Help With Understanding Capital Expenditure Depreciation

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Help With Understanding Capital Expenditure Depreciation

David M.
Investor · Cincinnati, OH · Member since 2014 · 61 posts · 35 votes

Hello, all.

I generally let my accountant do his thing, but I try to understand the ins and outs of taxes for my own benefit as well. I understand the concept of depreciation on a home over 27.5 years as an expense that has to be repaid, assuming the property doesn't lose an equivalent amount of value over that time (depreciation recapture). However, I'm struggling to wrap my mind around the idea that I have to depreciate, for example, a roof over 27.5 years.  If I sell the property 10 years after putting on a new roof, I miss out on claiming 17.5 years of that cost, or more than 2/3 of that cost. If my rental doesn't appreciate ( generally, mine don't; we buy in working class areas for cash flow), am I just out the difference between what I wrote off as depreciation, and what I paid in up-front cost to replace the roof?

This would be so much simpler if I could just write off the cost of the roof as an expense and deduct it in one year. Sigh.

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Corby GoadeBusiness Member
Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
7y

I am not an accountant, and this is a conversation you should have with your accountant, for sure. 

That said, no, you are't missing out on recapturing that expense. If you only depreciate for 10 years, theoretically, you are recapturing your additional 17.5 years through your profit in the sale, ie, the buyer is paying market value for the life that is left in that roof. 

This is why you fully write off repairs and maintenance in the year that they occur- by definition, those expenses don't add value or life to the house. A roof, furnace, cabinets, new plumbing, etc improve the value of a house and extend it's useful life, which is why you depreciate them. 

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  • Corby GoadeBusiness Member
    Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
    7y

    I am not an accountant, and this is a conversation you should have with your accountant, for sure. 

    That said, no, you are't missing out on recapturing that expense. If you only depreciate for 10 years, theoretically, you are recapturing your additional 17.5 years through your profit in the sale, ie, the buyer is paying market value for the life that is left in that roof. 

    This is why you fully write off repairs and maintenance in the year that they occur- by definition, those expenses don't add value or life to the house. A roof, furnace, cabinets, new plumbing, etc improve the value of a house and extend it's useful life, which is why you depreciate them. 

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  • Paul Allen
    Financial Advisor · Virginia Beach, VA · Member since 2017 · 502 posts · 508 votes
    7y

    The un-deducted portion of the roof is added to your cost basis in the property when you sell it.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    7y
    Originally posted by @David M.:

    Hello, all.

    I generally let my accountant do his thing, but I try to understand the ins and outs of taxes for my own benefit as well. I understand the concept of depreciation on a home over 27.5 years as an expense that has to be repaid, assuming the property doesn't lose an equivalent amount of value over that time (depreciation recapture). However, I'm struggling to wrap my mind around the idea that I have to depreciate, for example, a roof over 27.5 years.  If I sell the property 10 years after putting on a new roof, I miss out on claiming 17.5 years of that cost, or more than 2/3 of that cost. If my rental doesn't appreciate ( generally, mine don't; we buy in working class areas for cash flow), am I just out the difference between what I wrote off as depreciation, and what I paid in up-front cost to replace the roof?

    This would be so much simpler if I could just write off the cost of the roof as an expense and deduct it in one year. Sigh.

     Look at what @Paul Allen said. 

    Let’s say you had a roof replacement: 10k

    Two scenarios: 

    1) sold after full depreciation of roof. 

    Market value: 100k

    Basis: 50k ( just building)

    Gain: 50k. 

    2) sold with half depreciation: 

    Market value: 100k

    Basis: 55k ( 5k of basis of roof has not been depreciated) 

    Gain: 45k 

    So you basically got the remaining  entire deduction on the year of sale. 

    Depreciation matches revenue with expense, it’s called matching principle in accounting. It is a hassle but is very logical.

    Let us know if you have any questions. 

