Change in Repair/Capitalization Rules – Part 2


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The IRS has new rules for determining whether a repair expense is really a deduction or whether it is an improvement that you have to capitalize and then depreciate. Please make sure you check back on yesterday’s post for the Part 1 of this topic. And, of course, if we can help with this or any other small business or real estate topics, give us a call or drop us a note. We only work with business owners or investors. That’s our specialty and we have a lot of years of experience providing tax-saving, wealth-building and asset protecting strategies.

One of the big changes for real estate under these new rules is that a property is no longer considered just one thing (or two, if you count land and building). This is a big deal because in the past we were always encouraged to depreciate a property as a building for either 27.5 years (residential) or 39 years (commercial). We used to do something called component accounting, where amounts were allocated to various parts of the business. Then the IRS said we couldn’t do that. We moved to cost segregation studies, which honestly, is pretty close to the old component accounting that the IRS said we couldn’t use.

Now, that’s all changed. In fact, the IRS says we MUST use component accounting. There are 8 structural components for a building:

HVAC
Plumbing
Electrical
Escalators
Elevators
Fire Protection Systems
Security
Gas Distribution Systems

Your average single-family home rental probably isn’t going to have escalators or elevators and may not have a fire protection system either. That just means that you need to allocate basis to the remaining groups.

Once you have that done, you determine whether an expense is major compared to that value. For example, if you pay $10,000 to fix your office building, that’s not much in comparison. But $10,000 to fix an elevator may be a significant percentage and that means it’s more likely to be a capital expense.

The new rules are over 150 pages long. In these two blog posts (today and yesterday), I’ve just touched the surface of what’s changed. Don’t wait until it’s too late. This is what you need to do now! Talk to a tax pro.


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