Rehab costs - tax deductions?

Question

We are starting our rehab next week on my 1st rental property.  The house is in rough shape so we'll be doing a good bit of work:  new roof, windows, flooring, cabinets etc.

How much of this can I deduct as repair costs?

From some basic googling I understand improvements are not deductible?  How do you differentiate?

Example; Roof is shot and leaking so it will improve the value but also very necessary.

Edit- as I continue reading roof would be cap ex so not deductible.

Frank Chin · Answer

There's a recent discussion on the topic. See:  Capitalizing rehab expenses  Note CPA Natalie's comments. Its particularly tricky if you take a rental out of service for a prolong period, then rent it out again. I bought a property to rehab, closed on it in Oct, and all the expenses that year was capitalized. If was a failed flip, and I didn't rent it out till late the following year. To play it safe, everything was capitalized during the rehab period. I did expense legal, accounting fees during the period as I own other rentals, even though some of the expenses were incurred for the new property.

One other reason for using a CPA is you can defer to his professional judgement and if the IRS gets after you, you can point to your CPA. This happened to me when a state workman's comp inspector came to audit my books for one of my businesses, complaining about various things. Put her on the phone with my CPA, who yelled at her, "what are you doing there, you know I care of it". The state inspector works the area and knows my CPA. When she hung up, said "sorry, didn't realize he's your CPA, I'll talk to him". She left and that was the last I heard of it.

Tony Kempisty · Answer

Great insight. Thanks. Yea my taxes have always been straight forward so I will definitely be using a CPA from here on out.

I wondered about this and it does make sense - "However, repairs can only be deducted if you have the place rented out, else has to be depreciated"

Frank Chin · Answer

You're mostly right. Use a CPA, but the major improvements, like a new roof, has to be depreciated.

I started with properties that needed work, and in most cases a big rehab job. In one I had to replace the roof as soon as I got the place and had the purchase price reduced. However, repairs can only be deducted if you have the place rented out, else has to be depreciated.

None the less, replacing the roof, new carpeting, kitchen cabinets to do over the place falls under depreciation rather than repair.

My experience had been to componentize the depreciation rather than clump them all together when I did the first rehab. In other words, should have the roof in one depreciation account, kitchen cabinets in another, carpeting in yet another.

One amusing story with my carpeting was I included re-carpeting in the first major rehab in one large depreciation account, five years later replaced it with new carpets, then carpeting again 3 years later. Then my accountant asked why I have so many depreciation accounts for the same carpets. Fortunately I was able to write off the carpets I installed the 5th year, and the 8th year, when I did re-carpeting on the 10th year, but the original one, I stuck with as it's in one big depreciation account, not componentizing it.

Also, use a CPA as he's been advising me of new laws on depreciation, when a few years ago, advised me I could write off 50% right away on improvements I done. I'm involved with so many things that I can't keep up with tax law changes, and I even forgot the name of the law he mentioned.

Another thing is, after I got into it for a while, own a few rentals. like over 10 years, each property throws off some depreciation, year after year, improvements I did 3 yrs, 5yrs, 6 yrs ago, that I won't have to worry that I don't have deductions, I got it tucked away. I always operate with positive cash flow, as rents increase, the saved up depreciation that I can use in later years gives me deductions over time, thus some tax free cash flow. This was especially helpful when our W2 income was too high and deductions against W2 income was off the table.

If you're new at this, have a CPA get you on the right track.

Corby Goade · Answer

For the record, this is a question for your accountant.

As a general rule- a big ticket item that improves the value and livability of a property cannot be "written off," but it can be depreciated over time.

Repairs and maintenance can be written off in full the year you incur the expense- something like fixing a scratch in a wood floor or a hole in the drywall= a repair. If you replace an entire floor, that's an improvement and you would depreciate that.

As you do more of this stuff, you'll find that depreciation is very powerful and is an excellent tool for limiting your tax liabilities over time. You don't want to write off big ticket items all at once.

Best of luck!