Rental Property Repairs Safe Harbors

By Jason Watson, CPA
Posted Monday, August 5 2024

There are three safe harbors relevant to rental property owners and real estate investors-

• De Minimis Safe Harbor Election

• Safe Harbor Election for Small Taxpayers (sounds a bit condescending)

• Safe Harbor for Routine Maintenance

We’ll talk about betterment, restoration, adaptation and ameliorates (who uses that word every day?) in a bit. Let’s run through these, shall we?

De Minimis Safe Harbor Election

We’ll start with the easiest one. As outlined in IRS Notice 2015-82, the IRS increased the de minimis safe harbor threshold from $500 to $2,500 per invoice or item for taxpayers in 2015. What does this mean? Anything you purchase including repairs and maintenance that are $2,500 or less per line item on an invoice may be expensed and therefore deducted immediately (versus capitalizing as a fixed asset and depreciating).

You buy four dishwashers for your 4-unit rental property. The total invoice is $4,000, however, each dishwasher is $1,000. As such, since $1,000 is under $2,500, even in Canada, you can use the de minimis safe harbor.

The de minimis safe harbor doesn’t change your ability to deduct repair and maintenance costs that don’t qualify under the de minimis safe harbor. Is that double-talk? Maybe. How about this- you can use other safe harbors should you be unable to qualify under de minimis. Yay!

Some fine print- If the de minimis safe harbor is elected under Treasury Regulations Section 1.263(a)-1(f ), it must be applied to all materials and supplies that meet the requirements of de minimis, except for those the taxpayer elects to capitalize and depreciate. This sounds ominous but is quite minor.

Safe Harbor Election for Small Taxpayers

For the little people in the real estate investment world, we have a practical safe harbor for expenditures that would otherwise be deemed improvements requiring them to be listed as a fixed asset and depreciated. Yuck.

Two criteria-

• The building’s unadjusted cost basis is $1 million or less. This excludes land, land improvements, and personal property identified through a cost segregation study.

• You have less than $10 million in gross rental income across all activities.

If you meet these, then if the total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property are under 2% of the unadjusted cost basis and under $10,000, they may be expensed immediately as repairs and maintenance.

Read that again. It is the total amount for the tax year, not per item or per occurrence.

Quick example- you buy a rental for $600,000 and the building is $400,000 of the overall purchase price. You spend $5,000 on replacing the HVAC (fancy term for furnace with an air conditioner) and have an additional $1,000 in repairs and maintenance. Your limits are $10,000 or $8,000 (2% of $400,000) whichever is lower. You may deduct $6,000 as repairs and maintenance, versus capitalizing and considering the HVAC replacement as a separate fixed asset.

Keep in mind that is all repairs and maintenance combined. If you had spent $5,000 on the HVAC unit, plus another $7,000 on other repairs and maintenance, then you are limited. What if a part of your HOA dues includes maintenance of the landscaping? Hmmm…

Safe Harbor for Routine Maintenance

This one is a bit trickier, but certainly a nice and mostly underutilized safe harbor for rental property owners. According to the tangible property final regulations, you are not required to capitalize as an improvement, and therefore may deduct, amounts that-

• Keep the property in its ordinarily efficient operating condition, and

• You reasonably expect, at the time the rental property is placed in service, to perform the improvement more than once during the 10-year period beginning when placed in service for building structures and building systems, or more than once during the life of the unit of property for property other than buildings.

There is no clear answer as to what routine maintenance is, but the regulations provide a zillion examples and explanations regarding the requirement under Treasury Regulations Section 1.263(a)-3(k)(7)–

Example 25. Not replacement of major component or substantial structural part; windows.

U owns a large office building that it uses to provide office space for employees that manage U’s operations. The building has 300 exterior windows that represent 25 percent of the total surface area of the building. In Year 1, U pays an amount to replace 100 of the exterior windows that had become damaged. At the time of these replacements, U has no plans to replace any other windows in the near future. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The exterior windows are part of the building structure as defined under paragraph (e)(2)(ii)(A) of this section. The 300 exterior windows perform a discrete and critical function in the operation of the building structure and are, therefore, a major component of the building structure under paragraph (k)(6)(i)(A) of this section. However, the 100 windows do not comprise a significant portion of this major component of the building structure under paragraph (k)(6)(ii)(A) of this section or a substantial structural part of the building structure under paragraph (k)(6)(ii)(B) of this section. Therefore, under paragraph (k)(6) of this section, the replacement of the 100 windows does not constitute the replacement of a major component or substantial structural part of the building, and U is not required to treat the amount paid to replace the 100 windows as restoration of the building under paragraph (k)(1)(iv) of this section.

Yawn. There are a total of 31 examples if you cannot get enough. But! Keep this 100-windows out of 300 total ratio in mind as we explore improvements and repairs.

The routine maintenance safe harbor doesn’t apply to amounts paid for betterments. We’ll expand on this in a bit, but a betterment is generally fixing a major defect, expanding space such as an addition or finishing a basement, or materially increase productivity, efficiency, strength, quality or output of the unit of property (UOP).

However, the routine maintenance safe harbor does apply to certain restorations that would otherwise be improvements, including when you pay amounts to replace a major component or substantial structural part of a unit of property. Case and point is Example 25 above.

What gets really tricky is something like an HVAC unit. Replacing an HVAC unit might not be considered routine maintenance but rather a betterment (and therefore improvement, and therefore not eligible for this safe harbor). However, if you have 10 HVAC units atop your apartment building, all tied together as a system, and you replace 2 of them, then this might not be considered a betterment. The key to the restoration inclusion above, and safe harbor allowance, is the “replace a major component” phrase. In a single-family rental property, an HVAC system might be considered only having one component, and as such replacing it is a betterment.

Finally, the rule reads “reasonably expect.” What if you expect to perform routine maintenance more than once in a 10-year period, but don’t actually do so? It becomes more challenging, for sure, but if you can demonstrate that this particular maintenance expense is expected to not last 5 years, then you have a valid argument.