Forget BRRRR: Introducing the BARRRR Strategy for Investors

by | szikov.ru

Imagine you’ve placed an offer on a property that needs a bit of love. You know your strategy is to use the BRRRR (buy, rehab, rent, refinance, repeat) method. This method allows you to maximize the use of your cash and, essentially, acquire assets repeatedly with your original pool of funds.

Brandon Turner wrote a great article on the fundamentals of BRRRR. If this is the first time you’ve heard of this method, I suggest reading Mr. Turner’s article prior to continuing with this one.

The majority of our clients come from Szikov. Not surprisingly, this leads to us discussing and strategizing how to maximize the BRRRR with clients.

It wasn’t until recently, when speaking with a new client of ours, that I realized we can consistently save clients who are pursuing the BRRRR bookoos (American slang for French term beaucoup) of money by providing one piece of advice. And before today, that one piece of advice has not yet been discussed among BRRRR advocates.

Introducing the BARRRR

This is some next-level stuff. New Age innovation! I say with 100 percent confidence that the BARRRR method will save you thousands of dollars in taxes. So listen up!

As I mentioned above, the BRRRR method maximizes use of capital, but it is actually a very poor tax strategy for a number of reasons. So to enhance the BRRRR method, I’ve added an “A” for a key step I feel the standard BRRRR method is missing.

The “A” stands for Advertise.

Buy, Advertise, Rehab, Rent, Refinance, Repeat

That’s right, adding advertising is a relatively simple yet highly effective improvement. Consider it a much-needed addition that has the potential to save you gobs of tax dollars, perhaps allowing you to take your spouse out to that super high-end restaurant downtown (send me a thank-you card afterwards!).

Related: How I Bought, Rehabbed, Rented & Refinanced 14 Properties at Once

Why Advertising is Critically Important

What most real estate investors don’t fully understand is that the date you place your property “in service” matters immensely from a tax perspective. It’s the difference between writing off the majority of your rehab costs and being forced to capitalize and depreciate those costs. More on that in a minute.

The IRS says that when a property is ready and available for rent, it’s considered to be “in service.” And once the property is “in service,” the costs incurred are considered operating costs—rather than what I like to call “get ready” costs.

To repeat, there are two key components to placing your property into service: it must be ready and available. The key part that many investors miss is the “available” part. You’d be surprised as to what properties will qualify as “ready” in the eyes of the IRS. But if you never advertise the property for rent, you never make it available for its intended use. As a result, the property is not placed in service.

So if you don’t advertise the property for rent, the property is not deemed “in service,” and all costs incurred prior to the “in service” date are therefor considered “get ready” costs. Let me explain why “get ready” costs will significantly reduce your after-tax returns.

The Tax Disadvantages to “Get Ready” Costs

There are a myriad of rules surrounding repair and rehab costs. I won’t go into great detail in this article, but I have written extensively on these rules in the past, both on Szikov and my own blog. For this post, I’m going to explain the overarching strategy that pieces all the rules together to maximize your tax position.

Get ready costs are costs incurred prior to the property being “in service.” These costs can include travel, research, inspections, gut rehabs, materials, labor, painting, etc. Basically, anything that you can think of putting into a rental in order to place a tenant can be considered a “get ready” cost.

You want to minimize your “get ready” costs, and we help our clients strategically plan their rehabs in order to do so. The reason we want to minimize “get ready” costs is that we are forced to capitalize and depreciate these, generally over 27.5 years.

Capitalizing a cost simply means that we add that cost to the basis of the property, rather than immediately expensing it. Any cost that we add to the basis, we assign a depreciation schedule to. We then write off, via depreciation, a certain amount of the capitalized cost each year.

For example, suppose you made a $27,500 improvement to the structure of the property. We would capitalize that improvement (increase the basis of your property by $27,500), and then depreciate the improvement over 27.5 years. So each year, we get to write off $1,000.

Can you see why that’s a bad thing?

We are only writing off $1,000 every year for 27.5 years! You’ll be old and grumpy by the time you fully recover the cost of that improvement.

That’s the first major issue with being forced to capitalize an improvement—we recover our costs over a long period of time rather than writing it all off today, significantly reducing our immediate taxes.

The second, huge—but rarely addressed—issue with capitalizing and depreciating costs is that when you sell the property, you have to pay a tax referred to as “depreciation recapture” (formally called unrecaptured section 1250 gain). This is a tax assessed on the depreciation you have claimed over time. The tax ranges from 10–25% depending on your tax bracket. If you think you can avoid the tax by not taking depreication, think again. The IRS will impute depreciation that you “should have” taken and tax you anyway!

So to recap, when we have “get ready” costs (those incurred prior to the property being placed into service) we not only have to slowly write those costs off over time via depreciation, but we also get nailed by depreciation recapture on that depreciation when we sell.

Tax Advantages of Operating Costs

Unlike “get ready” costs, operating costs can be fully deducted in the year they were incurred. Additionally, there will be no depreciation recapture tax to assess on operating costs when the property is sold, because we wrote the costs off—we didn’t capitalize and then depreciate those costs.

