Hey, everyone, in this video, I'm going to talk about
how you can deduct as much as possible when remodeling a property.
I'm going to try and keep it simple.
It's like Greenly complicated to navigate.
And there's a lot of gray areas where you may have to make some judgment calls.
However, remember, even if you can't deduct it currently,
it just means that you have to depreciate that asset over time.
If you want more detail on depreciation.
Check out my other videos.
Essentially, you take the deduction over some pre-determined time
that the IRS gives, but obviously you'd rather deduct it now
and get that tax benefit.
So the first important distinction that you need to make when you're deciding
whether something is deductible in the current year or not.
As far as remodeling a property or doing some type of improvement
is whether what you're looking at is personal property or real property.
Now, personal property are things that are really movable.
They're not permanently attached to the real estate.
So here you can think of things like carpeting,
refrigerators or other
appliances, things that you could move easily.
They're not permanently put down.
You know, if you're thinking carpet, well, compare that to tiling.
Tiling is a lot harder to remove and if you remove it, you're generally
not getting it up in any kind of way where it's you can use it again.
So it becomes part of the real estate.
And so why this is important is because there are different exceptions
and limitations depending on whether it's personal property or real property.
The big one for personal property is you actually get
what's called a de minimis safe harbor.
And what this means is that if the cost
of a unit of personal property is 20 $500
or less, you can write it off, no questions asked.
How are you do have to remember to make that election
on your tax return to have that ability.
So this means that if you replace carpeting in a bedroom
and it costs less than 2500, you can write it off without any issue.
If you buy a new refrigerator for a rental property and it's
1200 dollars, you can write that off immediately.
Now, when we talk about real property, so this is the real estate,
things that are permanently attached.
These are the walls, the slabs, the differences systems of the building.
Right?
You have your age fax systems and your plumbing systems, your electrical systems.
All of that is part of the building.
This also includes the land improvements around the building,
the parking lots or the driveways, things like that.
All permanent structures.
That is considered real property and that falls under different limitations.
So before I get into how you determine whether something is an improvement
or more of a repair that you can deduct, let's talk about the two major
exceptions where you don't have to look any further.
The first one is the safe harbor for small taxpayers.
Now, this is for taxpayers that have a building with an adjusted basis.
In other words, typically your cost of $1,000,000 or less.
Also, you need less than 10 million in gross receipts,
which generally you're going to have less than that
when your property costs a million or less.
So if your property costs less than $1,000,000,
then you are actually allowed to deduct
any type of improvements or repairs to the property
as long as the total doesn't exceed 2%
of the cost basis or $10,000.
So at most,
if you have repairs or improvements during a year under this safe harbor,
if they're 10,000 or less, you can deduct them without questioning.
That's the first exception.
The second exception is the safe harbor for routine maintenance.
This means when you do a repair or you place something in service
that if you expect to do it
more than once in a ten year period, then you can deduct it.
So oftentimes, this would be like painting,
coding roofs, items that you're doing on a regular basis
that going to have to do more than once in a ten year period.
Those you don't have to go
into the more detailed rules to determine if it's deductible.
You can just write it off without question if it meets that safe harbor.
Now, look, we've talked about the various exceptions
that really once you've gone through those and you've taken the simple deductions,
now you get into the more complex analysis.
And I'm going to try and simplify this for you.
We use the acronym BAR or B.A.R.
So that means betterment, adaptation or restoration.
If you're doing something to the property
and it meet any of those definitions, then you'd have to capitalize it.
If it doesn't, that means you can deduct it right away.
So let's start with the B betterment.
This means like it would suggest that if you are bettering something
substantially, then you have to capitalize it and depreciate over time.
For example,
if you were upgrading the electric service on a single family house,
maybe you were going from 100 AMP service to 200 AMP service
that would now increase the output.
And what the house could do, the appliances that you could add on to it
and everything.
So you're bettering the asset or the real estate by doing that.
So you would have to capitalize the cost of doing that.
The next one is the A or adaptation.
This means if you're changing how the property is used.
So think of this as like converting spaces.
So for example, I had a client that in downtown
they were taking a property that was used as office
and it actually made a lot of sense to convert it to apartment units instead.
So the market for office space wasn't as hot.
There was other newer spaces, so it wasn't very competitive,
but there was a lot of need for apartments downtown.
So they decided to convert this office space to apartments.
So that would be adapting the use.
And so all those costs associated with that conversion
would need to be capitalized and depreciated.
The last one is the R and bar, which is restoration.
And what this means is that you have an asset
that is not performing its function
because of something that went wrong.
So here think of something like a roof that has not been maintained
or maybe it has been maintained, but it's older and it just has
a lot of leaks all over the place, so it's not performing its function.
So when you restore the roof and you peel off the coating and
and put down the new structure and then recode it,
that's really considered a restoration.
You're bringing the property from a nonfunctioning
type situation into a functioning situation.
So now you can rent the property and tenants actually want to use it.
So that's the bar test.
Again, if what you're doing on the remodel meets
any one of those, you have to capitalize it.
If it doesn't meet any of those, then you may be able to take a deduction for it.
So you really have to kind of analyze what you're doing to the property
and make a determination.
So hopefully this helps.
There's a lot more when you get into it.
So if you have specific questions, sort of reach out to your CPA.
So make sure to leave comments.
And I look forward to seeing you all next time.