Author: Simon Filip

Simon Filip, CPA, MSPA, MST

Beware of Phantom Income

Posted by Simon Filip on August 17, 2016

Real Expenses vs. Phantom Expenses

As a real estate investor, it is essential to know the difference between a real expense and a phantom expense. An investor might think a $1,000 roof repair is a good thing since he or she can deduct it as an expense. What if you never had to make that repair in the first place? You would have $1,000 of taxable income in your pocket. Being taxed isn’t automatically a bad thing, since that means you are making money on the property.

What is a Phantom Expense?

Depreciation is the perfect example of a phantom expense since it allows an owner of real estate to recover the value of the building against rental income. The IRS allows a deduction for the decrease in value of your property over time, irrespective of the fact that most properties never really wear out. Simply put, depreciation allows you to write off the buildings and improvements over a prescribed period of time, providing a “phantom expense” that is used to offset rental income.

Residential real estate and improvements are depreciated over a 27.5 year period. Commercial real estate and improvements are depreciated over 39 years.

Debt Amortization

In addition to a depreciation deduction, the Internal Revenue Code allows for the interest portion of a mortgage payment to be deducted for income tax purposes. The principal portion of a mortgage payment is treated as taxable income or “phantom income“.

During the initial years of a typical mortgage loan, the principal reduction (debt amortization) is normally offset by depreciation deductions and interest expense, decreasing taxable income. In the later years of a typical loan amortization, principal reduction will exceed interest expense and depreciation, thereby increasing taxable income and generating a seemingly disproportionate tax liability (the dreaded phantom income).

Disposition of a Property

A taxpayer may incur phantom income upon disposition of a property. Phantom income is triggered when taxable income exceeds sales proceeds upon the disposition of real estate. Usually, this results from prior deductions based on indebtedness. You may have deducted losses and/or received cash distributions in prior years that were greater than your actual investment made in the property. If you are planning to dispose of a property and believe you are in this situation, there are strategies to minimize the tax impact including IRC 1031 exchanges, which are discussed in my blog Understanding IRC Code Section 1031 and why you should care.

Real estate investors who want to maximize their after tax cash flow need to be cognizant of phantom income and compare their cash flow to taxable income. This analysis should be undertaken regularly as it may impact their investment returns. If you have questions about phantom income and your real estate, contact me at sfilip@krscpas.com or 201.655.7411.

Rental Income: There’s More to It than Just Collecting Rent Checks

Posted by Simon Filip on August 3, 2016

Payment for the occupancy of real estate is includable in the landlord’s gross income as rents. Generally, rents are reportable by the landlord in the year received or accrued, depending upon whether the landlord uses the cash or accrual method of accounting. What constitutes rent is not always obvious and depends on factors that include the lease and relevant facts and circumstances.

Types of Rents

Amounts paid to cancel a lease – It is fairly common for a landlord to receive payments in consideration for allowing a tenant to terminate their lease before the expiration date. This payment is included in the landlord’s rental income in the year of receipt.
Advance rent – Generally, advance rent is immediately taxable to the landlord. The regulations specify that advance rentals must be included in income for the year of receipt regardless of the period covered or the method of accounting employed by the taxpayer.
Security deposit – A security deposit that is refundable at the end of the rental period is excluded from income. If a landlord requires a security deposit to be used to pay the last month’s rent under a lease, it is included in gross income in the year of receipt.
Expenses paid by a tenant – If a tenant pays expenses on behalf of the landlord, those payments are considered rental income by the landlord. The tenant is entitled to deduct those expenses.

Improvements by Tenants

If a tenant makes an improvement to the landlord’s property that is a substitute for rent, the value of the improvement is taxable to the landlord as rental income.

Permanent improvements by a tenant usually enhance the value of the landlord’s property. The mere enhancement in value of the property does not, by itself, constitute rental income to the landlord. Court cases have held that a tenant’s payments for improvement costs will not be treated as deductible payments in lieu of rent unless it is demonstrated that both the landlord and tenant intended the payments to be in lieu of rent. If a landlord agrees to receive reduced rents in exchange for a tenant’s improvements, the cost of the improvement is plainly rent.

Net Leases

Under certain lease arrangements, also known as net leases, the tenant or lessee must pay specified expenses of the lessor. For tax purposes, these payments are treated as additional rental income by the lessor and additional rent expense by the lessee. Assuming the landlord would have been entitled to a business deduction if it was paid directly, the landlord is entitled to a business deduction for the amount paid by the lessee.