As you can see, classifying costs as operating costs comes with two huge advantages. First, we fully recover the cost during the current tax year because we get to write if all off. Second, we avoid paying a potentially devastating 25% tax on the depreciation of those costs because we’re not depreciating them at all.

But here’s the kicker: operating costs can only be incurred once the property has been placed into service.

Ah hah!

Now you can see why I’m advocating for the BARRRR method instead of the BRRRR method.

By advertising the property for rent prior to starting your rehab, you have met the IRS’s “available” requirement (remember, to be “in service” it must be ready and available). Now all you have to meet is the “ready” part. 

What constitutes “ready” for rent? As always, it depends and can be a myriad of factors. If you are running a full-gut rehab, your rental will not be “ready” until substantially all of the rehab is complete. IRS standards also indicate that a Certificate of Occupancy is a great indicator of when a property is “ready” for rent. However, this will be up to you and your CPA to decide based on your facts and circumstances.

I often tell clients that painting is always an operating cost unless you paint prior to advertising the property for rent. That’s literally the only time in which you’d be forced to capitalize the cost to paint.

Here’s an example:

Your painting costs $5,000 and you’re in the 25% tax bracket. If you advertise your property for rent prior to painting, you can deduct it in full this year. This will save you $1,250 in taxes. If you paint and then advertise your property for rent, you will have to depreciate the cost over 27.5 years, which will result in annual tax savings of $45.

Do you want to be reimbursed $1,250 today or save $45 a year over the next 27.5 years?

It is absolutely critical that you provide your CPA the flexibility to classify your rehab costs as operating costs as much as possible by advertising your property for rent as soon as you can. The tax savings may be massive.

It’s important to note that sometimes costs simply cannot be classified as operating costs even if they are incurred after advertising your property for rent. Costs that exceed $2,500 are almost always required to be capitalized and depreciated. So don’t think that you can advertise the property for rent and then deduct the cost of a new roof—that ain’t gonna happen.

Related: How I Made $40,000 on My Recent BRRRR Real Estate Investment

How to Solidify Your Advertisement Date

Documenting the date your property is advertised is an important piece of this strategy. If you don’t have any hard evidence that you advertised your property for rent by a certain date, good luck defending yourself during an audit.

In order to document your advertisement date, you need to advertise via a third party. Think Craigslist or Zillow. You can also stick a “for rent” sign in the front yard and take a time-stamped photo.

Regardless of how you choose to advertise, you’re going to need time-stamped proof. Always remember to obtain proof.

And hey, maybe you decide to jack up the rent once the rehab is complete, so you re-advertise the property for rent post-rehab. I’m not saying whether you should or shouldn’t do this, but what I do know is that advertising pre-rehab is key.

Additional Success Factors

When undertaking a rehab, always obtain itemized invoices from your contractors. I mentioned a $2,500 threshold as being one pertinent piece of the puzzle. Don’t let your contractors give you invoices that aggregate all the costs. Instead, obtain as many itemized invoices as possible—a $10,000 expense can be broken down into ten $1,000 line items which may be deductible. I’d also argue that this isn’t just a tax strategy, it’s a best practice for any business.

Another factor for success (that should go without saying) is to be very careful who you take advice from. Some of our clients work with property managers, realtors, and lenders who love to give them tax advice. Unfortunately, this advice is often wrong and misleading, and can cost clients thousands of dollars.

You shouldn’t trust the legal advice of a CPA, and you shouldn’t trust the tax advice of a property manager. Question everything, and go to professionals who specialize in the specific areas.

Conclusion

I hereby formally request that all further mention of the BRRRR strategy should be changed to BARRRR (one more time, buy, advertise, rehab, rent, refinance, repeat). Let your fellow investors know that the added “A” stands for “Advertising.” It also stands for “tax savings”—indirectly, of course!

When you advertise your property for rent, and once the rental is “ready” for rent, you place it into service. When you perform a rehab after you have placed your property into service, you have a much better chance at classifying your rehab costs as “operating” costs (versus “get ready” costs). And when you can classify costs as operating costs, you stand to save a hearty amount in taxes.

I have one more article on deck about the BARRRR strategy, and it will take a critical look at the “refinance” portion. Many folks don’t know that the interest on a refinanced property may not be deductible. More on that next time.

Go make some money!

Have you tried this strategy? Let me know your own experiences in the comments below!

About Author

Brandon Hall

Brandon Hall, owner of The Real Estate CPA, is an entrepreneur at heart who happens to be good at taxes. Brandon is a real estate investor and CPA specializing in providing business advice and creative tax strategies for real estate investors. Brandon's Big 4 and personal investing experiences allow him to provide unique advice to each of his clients.

168 Comments

  1. Cody Bray

    I am a CPA in CA and i am not sure about this statement “If you advertise it for rent prior to the rehab, you could deduct the countertops, cabinets, painting, labor, appliances, and potentially even the flooring.” I feel like the IRS only lets you deduct repairs and makes you capitalize new items (non-repairs like new countertops). Please let me know if i am incorrect on this.

