Capital Expenditure depreciated over life of property.

[Justin Fox]

So say you've been depreciating a property for 10 years.   Year 11 rolls around and you completely replace the roof.  Does that just increase the remaining depreciable balance (basis) for 17.5 years?  Or do you depreciate the roof separately for 17.5 years, or 27.5?

Also, say you make the improvement in June, do you apply the middle of the month rule to that improvement's portion for that first year?

Thanks,

Justin

[Dave Holland]

@Justin Fox

You would track the roof separately and depreciate it over 27.5 years and keep depreciating the rest of the building over the remainder of its useful life.  So the longer you own a property, it is more likely you'll end up tracking a lot more capital assets.  Also just FYI if you had the cost of the roof segregated, or you replaced the roof and then had to replace it again in 10 years (I hope you wouldn't but just as an example) then you would get to expense any remaining amount that had not been depreciated in that year.

For your second question, yes the mid-month convention applies where you would depreciate it from the midpoint of the month that the asset was placed in service.  

[Justin Fox]

@Dave Holland

Just so I'm following you correctly:  I would depreciate the roof separately and in the case that the 27.5 year depreciation (of roof) out-lived the life of the property, I would keep depreciating the roof regardless?  For instance, the roof is replaced year 26.

So if i had to replace the roof twice in 20 years, the roof would be depreciated twice individually and overlap?

Thank you for the info!

[Dave Holland]

@Justin Fox

Yes  that is correct, if you replace the roof in year 26, you depreciate the new roof for 27.5 years.  For the first 1.5 years it will be in addition to the building depreciation, and then by itself for the following 26 years.  Although it most likely wont be by itself because I'm sure you'll have other capitalized assets that you'll purchase over the life of the property (appliances, remodels, etc), but just as an example.  

If you have to replace the roof again before its depreciable life is up, then you'll expense the entire amount left of the roof being replaced.  For example if you put on a new roof for $10k, and need to replace it after 165 months (which is half of 27.5 years) you would expense the $5k that you didn't get to depreciate yet on the "old roof", and begin depreciating the "new roof".

Hope that helps

[Justin Fox]

@Dave Holland thanks a lot, that helps a bunch!  I'm using this information in an application I'm developing.  I'm not really going to use this as filing data but to fine-tune my contribution to my income tax account over the year.

I'm sure this applies not only to new roofs, but appliances, office equipment and etc, right?

I've been reading up on the straight-line depreciation and the salvage cost (which online sources says is almost always 0).  Most of my equipment I use is old/used anyway.  Is there a purchase amount threshold in which assets become deductible same year?

Better yet, is there a book I can buy that updates its editions that explains asset deduction/depreciation in detail?

Thanks again!

[Dave Holland]

@Justin Fox

Cool that's really interesting, would like to hear more about it.

Yes this applies to all capitalized assets.  There is a de minimus exemption for assets under $2,500 though so you can expense them in the year purchased rather than depreciate.  This used to be $500, and obviously opens up a lot more opportunity to write off expenses as a lot of items you normally would capitalize like appliances most likely were more than $500 but under the newer threshold.

My best advice is to look at the resources here on BiggerPockets. Amanda Han's tax book does a  great job to break out the rules 9don't know about if it will be updated though) and there are a good group of knowledgeable CPAs on the forums that are willing to help as well.  If you have any other questions too you can ask away on here or use my email in my signature.

Dave

[Justin Fox]

I've been reading up on the De Mimimis Safe Harbor Election and it seemed pretty straight forward.  I've read where they say to have a Capitalization Accounting Policy to even elect to use the $500 threshold.  

To use the $2,500.00 threshold you have to use not only the CAP, but also have an SRA which sounds a lot like a Cost Segregation Study, which isn't something I can probably afford right now (maybe ever).

The only thing I've bought this year that could be classified an asset is a 5 year old Brother All-In-One printer that I bought from someone for business use, for $60.  It has an ADF chute and was cheap : ).

Would this item need to be placed on a de minimis exemption page for my taxes and me keep some where in my rental records, written down, something like the following:

"The general capitalization policy for tax purposes is that all equipment and other fixed assets costing in excess of $500 per invoice (or per item as substantiated by the invoice) will be recorded as an asset. This policy will be in compliance of the IRS safe-harbor provisions described in Reg. 1-263(a)(1)(f). If a repair or improvement in excess of $500 is considered a betterment, adaptation or a restoration to a unit of property, such expenditure will need to be capitalized for tax purposes."

My only problem with the above is...  Will a $550 roof repair  (if I ever have one) or an appliance repair (motherboard) be considered a restoration or betterment?  Because that would suck, not only for deduction purposes but tracking them.

Thanks for all the great info.

I would rather post my questions here if you don't mind as others might find it helpful/interesting.

I'm buying that book today!

Thanks again!