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  • David M.
    OP
    Investor · Cincinnati, OH · Member since 2014 · 61 posts · 35 votes
    7y
    Originally posted by @Ashish Acharya:
    Originally posted by @David M.:

    Hello, all.

    I generally let my accountant do his thing, but I try to understand the ins and outs of taxes for my own benefit as well. I understand the concept of depreciation on a home over 27.5 years as an expense that has to be repaid, assuming the property doesn't lose an equivalent amount of value over that time (depreciation recapture). However, I'm struggling to wrap my mind around the idea that I have to depreciate, for example, a roof over 27.5 years.  If I sell the property 10 years after putting on a new roof, I miss out on claiming 17.5 years of that cost, or more than 2/3 of that cost. If my rental doesn't appreciate ( generally, mine don't; we buy in working class areas for cash flow), am I just out the difference between what I wrote off as depreciation, and what I paid in up-front cost to replace the roof?

    This would be so much simpler if I could just write off the cost of the roof as an expense and deduct it in one year. Sigh.

     Look at what @Paul Allen said. 

    Let’s say you had a roof replacement: 10k

    Two scenarios: 

    1) sold after full depreciation of roof. 

    Market value: 100k

    Basis: 50k ( just building)

    Gain: 50k. 

    2) sold with half depreciation: 

    Market value: 100k

    Basis: 55k ( 5k of basis of roof has not been depreciated) 

    Gain: 45k 

    So you basically got the remaining  entire deduction on the year of sale. 

    Depreciation matches revenue with expense, it’s called matching principle in accounting. It is a hassle but is very logical.

    Let us know if you have any questions. 

    This is very helpful, thanks. So say I bought a house for 50k, and the building is worth 40k. Fast forward 13 years, and I'm halfway through depreciating the structure, so my basis is 20k.  I add a roof that costs 4k.  My basis is bumped up to 24k.  If I sell in another 13 years, the house is completely depreciated, but I have a 2k basis because the roof is only halfway depreciated. Does that sound right?

    What happens if I have to replace the roof before the 27 year depreciation schedule for the roof is finished? Do I continue depreciating the old roof even if it's been replaced?

    Sorry if these are silly questions.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    7y

    @David M., 

    No silly questions. Trust me, depreciation is not easy. Still struggle after Masters degree, CPA, CFP, and years of experience.

    You are right, the roof is half way depreciated. 2k. 

    Yes you would continue to depreciate the old roof, so you still get the benefit of your investment. You could also dispose the old roof and take the deduction in that year  rather than taking depreciation over remaining years. It’s called partial disposition with complicated rules.

    [email protected]941-914-7779
    INVESTOR FRIENDLY CPA®5241 Reviews
    WebsiteView Page
    TaxMD™ | AI-Powered Tax Planning
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  • David M.
    OP
    Investor · Cincinnati, OH · Member since 2014 · 61 posts · 35 votes
    7y
    Originally posted by @Ashish Acharya:

    @David M., 

    No silly questions. Trust me, depreciation is not easy. Still struggle after Masters degree, CPA, CFP, and years of experience.

    You are right, the roof is half way depreciated. 2k. 

    Yes you would continue to depreciate the old roof, so you still get the benefit of your investment. You could also dispose the old roof and take the deduction in that year  rather than taking depreciation over remaining years. It’s called partial disposition with complicated rules.

    I have a bachelor's in business and do my own general ledger for the rental portfolio, but I work full-time as a teacher, so all the tax intricacies can throw me for a loop. Trying to figure out when I can quit teaching and manage/grow the portfolio full time, but one major impediment to having enough free cash flow to pay the bills is having to pay out of pocket for the capital expenditures but not being able to recoup that expense in the same year as a deduction. In a year with lots of capital expenditures, taxes could eat significantly into the profits I need to take home.

    I suppose it averages out in the long-run, since I'm writing off that depreciation in years where I don't have as many capital expenditures, but it makes it difficult to plan and make the jump full-time.

    Thanks for the information. It was very helpful.

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