    • Brandon Hall

      Hi Cody – I love conversing with other CPAs! So under the IRS Tangible Property Regs released in 2014, each component of a property is assigned to a Unit of Property (UOP) or is its own UOP. Per IRC § 1.263(a)-1(f)(1)(ii) you are allowed to write off up to $2,500 per item or per item on the invoice.

      The kicker is the anti-abuse rule, 1.263(a)-1(f)(6), that prohibits any attempt by the taxpayer to manipulate transactions to reduce individual invoice amounts for a single unit of tangible property to an amount less than the de minimis expensing threshold.

      So if you put these two together, you CAN write off countertops, cabinets, etc as long as (1) the materials and labor cost below $2,500 per component; and (2) you avoid the anti-abuse rule by appropriately planning and timing your rehab so as to avoid materially improving the same UOP.

      Hope that helps!

      • Kurt Stresau

        Brandon,

        Would disqualify even without the advertising component? I’m in the midst of an IRS audit, and the property was officially available, but I do not have time stamp records of advertisement. The IRS is choosing to regard my get ready expenses as capital investor expenses and not maintenance items. This is shifting all of those items into a capitalized category and substantially increasing my bottom line for the tax year in question (2014).

        They are basically saying that the first record I have of a property being available is the date of a tenant lease signature. That means all of my rehab costs and time are being treated as investor activities/costs.

        It would be nice to be able to refer their own Revenue codes back at them to push back.

        • Brandon Hall

          Hi Kurt – I’m sorry you’re going through all of that. This is a reason I wrote the article – placing your property into service via advertising is critical.

          How did you advertise the property for rent? Can you point to an email? A receipt at home depot where you bought the For Rent sign?

          How about applications? In your area, what is the average time it takes to place a tenant from application to lease start? Maybe you can get a few property managers to cite their data.

          For example, I find it hard to believe, and unrealistic, that a tenant applied, signed a lease, AND moved in all in one day. So if you can get a handful of property managers to say “in our area, the average DOM (days on market) for a rental unit of similar make is xx days” you may be able to persuade the auditors to at least give you some credit.

        • Kurt Stresau

          Brandon,

          I think I could probably make the case for a portion of the remodel period based on email exchanges with the realtor that does my tenant placement. I would then be in a position of proving when certain materials were PHYSICALLY INSTALLED, versus when they were purchased. That will draw a line-item scrutiny to my accounting records.

          Since I have multiple properties, there’s no way for me to PROVE that an expense for paint or a cabinet was installed in that particular house.

          I’m in somewhat of a no-win situation. By trying to defend the availability date, I open another level of scrutiny on individual purchases/expenses. If IRC 1263 has some type of blanket applicability regardless of state of availability, that would prove to be very useful information.

      • Rob Urban

        I just followed this strategy on a new rental purchase, total rehab was under $2500. The PM is now asking me to fill out a W9 authorization form which I find odd. Shouldn’t I be responsible for reporting my own taxes, this seems like double-reporting?

        • Thanks for your response but it just seems like adding the “A” component doesn’t really help in the case of most “real-world” BRRRR scenarios. Or have I missed something? Here’s my case… To over simplify the BRRRR strategy Into the form of an algorithm It looks like this Purchase Price + Repair Cost + Holding Cost < 75% Post Repair Appraised Value… I know you don't need a lesson on this and the basic algorithm is well known but the key in my experience is that the house in question has to be fairly seriously in need of repair such that this formula works so even in less expensive markets we're looking at numbers like this 25k PP + 10k RC + 3k HC = 38k towards a 50k asset value or maybe more realistic ones look like 50k PP + 20K RC + 5k HC = 75K on a 100k appraisable asset… so we're talking about 10-20k in rehab costs. To extrapolate further, I live in a market where I can't get a contractor to show up for a project under 40k and we're working on 300k-400k assets… the models still work for BRRRR but I'm just questioning whether (or how) adding the advertising into the equation is going to really help in actual real world BRRRR scenarios?

        • Brandon Hall

          Hi Johnny – awesome questions man!

          So first, it’s important to understand what I was trying to do here (and did not really succeed) in that I’m trying to teach people that you should not wait until the very end of the rehab to advertise. Adding the “A” to the already popular BRRRR method was simply a way to facilitate the point and get people to remember it.

          I would say in your situation it’s not going to be super beneficial. But I’d also bet there are expenses that can be deducted toward the end of your rehab that would otherwise not be deductible once the unit is ready for rent (but not advertised).

        • Yeah – Ok – I get it – I just thought it was a new magic bullet. I guess its a little less than I’d hoped and the title led me to believe but its still great info none the less and definitely valuable – thanks for doing the article

      • I’m just curious how you’re reading the second paragraph (your “kicker”) in a way that defends instead of explicitly prohibits what you’re doing? I have to say my read of that paragraph is that it is expressly designed to keep you from doing what you’re doing? Obviously if you’re going in and painting a room or a few rooms under 2500 it seems to make sense but by the very nature of BRRRR, generally speaking the R for Rehab is almost never limited to light painting… Just curious if you’ve been audited in the face of a larger rehab and whether or not the defense outlined here has been accepted by the IRS?