[Oleg Kio]

Justin, from what I understood reading the De Minimis regulations, you don't need anything special to use the safe harbor (no CAP, SRA, etc.), just have to file the election with your return every year. If you elect to use it, the maximum amount is $2,500 (there isn't a $500 anymore, that was in the pre-2016 version.)

This page covers it in good detail - https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations 

[Justin Fox]

@Oleg Kio thanks for that link, i came to the same conclusion as well.  After reading the de mimimis portion, it sounds like this is just a measure in order to simplify book keeping for small-time landlords/business owners, do you agree?  Have you ever taken this election for low cost tangible property acquisition? 

Thanks again!

[Account Closed]

Under the new tangible property regulations I would expense the roof if the new roofing material was similar to the old roofing material (example asphalt shingle to asphalt shingle) (unless the roof was already in a state of disrepair when you acquired the property and it has not deteriorated to a complete state of disrepair. We only have to capitalize if we have a betterment when compared back to the condition it was in when we placed it in service, adapts property to a new of different use, or is a restoration (restoration I do not believe applies because it was not in a complete state of disrepair....ie basically falling in). Each of these tests have a bunch of stuff under it, most people dont understand them, but i have been writing off roofs often when the facts are on my side - often they are. The new Regs a few years ago totally changed the rules on what must be capitalized and each expenditure should be analyzed carefully. Google tangible property regulations if you cant sleep one night! PM me if you need an opinion on capitalize vs expense as it pertains to your fact pattern

[Natalie Kolodij]

@Justin Fox to utilize the $2,500 you just need to make the election on your tax return and have a written policy in place as of the beginning of the year. 

It was super nice of them to bump this up since...an i phone ...would exceed the previous $500 amount. +1 for the IRS. 

[Account Closed]

The de minimus safe harbor under the new regs has now been bumped to $2,500 per invoice per item. If i have a $50,000 invoice detailing it was for 25 computers at $2,000 each you can write that off. You have to also expense the item for book purposes, and you MUST adopt a policy to do this on all assets below that or some other threshold. Best practice for adopting a policy is to create a one page policy for your files and sign and date it, and the expense everything under the threshold for book and tax. If above the threshold go through the steps to see if you must capitalize (betterment, adaptation, restoration) and if you dont just expense it, also consider the routine maintenance safe harbor. This is where you reasonably expect to perform the maintenance at least twice during the properties ADS life. The regs are almost 100 pages long but if you can absorb them you will ABSOLUTELY find you cant currently expense a lot more than you think in all businesses. To me these are very taxpayer friendly rules!

[Oleg Kio]

@Justin Fox I agree, I think that was the intent of the new regulations, to simplify (and possibly encourage more spending which should help the economy.) I've taken the election in the past and certainly plan to do so this year.

As @Account Closed mentioned, that $2,500 limit is per item as well so if you replace 20 windows in a house and the total invoice is $12,000, I believe you can still expense the whole thing as long as the invoice clearly states that there were 20 windows.

Amanda Han wrote an article about it - https://www.biggerpockets.com/renewsblog/2015/11/27/breaking-new-tax-change-that-can-save-thousands-for-real-estate-investors/ - and I think Brandon Hall wrote some as well (for some reason I can't seem to tag them.)

[Andy D.]

@Oleg Kio While you are (as far as I understand) correct with respect to the limit applying per item, your example of the 20 windows is somewhat unfortunate as they would not - in all likelihood - fall under the de minimis rule as they would be considered a (capital) improvement. And those still need to be depreciated over the applicable time lines for such items.

The devil remains in the details when it comes to the question of what falls under the de minimis safe harbor rules and what needs to be depreciated. A CPA will help fight that (mental) battle.

[Oleg Kio]

@Andy D. The way I read the IRS rules - https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations - these safe harbors (de minimis and small taxpayer) are meant as an exception to the capitalization rules. While in the past you would have been required to capitalize those windows since they are an improvement, using the de minimis safe harbor you get to expense them in the same year instead, as long as each item is under $2,500 and you file the de minimis safe harbor election.

We may be addressing slightly different things here. The way I understand it, this can't be used for improvements prior to the unit being ready for rent (maybe this is what you meant?) But once it's ready for rent (or you have a renter in there) you should be able to use the DMSH.

Brandon Hall has a couple of nice articles about it - https://www.biggerpockets.com/blogs/6032/41669-understanding-the-safe-harbor-rules-and-keeping-money-in-your-pocket and https://www.biggerpockets.com/renewsblog/2015/11/27/breaking-new-tax-change-that-can-save-thousands-for-real-estate-investors/

[Justin Fox]

@Oleg Kio 

Would the 20 windows fail to meet the regs and have to be capitalized if they were an upgrade in efficiency?  Say, Low-E double pane vinyl from single pane wood?  Even if that upgrade in efficiency wasn't the reason but was the result?

Do SHST and DMSH have the same qualification requirements? Also, do they both have the same 10,000 or 2% of unadjusted basis (which I assume is basis including land but not including: HUD line items for refinance and etc) expense cap (including the ongoing maintenance safe harbor)?

