Rental Property Renovations (Rehab)

By Jason Watson, CPA
Posted Monday, August 5 2024

In a previous section, we discussed repairs versus improvements. In that section we listed three safe harbors for real estate investors plus the betterment, restoration or adaptation thresholds. We also discussed cost segregation in crazy detail.

We will smash all this up with renovations and rental property rehabs.

Excruciating Detail

The first consideration with renovating your rental property is to keep excruciating details on what was purchased. A refrigerator. A cabinet. A light fixture. Parse those out best you can. Why? As you learned with cost segregation, if we can clearly identify 5-, 7- and 15-year property, we can accelerate depreciation without the need of a cost segregation report.

Hospital Corp of America v. Commissioner

We mentioned the Hospital Corp of America v. Commissioner tax court case in our Cost Segregation Study section. This is the landmark case that allowed the property owner to detail their renovations line by line, and assign certain items to be 5-, 7- and 15-year property (and therefore eligible for accelerated depreciation with bonus depreciation or Section 179 expensing).

In summary, this tax court case and the various IRS memos state-

• a typical property’s structure has a 27.5- or 39.0-year depreciation schedule (recovery period),

• land improvements have a 15-year depreciation schedule; and

• certain other building components qualify as personal property with a 5- or 7-year depreciation schedule.

Nothing is mentioned that a rental property owner must use a cost segregation study or report provider.

Can you identify and accelerate depreciation on certain items? Yes. Keep in mind the IRS Publication 5653 Cost Segregation Audit Techniques Guide (ATG) which uses the phrase “factually intensive” seven times.

Examples of 5-Year Property

Here are some examples to consider-

• Removable Floor Coverings (Carpeting, Floating Laminate/Vinyl)

• Kitchen Cabinets and Countertops

• Appliances* (Ovens/Stoves, Refrigerator, Dishwasher, Washer / Dryer, etc.)

• Electrical Wiring and Outlets Related to Telecommunications

• Security Systems

• Window Air Conditioning Units

*Includes any mechanical, electrical, etc. work directly related to installation.

Examples of 7-Year Property

Here are some examples to consider-

• Furniture and Decorations

• Window Treatments

• Ceiling Fans

• Closet Shelving

• Decorative Trim and Wallcoverings

• Decorative Light Fixtures*

*Includes any mechanical, electrical, etc. work directly related to installation

Examples of 15-Year Property

Here are some examples to consider-

• Shrubbery (Landscaping, Tree Removal)

• Gutters

• Fences

• Retaining Wall

• Roads (Driveways, Walkways, Sidewalks)

• Trenching and Piping*

• Sprinkler and Irrigation Systems

• Drainage Facilities

• Swimming Pools and Hot Tubs**

• Patios and Decks

• Outdoor Lighting

* If NOT connected to existing piping system of the building.

** Hot tubs that are above-ground (i.e., not attached) might be considered 5- or 7- property.

Painting

Painting is a conundrum since it can either be considered maintenance or an improvement. Here is the blurb from the IRS-

By itself, the cost of painting the exterior of a building is generally a currently deductible repair expense because merely painting isn’t an improvement under the capitalization rules. However, if the painting directly benefits or is incurred as part of a larger project that’s a capital improvement to the building structure, then the cost of the painting is considered part of the capital improvement and is subject to capitalization.

Plumbing Fixtures

A noted item that is not listed are plumbing fixtures. If a ceiling fan is good to go, why isn’t a faucet? If a countertop is good to do, why isn’t a sink? In AmeriSouth XXXII, Ltd. V. Commissioner, T.C. Memo 2012-67 (2012), the tax court specifically called sinks, garbage disposals, and laundry drain and waste lines as Section 1250 property and therefore part of the building structures. Interestingly, dryer gas lines were considered Section 1245 property.

Tax Court Guidance

There is an incredible list of court cases from IRS Publication 5653 Cost Segregation Audit Techniques Guide (ATG) on pages 75-84. Starting on page 84 is a list by CSI MasterFormat Divisions. Here is a snippet of some of the divisions (2004 version superseding 1995)-

Division 03 – Concrete
Division 09 – Finishes
Division 10 – Specialties
Division 23 – HVAC
Division 26 – Electrical

There are over 30 divisions. Within each division are “subdivisions” with a check mark next to either Section 1245 property or Section 1250 property. Check it out!

Let’s not forget Whiteco Industries, Inc. v. Commissioner, 65 Tax Court 664 (1975) where the tax court set forth the following six questions that real estate investors can use to determine whether property is inherently permanent and thus a structural component excluded from the definition of tangible personal property-

• Can the property be moved? Has it been moved?

• How difficult is removal of the property, and how time-consuming is it?

• Is the property designed or constructed to remain permanently in place?

• Are there circumstances that tend to show the expected or intended length of affixation—or that the property may or will have to be moved?

• How much damage will the property sustain upon its removal?

• How is the property affixed to the land? (For example, permanently glued bathroom tile vs. removable billboard.)

Rental Property Renovations Summary

Here are some steps to take with your rental property rehabilitation or renovation-

• Keep line-item detail. Record keeping is a must!

• Classify the items into 5-, 7- and 15-year buckets.

• See if you have any wiggle room within the rental property safe harbors (de minimis, routine maintenance and small taxpayer). Unlikely, but check them out anyway.

• Add these buckets to your fixed asset listing and depreciation schedules.

Not sure how all this works? Give your depreciating buddies at WCG CPAs & Advisors a jingle.