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Depreciation means guaranteed loss?
Old 03-07-2015, 06:07 PM   #1
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Depreciation means guaranteed loss?

Been doing rentals for over 15 years. Lucky in never having a major repair that I couldn't handle. Well, last year we needed to dig up an old sewer line and replace it. Would have done that myself but needed to deal with where it tapped into the main line and if that went wrong it would have cost a bundle. Sooo... bit the bullet and paid a licensed plumber to handle it all so even the backhoe was on his liability. Total cost over $2K.

So for really the first time, other than rehabbing a new purchase, we had to schedule depreciation for a repair. Based on 27 year straight line depreciation, this repair will be reimbursed at just about the rate of inflation. If inflation goes up, we will be reimbursed LESS than the inflation on the cost of the repair. Never had to think about or deal with this before. Then, if we sell the house, we will have to pay 25% of the depreciation as recapture?

Gotta ask, do I have all this right? Anyone with ways to avoid this in the future? Up until now rental economics have been great with the only problems from our choice of tenants. If we have a tornado and need roof replacement this is really going to hurt!

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Old 03-07-2015, 06:15 PM   #2
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I believe repairing a sewer line would be a currently deductible expense. The IRS has issued guidance on this: Depreciation & Recapture

The key section, I think, is:

======================================
Repairs, such as repainting, replacing roof shingles, and replacing a rain gutter on a residential rental property:
  • Are generally currently deductible expenses.
  • Do not improve the property but keep your property in an ordinarily efficient operating condition.
======================================
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Old 03-07-2015, 06:23 PM   #3
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CPA said based on the total cost and the nature of the repair he thought it had to be depreciated. The original line was old clay pipe. Replacing it with PVC "extended the life substantially" and thus had to be depreciated. He had us sign a form that established a policy of depreciating repairs over $500.

But, based on what you posted, if roofing shingles, with a 20-30 year life are ok then I don't see why this shouldn't be OK as well. I'm actually surprised that shingles are ok to expense. I plan to take it up with him again after the tax season is over.

Its obvious to me that adding on to the house should be depreciated but not this.
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Old 03-07-2015, 06:36 PM   #4
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Based on your policy, you would depreciate a roof. You have established a business policy of depreciating anything over $500. I'm not sure why you set that so low, but that's you policy. If this is the first time you've ever gone over $500 (invoking the policy), I would allow you to amend the policy if I were your accountant. The important thing is not to wait until tax season is over. Many times, once you make an election or complete the transaction, there's no looking back. Talk to your CPA now. I like the argument that it is no different than the roof with a similar life expectancy.
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Old 03-07-2015, 08:48 PM   #5
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Quote:
Originally Posted by ArkTinkerer View Post
CPA said based on the total cost and the nature of the repair he thought it had to be depreciated. The original line was old clay pipe. Replacing it with PVC "extended the life substantially" and thus had to be depreciated. He had us sign a form that established a policy of depreciating repairs over $500.

But, based on what you posted, if roofing shingles, with a 20-30 year life are ok then I don't see why this shouldn't be OK as well. I'm actually surprised that shingles are ok to expense. I plan to take it up with him again after the tax season is over.

Its obvious to me that adding on to the house should be depreciated but not this.
I don't have specific experience in the rental market, but from a plumbing perspective, I would argue that it's more of a repair.

Clay pipe is typically not permitted by local codes to be installed anymore, since PVC is the standard for installations such as this. As such, it's not like you decided "Let's dig up this old clay pipe that was working just fine and put in PVC". A clay sewer pipe can last 100+ years - unless it's damaged by a tree root or some other cause. Just like a PVC pipe could last 100 years - unless damaged by a tree root or some other cause. So it's not like you took it upon yourself to simply replace it because you wanted a different pipe, or you could have gone with a 20 year clay pipe but opted to pay more for a 100 year PVC pipe.

Also, on a different note, many sewer districts have a 'sewer lateral insurance program', where you pay maybe $25/year for insurance in case there are problems with your sewer and need it worked on where it taps into the main. Did your rental have this annual fee levied by them? It often appears on your real estate tax bill each year.
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Old 03-07-2015, 09:22 PM   #6
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I agree, I would view this as a repair assuming that you had a leak and fixed the leak. the fact that you replaced an inferior material with a better material doesn't change the fact that there was a "problem"... a leak... and you did what was needed to fix it.

In post #2 where they are replacing roof shingles as a repair, I think that they are talking about replacing a small section to address a leak... I would consider a replacement of all the shingles... like in a new roof... to be a major repair that would be capitalized and depreciated... that is what we did when we put a new roof on my Mom's rental property but if we did a sewer line repair as you describe I would expense it and take the risk that it might be challenged. As I see it, the worst thing the could do is require you to capitalize it and I think they have bigger fish to fry.
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Old 03-07-2015, 10:08 PM   #7
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We've already submitted the forms for the year. I think no matter what we should be able to change the LLC "policy" limit if for no other reason than inflation. I wonder how much of the issue is that we replaced the clay tiles with newer and better PVC has to do with it? It is supposedly an improvement. The issue was clay tiles got penetrated by tree roots. PVC should not have this issue unless the pipe gets cracked somehow.

I still find it a problem that by spreading out the depreciation we take a big hit only to have it compounded by the recapture. I hate taxes to begin with but this strikes me as particularly unfair.
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Old 03-07-2015, 11:36 PM   #8
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I have 2 rentals, and I would treat this as a repair.
When I replaced the AC with a new one, it was better than the 30 yr old one, but I expensed it, as it was not possible to do a replacement with something as bad as the old one.
Now if I add AC to a house, that would be a depreciation.