I think I'll just depreciate the damn printer and the drum, jesus, this ain't worth it.

[Oleg Kio]

The way I read the regs, SHST and DMSH are unrelated and have separate requirements. The 10k and 2% rule does not apply to DMSH, only to SHST.

Since both harbors are meant as exceptions to capitalization/depreciation rules, I don't think it matters that it's an improvement as long as you meet the rest of the requirements - property is rented (or ready for rent already), you file the election and each item on the invoice is less than $2,500.

I would expense toner as supplies.

Printer should certainty qualify for DMSH (and maybe even as supplies since it's under $200.)

[Andy D.]

Sorry for this long post but topic of taxes is never an easy one!

@Oleg Kio While I certainly agree that these rules are meant to make it simpler for small tax payers, one should not forget that the "normal business" these rules are most likely primarily aimed at is not real estate business involving buildings but rather your typical mom & pop shop selling or producing whatever. I believe one should read anything related to this topic, like what you had quoted above, with that in mind.

I'm by no means a (US) tax expert but one thing I know is that once it comes to buildings, depreciation is what every cost related to this building has to - prima facie - be tied to. Claiming an expense related to buildings (and the associated business of course) is generally an exception. Related to this we then have the constraints with regard to the topic of "improvement", making it even more difficult (just like @Justin Fox example above shows) . But that aside, even if an expense clearly does not lead to an improvement/betterment (say, you bought the replacement item used, making it pretty much the same thing you had before but now working again - status quo ante) one would still need to take into consideration whether the new purchase is connected to an item that is/becomes an integral part of a building/structure.

Let me try to explain my thinking with an example: I guess we all agree that we cannot expense a building. Every building has a roof. I guess we also agree that we would need to depreciate a roof, rather than expense it, right? For giggles, lets assume you could get a new roof for $2499 including labour. Would you, Oleg, now go ahead and expense that roof under DMSH or whichever variant this could be put under re expensing? I certainly wouldn't as the roof is an integral part of the building. Heck, it's very much connected to the buidling and making the building useless if it wouldn't be there. My understanding is that in such a situation the roof becomes tied (literally) to the buildling and therefore inelligible for being an expense for tax purposes. It will have to be depreciated/capitalized, irrespective of any safe harbour rules that might exist. I'm pretty sure this is not up to debate. But maybe someone really knowledgeable can confirm this.

Taking the above roof example, I'm now looking at your example of windows. To me the logic is the same: a building without windows is useless, it's uninhabitable. Windows are an integral part of the building. Windows therefore should not be allowed as an expense but would need to be depreciated over their meaningful life time (as per IRS rules). Again, someone please confirm.

Somewhere I actually read (can't remember the source, though, but I believe it was actually an IRS example) that if you were to buy a new motor for an HVAC unit you could not expense (but have to depreciate) that motor as it itself is an integral part of the HVAC which, in turn, itself is an integral part of the building. Again, a building without an HVAC would - at least in the so called "civilized" world - be considered uninhabitable. It's therefore integral to the building's use. Since the motor is needed for the HVAC to function, the motor of the HVAC itself is an integral part and therefore to be depreciated. At least this is what I remember to having read, and to me it makes sense.

So the question is - the way I understand it - whether something is an integral part to a buildling or not. If not: expense allowed (within the limits of safe harbor etc, of course). If yes: capitalization/depreciation. Looking at a fridge/stove/ceiling fan, all items of that sort are neither (really) attached to the buildling nor are they required for the buildling to provide its primary function: shelter. And now for the fun questions: water heater. It's clearly attached to the building, or rather its guts (= pipes), yet quite easily removed. Hhm. Does a building still provide its main function when there is no water heater? I, personally, believe it would. You still have running water (which is, generally, crucial, for obvious reasons), it's just not warm. I would, therefore, expense a water heater and not depreciate it.

So I repeat what I said at the beginning of this post: the new relaxed rules with respect to expensing are - most likely - limited to items that are not an integral part of something that has to be depreciated (such as a building) as these safe harbor rules were not meant to change the principle of depreciation vs expensing. Nonethelesss, I'm looking forward to clarification by the IRS! Until then I'm playing it safe.

[Andy D.]

@Oleg Kio With respect to your post about the aspect of improvement not being relevant when safe harbor applies: I agree with you there. With my above explained limitation: if something can be expensed and does not have to be depreciated as an integral part of a building then it should not matter if the new item is an improvement or not.

Replacing a 15 year old simple range with one that has a self cleaning oven with 10 different functions and has a glas cooking field and basically also does the shopping for you all in one is clearly an improvement over that 15 year old one which always burned the turkey on the one side. Yet, a range is not integral to the buildling and therefore can be expensed. With the new rules we now do not need to think about it being an improvement or not.

This is how I understand it, but again, I'm not a CPA, nor should anyone take this for granted. Consult your tax advisor to confirm.