Same-year deductible?

[sfskseg]

Hello,

I purchased a rental property six months ago and am preparing to file my first 1065. As this is my first "business" I am not completely sure what deductible as an expense. Beyond that, I'm not sure what can be deducted completely from 2012 vs what should be amortized. Through some research, I have put together a list of my expenses and have divided it into three groups:
- Group 1 is a list of expenses that I am reasonable sure are completely deductible from 2012
- Group 2 is a list of items that I believe should be amortized
- Group 3 is a list for which I have no idea

I was hoping someone could look over the lists and give some feedback, particular group 3

ITEMS I BELIEVE ARE COMPLETELY DEDUCTIBLE IN 2012
Home Inspection
Incorporation legal fees
Door knobs / Keys to property
Cleaning supplies
Printer ink (used for lease agreements)
Checks (for business bank account)
All utilities (these are included in the rent)
Repairs to A/C
Various items to repair toilet (flapper, floater)

ITEMS I BELIEVE SHOULD BE AMORTIZED - NOT SURE OVER WHAT AMOUNT OF TIME
Washer/Dryer
Refrigerator
Curtains (furnished)
Furniture (furnished)

ITEMS I HAVE NO IDEA
Garage door opener (the remote control)
Dryer exhaust tube
Outdoor hoses/sprinklers
Outdoor light unit
Various tools for repairs
Smoke detectors
Window A/C units. Purchased in emergency situation when A/C went out (110 degrees+) and wouldn't be repaired for a week. They are not intended for regular use.


Thank you

[sfskseg]

Two more items I just remembered. I believe both are immediately deductible:
Home owner's insurance
Interest paid on mortgage

[tallen]

The IRS says that anything with a useful life of greater than a year should be capitalized and depreciated (or amortized) rather than expensed, "unless the cost is minor." BUT they give no guidance on what constitutes a "minor cost." Accountants use something called the "materiality convention" to establish capitalization thresholds. In our business, we are using a $500 threshold for equipment items, $1,000 for bulk purchases of equipment less than $500, and for projects that might represent "improvements" to our cottages we are using a threshold of the lessor of $5,000 or 10% of the replacement cost of the building.

So applying these thresholds to your situation, if the washer, the dryer, and the refrigerator each cost less than $500 (including any tax, delivery, installation, etc...), then we would expense them rather than capitalize them. If however, we purchased all three appliances at the same time from the same dealer, and the total order was greater than $1,000 (including tax, delivery, installation, etc...), then we would capitalize the purchase.

In general, the stuff in your third list can probably be expensed (unless you bought more than $1,000 of "various tools" in one shopping spree at your local hardware store ;-)

I am not an accountant or tax expert, use my advice at your own risk.

[Evan]

Hello,

I purchased a rental property six months ago and am preparing to file my first 1065. As this is my first "business" I am not completely sure what deductible as an expense. Beyond that, I'm not sure what can be deducted completely from 2012 vs what should be amortized. Through some research, I have put together a list of my expenses and have divided it into three groups:
- Group 1 is a list of expenses that I am reasonable sure are completely deductible from 2012
- Group 2 is a list of items that I believe should be amortized
- Group 3 is a list for which I have no idea

I was hoping someone could look over the lists and give some feedback, particular group 3

ITEMS I BELIEVE ARE COMPLETELY DEDUCTIBLE IN 2012
Home Inspection adds to basis of property, if residential depreciate 27-1/2 years, or 39 years
Incorporation legal fees organizational costs
Door knobs / Keys to property ok
Cleaning supplies ok
Printer ink (used for lease agreements) ok
Checks (for business bank account) ok
All utilities (these are included in the rent) ok
Repairs to A/C ok, unless it extends the useful life -- but most likely expense
Various items to repair toilet (flapper, floater) ok

ITEMS I BELIEVE SHOULD BE AMORTIZED - NOT SURE OVER WHAT AMOUNT OF TIME (depreciate)
Washer/Dryer 5 years
Refrigerator 5 years
Curtains (furnished) 5 years
Furniture (furnished) Depending, 7 years.

ITEMS I HAVE NO IDEA
Garage door opener (the remote control) - expense
Dryer exhaust tube - repairs/maintenance
Outdoor hoses/sprinklers - 5 years
Outdoor light unit repairs/maintenance
Various tools for repairs - repairs/maintenance
Smoke detectors. - repairs/maintenance
Window A/C units. Purchased in emergency situation when A/C went out (110 degrees+) and wouldn't be repaired for a week. They are not intended for regular use. - 7 years

Thank you

Generally, if a repair enhances the useful life of your property, you should capitalize it. When in doubt, ask an accountant. As this is the first year your business, I'd highly suggest hiring a CPA anyways.