From experience, most lessors (landlords) recognize income only for the actual rent paid, and the lessees (tenants) generally deduct the net leases expenses paid as expenses other than rent.

Before entering into a lease, it is important for a landlord to consider the provisions included in the lease and their impact on taxable rental income.

Your tax professional can help you determine the tax effects of any rental arrangements you may have. As always contact me at sfilip@krscpas.com if you have any questions.

Understanding IRS Rules for Self-Rentals

Posted by Simon Filip on July 20, 2016

Owner or renter – or both?

Tax effects of self rentals Self-rental is an arrangement in which a business and property that it rents are both owned by the same person(s). It is common for a taxpayer to own an operating business and also own the accompanying real estate. That person has to materially participate in the operating company for the self rental rules to apply. If the operating company is an entity that the owner(s) actively participate in on a day-to-day basis, in most cases the owner(s) would be considered to materially participate in that activity.

Additional details on material participation can be found in Internal Revenue Service Publication 925.

The passive activity loss rules

As discussed in my blog post, Passive Loss Limitations in Rental Real Estate, the IRS Code generally prohibits taxpayers from deducting passive activity losses against other income, including salaries, interest, dividends, and income from nonpassive activities. Generally, a passive activity loss can only be used to offset other passive income.

The IRS considers most business activities to be nonpassive if a taxpayer materially participates in the business. One of the exceptions to this rule is rental real estate. Rental real estate activities are generally considered passive regardless of level of participation.

Trapped losses

Passive losses can only offset other passive income. Assuming a taxpayer incurs a loss on the rental of property to a business in which he or she materially participates, absent any other passive income during the year, the loss will not be deductible. However, the loss is carried forward to future tax years to offset income from the activity.

If there are unused passive losses from the activity when the property is sold, such suspended losses from that activity are recognized in the year of disposition.

How self-rental rules can apply

What does it all mean? Here’s an example to help you understand how the rules apply:

A taxpayer owns a warehouse which is rented by his distribution company that he materially participates in as owner and president. During the year the rental warehouse incurs a loss of $50,000, while the distribution company has $50,000 of income.

Does the $50,000 of losses incurred by the warehouse offset the $50,000 of profits from the distribution company?

No. Because the property was essentially rented to himself (i.e., to a business in which he materially participated), the self-rental rules apply. In the case of a self-rental, income is treated as nonpassive and loss is treated as passive. The self-rental rule characterizes the $50,000 of rental loss as passive which cannot offset the nonpassive income from the distribution company.

If you are currently involved in a self-rental or are considering this transaction, there are methods whereby you can avoid or reduce the disadvantageous tax effect of the self-rental rule. Contact me at 201.655.7411 or sfilip@krscpas.com and I can help you understand which methods are most advantageous to you.

Investor vs. Dealer

Posted by Simon Filip on July 6, 2016

Purchasing real estate assets? This post explains what you need to know about the important distinction between real estate investor and dealer for tax purposes.

A real estate developer is taxed differently than a real estate investor. Real estate investors purchase real estate with the intention of holding properties and gaining financial return. Typically, real estate dealers acquire and sell real estate as part of their everyday business.

career or new opportunity concept, business background A real estate professional who is involved in buying real estate with the intention of selling for a profit in a short time frame, or flipping is usually considered a dealer. Contractors and builders who build houses and commercial structures, and subsequently sell the finished property to customers are also considered dealers.

A question that arises often is whether a real estate developer who purchases properties (sometimes raw land or an outdated property) and makes improvements should be considered an investor or a dealer. Real estate developers are usually treated as dealers by the IRS because they are in the business of buying and selling real estate. However, if the developers work on individual and sporadic long-term projects, they may be able to take a position they should be taxed as investors.

Why does it matter to real estate professionals?

When a real estate investor sells property that has been owned for more than one year, gain on the sale is taxed at the favorable long term capital gains rates, currently 15% or 20% depending upon income (plus the 3.8% net investment income tax, if applicable).

When real estate dealers sell their properties, those properties are considered inventory and any gains are taxed at the dealers’ ordinary income tax rates. Currently, Federal ordinary income tax rates can be as high as 39.6%.

The Internal Revenue Code offers general guidelines regarding activities that reach the level of a trade or business. However, Internal Code does not provide specific guidance regarding real estate activities. Consequently, court cases have been the primary source for defining what level of activity determines a trade or business in real estate development and, therefore, the nature of the income.