I do my own taxes, after a couple of years, why pay a CPA to do what you know so well ? Besides they come up with self protecting rules like having you sign that $500 limit thing, that is not really for your benefit, more the CPA's.

Worse thing about rentals in retirement is you probably are in 15% bracket, so at best you save 15% when depreciating, but when you sell you will recapture all that depreciation at 25%.
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Old 03-08-2015, 12:38 AM   #9
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Just from memory.... and I did taxes a LONG time ago...

The plumbing is a current deduction...

Fixing a leaking roof the same...

Replacing an old roof with a new roof is a capital improvement...


I do not know this.... but does rental property qualify for sec 179?
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Old 03-08-2015, 12:39 AM   #10
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IRS Publication 527 (Residential Rental Property) specifically identifies a new roof, furnace replacement, water heater, etc as examples of "improvements" that must be capitalized. No specific mention of new sewer line, but given the size of the expenditure, upgrade to PVC material, and the resulting increased utility and useful life (similar to a new roof, furnace, water heater), I would say your accountant probably made the correct call.

I went through this same thought process this year for a fence replacement on one of my rentals that cost $2,400. I reluctantly capitalized it, mainly based on the dollar amount.

This is obviously a gray area so I suppose there's little harm in taking a more aggressive position and hoping for the best. But based on all the examples provided by the IRS of typical repair expenses vs typical capital improvements, it seems clear to me that they simply put more weight on the amount of the expenditure vs arguing the technical merits of whether replacing a water heater increases the utility and useful life of the house, or just maintains it in ordinary tenantable condition.

My return isn't filed yet, so I could still change my mind on the fence...
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Old 03-08-2015, 01:36 AM   #11
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Id find a new accountant.


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Old 03-08-2015, 09:17 AM   #12
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Any accountant that has you sign a "policy" form that requires you to depreciate any expenditure over $500 is egregiously over conservative and should be replaced immediately. I have had a lot of A/C and roof repairs over 20 years that were over $500. Those are expenses, not capital improvements. If you install a new roof, that's a capital improvement. If you go in after a storm and replace a significant number of shingles at $650, that's an expense that allows the roof to continue to do its job until it reaches the end of its service life. If I install a new A/C unit, the CPA capitalizes that. If I replace the compressor only for $1,100, it's expensed. The new compressor allows the unit to complete its service life or may extend it for a short time in comparison to the unit's total service life.
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Old 03-08-2015, 09:21 AM   #13
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I know some things can be depreciated over a shorter period. Has anyone here ever done that? I don't think it would help in this case since I don't expect to ever replace the sewer line again. But for something like an AC or water heater with a 10 year life it would make sense to depreciate over 10 years and not 27.
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Old 03-08-2015, 09:44 AM   #14
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New regulation took effect Jan 1, 2014. The size of the cost is no longer a consideration. The regs are very detailed. Definitely seek advice. Final guidance by the IRS has only been released three weeks ago (Retroactive to Jan 1, 2014)

Implementing the new tangible property regulations
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Old 03-08-2015, 09:50 AM   #15
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Quote:
Originally Posted by ArkTinkerer View Post
I know some things can be depreciated over a shorter period. Has anyone here ever done that? I don't think it would help in this case since I don't expect to ever replace the sewer line again. But for something like an AC or water heater with a 10 year life it would make sense to depreciate over 10 years and not 27.

You have not choice on the life... it falls into a category and must be depreciated at that rate...

If you are running a company, you can choose a life that is different, but it does not change tax....
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Old 03-08-2015, 10:30 AM   #16
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New regulation took effect Jan 1, 2014. The size of the cost is no longer a consideration. The regs are very detailed. Definitely seek advice. Final guidance by the IRS has only been released three weeks ago (Retroactive to Jan 1, 2014)

Implementing the new tangible property regulations
Its looking like our CPA knows his stuff. He set our limit to the max within the rules. From your link:

One such exception is for items that qualify as materials and supplies. Generally, an item that costs $200 or less or has an economic useful life of 12 months or less qualifies as a material or supply. If the tangible property qualifies as materials or supplies, the taxpayer receives the more favorable treatment of a current deduction when the item is used or consumed, instead of having to capitalize the cost. The regulations provide an election to substitute a taxpayer’s capitalization threshold (items expensed if they are under a certain dollar amount) in certain circumstances for the $200 limit under the de minimis rules.

The de minimis election is made annually, and the threshold maximum amount depends upon whether the taxpayer has a capitalization policy in place at the beginning of the year and whether the taxpayer has an applicable financial statement (generally, an audited financial statement). If a taxpayer has an applicable financial statement, the maximum threshold is $5,000; if the taxpayer does not, the threshold cannot exceed $500. Taxpayers will need to review their policy for what constitutes materials and supplies and whether the de minimis election is advantageous. Implementation of the materials and supplies rules and de minimis elections may require additional efforts to capture the information necessary to comply with the new regulations and take additional time to implement.
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Old 03-08-2015, 03:57 PM   #17
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I think this passage may give you a chance to expense your case:

From the linked article:

"Also included in the new regulations is a safe harbor for qualifying small taxpayers to expense expenditures related to certain real property if the expenditures do not exceed a certain threshold. Generally, that threshold is the lower of 2% of the unadjusted basis of the building or $10,000 for buildings with a basis of $1 million or less."

I can't claim to be the best understander of this kind of reg., but it sounds like this gets you out.

I also believe that this reg will get adjusted by letter or case law as time goes on, since it affects so many taxpayers.
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Old 03-08-2015, 04:33 PM   #18
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Good catch! Thanks! Might help in the future but not this time.

House (can't include the ground) is about $60K. So it would bump to $1.2K but the repair was over $2K.

Always some catch that makes it have to be depreciated. Kind of like the saying "Heaven is always 6" higher than you can reach."
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