        • Brandon Hall

          Hi Johnny – thanks for your thoughtful comment and questions.

          The $2500 threshold is set by the De Minimis Safe Harbor which allows us to write off costs under $2500. The anti-abuse rule says that you cannot break down a larger expenses into smaller items to get under the $2500 “per item” if the components are interdependent on each other. So you can’t break down a $5000 HVAC job into all of the components that make up the HVAC job and then deduct that cost.

          When the cost of a repair/maintence item is above $2500, we can no longer use De Minimis so we must then ask – is this repair a Betterment Adapation or Restoration of the unit of property and does it materially improve the unit of property?

          Painting affects the structure unit of property. Painting does not materially improve the structure unit of property (doesn’t affect the way the structure is used and doesn’t make it operate “better”) so regardless of the price (generally), painting is not subject to capitalization thresholds.

          So if your painting costs $5000, it will not qualify for De Minimis as it is over $2500, but it’s also not an improvement to the unit of property, thus it’s fully deductible.

          I suppose I used a bad example as the numbers are confusing folks.

          Just remember as a best practice: if the repair costs less than $2500, it’s deductible. If it costs more than $2500, does it materially improve the unit of property it affects by means of a betterment, adaption, or restoration? If yes, capitalize and depreciate. If no, currently deductible.

          And yes we have defended our clients’ tax positions when under examination where we have substantiated the placed in service date and deductibility of certain repair items.

          Thank you for asking great questions!

        • Kurt Stresau

          Brandon,

          I’m curious if the De Minimis Safe Harbor is something that would be applicable in my case (2014 audit of a BRRRR, LLC-held, reported on my Schedule E). I’m a very hands-on remodeler/investor, and I generally do all of my work myself. That means within the scope of each specific update during a BRRRR, I have decent records regarding the purchase of materials. I went back and looked, and literally every item was under the $2500 threshold. Would it be an oversimplification that the De Minimis would apply to each line item and therefore every expense during the 2014 rehab is expensible?

  2. Sonia Spangenberg

    Question, I have a property that has had a complete demolition and there are no systems in place. So once I install systems and start framing, would that be a good time to advertise for rent? If the availability is a few months out will that affect the acceptable advertisement date? What is the fine line here? Since it was a complete demo, does that rule out being able to use the operating cost designation for the kitchen, bath, flooring and paint expenses?

    • Brandon Hall

      Hi Sonia – yes, do all the major work, hang the drywall, then advertise for rent. If you are carpeting, advertise prior to carpeting. Same thing with cabinets and countertops.

      That said, when are clients are performing a gut rehab, you may be required to capitalize a majority of your rehab cost regardless of the date you advertise.

      But you can definitely paint, lay carpet, buy cabinet hardware, install faucets, etc AFTER you advertise it for rent – and none of those would be considered material improvements in my book.

  3. Nick B.

    Brandon,

    How does this strategy apply to apartment complexes? Let’s say we buy a 100-units property with the intent of renovating all units in the span of one year. The property is currently 70% occupied and that makes it “available” and “ready”, correct? Does this mean that the entire renovation cost can be written off as operating expense in the first year? Provided, of course, that each invoice is broken down to items that cost less than $2500.

    Thanks
    Nick

    • Brandon Hall

      Excellent question! Tax rules surrounding large apartment complexes can get complicated quickly. Often times, the placed-in-service rules are a non-issue for large apartment buildings as they are already in service upon acquisition. If that’s not the case, then the apartment building is in service once it is ready and available for rent.

      The key with apartment buildings though is that you have to look at how the rehab affects the Unit of Property (UOP) as a whole.

      For example, let’s say you buy a 100 unit building (all units under one roof, not multiple buildings) and you replacing the flooring in 10 of the units. I’d argue that replacing 10% of the flooring excluding the common areas are not a material improvement to the building UOP as a whole. The building UOP is made up of foundation, walls, floors, stairs, common area floors, roofing, and other structural components.

      With our clients that have apartment buildings, the analysis we typically run internally is looking at how the repairs affect the UOP.

  4. Stu Basham

    Hi Brandon,

    This article is amazing. My wife and I are about to start doing the BRRRR strategy and will definitely apply this. I’m a nerd and really like learning about this stuff but don’t necessarily want to be a CPA. Any advice on where I can learn these tax strategies or books to read? Thanks for sharing!

  5. Angelou Masters

    Next level…..New age innovation…..You are correct sir! One of the best pieces of information I have ever read on Szikov and it will save us all a ton of money from now into infinity! No more Brrrr the high tech way to go is BARRR! Brandon Turner chime in.