The main factor in determining if a taxpayer is a real estate investor or a dealer is his or her intent with respect to the property. The mere fact that an individual holds a piece of property for a short period of time does not automatically cause him or her to be a dealer. Often an individual purchases real estate with the intent of holding it for investment purposes, but sells it earlier due for financial or economic reasons.

Consider the Winthrop Factors

A case often cited when determining dealer vs. investor status is United States v. Winthrop. In determining whether the gain from sales was ordinary or capital in nature the court relied on a series of facts and circumstances in the Winthrop case. These have become commonly referred to as the “Winthrop Factors.”

Subsequent court cases have enumerated the following 9 Winthrop Factors:

The purpose for which the property was initially acquired
The purpose for which the property was subsequently held
The extent of improvements made to the property
The number and frequency of sales over time
The extent to which the property has been disposed of
The nature of the taxpayer’s business, including other activities and assets
The amount of advertising/promotion, either directly or through a third party
The listing of the property for sale through a broker
The purpose of the held property at time of sale; the classification as an investor or dealer is determined on a property-by-property basis.

Talk to your tax professional

With such a wide disparity between the maximum capital gains tax rate of 20% (plus the net investment income tax 3.8%) and the tax rate on ordinary income of 39.6%, it is important to consult your tax advisor regarding newly acquired real estate assets and established investments.

Accounting Methods for Construction Contractors

Posted by Simon Filip on June 22, 2016

For construction contractors, there are more options for accounting methods than those available to other business taxpayers due to the unique nature of construction activities and the inherent imprecision that can arise in measuring profit at different points in time during a construction contract. The IRS provides several steps for construction contractors to follow when determining which accounting method is appropriate.

Concept of construction and design. Cash method – under the cash method, revenues and expenses are recognized based upon receipt and disbursement of funds. Contractors are generally eligible for the cash method of accounting, if they have $10 million or less in gross receipts annually for each of the past three years.

Accrual method – under the accrual method, revenue is generally recognized when all the events have occurred that fix the right to receive the income, and the amount of the income can be determined with reasonable accuracy (i.e., as billing invoices are issued). Expenses are deductible when all events have occurred that establish the fact of the liability, the amount can be determined with reasonable accuracy, and economic performance has occurred.

Completed-contract method (CCM) – under the completed contract method, no profit is recognized on a construction contract until completion of the contract.

Although the completed-contract method allows you to defer taxes on your income, it prevents you from deducting losses on unprofitable jobs until the contract ends. It can also push taxpayers into higher tax brackets by bunching income into a single year.

Percentage of completion method (PCM) – the percentage of completion method is a variation of the accrual method, where revenue recognition is measured not by a reference to billing but rather by applying an estimate of relative completion of a contract to the overall contract value. To determine how much income to report for each contract, calculate your project completion factor by dividing deductible project costs for that year by the total estimated cost to complete the project. For example, if you spent $100,000 on a project that will cost $1 million to complete, your project is 10% complete. Multiply that 10% factor by the contract’s total value to determine how much income to report.

Choosing the right accounting method

The choice of accounting method can have an important impact on tax-related disbursements. Effective tax planning relies heavily on the concept of deferring the payment of tax. Construction contractors and their advisors need to consider the optimal method under their specific circumstances provide the greatest benefit.

If you have questions about the accounting method you should be using for your construction firm, contact me at sfilip@krscpas.com or 201.655.7411.

Foreign Withholding of Income Tax on Real Estate Transactions

Posted by Simon Filip on June 8, 2016

Whether a person is considered a “U.S. person” or “non-U.S. person” will determine which income is subject to federal income tax. This also determines withholdings on that income, which may include earnings from real estate trade/business, passive rental income or sale of property.

Basic Rules

Foreign Withholding Non-U.S. persons are subject to income tax only on their U.S. source income (income earned within the United States). According to the Internal Revenue Service, most types of U.S. source income paid to a foreign person are subject to a withholding tax of 30 percent, although a reduced rate or exemption may apply if stipulated in the applicable tax treaty.

What’s a U.S. or Non-U.S. Person? A U.S. person includes citizens and residents of the United States. For income tax purposes, U.S. residents include green card holders or other lawful permanent residents who are present in the United States. A person is also a U.S. resident if he has a “substantial presence” in the States.

