Capital Expense or not?

Question

Hi everyone,

I inherited a tenant when I purchased a property 6 years ago and this tenant moved out. Tenant has been there for over 20 years so the unit has a ton of updating that it needs so that the unit is brought back to life.

The software I use to keep track of income/expense for this property has a category for renovations under capital expense. All the improvements I am doing is going under this category (new bathroom, new plumbling, new kitchen cabinets, new tile, new flooring, appliances, etc...)

I dont know how classify my labor expense. There is two guys who is doing this turnover for me. One is my bro in law and the other is a friend. Could their labor expense be classified under capital expense as well because they are doing work under a capital expense category or is this just labor expense? Thank you everyone

Nathan Gesner · Answer

Yes, labor costs are generally included as a capital expenditure when renovating a rental property. Capital expenditures (CapEx) refer to significant expenses used to acquire, upgrade, or maintain a property, extending its useful life and increasing its value. These expenditures are capitalized, meaning they are added to the property's basis and depreciated over time.

Examples of Capital Expenditures

• Building Additions: Adding a new room, deck, or other structural improvements.
• Major Renovations: Remodeling a kitchen or bathroom, replacing the roof, or significant electrical and plumbing upgrades.
• Appliance Replacement: Installing new HVAC systems, water heaters, or other major appliances.
• Structural Repairs: Replacing the foundation or significant repairs to the building’s structure.

Labor Costs

• Labor Costs: The costs paid to contractors, electricians, plumbers, carpenters, and other professionals involved in the renovation are part of capital expenditures.

Example of Capital Expenditures with Labor

Suppose you renovate a rental property, including a new kitchen and bathroom.

• Materials: $15,000
• Labor Costs: $10,000
• Total Capital Expenditure: $25,000

This $25,000 would be capitalized and added to the property's basis. You would then depreciate this amount over 27.5 years, allowing for annual depreciation deductions on your tax return.

Basit Siddiqi · Answer

You want to see if certain items that normally need to be capitalized that can be immediately expensed via the de minimis safe harbor election.

Randy Rodenhouse · Answer

Capital expenditures include material and labor, but does not include your own labor. However, not everything has to be capitalized (and in turn is depreciated).  Capital expenditures (CapEx) are typically items that will be used in the course of business for more than 1 year.

Michael Plaks · Answer

You qualified several responses to your question as "awesome." Well, I would not.  :)Here's the crux of the matter.1. On any project, labor and materials are combined. If you bought $1,000 worth of tile and paid your friend $500 to install it, you spent $1,500 for a tile job.

2. However, not every project goes into "capital expenses" - or, rather, there're different kinds of capital expenses. For example, appliances can be deducted 100% immediately, while your new bathroom will be slowly deducted ("depreciated") over 27.5 years. If you throw everything into one "capital improvements" bucket, you lose these benefits.

3. That said, you may not need these benefits anyway, depending on your overall tax situation.

Yes, it is super complicated. Blame our awesome tax laws created by Congress.

Melanie P. · Answer

I would capitalize the plumbing and bathroom remodel and expense as tenant turnover the kitchen cabinets, any appliances other than an HVAC system, and the tile/other flooring you listed. One bad tenant can trash out all of the items mentioned as expenses.

You can only deduct labor "costs" that you actually pay and can prove you paid. Are your buddy and brother in law professional contractors or just handy? I encourage you to use licensed professionals for the plumbing and bathroom. Mistakes there can turn out to be very expensive and impact your property and neighboring properties.

Tarcizio Goncalves · Answer

Thank you Nathan. Appreciate the context here. This is awesome

Tarcizio Goncalves · Answer

Thank you Randy. Appreciate the reply here.

Tarcizio Goncalves · Answer

This is awesome, thanks Allan

Allan C. · Answer

@Tarcizio Goncalves you’ve already received good input on what counts as capital expenditures. However, as you gain experience you’ll want to minimize how much you capitalize and shift costs towards expenses.

Many items that are capitalized gets depreciated over 15+ years. If you expense the expenditure then you write it off fully within the year costs are incurred. This minimizes the income tax you pay not only within the first year, but future years until your income exceeds total renovation expenses. This has a very large positive impact on your wealth potential.

So how do you expense items that are normally capitalized? There are several safe harbors that you can take as a small business operator. Talk to an accountant about de Minimis Safe Harbor and Safe Harbors for Small Taxpayers. Tax optimization is a powerful aspect of investing and most people don’t take advantage of all the options.

Capital Expense or not?

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Examples of Capital Expenditures

Labor Costs

Example of Capital Expenditures with Labor