  6. Tim Sabo

    Excellent article Brandon. I’m no tax guy, but this was a very informative article that I was able to easily follow. I showed it to my wife, and she said it wouldn’t matter if we are already taking a loss. To me, it all matters, because I don’t have any desire to give Uncle Sam one cent more than I need to for anything: the government wastes every cent it gets on foolishness, and I believe it serves us better in our pocket.

    As for the available status, and time stamping, why not keep it simple: the day after closing, run a small ad in your local newspaper advertising the property. There’s your time stamp and availability is covered. On to the ready part.

    Thanks for such a logical article on such a challenging subject.

    • Brandon Hall

      Thanks for reading and the kind words Tim. Please tell your wife that it absolutely DOES matter even if you are already taking a loss. The reason it matters is due to the depreciation recapture that I explained in the article. If you can’t write something off and you have to capitalize the expenses, you will pay a 25% tax on the depreciation when you sell the property. If you can write it off today, you won’t pay that 25% tax.

      • Hi Brandon,

        My first comment on Bigger Pockets! I just bought my first 3-family in East Boston, and now listening to your podcasts (2 per day!), as I prepare for my next few deals.

        On your recent comment, I think I disagree on one thing: In the case of a loss year, it seems to me that it would be most advantageous to capitalize. That’s because if future years show positive income, the depreciation will be a helpful deduction against those earnings, and the recapture means the tax impact is deferred upon sale (as opposed to each profitable year). Of course, this assumes the recapture rate when you sell is the same or less than your marginal tax rate during those years of earnings.

        Would you agree?

        • Ron Trinh

          Hi Farhan,

          Congrats on your first property!

          Unfortunately, with tax, It really depends on the facts and circumstances. I have not been practicing as long as Brandon, but I have learned a few things in my career working in the real estate tax space. Just wanted to provide some food for thought below in the meantime.

          Generally, a rental would be considered a passive activity. Incurring a net loss from the passive activity usually allows the loss to be carried forward and used to offset passive income (usually in RE investing, rents) in the future. So if this is a passive activity and you expense the repairs, etc., you may be able to offset passive income with the net passive losses you generated from earlier years. Doing so should avoid the recapture tax as Brandon mentioned earlier since you are not capitalizing those assets to the building (27.5 yrs). The downside is that you cannot offset non-passive income (W-2 wages, Sch C income, etc.) with passive losses unless you are “actively participating” in the rental activity or a real estate professional.

          I understand this may cause you to have even more questions, but just wanted to give you another perspective in favor of expensing vs. capitalizing.

          Good luck!

  7. Jason Homa

    That is some great financial wizardry! Thank you.
    What if someone wants to rent it as soon as it is advertised? How close to the actual ready to move in date do you advertise? Could a listing not get a little stale if you actually postponed showing/renting until it is ready?

  8. Lawrence L.

    Great article Brandon, awesome. Question when you wrote……$10,000 expense can be broken down into ten $1,000 line items which may be deductible. I’d also argue that this isn’t just a tax strategy, it’s a best practice for any business. What do you mean by line items?

    • Brandon Hall

      What I was referring to there is when a contractor gives you a lump sum invoice, you should have it itemized. You cannot break down some invoices to “abuse the rule.

      Example of abuse: HVAC costs $5k to install, you have contractor break the invoice down to $2400 labor, $2000 motor, $600 other parts and materials. Because the repair materially improves the HVAC unit of property, we have to aggregate the cost and take the total $5k into consideration rather than the itemization.

      But if a contractor is performing work in different areas of your home and gives you a $5k invoice for “repairs” then I’d want that to be broken out so that we can see if anything on that invoice is actually deductible.

  9. John Barnette

    Interesting article. Will discuss with my cpa who is also quite realike estate savvy. So I did in fact advertise an apartment on Craigslist as being available (soon, or at the middle or month, or upon installation of new laminate floors). In the past my cpa has segregated depreciation schedules of these medium term capital expenditures as discussed in other BP articles. Maybe 7 yrs for flooring or appliances? I think. But you suggest the costs of materials and labor for said 1 unit of 8 unit building can be written off in my 2017 operating expenses? Same for carpet replacement in anorther unit advertised in a similar format?

  10. Taj Hayden

    I feel like I just saved more than all the Geico commercials combined and I don’t even have my investment property yet! I see now that I need to create a new sub-folder in my REI bookmarks titled “Taxes”. Thanks for writing this!

  11. Erik Whiting

    I like the premise behind this article, but now I need some clarification.

    “Your painting costs $5,000 and you’re in the 25% tax bracket. If you advertise your property for rent prior to painting, you can deduct it in full this year. This will save you $1,250 in taxes. ”

    “Costs that exceed $2,500 are almost always required to be capitalized and depreciated. So don’t think that you can advertise the property for rent and then deduct the cost of a new roof—that ain’t gonna happen.”

    Why provide an example that is double the amount that “ain’t gonna happen?” Is the idea to somehow split up the aggregate cost of the $5,000 paint job into two $2,500 invoices, or five $1,000 invoices? Would the IRS look kindly on five invoices from the same contractor for $1,000 each, all within a few days of each other?

