From apartment complexes to condos or rental single-family homes, more property owners are seeing the value of investing in housing and renting it to occupants. It’s well understood that one of the biggest advantages of owning a rental property is the tax benefits and deductions available to the owner. However, when you replace or fix a major appliance inside a rental property, a major consideration is the taxes potentially paid or deducted. And when you have to replace the AC system, you might want to consider air conditioner depreciation as a cost-effective method to spread your tax savings and investment over a long-term period.
In the information below, we will talk about the depreciation of air conditioning systems and how it impacts those who own rental properties.
What is Air Conditioner Depreciation?
Anytime you replace or repair an item inside a rental unit there are two general financial options to consider:
- First, if you repair an item like an AC unit, you can deduct the total cost of the repair on that individual year taxes. This is known as a single deduction.
- Second, according to current IRS tax regulations, if you replace the unit, you have the option to depreciate that cost and spread it out over a period of up to 27.5 years.
If an item within the property is repaired, it restores the property value to status quo (or where it was prior to the item being damaged). It makes sense to assume that when you decide to replace a broken component or major appliance like an AC system, you would increase your property value. Here is a practical example that explains what we’re talking about.
For the sake of argument, let’s assume that you decide to make a repair to your home AC system that costs you a total of $1,000. The licensed HVAC contractor in Scottsdale arrives and makes the repairs, you pay them and everybody is happy. At the end of the year, when you file taxes for that property, you’ll have to deduct that repair cost during that individual year.
Now, let’s assume that the property owner decides to purchase a new, energy efficient AC system and their investment cost is $3,000. This is an example of a depreciative deduction where you would deduct a little more than $100 per year up to the 27-year limit.
Of course, you’ll want to consult with your accountant to determine which option is best, and what additional deductions you can make annually. But in general, especially for those planning on owning properties for extended periods of time, upgrading their older system to a new one seems like the smarter investment.
How Does the IRS Classify Repairs vs. Improvement?
The IRS tends to make changes to their tax laws and regulations every year; which is a major reason why several home and business owners hire an accountant to keep track of the revolving door in Washington DC. As of January 1st, 2014, the IRS classified a property improvement under three different sections:
- Betterment of a property
- Adaptation of the property
- Restoration of the property
The easiest way to remember this is under the acronym BAR. All three equate to an improvement of the property and qualify the large expense as depreciation – not a deduction.
What Is Betterment?
You can create air conditioner depreciation under the betterment classification if:
“The improvement ameliorates a material condition or defect in the property that existed before you acquired the rental property.” This means if you add a new air conditioner that increases the size of the property in some way (this is not typical). However, one that is common is if the addition of the new AC unit creates a material increase, which increases the productivity, quality, capacity or strength of the property.
What Are Adaptations?
The adaptation depreciation is commonly used if you’ve completed a room addition or have built onto the space of your property. In this case, when you buy and install an AC system needed to keep that additional space cool, it’s considered depreciation as opposed to a deduction. However, this is very rarely used and should be directed to you by your accountant.
What Is Restoration?
This one is pretty simple to consider. If the addition or replacement of the new air conditioner restores the property value, this is when you’d use this classification.
As with any home improvement project, there are different ways for a rental property owner to benefit financially. The best way to stay on top of the always evolving standards set forth by the Internal Revenue Service is to work with a professional accountant. However, an HVAC contractor can help you pick the perfect sized system for any rental property or recent upgrade.
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