One of the biggest advantages of owning a rental property is the tax benefits and deductions available to the owner. Whenever 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 efficient method to spread your tax savings and investment over a long-term period – up to 27.5 years. Discover air conditioning depreciation and its impact on rental unit owners.
Fact #1 – What is Air Conditioner Depreciation?
In general, when you replace or repair an item inside a rental unit, you have two options:
- First, if you repair an item like an AC unit, you can deduct the total cost of the repair on that individual year taxes. That’s known as a single deduction.
- Second, if you replace the unit, you have the option to depreciate that cost and spread it out over a period of a few years. Based on recent IRS regulations it is up to 27.5 years.
When you repair an item, you’re returning the value of the home to status quo. However, when you replace an item, you are making an improvement, increasing the value of the property. So how does that impact you financially? Here is an example:
Let’s say 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. However, if you replace the unit, and the cost is $3,000, you’ll have to depreciate this cost over a period of 27.5 years. So instead of having $1,000 tax deduction, you’ll only have about $105 deduction each year.
That’s a huge difference. But you’ll get that same deduction every year you file taxes and own that rental property. So you’ll have to determine what is best for your individual needs.
Fact #2 – How Does The IRS Classify Repairs Vs. Improvement
Began 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?
This is typically used for room additions or adapting the space to create greater value. Not typically used in AC depreciation.
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 you can see, there are some new restrictions that the IRS has made in 2014 that actually help allocate tax deductions over a larger period. For more information about air conditioner depreciation and how to best use this deduction for your individual rental property, always defer to legal or accountant advice.