    Also this is a concern. How can we say the property is “available and ready” if, for example, we’re doing a gut rehab? I agree the ‘available’ part is doable the date you post it for rent, but “ready?” I think you’d have to have a veeeerrrry lenient auditor to let that slide.

    For example, I purchased a “pig” earlier this year for $16,000. Put $12,000 into it. I doubt the IRS would believe it was in any way, shape, or form livable “As is” when my rehab budget was 75% of the purchase price. I’ve never been thru an audit, but I have a friend who is an IRS auditor, and she has what she calls the “eyebrow test”….if someone tries to claim something that makes her raise her eyebrows, she denies it.

    I’ll begin exploring this strategy further, especially where the repair costs are far lower compared to the purchase price of the property. My appreciation for making me think.

    • Brandon Hall

      Hi Erik – notice that I said “Costs that exceed $2,500 are *almost* always required to be capitalized” – keyword = “almost.”

      Painting falls into the scope of “almost” as painting is a maintenance item regardless of cost. It does not materially improve the building UOP thus is not required to be capitalized UNLESS you paint PRIOR to advertising the property for rent.

      The point is not to get “five invoices” – the point is to itemize your invoices. Instead of a contractor handing you a $5k invoice, you should ask that the invoice be extremely itemized. This is not only a tax best practice, it’s also a business best practice.

      And no, if you received five invoices from the same contractor for $1,000 ea, you would likely be abusing the De Min Safe Harbor Rule, 1.263(a)-1(f)(6), that prohibits any attempt by the taxpayer to manipulate transactions to reduce individual invoice amounts for a single unit of tangible property to an amount less than the de minimis expensing threshold.

      I never suggested that anyone abuse the rules. I’m simply showing people how they can structure their new purchase and the timing of the rehab to enjoy huge tax benefits.

      re: gut rehab – if you advertise it for rent in the beginning, all you have to do is then prove it’s livable and “ready” which is relatively liberal in the IRS’s eyes. In the article, I mention that you can’t necessarily deduct the key rehab components of the gut, like flooring, framing, roofing, etc, but if you advertise it for rent, at some point your property will become “ready” and since it was already “available,” all costs after “ready” will have the potential to be deductible. But what “ready” means for you is for you and your accountant to figure out.

  12. Jerry Kisasonak

    This certainly is a thought-provoking post! My question would be this:
    Let’s say I bought 5 rental homes this year. I expense a large part of your rehab cost by utilizing the tax loophole you discussed. These 5 homes are leased up and stabilized, and it is now Q2 2018. I head to the bank to refinance. The bank asks for my tax returns, and they see that all five of these properties are showing a big loss because the renovations are expensed and not capitalized. In short, it appears that these properties aren’t profitable. How would an investor who is using the BARRRR strategy overcome this?

    • Brandon Hall

      Great question! If it’s a non-recourse loan (rare for residential) then I’d say we need to think carefully about what we actually write-off. The benefit is that we can still write-off some amount of the rehab, but maybe not the full potential of what we could otherwise.

      If you are pursuing a recourse loan, then your other income streams will be evaluated for DTI purposes. So then it becomes a balancing act with writing things off but maintaining an appropriate DTI level.

      At the very least, we will have additional write-off that we didn’t have before, but we may not be able to write-off 100% of what we could have if DTI is going to be a problem.

      • Jerry Kisasonak

        Brandon, I wasn’t referring to DTI or anything of that nature. I’m referring to cashflow. If these new acquisitions aren’t showing that they’re throwing off positive cashflow because you’ve expensed the rehab instead of capitalizing it, the lender’s DSCR requirement will be well below the average (1.2 DSCR) that most banks like to see.

        • Kurt Stresau

          Jerry,

          (Me: 11 Units, mixed between SFR and Duplex). I had a mixed bag of conventional residential mortgages and started using commercial lending at my local credit union. At one point, I went back to sit with them and discuss a future project. They were concerned about Debt Service Coverage Ratios for a couple of my properties, specifically based on your concern, that startup rehab costs, expensed for the first year, impacted the bottom line of cash flow and showed substantial negative cash flow.

          I countered this by generating a business plan, documented with pretty charts, graphs, and data analysis (since I’m an engineer), and showed that based on my business strategy literally every property had a dip in year 1. I then documented the upswing in year 2 and 3 on those properties of appropriate age (showing my business plan worked). I convinced them to accept/perform a Debt Service Coverage analysis EXCLUSIVE of a clear set of one-time rehab costs, and the picture got MUCH prettier. They were willing to listen at that point

          Key: You have to meet fact to face, and it has to be a lender that is willing to talk. One of the big banks…they won’t even sit down for coffee.

          Hope that helps.

