Expensing vs Capitalizing

[Andrew Yu]

I have questions on whether I should expensing or capitalizing my costs on remodeling a property. I feel expensing is always a better option, since it deducts the overall taxable income to the most amount immediately. Capitalizing is using depreciation over time, when you sell the property, you have to recapture the accumulated depreciation. I feel capitalizing is a zero-sum game, basically you don't deduction overall if you sell. 

Correct me if I'm wrong. Sometimes I fix & flip immediately, sometimes I fix & keep as rental for a couple years then sell. What should I do here on my cost?

[Ashish Acharya]

Originally posted by @Andrew Yu:

I have questions on whether I should expensing or capitalizing my costs on remodeling a property. I feel expensing is always a better option, since it deducts the overall taxable income to the most amount immediately. Capitalizing is using depreciation over time, when you sell the property, you have to recapture the accumulated depreciation. I feel capitalizing is a zero-sum game, basically you don't deduction overall if you sell. 

Correct me if I'm wrong. Sometimes I fix & flip immediately, sometimes I fix & keep as rental for a couple years then sell. What should I do here on my cost?

You are right, kind of. 

First of all,  you don’t get to expense everything. There are rules to determine if you can expense or capitalize. Most of the capital improvements cannot be expensed. 

Also depreciation is not a zero sum game. The deduction you get over the time decreases your ordinary income, taxed as the ordinary income at the higher tax rate. When you recapture it, you just pay maximum of 25% or lower rate depending on your bracket. Also you don’t recapture If you have a loss.

It might be hard to grasp, but Depreciation was meant to recover your cost over time as most asset depreciate in value over time. Thus when you dispose the depreciated asset, you recover all your cost.

Now if you can sell the asset at more than purchased amount, then your asset really didn’t depreciate it, did it? So you have to recapture depreciate that really didn’t happen. Congress is nice enough to allow us to recapture It at lower rate than what you originally offset higher rate ordinary income.