A non-U.S. /foreign person, or nonresident alien (NRA) includes (but is not limited to) a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, a foreign estate, and any other person that is not a U.S. person. You can read more on these definitions here.

Withholdings on real estate ventures

If you are a non-U.S. person it is important to consult with tax and/or legal counsel to determine if you are subject to withholding. Below are several situations that could require U.S. withholding with respect to real estate.

Trade or business – A non-U.S. person is considered to be engaged in a U.S. trade of business if they regularly undertake activities such as developing, operating and managing real estate. If this is the case, the income is not subject to withholding; rather, the non-U.S. person files an income tax return and computes their applicable tax.
Passive rental income – Income from a rental property is typically considered passive income (refer to my previous blog on Passive Activity Losses for details). Rental income is subject to a 30 percent withholding tax unless it is reduced under an income tax treaty. The 30 percent withholding rate is applied to the gross rents and is reported on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding.
Sale of property – The Foreign Investment in Real Property Act (FIRPTA) requires a FIRPTA withholding tax of 10 percent of the amount realized on the disposition of all U.S. real property interests by a foreign person. A purchaser of U.S. real property interest from a foreign investor is considered the transferee and also the withholding agent. The transferee must find out if the transferor is a foreign person. If the transferor is a foreign (non-U.S.) person and the transferee fails to withhold, the buyer may be held liable for the tax.

Withholding on foreign partners in a partnership

In addition to filing an annual partnership tax return (Form 1065), if a partnership has taxable income that is effectively connected with a U.S. trade or business, it is required to withhold on income that is allocated to its foreign partners.

The withholding rate for effectively connected income that is allocable to foreign partners is 39.6 percent for non-corporate foreign partners and 35 percent for corporate foreign partners (2016 withholding rates). There are tax treaties with many countries that can reduce the withholding requirements and these should be reviewed.

Note that withholding is calculated on taxable income, not distributions of cash. A partnership needs to be aware before distributing cash to foreign partners that there may be a withholding obligation.

Are you a non-U.S. person with real estate interests in the United States? Or, are you a U.S. citizen or resident working or investing in real estate? I can answer your questions regarding tax issues around passive income losses and other real estate financial considerations; contact me at sfilip@krscpas.com or (201) 655-7411.

Interest Tracing on Debt-Financed Distributions – What’s Deductible?

Posted by Simon Filip on May 25, 2016

Dollar_Signs_iStock_000002198189_Large Many pass-through entities, including limited liability companies, are often tempted to cash out on the appreciation of their real estate holdings through refinancing. The members then have the discretion to use these funds as they see fit, including investing in other properties and projects or for personal use. It is often assumed that interest on the new mortgage is fully deductible for income tax purposes; however, that is not necessarily the case.

Interest Tracing of Debt-Financed Distributions

When a partnership distributes some or all of the proceeds from a debt, the distribution is called a debt-financed distribution. Under the interest tracing rules, the recipients of the debt-financed distributions are required to trace the expenditures made with the distributed proceeds in order to properly allocate the interest expense.

Interest Deductibility

After each recipient of debt-financed distributions traces how the funds were used, they must then classify Interest Tracing on Debt-Financed Distributions docx the expenditures in one of four categories:

1. Personal expenditures – personal interest expense is generally not deductible. An example would be using the proceeds to pay off a credit card debt.
2. Trade or business expenditures – funds are used in an expenditure that you are actively engaged in for profit. Let’s say the sole proprietor of a law firm purchases a computer server with the proceeds from a debt financed distribution. The portion of the interest expense used to purchase the computer server would be deductible on the owner’s Schedule C.
3. Passive activity expenditures – if proceeds are used by the member to make an investment in a separate partnership or pay expenses on behalf of an entity in which he does not materially participate, the interest would be subject to the rules governing passive activities (see my previous blog on Passive Loss Limitations).
  For example: Bill receives $100,000 in debt-financed distributions from his investment in a real estate partnership. He then uses that money to invest in a new LLC that purchased rental real estate. The interest expense related to the $100,000 of proceeds will be used to compute Bill’s net income or loss from his passive activities on Schedule E.
4. Investment activity expenditures – if the proceeds are used in investment activities, the interest is treated as investment interest expense.
  For instance, Bill used the proceeds to purchase Apple stock. The interest expense is reported on Form 4952 (Investment Interest Expense Deduction), and is potentially deductible on Schedule A as an itemized deduction.

