assessment. With an updated appraisal it might be tough to win an IRS argument though if you were to use the assesment, if the IRS sees an advantage to using the most recent appraisal.

I'm a huge fan of the 2500 de minimus it gets you the deduction today AND when you do to sell the asset is not covered under Section 1245 recovery. So it potentially could save you even more at the time of sale. There should be no reason it would cost any more, if anything it should be cheaper.

Hope this helps,

Justin

Sorry for any editing mistakes, on my phone. 

[Linda Weygant]

1.) Is it permissible to use the de minimis safe harbor election and expense the renovation costs that fall below $2,500 instead of capitalize them?

2.) Is the house considered “placed in service” on the day it was listed for rent?

No, despite the BP blog post that seems to indicate that advertising is some kind of magic bullet.  It's not.  In order to be considered "In Service", the dwelling must be ready and available to rent.  In other words, if somebody qualified came up and knocked on the door, could they move in the next day?  Odds are good that if you're doing flooring, the answer is No.  If there is no running water in the kitchen because you've got the countertops torn apart, then you do not have a habitable home (by most county standards).  Therefore, your asset is not In Service and De Minimus Safe Harbor would not apply.

3.) When calculating the cost basis of a home, is it permissible to use the allocation of building to land from the county property tax assessment instead of an appraisal? Our CPA said we had to use the appraisal as it is more accurate.

Yes, it's permissible if no other more accurate allocation is available.  I use the following in order of preference:

1.  Appraisal (including insurance appraisals/valuations).

2.  Survey (if it includes a valuation)

3.  Property Tax assessment from the county (where available)

4.  If none of those are available, I will sometimes use a percent of building footprint vs total lot measurement

5.  Gut feel if nothing else is available (but documented as to how I arrived there).

4.) Our CPA has been depreciating new appliance purchases from all of our rental properties instead of expensing them in the current year using the de minimis safe harbor election. When asked, she said she didn’t think it would make much of a difference and would likely cost us more in professional fees for her to use that election. Does this sound right to you?

Appliances are not eligible for De Minimus Safe Harbor.  They are a completely separate Asset Class (Equipment) vs Building/Improvements.  They are eligible for Bonus depreciation at 50% in the first year and then depreciated thereafter.  Starting in September 2017, the bonus depreciation is at 100%.  However, just because your CPA is not maximizing your equipment depreciation, that does not necessarily mean they are wrong.  Depreciation elections are based on a whole list of items such as projected future passive income, current level of other earnings, anticipated exit date (if you've shared that), etc.

Her reasoning of "more in professional fees" makes no sense.  In my software, it's literally a button click and a confirmation.  Even though it prints out on a separate page, I don't charge extra for that.  

[Michael Plaks]

@Linda Weygant

About "Appliances are not eligible for De Minimus Safe Harbor. They are a completely separate Asset Class"

Tangible property Regs refer to "tangible property." Where did you see that it's asset class - specific?

[Linda Weygant]

@Michael Plaks - My reading of Treas. Reg. § 1.263(a) and related regulations.  

"The de minimis safe harbor election does not include amounts paid for inventory and land. Additionally, it does not apply to rotable, temporary, and standby emergency spare parts"

Essentially, an appliance or other equipment installed in a building is considered Rotable and Temporary when installed in a UOP (defined as a building, in this case).  

The nature of kitchen and laundry appliances is such that they are, essentially, plug and play (rotable).  You swap them out on a fairly regular basis either as preventative measure when they are nearing the end of their life, or as a restorative measure when they break.  

While I could see a case being made for a higher end appliance (which may cost more than $2500 anyway), the vast majority of appliances utilized in a rental scenario, in my opinion, meet the definition of rotable and temporary.

[Michael Plaks]

Thank you for your explanation, @Linda Weygant.

I believe your interpretation that appliances are "rotable spare parts" is a stretch. They are not parts at all, they are separate assets. 

If this is the extent of your support, then I stand by my position that appliances are eligible for the de minimis.

[Linda Weygant]

No - not spare parts.  That's not the interpretation and that's not what I said.  There are a couple of different descriptors there and you focused on the one that I did NOT underline.  Note that the sentence I quoted does not indicate that ALL THREE conditions of rotable, temporary or spare parts must be present for the election to not be applicable.  

The issue is that the appliances are temporary in nature.  They are not permanently affixed to the structure, are removable and replaceable (and are removed and replaced frequently).

The way that my tax professor explained it to me is that you could take any one of these items and place it in the middle of a field, on a sidewalk, wherever.  You hook it up to a water and power source and it performs its intended function as is, where is, regardless.

Not so with drywall, countertops, flooring, roofs, etc.  These items become a permanent part of the asset in order to function as intended and, indeed, MUST be affixed in order to operate.

So the appliances have a temporary nature.  They are also rotable, which I outlined in my original answer.  An item only has to meet one of the three conditions I mentioned earlier.  Appliances meet two of them, therefore my interpretation is that appliances are not eligible for De Minimis treatment.

But it's all good, I'm not here to argue.  You serve your clients and I'll serve mine.

[Michael Plaks]

Originally posted by @Linda Weygant:

The issue is that the appliances are temporary in nature.  

The issue is that appliances are not parts. :)  Peace.

[Brian Schmelzlen]

1) Yes, you can use the de minis election for the plumbing and electrical work, countertops, and garage door as it looks like they were separately listed on your invoice (or you had multiple invoices) since all are less than $2,500.  The only issue I see is if a contractor gave you a lump-sum price and you are trying to allocate the cost.

2) Yes, I am on the opinion that a house is considered placed in service on the day it is listed for rent as long as it is being legitimately put up as available to be rented.  If you are advertising it but have no intention of letting anyone actually rent it for a few months while you make improvements, that would not work.

3) While I think there is an argument to be made for using the property tax assessment, I think if you have an actual appraisal that lists the value of the land and building you would have to have a strong justification for doing so (assume that you are going to have to defend the decision to the IRS).  Essentially, I think you would have to believe that the appraisal is not accurate.

4) In the past it definitely made a difference.  Starting in late September 2017 under the new tax law, it no longer does.  There is now 100% bonus depreciation available for new fixed asset purchases.