  13. Catalino Rodriguez

    Hi Brandon,

    I am getting ready to buy my first rental property here soon and after reading this article I definitely will rethink my strategy a bit to maximize the tax savings. The one property I am looking at is already “rent ready” however I would like to do a few things like remove carpet, repaint some areas and upgrade the kitchen and bathrooms. I was initially thinking that I would have to wait til turnover time but I think I may be able with this method to do it immediately after I advertise the property. By doing the upgrades I mentioned I can actually list the property at market rate because as is in its “rent ready” state is rents for under market rates. So this method potentially gives me great tax savings but also greater cash flow from the beginning as well!! Makes me like this possible property even more. Thank you so much for the excellent post!

  14. John Barnette

    Ok another question of clarification. Long term capital components such as H2o heaters, appliances, windows, furnaces, etc.

    How to honestly and aggressively write these costs off? When either currently leasing a place or advertised and “in finishing stages” of remodel.

    Thanks Brandon

  15. Toni Annis

    So would rehabbing between tenants be operating expenses or would they be depreciated?
    Ex. We bought a house in May. Previous owners actually rented it back from us for one month while they got their new house ready. We then rehabbed it and put new tenants in the end of Aug. None of our rehab was really big stuff. New paint, floor in a couple of rooms, some new windows. Total Rehab cost was around $6000 – $7000.

  16. Mike Laurenzi

    Great article Brandon. I am in the process of doing my first BRRRR (soon to be BARRRR).

    A few questions:

    What does the IRS consider as “rent ready”? It’s not a total gut job but does need at least a new bathroom sink.
    If I am going to rehab the kitchen and bathrooms, is the house rent ready without a kitchen and bathrooms why I rehab?
    If I list my rental as being available for rent in 5 months (while I rehab to make it better), is it really rent ready or available when I advertise?

    • Amber Hooks

      Mike, I am in a similar situation and have similar thoughts as you. My gut says that it’s the spirit of the law. Of course, as I stated in my own comments, I am still processing this information and once I do my opinion may change. My thought is that if you wouldn’t show a potential renter the property and put a renter in the property the day you put it up for rent then it isn’t ready and available. If the Home only has one bathroom and you are remodeling the bathroom (no shower, no tub, no toilet, no sink) then even if it is being marketed, how can you substantiate that it is ready and available? No bathroom is not a livable condition. Just some thoughts, and maybe Brandon can comment as well.

      • Brandon Hall

        Hey folks – the premise that I’m trying to push is that you must advertise before the property is ever rent ready. But is does still need to be *ready* for rent prior to it being “in-service” regardless of when you advertise.

        It is a case-by-case analysis – generally we do not write off any of the major rehab costs. But things like painting, laying carpet, some fixtures, appliances, etc can potentially be written off if timed correctly.

        If your locality requires a certificate of occupancy, then that’s going to be the placed-in-service date.

        Since most investors advertise after the rehab, they only ever place it into service after the rehab, thus not providing their accountants with flexibility to potentially write-off some of the costs.

  17. Amber Hooks

    Brandon,

    Thank you for posting this thought provoking material. I enjoyed reading and thinking about it, so much so that I went to the Regs. you cited to learn more. I am still digesting the information. I am sure I will have questions once I process it all.

    But, one question I have is how this may have any relation to Sec. 179?

    Thanks!

  18. Steven Hamilton II

    Brandon,

    I expect better advice and posting from you. Not guru like talk that does not hold up. I’m on POA of 50 ACTUAL AUDITS (Office or Field) at any given time throughout the year.

    I’m going to strongly disagree with you as someone who actually has experience representing these items before the IRS. READY AND AVAILABLE FOR RENT. Not just listed. If you are doing work on it guess what…. not available.

    Regs. Sec. 1.167(a)(11)(e)(1)(i) generally to require actual operational use in the trade or business, citing Consumers Power Co., 89 TC 710 (1987), and Oglethorpe Power Corp., TC Memo 1990-505,

    Regulations on Repairs and Maintenance

    The 2013 final regulations under Code Sec. 162 provide a taxpayer may deduct amounts paid for repairs and maintenance to tangible property if the amounts paid are not otherwise required to be capitalized (Reg. Sec. 1.162-4T(a)). Generally, a taxpayer must capitalize the related amounts paid to improve a unit of property owned by the taxpayer. A unit of property is improved if the amounts paid for activities performed after the property is placed in service by the taxpayer are for a betterment to the unit of property (see ¶99,560.35), restore the unit of property (see ¶99,560.40), or adapt the unit of property to a new or different use (see ¶99,560.45) (Reg. Sec. 1.263(a)-3(d)).

    Property other than buildings
    In the case of real or personal property other than buildings, the unit of property is, and the analysis applies to, all components that are functionally interdependent. Components of property are functionally interdependent if taxpayers cannot place in service one component of property without placing in service another component of property. For example, because the components of a train, such as the engine, generator, and batteries, are functionally interdependent, the train would be a single unit of property. On the other hand, a laptop and a printer are not functionally interdependent, and would be separate units of property.

    You’d have a very very hard fight in front of the IRS.

