Capitalize or Expense

[Terry D EA]

Keeping in mind the new regs on repair and maintenance. I have a client who is planning on putting a new roof on his rental home. Here is the question(s):

1. Does a new roof increase the value or the property? Personally, I say no. It stabilizes the value and is clearly a maintenance item. But... the 5,000.00 safe harbor thing so capitalize or expense? What about 179 Expense?

 

[Terry D EA]

Well here is the answer. I think we all can agree this is a gray area but here is what I found. As it reads at the end, the roof replacement is an expenditure that is a restoration and therefore must be capitalized. This article mentions s manufacturing building but I cant' see where residential real estate would be treated any differently. Agree??

Example 14. Replacement of major component or substantial structural part; roof

K owns a manufacturing building. K discovers several leaks in the roof of the building and hires a contractor to inspect and fix the roof. The contractor discovers that a major portion of the decking has rotted and recommends the replacement of the entire roof. K pays the contractor to replace the entire roof, including the decking, insulation, asphalt, and various coatings. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount is paid to restore the building structure or any building system. The roof is part of the building structure as defined under paragraph (e)(2)(ii)(A) of this section. Because the entire roof performs a discrete and critical function in the building structure, the roof comprises a major component of the building structure under paragraph (k)(6)(ii)(A) of this section. In addition, because the roof comprises a large portion of the physical structure of the building structure, the roof comprises a substantial structural part of the building structure under paragraph (k)(6)(ii)(B) of this section. Therefore, under either analysis, K must treat the amount paid to replace the roof as a restoration of the building under paragraphs (k)(1)(vi) and (k)(2) of this section and must capitalize the amount paid as an improvement under paragraph (d)(2)

[Pacun]

I have always understood that a roof replacement is a capital expense and the EA exam hammers that question.

[Terry D EA]

Pacun I understand perfectly that a roof replacement is a capital expense. However, this topic has been tossed around from several angles. In past years there has been discussion regarding identifying the useful life of a roof. Any roof on any building will eventually need to be replaced. It fails to make sense that it is a "Capital Improvement". Replacing a roof doesn't add to the value of the property if the roof is replaced with materials of similar kind. I would agree the value would increase if a metal replacement roof were installed. Bottom line, there is no choice but to capitalize. I guess I shouldn't try to make anything that resembles common sense out of this.

[michaelmars]

you must capitalize but you can write off the remaining cost of the old roof. there are formulas to do this where you take the cost of the new roof and work backwards using the Construction Price Index to see what that roof would have cost when the client first bought the building. That amount less the applicable depr on it gives you the amount to write off.  This is covered under the new "partial asset disposition regs" This is why the 3115's were so important last year to elect these new methods and why I kept saying any real estate return not electing the new regs and/or filing a 3115 is malpractice.

Guy buys a building 10 years ago for $1,000,000. lets say $100,000 gets allocated to the roof. 100,000/27.5 (residential) x 10years gives you accumulated depr of $36,363, you have a write off this year of $63,637.  That's a heck of a deduction to miss.

AS for sec 179, this only applies to machinery and equipment, not improvements.

[JJStephens]

I did an IRS webinar about six months ago on which this question arose during the Q&A time. The presenters said that the new rules generally require the new roof to be capitalized. However, they acknowledged that the facts and circumstances might occasionally allow for expense treatment. They emphasized those would be very rare exceptions and that IRS is trying to force it to be capitalized.

[Catherine]

1 hour ago, JJStephens said:

I did an IRS webinar about six months ago on which this question arose during the Q&A time. The presenters said that the new rules generally require the new roof to be capitalized. However, they acknowledged that the facts and circumstances might occasionally allow for expense treatment. They emphasized those would be very rare exceptions and that IRS is trying to force it to be capitalized.

There are also splitting issues where you can expense the portion that - for example - fixes holes and leaks, and then capitalize the rest.  Of course, figuring out where those costs split is left as an exercise for the accountant.  The IRS does *not* provide the dart board for making that determination! (Hey, IRS - that last sentence was a JOKE.  We don't actually use dart boards.)

[Lion EA]

Where can I buy a tax dart board?  That would be easier on my neck that looking at my ceiling and exercise my hand/eye coordination at the same time.  I want one with a replacement center so I can add a picture.  Political candidates right now, but clients, too.  Don't tell.

[BHoffman]

Magic 8 Ball.  Works every time

[Terry D EA]

10 hours ago, michaelmars said:

you must capitalize but you can write off the remaining cost of the old roof. there are formulas to do this where you take the cost of the new roof and work backwards using the Construction Price Index to see what that roof would have cost when the client first bought the building. That amount less the applicable depr on it gives you the amount to write off.  This is covered under the new "partial asset disposition regs" This is why the 3115's were so important last year to elect these new methods and why I kept saying any real estate return not electing the new regs and/or filing a 3115 is malpractice.

Guy buys a building 10 years ago for $1,000,000. lets say $100,000 gets allocated to the roof. 100,000/27.5 (residential) x 10years gives you accumulated depr of $36,363, you have a write off this year of $63,637.  That's a heck of a deduction to miss.

AS for sec 179, this only applies to machinery and equipment, not improvements.

This election has been made by all of rental clients. Honestly, I forgot about this part and had to look at the election methods document was created. With further research, the election can be made with a timely filed tax return for years following 2012. Thanks for the reminder.

[mrichman333]

Nothing to do with the regs. But if I'm looking to buy a home one home needs a new roof and one doesn't I'm buying the one that doesn't.  A new roof in NJ will cost about 20K

[clay]

No section 179 unless the rental property is part of a business.

Section 179 only applies to a trade or business (e.g Sch C).

 

[michaelmars]

On ‎03‎/‎06‎/‎2016 at 9:13 PM, Terry D said:

This election has been made by all of rental clients. Honestly, I forgot about this part and had to look at the election methods document was created. With further research, the election can be made with a timely filed tax return for years following 2012. Thanks for the reminder.

yes but last year was the ONLY year you could elect to do a retroactive partial asset disposition.  Take the above example but he did a new roof in 2005 and 20010, last year you could have written the extra roofs off, now you can only do it in the year that they add another new roof.

We did cost seg studies and for a few thousand dollars in fees, we got to write off duplicate and triplicate roofs, hvac's elevators, etc.  And not to forget tenant improvements for past tenants in commercial properties.

[Terry D EA]

I got it but in 2016 is when he is going to replace the roof. There aren't any other previous roof repairs during the time he has owned the property. So, I cannot write off something that hasn't existed. There is only one of my clients this may have affected and I looking at his records, there is nothing I can do either. So, once again, this is a mute issue for these folks. You win some you loose some.

[Lion EA]

The building doesn't have an existing roof?!

[michaelmars]

Terry, you need to get a handle on these new regs.  You should take a seminar on PAD's asap.