As discussed in a previous column (“IRS finally provides guidance on building repairs vs. improvements”), the IRS has issued its final regulations governing how to determine whether an expense to fix or replace business property is a currently deductible repair or an improvement that must be depreciated over many years (27.5 years in the case of residential rental properties).
Among the 222 pages of the new regulations are several brand-new “safe harbors” intended to help taxpayers avoid having to deal with the complex issue of whether an expense is an improvement or repair. They are called “safe harbors” because if you take advantage of them, you’ll be safe from the IRS.
Several of these safe harbors are particularly important for owners of rental real estate.
One of these is the routine maintenance safe harbor. Expenses that qualify as routine maintenance under this provision of the new regulations (IRS Reg. § 1.263(a)-3(i)(1)(i)) are deductible in a single year.
What’s “routine maintenance”?
Routine maintenance consists of recurring work a building owner does to keep an entire building, or each system in a building, in ordinarily efficient operating condition. This includes:
- inspection, cleaning, and testing of the building structure or each building system;
- and replacement of damaged or worn parts with comparable and commercially available replacement parts.
Routine maintenance can be performed at any time during the life of the property. There is no annual dollar limit with this safe harbor.
However, building maintenance is considered to be routine only if, when you placed the building into service, you reasonably expected to perform such maintenance more than once every 10 years. For example, if your building’s roof requires maintenance — including inspection and replacement of damaged shingles — only once every 15 years, such work would not fall under the safe harbor. On the other hand, if your building contains an HVAC unit that you reasonably expected to require extensive maintenance every four years, the work would fall within the safe harbor.
What if you reasonably expected you’d have to do certain maintenance more than once every 10 years, but it turns out it was not required? This is not necessarily a problem. The IRS says that you’ll still qualify for the safe harbor if you can show that, when you placed the property in service, you reasonably expected you’d have to perform the maintenance more than once in 10 years. However, your actual maintenance experience with similar property will be considered in determining whether your expectation was reasonable.
No betterments or restorations
The routine maintenance safe harbor is for expense property owners incur to keep their property in ordinarily efficient operating condition. It is not supposed to be used to currently deduct major remodeling or restoration projects. It specifically does not apply to expenses for betterments or restorations of buildings or other business property in a state of disrepair.
One example the IRS provides in its regulations is that of a cattle rancher who allows its irrigation system canals to fall into such a state of disrepair that they no longer function. The expenses the rancher incurs to drain the canals and do extensive cleaning, repairing, reconditioning and replacement of parts do not fall within the safe harbor.
A boon for the landlord
For the average residential landlord, the routine maintenance safe harbor is pretty great. Here is an example from the IRS regulations of it in action: H buys an office building that contains an HVAC system that requires maintenance by an outside contractor every four years. This includes disassembly, cleaning, inspection, repair, replacement, reassembly, and testing of the HVAC system and many of its component parts. If inspection or testing discloses a problem with any component, the part is repaired, or if necessary, replaced with a comparable and commercially available replacement part. This expense qualifies for the routine maintenance safe harbor and is currently deductible by H. No muss, no fuss, just deduct it.
Small taxpayer safe harbor
In last week’s column (“Good news for owners of smaller residential rental properties”) we covered the small taxpayer safe harbor under the new regulations that permits a commercial or rental building owner to deduct all expenses for repairs, maintenance, or improvements up to an annual ceiling equal to the lesser of 2 percent of the original cost of the building or $10,000.
Any expense you deduct under the routine maintenance safe harbor is counted toward your annual limit under the small taxpayer safe harbor. For example, if your annual limit is $5,000 and you deduct $4,000 to deduct maintenance under the routine maintenance safe harbor, you’ll only be able to deduct $1,000 under the small taxpayer safe harbor.
No amount is deductible under the small taxpayer safe harbor if the annual limit is exceeded. Thus, for example, if your annual limit is $5,000 and you deduct $6,000 under the routine maintenance safe harbor, you won’t be entitled to any deduction under the small taxpayer safe harbor.
The small taxpayer safe harbor is claimed each by filing an election with your tax return. You don’t have to elect it in any given year if you don’t want to. You could arrange things so you do a lot of routine maintenance for a building in one year and then do little or no such maintenance in the following year. This way you can take full advantage of the small taxpayer safe harbor that year to currently deduct expenses that would otherwise be improvements you’d have to depreciate.
Stephen Fishman is a tax expert, attorney, and author who has published 20 books, including “The Real Estate Agent’s Tax Deduction Guide,” “Working for Yourself,” “Deduct It!,” and “Working with Independent Contractors.” His website can be found at fishmanlawandtaxfiles.com.