Real Estate Tax Strategies With Repair Expenses | USTaxAid

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Real Estate Tax Strategies With Repair Expenses

Written by Diane Kennedy, CPA on July 4, 2021

A few years ago (seven to be exact), the IRS gave us some rules on how to handle repairs to your property for tax purposes. You can expense them. Or you can capitalize the expenses as an asset which can be depreciated. And that means you have a wide variety of possible depreciation options. (Accelerate it, stall it, slow it down, catch it up, or even stop it completely)

Although the rules seem pretty specific on whether you have an expense or an asset, there actually are options if you meet various safe harbor rules. The key is what is best for your strategy. 

High-income Client With Fixer-Uppers

Stacey was a high-income app designer with her own company. She had a few apps that continued to provide high income for her and she was always designing more. 

Her income was going to continue to climb as long as she continued to work. At some point, her apps needed refreshing and updating so she had to keep working. 

Her solution as a longer-term income source was to invest in real estate. Since she had money now, she often bought properties that were fixer uppers. But her goal wasn’t to sell them. She didn’t need more profit to show on her tax return.

Her goal was cash flow. 

There were two things we did with her tax planning that were important to her own situation. 

Customized Tax Strategies For This Unique Situation

First of all, we made sure she put the properties in service as soon as possible. Obviously, if she bought a duplex that was falling down, she couldn’t rent it. But if she was able to rent at least part of a multi-family unit, she could begin to expense some of the items.

Her income was higher than the AGI threshold of $150,000, so any passive real estate losses couldn’t be deducted against her other income. If she could have qualified as a real estate professional, that would have been an option but, in her case, it was physically impossible to work more hours in real estate activities than any other trade or business.

That meant our goal was to make sure she had enough expenses to cover the rental income she made.

We always deduct direct expenses that are related to owning the property. That includes expenses like mortgage interest, property tax, utilities and the like. Normally, we throw repairs into that when doing the calculation. But, remember, there are options with repairs.

But in Stacey’s case, we had another option. So, for her, we next looked at all of her indirect expenses.

Both direct and indirect expenses are “use it or lose it” propositions. If you don’t take the deductions in the current year, you lose them unless you are able to go back and amend. In general, I’m not a huge fan of amendments, they cost you money, they extend the time that IRS and states have to audit you and they wave a flag right in the auditor’s face. “Audit me!” 

I’d rather see you get your tax return right the first time. 

After the direct and indirect expenses, Stacey was running a slight loss on her properties. That didn’t mean they were losers, though. Remember we calculate the COCR based on direct expenses only. The properties provided cash flow. She just was able to pick up expenses that she normally wouldn’t have been able to including her cell phone, cell phone service, auto and education she took to learn how to be a better real estate investor. Those were all indirect expenses. 

In the end, she didn’t need to take advantage of the repair expenses. If she took the expense, that meant she’d have a loss which would have been suspended.

Instead she could capitalize them and then just wait on depreciation. For now, she didn’t create any losses she couldn’t currently use.

Above was an excerpt from my new book Less Tax for Mom & Pop Landlords, coming out soon!

Not sure whether we’d be a good fit for your tax strategies, tax prep and tax representation? Contact Us

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