Regulations

Building improvements can be a losing proposition for landlords at tax time

Real Estate Tax Talk

In last week’s column (“Understanding the IRS’s ‘new math’ for landlord repairs”) we explained that the cost of a change to residential real property or commercial property must be depreciated over several years if it constitutes an improvement to the unit of property. The “unit of property” is the building as a whole and up to eight separate building systems.

There are three types of improvements:

  • betterments.
  • adaptations.
  • restorations.

Any expense for a change that does not fall into one of these categories is a currently deductible repair.

So, let’s sidle up to the bar and look at he first of these categories: What exactly is a “betterment”? An expenditure is for a betterment if it:

  • ameliorates a “material condition or defect” in the unit of property that existed before it was acquired or when it was produced — it makes no difference whether or not you were aware of the defect when you acquired the property.
  • is for a “material addition” to the unit of property — for example, physically enlarges, expands or extends it, or
  • is reasonably expected to “materially increase” in the unit of property’s capacity, productivity, strength or quality.

However, there is no betterment if you replace part of a unit of property with an improved, but comparable, part because the old part wasn’t available. For example, the IRS says there would be no betterment if a building owner replaced the entire wood-shingle roof of a building with comparable asphalt shingles because wood shingles were unavailable.

Here are few examples of betterments vs. repairs:

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Betterment Repair
Replacing entire wood-shingle roof damaged by storm with asphalt shingles far superior to old wood shingles Replacing entire wood-shingle roof damaged by storm with same type of wooden shingles
Remediation of contaminated soil caused by leakage from underground gas storage tanks that were in place when landowner purchased the property Replacing asbestos insulation in an old building that was constructed when dangers of asbestos were unknown
Replacing unreinforced building parapets and cornices in good condition to comply with revised building code Removing drop-ceiling and repainting original ceiling — Reason: It does not result in a material addition to the building structure or a material increase in its capacity, productivity, efficiency, strength or quality.

The moral of the story is, if you want a current repair deduction, you should never upgrade — use parts and components that are the same as, or comparable to, the ones you’re replacing.

Building refresh

Work you do to refresh a rental after a tenant moves out is not a betterment and need not be depreciated. For example, the cost of painting an apartment or refinishing the floors after a tenant moves out need not be depreciated. However, a refresh combined with substantial remodeling would likely have to be depreciated. Also, any refresh you pay for before a building is available to rent must be depreciated.

Environmental cleanup costs

Generally, you can claim a repair deduction for environmental cleanup costs for contamination that occurred while you owned the property. Reason: In this event, you are merely restoring the property to its previous condition. However, if you purchase contaminated property, the cleanup costs are a betterment that must be depreciated over many years.

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.