HVAC replacement in single-family rental - deduct or depreciate?

Question

Hello,

We have a general question about recording for tax purposes HVAC replacement in a single-family rental property.

For the scenario below - is there an option to deduct the expense (fully/partially)?

Scenario:

For a single-family home rental property, the HVAC inspection identified that the furnace had a defective heat exchanger and needed to be fixed as soon as possible (safety hazards). Because the furnace was very old, the only repair option was to replace the entire furnace and the attached AC unit. The whole HVAC was replaced and each component (coil, furnace, compressor) was invoiced separately with amount less than $2500.

Based on our research, this seems to be a controversial case with several possible interpretations (below) we want to check with the community about their experience for the same.

1. No, as this is a replacement of unit of property” (UOP) explicitly defined by IRS – this is an improvement with 27.5 years lifetime and can be only deprecated. Also, de minimis safe harbor (DMSH) election can’t be applied in this case either.

2. Yes, this could possibly use (DMSH) as each item in the invoice is less than $2500

3. Yes, this could possibly be considered as a repair as it helps to keep the property habitable and in good working condition.

4. Other interpretations

Eamonn McElroy · Answer

DMSH applies at the unit of property level, not the invoice line item.

The HVAC is part of the HVAC subsystem of the building unit of property. If you have a DMSH election in place for the tax year and the total expenses allocable to the HVAC subsystem are more than $2,500, you would capitalize.

If there is no DMSH election in place, you'd apply the betterment, adaptation, restoration (BAR) tests to make an expense vs capital expenditure determination.

Either way, if the allocable costs are capitalized, my firm takes a partial asset disposition for the old system, which helps.

Eamonn McElroy · Answer

@Brian S.

Assuming you're taking the position your rentals rise to the level of a trade or business, it would appear on Form 4797.

Might be time to change to a higher caliber professional if your EA is not aware of partial asset dispositions.

Eamonn McElroy · Answer

@Christopher Smith

It's called the "Safe Harbor for Small Taxpayers".

Have to consider all repairs, maintenance, improvements, and "similar" activities on the eligible building property for the 2% test.

It is useful sometimes.

Christopher Smith · Answer

There is a 2% exception provision to capitalization, which is the one that I use more than any other.

I believe it provides that if all repairs in a year are less than 2% of your unadjusted cost basis in the property you don't need to capitalize. For most of my CA properties that's at least 6,000 before I need to worry about capitalizing.

HVAC replacement in single-family rental - deduct or depreciate?

HVAC replacement in single-family rental - deduct or depreciate?

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