[Evan]

Two more items I just remembered. I believe both are immediately deductible:
Home owner's insurance
Interest paid on mortgage

Correct. These are current period expenses.

[Evan]

The IRS says that anything with a useful life of greater than a year should be capitalized and depreciated (or amortized) rather than expensed, "unless the cost is minor." (Note that "improvements" to capital Property,Plant & Equipment must also be capitalized.) BUT they give no guidance on what constitutes a "minor cost." Accountants use something called the "materiality convention" to establish capitalization thresholds. In our business, we are using a $500 threshold for equipment items, $1,000 for bulk purchases of equipment less than $500, and for projects that might represent "improvements" to our cottages we are using a threshold of the lessor of $5,000 or 10% of the replacement cost of the building.

So applying these thresholds to your situation, if the washer, the dryer, and the refrigerator each cost less than $500 (including any tax, delivery, installation, etc...), then we would expense them rather than capitalize them. If however, we purchased all three appliances at the same time from the same dealer, and the total order was greater than $1,000 (including tax, delivery, installation, etc...), then we would capitalize the purchase.

In general, the stuff in your third list can probably be expensed (unless you bought more than $1,000 of "various tools" in one shopping spree at your local hardware store ;-)

I am not an accountant or tax expert, use my advice at your own risk.

If you spend $300 on a dryer in January, $300 for a new washer in March, I'd look at that and say you spend $600 on a washer/dryer and should be capitalized it. You can establish a safe threshold of say $250 to $500 to capitalize, but you are responsible for lumping similar items during the year in that bucket and follow it consistently. $1K is a bit too high in my opinion, but I've seen companies use that threshold when there were countless $250-$500 items and it would be a burden to track. That's your burden to prove, and the IRS could determine your methods are not reasonable.

At a minimum, just be consistent with what you do from year-to-year.

[tallen]

Thanks for the comment, Evan. Of course, capitalization thresholds have to be scaled to the size of the business. Where I work for my "day job," equipment isn't capitalized unless it exceeds $5K; at the Department of Defense, their threshold is $100K!

[sfskseg]

Thanks for the line-by-line response, Evan. A couple clarifications. You mentioned "organizational costs" and "repairs/maintenance". I'm not sure which category that would put them in, if any.

Also, considering the [hopefully] one-time use of the window A/C units I would really prefer to expense this year and be done with it. Are there any circumstances that would allow that, or do you solidly recommend a 7-year depreciation? If so, may I ask why? I'd like to understand the rationale for next time.

[Evan]

Thanks for the comment, Evan. Of course, capitalization thresholds have to be scaled to the size of the business. Where I work for my "day job," equipment isn't capitalized unless it exceeds $5K; at the Department of Defense, their threshold is $100K!

Again, it will depend on the volume of transactions. They also probably have many transactions above that threshold, and when you consider the number "below" that threshold, it just wouldn't be worth the effort to depreciate them because it isn't material (in relation to the volume of transactions and average transaction size). That's why your "day job" may be able to get away with it and still be deemed reasonable.

If you own a few rental properties, it's going to be hard to justify unless the rental properties have several hundred units within each of them. But even then, I've audited rental properties even those with thousands of units still used $1K max. So if you're managing 3 - 5 units, good luck with a higher threshold especially if you're not doing much on a day to day basis. And if you DID depreciate them, it COULD have a material difference on your income. Not the case with your "day job".

[dave@businessecon.org]

As a former CPA and still doing some accounting work; I would suggest that you use the local commissioner of revenue's guidelines for accounting for personal property to pay personal property taxes as a rental owner. You might as well follow the same routine for both the local government and the IRS. In general, I used $300 as the cut-off. If the item was a long term type of an asset and is worth more than $300 than go ahead and place it on your fixed asset list. As for repairs and maintenance elements, use your common sense. If the repair is material in nature such as a new roof or a new water heater, use the IRS guidelines to depreciate this repair. But if the plumber is replacing the guts inside the commode, just expense this. I have been through several audits and it really comes down to the auditor's training and feeling. Most will not fault you for expensing out small priced stuff, they don't like the paperwork either. As a matter of fact the IRS use the 'Dimenimus Rule' (I hope I spelt it correctly) as their governing principle. Believe me, $300 is safe.

Dave