If you are a member of a partnership or other entity with real estate holdings, and are considering cashing out and investing your debt-financed distribution in other assets, be sure to consult a tax professional to ensure your audit trail is complete.

If you’d like to discuss your potential transaction or have questions about interest tracing rules, contact me at sfilip@krscpas.com or (201) 655-7411.

Passive Activity Loss and the Income Tax Puzzle for Real Estate Professionals

Posted by Simon Filip on May 12, 2016

Does being a real estate professional have income tax advantages?

real estate professionals It all comes down to passive and non-passive activities related to property.

As discussed in a previous post, the IRS recognizes two types of passive activities as they relate to investment real estate, one of those being “trade or business in which the taxpayer does not materially participate.” The other passive activity being rentals, including both equipment and rental real estate.

Generally, rental real estate activities are passive regardless of one’s participation but there is an exception for real estate professionals.

For most taxpayers, income and loss from real estate is considered passive, with passive activity losses generally limited to passive activity income. However, real estate professionals must treat rental real estate activities in which they materially participate as non-passive activities. Therefore, a real estate professional can deduct rental real estate losses from other non-passive income.

How the real estate professional designation affects income taxes

For income tax purposes, the real estate professional designation means you spend a certain amount of time in real estate activities. According to the IRS, real estate professionals are individuals who meet both of these conditions:

1) More than 50 percent of their personal services during the tax year are performed in real property trades or businesses in which they materially participate and 2) they spend more than 750 hours of service during the year in real property trades or businesses in which they materially participate.

real estate professionals Any real property development, redevelopment, construction, reconstruction , acquisition, conversion, rental, operations, management, leasing or brokerage trade or business qualifies as real property trade or business.

It is important to note that services performed as an employee in real property trades or businesses do not count unless the employee is at least a 5% owner of the employer.

Once it is determined a taxpayer qualifies as a real estate professional (by meeting both of those criteria), non-passive treatment is available only for rental real estate activities in which the taxpayer materially participated. To meet the material participation standard, a taxpayer can elect to treat all interests in rental real estate activities as a single activity. If the election is made, material participation is determined for the combined activity as a group. Since these decisions have implications for one’s income tax liability and potential deductions, it is important to review these guidelines with your accountant and/or trusted tax adviser, and to gain a full understanding of the differences between passive/non-passive income and expenses.

Example

David owns a real estate brokerage firm. He works full time as a broker and also owns three rental properties. David materially participates in his rental properties and does not employ any management company. HIs material participation comprises finding tenants for his rentals, overseeing repairs, and approving all leases.

Let’s assume that David’s income is $200,000 from the brokerage firm and rental losses associated with the properties he owns are $30,000. David would be able to deduct the $30,000 in full from his gross income because he is a real estate professional and materially participates in the rental properties. If he was not a real estate professional, the $30,000 of losses would be suspended until he had passive income from the properties.

Are you puzzled about whether or not you qualify for these deductions?

Need some help understanding how these passive or non-passive activities might relate to your income tax puzzle, as a real estate professional? I’m here to help; contact me at sfilip@krscpas.com for a consultation. You may also want to check out New Tax Law Explained! For Real Estate Investors.

Passive Loss Limitations in Rental Real Estate

Posted by Simon Filip on April 27, 2016

If you think purchasing a rental property will make a great tax shelter, you may need to dig a little deeper into “passive loss limitations” and how they may affect your real estate investment.

rental property and passive loss limitations First, consider that your rental property (like many other businesses) may not yield positive cash flow at first. Improvements to the property, tenant issues, and other expenses may end up putting you in the negative column. If you do end up with a rental loss, you are subject to complex IRS rules regarding how much of your rental losses you may deduct from other income you earn during the year.

Rental property ventures are treated differently than other business investments by the IRS. In the rental property investment realm, these are “passive loss” limitations.

What is a Passive Activity?

The IRS recognizes two types of passive activities:

Rentals, including both equipment and rental real estate, regardless of the level of participation.
Trade or businesses in which the taxpayer does not materially participate.

To that second point, you are considered to materially participate in an activity if you are involved in the operation of the activity on a regular, continuous, and substantial basis. Generally, real estate activities are passive activities even if you do materially participate. (There is an exception for real estate professionals, which I will discuss in a future blog.) Passive activity loss limitations are reported on your tax return using Form 8582. You can learn more here about passive and non-passive activities as defined by the IRS.

