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R. Klein, EA
R. Klein, EA, Enrolled Agent
Category: Tax
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Experience:  Over 20 Years experience
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U.S. Federal Income Tax and California Income Tax Question:

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U.S. Federal Income Tax and California Income Tax Question:

I purchased a foreclosure condominium with significant deferred maintenance issues 10 months ago. I will gross roughly $24,000 for tax year 2013 from a disability annuity. My husband will gross roughly $125,000 from his job as a production engineer.

My husband will have roughly $25,000 federal withholding for tax year 2013 due to the number of exemptions he claims on his Form W-4 (2013).

I plan to pay roughly $20,000 to repair the condominium (rental expense?) to rent during the months of October, November and December of 2013 (rental income is expected to be $1,500/month or a total of $4,500 for tax 2013). These repairs to the condominium must be done before I can rent the unit. I plan to continue renting the condominium during all of 2014.

If my husband and I file a joint tax return for 2013 (we filed jointly for 2010, 2011 and 2012), can I deduct the full $20,000 I pay to prepare the condominium for rental during the last three months of 2013, from our joint 2013 Federal and California tax returns? In other words, can the $20,000 in rental preparation expense be used to offset my husband’s income from his job as a production engineer (after offsetting the rental income of $4,500 for tax year 2013).

Randalltax : Thank you for your question. There are two main issues you bring up.
Randalltax : First, determining the difference between a repair and a capital improvement is crucial.
Randalltax : In general, if you are making a repair to extend the life of an item, it can be deducted as a repair, while replacing an item that starts a new "life" must be depreciated. Normal residential depreciation is over a 27.5 year period, so very little is deducted each year.
Randalltax : an example is HVAC unit. You might need to replace a blower motor, which might be considered a repair, but lets say you need to replace the entire exterior condenser. Since that is a major component, you would have to depreciate this as a capital replacement.
Randalltax : another rule of thumb is if the repairs in total cost more than 10% of the value. If so, you are likely considered to have a capital expense. In the case of work so major that you likely cannot even make the unit available until major components are fixed, such as roofing, etc, then you likely will categorize the entire job as a capital improvement and will not be able to deduct any of the repairs in the first yea as an expense.
Randalltax : all of this might be moot anyway, based on your income.
Randalltax : when your AGI is over 100k, you are subject to the start of limitations on deducting losses in a passive activity ( which all rentals are passive). When your income is over $150k, then NONE of your passive losses may be deducted currently. Instead, the losses are pushed forward to the next year until you can use the loss against income from the same activity or until you sell the property to release the loss.

Would painting the interior of the condo be considered a repair? Would refinishing the kitchen cabinets (as opposed to replacing them) be considered a repair? On my husband's income, I was assuming a maximum profit sharing bonus.

Randalltax :

Interior paint and refinishing are generally repairs, not capital improvements. Replacing the cabinets with new work would be a capital expenditure.

Randalltax :

If your AGI, not including the rental loss is between $100K-150K, you are subject to the phaseout rules, meaning only a portion of your loss may be deductible. The closer you are to the $150K figure, then the less is allowed. Even if your income was below $100K, the maximum allowable loss to you would be $25K in one calendar year. There is a $25K limit on losses unless you are a bona fide real estate professional.

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