Hi.
I'm Ben with IRStaxrelief.com.
This past month or so, I've received two phone calls.
And I also got an email this morning from a client.
All three of them own rental properties,
and all three of them wanted to know
what is the difference between a capitalized expense
and a repair expense for a rental property?
In particular, what can they do to ensure that the IRS will not
try and reclassify it as a capitalized expense?
Now, let me start out by saying there's
nothing you can do to keep the IRS from challenging
your deductions.
They do it all the time.
The IRS wants these expenses to be capitalized,
and you want them to be classified as repairs.
The reason why is, if it's a repair,
you get to write it off immediately.
If it's capitalized expenditure, you
have to write that off over the class life of the asset.
Now, a residential rental property
is 27 and a half years.
So that's quite a long time.
A $27,000 deduction-- that's going to get
you less than $1,000 a year.
That's not going to help you match on your taxes.
In fact, let me read this email that I got this morning.
It says, "Ben, in order to insure the IRS will agree
with a particular expenditure in our property
be deemed as an expense and not an expenditure that needs to be
capitalized, what can be done?
Does the invoice or receipt need to be worded in a certain way?
Is there a timing of payments, perhaps?
In particular, we have a property
that needs to be painted at a cost of $25,000,
and would love to expensive it fully this year
and not over 27 and a half years."
Let me start out by saying that the cost has nothing
to do with the repair being classified as a repair
expense or a capital expenditure,
although large expenses are generally capital expenditures.
But that shouldn't be what comes to your mind
when you decide if it should be a capitalized or repair
expense.
The IRS will ask two questions.
In fact, when I was an IRS agent,
the two questions that I was trained to ask are-- one,
does it substantially improve the life
of a home, the rental property you have?
And two, does it substantially increase
the value of the property, or does it change the use
that you originally intended?
So let's go into a few examples, and let's talk about this.
Now, if you repair a wall in a rental property,
does that prolong the life, or change the use,
or substantially increase the value of the property?
No, it doesn't.
What you're doing by painting it, is
you're restoring it back to the original condition.
So that would be a repair expense.
Now, there's always exceptions to the rule.
And I just want to mention one thing very quickly.
If you are doing a remodel project,
all of those expenses-- whether they would initially
be repair or capitalized-- are all
going to be pooled into one category,
and they're going to be capitalized.
So resist the urge, when you're there painting the wall,
to go ahead and replace the floors
and get new granite countertops and do all these remodels.
Because if you do that, you will no longer
have a repair expense for the painting.
You have to spread everything out over 27 and a half years.
So be careful of that.
Now if there's a windstorm and shingles
get blown off your roof, and you have
the repairman come out and repair that,
that will be a repair expense.
If your roof is 25 years old and you replace the whole roof,
that will be a capital expenditure.
Why?
Because for one, it will definitely, significantly
prolong the useful life.
You now have a 40-year roof.
It will also increase the value of your home.
Painting the walls-- yeah, your house might sell first.
But no one's going to appraise it for a higher value
because you have a brand new paint job in your home.
Your HVAC goes out in your rental property.
The repairman comes and he says, "You know what?
You need a new motor in this, so we're
going to replace the motor."
That could be classified as repair,
because it's not going to significantly enhance
the life of it.
Now, if he replaces the entire unit,
that will be a capitalized expenditure.
Don't focus on the cost, but focus on those criteria
when you're deciding if it should
be a capitalized expenditure or a repair expense.
So remember, the two questions is, does it significantly
improve the value of the property
and does it significantly increase the life,
or are you just restoring it back to the original condition?
If there's anything particular that you want to know,
feel free to email us, call us, or comment on this video,
and we'll try to answer that for you.