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 extremely 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 predetermined 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,
OK, refrigerators or other appliances things that you could move easily.
They're not permanently put down 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 different systems of the building, right?
You have your age
facts systems and your plumbing systems and 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 tax payers.
Now, this is for tax payers that have a building with an unknown adjusted basis.
In other words, typically your car 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 cost 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 or
coating roofs, items that you're doing on a regular basis.
You're going 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, 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 those for you.
We use the acronym Bar 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 be 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 are upgrading the electric service on a single family house,
maybe you're 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 an office,
that 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 as 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.
And so it's really not performing at function, right, to keep it dry
on the inside and everything else and protect the rest of the property.
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 non functioning
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, try to reach out to your CPA.
So make sure to leave comments.
And I look forward to seeing you all next time.