Unofficial Tax Advice - Maintenance vs Improvements
By Marc Guillaume, LBA Secretary
De minimus Safe Harbor anyone? This year, my partners and I decided to sign on with a CPA. We’d been doing our own taxes up to this point but during a recent conversation securing a bank loan, the loan officer suggested that for future loans, they would like to see a CPA involved.
CPAs are nice and all but there is one problem - you need to clearly state which expenses were maintenance (and deduced the year the money was spent) and which expenses are improvements (and need to be capitalized over time. Basically an improvement gets cut into 27.5 little pieces and spread out over 27.5 years. Meaning that $275 new window you installed will reduce your taxes $10 for the next generation.)
Enter the De Minimis Safe Harbor, a very nice provision in the tax code that lets small time landlords, who keep their own books, treat improvements that are less than $2500 as if they were maintenance. Great! But, what’s an improvement?
Basically, an improvement is anything that’s not maintenance - anything that you can reasonably expect to do again in 10 years. I can certainly expect to pay for a furnace tuneup another time in 10 years so that’s clearly maintenance but I’m not expecting to upgrade my windows in 10 years, so windows are clearly an improvement. Would I expect to replace the carpet in my building’s entry way? I wouldn’t but maybe you like a really high quality place. Clearly, there’s some wiggle room here. Painting an apartment? Definitely maintenance.
So, you’ve split out maintenance from your expenses (as well as cleaning) leaving you with a whole mess of depreciation? Enter the De Minimis Safe Harbor. Problem I ran into was exactly how do you apply it? Enter the CPA. They used a phrase that I didn’t see in any of my research - the project. Turns out, Project is an operational definition - if you treat something as a project, it is a project. Now, you can’t say, “Well, I did separate 10 window replacement projects on my 3-family this year,” and just go to Home Depot on 10 separate days. The IRS has an anti-abuse rules (Regs. Sec. 1.263(a)-1(f)(6)) (not showing off or anything) So no, you most likely did one window replacement project that had 10 windows in it - unless you had some compelling reason and are ready to defend this to your CPA and the IRS.
But how about an apartment renovation? There’s a next level here, called the Unit of Property. (Yes, there is a quiz at the end.) A UOP breaks down a project’s expenses into the common parts of a building (Overall building like windows and walls and roof and floors, electrical, plumbing, HAC, security, fire safety plus also elevators and (strangely enough) escalators.)
So, if you’re renovating an apartment and the plumbing comes in at $2000 and the replacement floor is $2000, you can expense them both and not have to depreciate them. Even though the “project” of renovating the apartment was more than $2500, inside the project, there were multiple Units of Property.
We recently completed an apartment renovation in Vermont (where I can do some work that I shouldn’t do in Mass.) Here’s a rough breakdown of the expenses.
I paid a couple guys to put in flooring. Total for flooring and labor was $1800.
I paid another guy to change out two sinks (one invoice, $300)
I paid the same guy to paint (another invoice, $360 plus paint at $200)
I put in a minisplit where I did all the labor. Minisplit parts ($2100)
Electrical work I did - upgrades for the minisplit ($300) and light fixtures ($200)
I paid a 3rd guy to clean ($180).
I put in new locks ($45)
The total for the apartment renovation project was $5485. So, first cut gets out maintenance and cleaning, so subtract out the painting and cleaning, leaving a total of $4745.
Normally this would be capitalized because we’re over the de minimus limit but this needs to be broken down into the Units of Property.
Building Overall: 1800
Leaving us with an almost $5485 project that can be legitimately expensed.
In summary, the De Minimus Safe Harbor is your friend as long as you break down your expenses based on the project and the Unit of Property. I’ve changed my book keeping method to better reflect this so hopefully tax time next year will be easier!
If you will reasonably repeat the project in the next 10 years, it’s maintenance and you expense it.
A legit Project whose UOP parts each cost less than $2500 - expense it.
A contractor sends you a bill for more than $2500 that’s not maintenance - depreciate it.
You decide to have your tenants pay the heat. You find a minisplit installer who will install the units for $2000. You buy a nice Daikin unit online for $2200, including the parts. You submit the separate recipes to your CPA as expenses. What does she say?
You want to upgrade the windows on your 4-unit building but don’t want to disturb your tenants so you plan to change the windows only when a unit is vacant. In January, Unit 1 is vacant so you spend $2200 to have the windows changed. In October of the same year, a different tenant moves out and you spend $2400 to have those windows changed. Since windows are clearly an improvement, you depreciate them and get about $167 off your income each year for the next 27.5 years. Correct? 3. You read an article in your local landlord newsletter about how to apply the De Minimus Safe Harbor. The IRS calls and it turns out you applied the safe harbor incorrectly. You tell the auditor the source of your information and they drop their phone, they’re laughing so hard. Should you feel embarrassed?
Answers: 1) Your CPA reminds you of the Anti-abuse clause and says you can’t split up a project to make it look smaller than $2500. The project is installing the minisplit and you need to depreciate the $4200 cost.
2) You can expense this window project because when you did the January windows, you had no way of knowing the other tenant would move out. These are legit separate projects and since they’re under $2500, you can expense them.
3) Yes, feel embarrassed. Don’t take tax advice from a nobody, even if that nobody is the secretary of the LBA!