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Residential rental owners: you need to know about this tax election

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  • Residential rental owners: you need to know about this tax election

    The Safe Harbor Election for Small Taxpayers, effective 1/1/2014, is helping a lot of our landlord clients out and it may save you taxes this year. It allows landlords to deduct certain costs that would otherwise have to be capitalized and depreciated over 28.5 years. Your deduction is limited to the lesser of $10k per building or 2% of the unadjusted basis of the property.

    The requirements of the election are:

    • Average annual gross receipts less than $10 million; and

    • Property with an unadjusted basis of less than $1 million; and

    • The total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property doesn't exceed the lesser of-

      • Two percent of the unadjusted basis of the eligible building property; or

      • $10,000; and



    • You make the election to use the safe harbor for each taxable year in which qualifying amounts are incurred.


    The $1M basis is per property, not the aggregate of all properties you own. Also, you do not deduct any depreciation when determining the unadjusted basis of the property but you do include improvements to the property. This article from Nolo explains most of what you need to know. While it uses the adjective "residential", I cannot find that in the regs and believe that commercial real estate would qualify, also. This is even better as improvements for commercial real estate must be depreciated over 39 years.

    So, for example, if you put a $5,000 new roof on a  $250k rental house, you can now elect to deduct it in the year of installation and payment instead of depreciating over 28.5 years. If you replace $10k of windows on a $500k apartment building, you can deduct it in the same year.

    I haven't seen a lot of discussion about this election so be sure you're taking advantage as part of your tax-saving (deferral) strategy.
    Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

  • #2
    Very interesting and (I think) would have been great to know a month ago since we just filed our taxes and running some quick back of the envelope math I'm not sure if it would be worth paying our guy to do an amended return.

    Here's my math.

    We bought our rental duplex for $50K in late 2010, so it now has 5 years of accumulated depreciation, making the current basis ~$41K. 2% of the current basis is $820. The roof we put on in May was $8,700. We deducted 8 months of depreciation for it, about $200.
    The difference between the two is ~$620, which for us in the 28% tax bracket would mean ~$175 more in our pockets for the 2015 tax year if we had used this safe harbor election.

    Am I correct that this wouldn't really change how we would depreciate the remainder going forward? What's your take on filing an amended return for the sake of $175? Our return was particularly complicated this year with solar and other home energy credits and to me $175 doesn't feel worth the risk of increasing our chances of audit.

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    • #3
      I'm glad someone actually read the post :-) - thanks!

      First of all, the IRS FAQs for this safe harbor reg stipulate:

      The total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property doesn't exceed the lesser of-

      • Two percent of the unadjusted basis of the eligible building property; or

      • $10,000.


      Because the cost of your roof exceeded 2% of your basis of $50k (depreciation does not count), I'm not sure that you would have qualified in the first place. The reason I am not sure is that FAQs are not authoritative and I have read an article stating that you are limited to 2% (or $1k, in your situation), which makes more sense.

      Even so, I wouldn't recommend amending if free amendments are not included in the agreement you signed with your CPA. Here's why: you're "only" in the 28% bracket. The deduction would be more valuable if your bracket rises in the future.

      fwiw, amending a return for reasonable cause does not increase your chance of audit, at least in my 35 years of filing returns. It also wouldn't lengthen the SOL (Statute of Limitations) for you because you filed before the due date.

      small plug: my April newsletter and blog post discusses actions that will increase your chances of being audited. I'll post a link to it when I complete it (or you can sign up on my website).
      Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

      Comment


      • #4
        Thanks for clarifying.  I think I need to look a little more into this since we definitely pay more than $1K total in maintenance and repairs on a yearly basis, but I don't think I've ever noticed any limit to being able to deduct them.   I'm not counting improvements in there, but just the bug guy + septic clean out would be $800 in maintenance alone, so I know we hit $1000 easily between those two categories.

         

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        • #5
          Another clarification - there is no limit to deducting repairs. This limitation is for work that would otherwise have to be capitalized (depreciated over a period of years). The purpose of the rule is to allow you to immediately deduct costs you would otherwise have to recoup over 28.5 or 39 years. It has only been in place since 2014. Hope this helps.
          Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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          • #6
            Thanks for the article. TurboTax seemed to prompt for this correctly this year.

            Comment


            • #7
              Thanks for posting, I wish this started a couple years ago.

              I see that the business assets/expenses safe harbor de minimis for 2016 is up to $2500 (I believe from $50).  Any guess as to if that will remain and/or increase for 2017?

              Comment


              • #8




                Thanks for posting, I wish this started a couple years ago.

                I see that the business assets/expenses safe harbor de minimis for 2016 is up to $2500 (I believe from $50).  Any guess as to if that will remain and/or increase for 2017?
                Click to expand...


                I think you left out a zero. It was $500 and now up to $2,500. I see no reason this will be discontinued but I have no idea about an increase. My guess would be that it will remain at $2,500 since it was increased so substantially for 2016.

                Of course, a lot of rules and thresholds will likely change with tax reform, if and when it happens.
                Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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