Hi Nicholas,
Thanks so much for your reply. I noticed on the Stessa.com (property management site) that there may be a much less strict definition of whats available and ready for use. I bold and underlined the relevant portions. I also remember seeing a few other sites that say similar things. Anyway, just want to se what your thoughts are on this. I would suspect others may find this conservation very useful as well. I am still looking for an IRS pub that specifically addresses this bu so far no luck.
The Importance of Date Placed In Service
When you first purchase a rental property, it will be considered “placed in service” on day one if there’s an existing tenant in the property. If there’s no existing tenant, then the property is assumed to be not yet in service.
To place a property into service, you must meet two requirements:
- the property must be ready for use; and
- the property must be available for use.
Generally, your rental is ready for use when the city or locality of your rental property will conservatively issue a Certificate of Occupancy. The rental property is considered available for use once it’s advertised for rent.
Rental property investors will often purchase a property vacant and in need of significant renovations before it’s ready to rent. Any renovation costs incurred before you place the property in service must be capitalized and depreciated, generally over 5, 7, 15, or 27.5 years (5, 7, and 15-year property is eligible for 100% first-year depreciation), regardless of whether or not they are actual capital improvements or simply repair and maintenance business expenses.
The key point here is that costs that are capitalized and then depreciated are recovered over several years and then are subject to depreciation recapture (a 25% tax when you sell the property). Regular repair and maintenance expenses are fully deductible business expenses in the year incurred and are not subject to depreciation recapture.
Successfully manage this distinction from a tax perspective by completing the minimum amount of work necessary to get the property ready for lease, then immediately advertise it for rent.
As mentioned above, the definition of ready for lease will be determined by the building codes in your locality, but is typically when sheetrock is on the walls and the flooring is finished. In other words, if the property is habitable and no longer dangerous and someone could live there, it’s probably also ready for lease.
Once the property is in service you can finish the renovation and deduct some of the costs as repair and maintenance expenses in the current year. Other start-up costs such as appliances, which are normally considered capital improvements, become deductible in the current year under the de minimis safe harbor provision of the tax code.
Note that some renovation costs will always be considered capital improvements regardless of whether or not a property has already been placed in service (for example, replacing the entire roof).
Examples of renovation items you want to complete before you place the property in service:
- fixing structural issues (for example, cracks in the foundation)
- replacing an entire roof, floor, bathroom, kitchen, or plumbing system
- adding a deck or new HVAC system
Examples of renovation items you want to do after you place the property in service include:
- painting
- installing appliances
- replacing a doorknob or window
- repairing an existing plumbing system
- other minor repairs
