Are all reno costs part of the initial cost basis?

Question

I bought a foreclosure(3 plex) in Feb. $55,000.  Renovated ($30,000) til May 1st when I rented it out. Are all reno costs part of the initial cost basis? I also did another $20,000 in siding, windows and roofing during the summer.

Brandon Hall · Answer

@Ken Hipp  Dave NA

Costs incurred to place a property into service are capitalized. So yes, your renovation costs prior to renting out the house will be included in the cost basis and depreciated.

There are two interesting rules that few know about and further understand. The first is the safe harbor rule for routine maintenance. It states that if tax payers reasonably believe they will need to conduct the same repair twice within ten years, they can expense the cost of the repair rather than capitalizing and depreciating it. (What is the estimated useful life of your windows and can you back that up?)

The second is the safe harbor for taxpayers with gross receipts of less than $10MM who own buildings which took effect Jan. 1, 2014. If you qualify, you are not required to capitalize improvements if the total amount paid for repairs, maintenance, improvements and similar activities during the year that are performed on the building does not exceed the lesser of $10,000 or two percent of the unadjusted basis of the building. No amount is deductible under the safe harbor for buildings if either limit is exceeded. This rule is applied separately to each building owned by the taxpayer. Since you spent over $10,000 in annual expenses on your building, you will not qualify, but the rule is important to keep in mind for future use.

Example: You own a rental with a $100k unadjusted basis. You incur plumbing costs of $200, carpet replacement costs of $800, and you replace two windows at a cost of $800. Under the safe harbor rule, you can expense the entire amount of $1,800 because you are below the threshold of $2,000 (2% of $100k).

Bill Y. · Answer

Brandon,

Thanks for the explanation and blog link...that makes sense.  Do the De Minimis items show up under a line item in the Schedule E? Is there a separate form just for listing all of the De Minimis items?

Thanks!

Brandon Hall · Answer

@Bill Y. I wrote a blog post on it here.

I'm not aware of any sort of minimum holding period or need to pro-rate the 2% limit.

Small tools are personal property so they would fall under the De Minimis rule. So per your example of deducting four $400 items for a total of $1,600 - yes you can expense and deduct these amounts currently rather than depreciate over a number of years.

The routine maintenance safe harbor is applied to the 2% limit of the Safe Harbor for Small Taxpayers but the De Minimis expenses are not applied to that limit. So per my $100k example where you have a 2% cap for expenses, regardless of the amount you expense under the De Minimis, you still have the full 2% from the Safe Harbor for Small Taxpayers.

Bill Y. · Answer

Brandon,

Is the 2% adjusted for a partial year ownership?  For example of a property were purchased and rented for 130 days of  the 365 would the 2% be calculated for that year be based on 2%*180/365*(Unadjusted Basis) or would it still be 2%*(Unadjusted Basis)?

Do small tools like a hammer or shovel fall under this 2% as well?  Do these fall under the safe harbor de minimis rule?  If you deduct say 4, $400 items under the safe harbor de minimis rule would that $1600 also show up under the 2% small taxpayer safe harbor rule?  (i.e. can you have 2% under small taxpayer safe harbor + some items that fall into the de minimis rules)?

Thanks!

Ken Hipp · Answer

Thank you to all, that is pretty much what I thought from reading earlier post.

Dave Toelkes · Answer

Yes, all your renovation costs are a capital improvement and the cost is added to your basis.  Your depreciation basis is your cost basis minus the cost of the land the property sits on.   Once the property is placed in service, you can begin depreciating.  After the property is placed in service, additional capital improvements (such as the siding, windows and roofing) are depreciated on a separate 27.5 year schedule.

If you are really asking if you can expense any of the cost of your renovation, the answer is no.  It has to be capitalized, then recovered through depreciation.

Trevor Ewen · Answer

If you're asking from a tax perspective, I would talk to an accountant.

If this is more from a theoretical perspective, then yes. I always look at a blighted property with the repair cost in mind as part of my 'Money Due Now.' The main reason is that it will not cash flow/be inhabitable till those repairs are in. Even if I can stretch them out over 4 months and not put them into my loan, it's still money paid before the investment makes money for itself.

Are all reno costs part of the initial cost basis?

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