How do I account for out-of-pocket rental expenses vs. financed expenses on my tax return?

by William B. McAllister, CPA | Mar 07, 2018

I have rented my second home for the past three years. In 2017, I incurred a number of costs—new water heater, new furnace, and repairs to the air conditioning unit. The new furnace was installed in December 2017. I paid $1,115 out of pocket and financed the remainder (about $6,000). My first payment for the financed balance was not due until January 2018. Can I claim these expenses on my taxes? If so, how do I account for the portion that I paid out of pocket vs. the portion that I financed?

Costs related to the operation of rental property will depend on a number of issues:

  1. Are records being maintained on the accrual or cash basis of accounting?
  2. Has a policy been established to define asset purchases subject to depreciation versus expenditures that may be written off as expense at the time the items (repairs) are completed and placed in service?
  3. Contractual obligations to acquire assets subject to depreciation should be recorded at their total cost, which includes any down payment and financing obligation to acquire the asset. Depreciation is subject to many options that may be elected to write off the cost of the items acquired.
  4. The original cost of the property that was converted from a second home to a rental is also required to be depreciated from the time the property was placed in service.

The issues cited above emphasize the challenges one faces in recording transactions relating to rental activities.

Your specific question identifies three items of cost incurred during the 2017 tax year: a new water heater, a new furnace, and repair of an air conditioning unit. You paid $1,115 out of pocket and financed about $6,000 to pay for the expenditures. It is necessary to identify the actual cost of each of item. Determination of how to treat the expenditure as an expense or as an expenditure to capitalize can then be accomplished. Only interest expense for the future financing payments will be deductible, since the asset will be depreciated over a period of time.

Depreciation and property expense rules involve many options. Each taxpayer’s financial circumstances may have an impact on the decisions made regarding the appropriate choice to capitalize or expense the expenditures incurred in the operation of the rental property. For more information, read IRS Publication 946 regarding depreciation.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: William B. McAllister, CPA, is a sole practitioner in Honesdale, Pa.

The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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