What Triggers Passive Loss Limitations?

Income tax losses from rental properties and limited partnership investments in which you do not materially participate are subject to the passive loss limitations. Generally, passive losses are limited to passive activity income. Any passive losses that have been disallowed are carried forward to the next taxable year.

Special Allowance for Rental Activities

There is a special $25,000 rental loss allowance but the real estate investor must meet two conditions to qualify, based on modified adjusted gross income (MAGI) and active participation in the activity:

1 – Taxpayers with MAGI of less than $100,000 may claim up to $25,000 in rental losses. For every dollar over $100,000 the allowance is reduced by 50%, and it is completely phased out/reduced to zero when the MAGI reaches $150,000.

2 – You must also actively participate in the running of your real estate. This is a simple level to attain. You do not have to work any set number of hours to actively participate, you simply have to be the final decision maker about approving tenants, arranging for repairs, setting rents, and other management tasks. If you manage your rentals yourself, you will likely satisfy this requirement.

Disposition of Interest

Time to sell? Generally, you may deduct the entire amount of previously disallowed passive activity losses in the year you dispose of your entire interest in the activity. If you dispose of your interest in a passive activity during a divorce or by gift, the suspended losses are not deductible and adjust the basis in the property.

If you are thinking of investing in rental property as a tax shelter, it is best to discuss this somewhat complex arrangement with a qualified tax or real estate professional, or certified public accountant with expertise in real estate transactions and accounting.

If you’d like some additional insights into passive loss limitations as they relate to real estate investments, contact me at sfilip@krscpas.com or (201) 655-7411.

Tangible Property Regulations and the IRS

Posted by Simon Filip on April 18, 2016

Repair regulations provide guidance for classifying repairs and improvements

Deductible Repairs or Capital Improvements?

Are your property repairs deductible? The Internal Revenue Code, the Internal Revenue Service (IRS), and taxpayers have been in conflict over whether expenditures on tangible property are deductible now, or must be capitalized and recovered through depreciation over time. The distinction between deductible repairs and capital improvements has been determined largely through case law and is based upon facts and circumstances.

In an effort to reduce disputes with taxpayers, the IRS issued final regulations in September 2013. These are commonly referred to as the “repair regulations”, and provide rules regarding the treatment of expenditures for acquiring, maintaining, or improving tangible property.

Under the repair regulations, the IRS provided guidance to determine whether an expenditure made for a building is an improvement. The first step is to determine the identifying unit of property. In real estate, the unit of property would commonly be considered the building; however, there are special rules to determine the unit of property for buildings.

Determining the Unit of Property

When applying the improvements standards, the unit of property for a building comprises the building and its structural components (doors, windows, roof, etc.) plus each of the eight specifically defined building systems:

Heating, ventilation, and air conditioning systems (HVAC)
Plumbing systems
Electrical system
All escalators
All elevators
Fire protection and alarm systems
Building security systems
Gas distribution systems

Improvement Standards

Once you have determined the unit of property, the next step is to determine whether an expenditure for the unit of property is a deductible repair or capitalizable improvement. An expenditure is a capitalizable improvement if it can be qualified as a betterment, restoration, or adaptation. They are defined as follows:

Capitalizable betterment:
- Corrects a material condition or defect that existed before the taxpayer’s acquisition of the unit of property.
- Is a material addition (including physical enlargement, expansion, extension, or addition of a major component) or a material increase in capacity of a unit of property?
- Is reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of a unit of property.

Capitalizable restoration:
- Returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use.
- Results in the rebuilding of the unit of property to a like-new condition after the end of its class life.
- Replaces a part or a combination of parts that are a major component or a substantial structural part of a unit of property.

Capitalizable adaptation:

The amounts paid to adapt a unit of property to a new or different use that is not consistent with the taxpayer’s ordinary use of the unit of property at the time it was originally placed in service. For a building to qualify for the adaptation standard, the amount paid to improve it must adapt the building structure or any one of its building systems to a new or different use.

The Takeaway

The repair regulations attempt to resolve the controversies that have arisen over the years between the IRS and taxpayers over how to classify certain costs that are deductible in a current tax year versus fixed assets that have to be capitalized and depreciated over a number of years.

If you have any questions about whether improvements to your tangible property are currently deductible or must be depreciated over time, contact Simon Filip for a consultation at 201.655.7411 or sfilip@krscpas.com.