Owning a rental unit opens the door to income opportunities and offers the ability to grow wealth over the long term. But real estate can also leave you with a significant number of tax liabilities, especially when you overlook valuable tax deductions.
It might be straightforward to deal with costs like property management and real estate commissions. But what happens when you have significant repairs?
Luckily, the Internal Revenue Service (IRS) allows rental property owners to expense costs incurred in improving the property to help lower their rental income tax liability. Such improvement costs include adding rooms, landscaping improvements, and other expenses like roofing.
We’ll help you understand how the expenses for a new roof qualify as allowable deductions and how you can expense the amount.
Key takeaways
- Rental property experiences wear and tear, requiring investors to make repairs and improvements to keep a home safe and habitable for a tenant.
- Repair costs can be expensed the year the expenditure is incurred, while improvements are added to the property cost basis and depreciated over an extended period of time.
- The cost of a new roof on a rental property is expensed by depreciating the improvement cost over 27.5 years.
How to expense a new roof on rental property
In most cases, a new roof will fall under a capital improvement. However, the tax treatment for a new roof is different from a minor roof repair. That’s because the IRS treats a new roof as an asset on its own, meaning it is prone to deterioration or obsolescence.
These things lead to depreciation of assets, meaning you must expense your new roof on a rental property as a depreciation expense and not a regular rental business expense. In addition, the depreciation expense for the new roof must be treated separately from the depreciation expense of the building itself, as the new roof is recognized as a separate asset from the existing building.
You can claim the deduction using Schedule E on Form 1040. You also need to file Form 4562 when your new roof is installed and is in service.
Before depreciating your new roof, you must ensure you meet the set requirements by the IRS. In order to depreciate it, the property must:
- Be under your ownership and not rented from somebody else
- Be held either for investment or business purposes
- Have a determinable useful life
- Have a useful life of more than a year
If your property meets these guidelines, here is how you can expense a new roof on it.
1. Figure out the depreciation timeline
First, you need to know the start and end dates of depreciation expenses for the new roof. These dates apply when you start and stop depreciating the roof. The depreciation will begin when the roof is in service and end when you have fully depreciated its cost.
How do you figure out the starting date? Does the property currently have a tenant? If yes, your depreciation date will start on the day the roof is installed. But if you do not have a tenant when installing the new roof, your service and depreciation dates begin on the date you lease it again.
How long the depreciation period runs will depend on whether the property is a residential rental unit or a commercial rental unit. The IRS allows for a recovery period or a useful life of 27.5 years for residential rental property and its improvements and additions. The useful life of a commercial rental unit, together with its improvements and additions, is 39 years.
2. Choose the depreciation method
The straight-line method is the most common and ‘straightforward’ depreciation method to calculate depreciation expenses for a new roof. On this basis, the depreciation expense amount will be the same throughout the roof’s useful life. It is calculated by dividing the cost of the new roof by 27.5 years.
For example, if the new-roof cost on a residential rental property is $20,000, your depreciation amount will be $727 ($20,000 / 27.5). Therefore, $727 is the depreciation expense you will claim every year for the roof’s useful life over the next 27.5 years.
Keep in mind that the starting date for depreciation is the service date of the roof. So even if you installed the roof in the middle of the year, you could claim the expense for those few months it will be in service in that first year using the applicable convention.
Example of depreciation expense for a new roof
Let’s assume an investor purchases a single-family rental (SFR) property for $120,000, which includes a lot value of $10,000. One year later, the roof needs to be replaced, something the investor knew about and budgeted for when the property was purchased.
When the property is purchased, the cost basis for depreciation purposes is $110,000, which is determined by subtracting the purchase price from the lot value because land is not a depreciable expense. In the second year, the cost basis increases by $20,000, and depreciation of the roof begins.
Here’s how the depreciation expense would be recorded during the first 2 years of ownership:
Can bonus depreciation be used for a new roof?
Bonus depreciation allows property owners to immediately write off the cost of a capital improvement.
In 2017, the Tax Cuts and Jobs Act made significant changes to depreciation rules, including allowing real estate investors to expense 100% of certain capital improvement costs in the tax year the expenditure was incurred. As a result, bonus depreciation can reduce tax liability in the first year, and even create a net loss for income tax purposes.
Unfortunately, bonus depreciation only applies to assets with a useful life of 20 years or less, such as appliances. Remember that the IRS classifies some additions and improvements as assets with the same recovery period as the property itself. One of those improvements or additions is a new roof. Due to this, a new roof expense on a rental property does not qualify for bonus depreciation.
Repairs vs. improvements on rental property
Repairs and improvements mean 2 different things when it comes to tax matters. Repairs are changes you make to a rental property to keep it in its original condition. On the other hand, improvements are changes you make to add more value to the property, adapt it for a different or new use, or restore it to its previous glory.
Let’s say the roof on your rental property is leaking. You could opt to do something about the leaking part only, like a patch or replacing a few shingles. This would be repairing the roof. But, if you were to replace the entire roof or a significant part of it, you’d be making improvements.
When it comes to deductible expenses, the cost of repairs can be claimed the same year they are incurred. However, improvements are capital expenses that you depreciate over the item’s life or a specified period.
Keeping track of repairs, improvements, and capital expenses can quickly become complicated, even with just one rental property.
To ensure that you claim every rental property expense deduction possible, consider signing up for a free account with Stessa, a Roofstock company. Stessa automatically tracks income and expenses, categorizes costs as expenses or depreciable items, and updates the real estate balance sheet.
Tens of thousands of investors already use the rental property financial management software to track over 250,000 properties with over $60 billion in asset value.
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Final thoughts
The bottom line is that you can expense a new roof on rental property by claiming an annual depreciation expense. A new roof on the property qualifies as an improvement, restoration, or betterment of the property, meaning it is a capital improvement. The new roof is also treated as a separate asset from the existing structure of the property, which means you can depreciate it over its useful life of 27.5 years.
It is crucial that you create a record trail to prove the deductions claimed on your tax return are true and accurate. For example, keep before and after pictures of the property and invoices and receipts for all payments done. Investors may also wish to consult their tax advisor or certified public accountant (CPA) to ensure the tax calculations for the new roof meet the latest IRS regulations and are as accurate as possible.
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