    • Brandon Hall

      Hi Steven – I don’t disagree with you about the readiness part (I mentioned this in the article). What you’re totally missing is the fact that few investors know they actually have to ADVERTISE the property for rent in order to place it into service.

      That said, the unit does NOT have to be operational to place it into service. The regs you cited are taken into account, however they are open to interpretation (I’m surprised you’re not citing case law as there is plenty of it out there). This is clearly outlined by the following:

      In Rev. Rul. 76-238, the IRS responded to a request and considered the building to be placed in service on the date its construction was completed and it was made available for installation of machinery and equipment. Similarly, the Service considered the machinery that was installed in the building over a period of months to have been placed in service when the “entire production line was available for the production of an acceptable product…notwithstanding later testing to eliminate defects which prevented attainment of planned production levels or the meeting of acceptable quality control parameters.” In other words, “availability for a specifically assigned function” in the case of machinery does not necessarily mean that the machinery be put to actual operational use. (Note you could not use this to defend the building PIS date but I’m trying to make a point).

      Sears Oil Co., 359 F2d 191 (2d Cir. 1966): court concluded that “depreciation may be taken when depreciable property is available for use ‘should the occasion arise,’ even if the property is not in fact in use”

      Relying on the Sears case above, in SMC Corp., 675 F2d 113 (6th Cir. 1982), the court held that a fully operational crane and shredder installed by a taxpayer had been placed in service even though a utility company had not yet completed the electrical lines needed to power the equipment.

      Williams, T.C. Memo. 1987-308. In Williams, the taxpayer argued that its mechanic shop was placed in service when it opened for business for occasional auto repairs, even though the building was still undergoing substantial renovations. The Williams court concluded that whether the shop was open for business was irrelevant.

      Stine, LLC, No. 2:13-03224 (W.D. La. 1/27/15) – The court concluded that there was no authority to support the IRS’s position that “placed in service” means “open for business.” Instead, the appropriate inquiry is whether a building is in a condition of readiness and availability to perform the function for which it was built—in this case, to house racks, shelving, and merchandise. (Note – the IRS formally rejected Stine’s outcome via AOD 2017-2 citing Rev Rulings 76-256 and 76-428, however we have seen courts completely disregard the IRS’s interpretations and formal opinions on matters)

      And more relevant to the article, we have Livingston, TC Memo 1966-49 (not precedent) where the IRS argued that depreciation is not allowable on a building under construction that is not yet being used in a business operation. The court rejected this argument, holding that depreciation is allowable on portions of the building from the date such portions became completed for use in petitioner’s business, even if the entire building project is not yet complete.

      There are plenty of factors to consider, but it’s clear that the Second, Fifth, Sixth, and Eighth Circuits, among others, reject an “actual operation” requirement to be “in service” allowing depreciation to be taken even if the property is not in fact in operational use.

      You also have the IRS’s Audit Tech Guide for rehab credits under Sec 47 indicating that a Cert of Occupancy = placed-in-service date.

      On the flip side, we DO have to be wary of “readiness and availability” for use – I’m not tossing out the readiness part, I’m just telling people to go ahead and meet the availability part immediately rather than waiting.

      Additionally, I know fully and well how UOPs interact with one another. I’m also aware of the anti-abuse rule requiring aggregation of costs related to one UOP – 1.263(a)-1(f)(6), prohibits any attempt by the taxpayer to manipulate transactions to reduce individual invoice amounts for a single unit of tangible property to an amount less than the de minimis expensing threshold.

      My POINT of the article is to advertise the property immediately upon buying. In some cases, that will NOT be the day that it was placed in service based on the scope of the work. But you have a much better case to argue that it was in service once certain improvements had been completed versus waiting until a certain time to advertise for rent and definitely not placing it into service.

      This method provide flexibility, and we’ve had plenty of success defending it.

      Cheers.

      • Steven Hamilton II

        You are disregarding the readiness part. And I did cite the primary case in setting any of the others. If you are planning to rehab before renting it is NOT ready and available. You’re article spouts a bunch of promotion of doing it earlier and taking the deduction in a case that will not substantiate. You are offering advice that is not on par. A cert of occupancy means that is ready for rent therefore a long as it is available.

        The Livingston memo is a great one but you are not taking proper interpretation, if I buy an office building and move into half while the other half is being renovated I can take depreciation on that portion. That is not a question. But if you are making improvements to the building you run into issues as well.

        You need to be careful as your messages run along the lines of structuring. See my comments on units of property being codependent upon another.

        • Brandon Hall

          Steven – In my article, I’m not disregarding the readiness part, I’m downplaying it intentionally to prove a point about advertising. You MUST advertise your property for rent before it is ever placed into service (the point of the article).

          Would you rather have a client that performed a $50k rehab and advertised it for rent prior to or during the rehab or after the rehab occurring?

          It’s about flexibility. We’re not writing off the entire rehab, that would be ridiculous. But we are providing ourselves with flexibility to write off components of the rehab that we would not have otherwise done.

        • Brandon Hall

          Hi Steven – I went back through the article and you are right in that I did not adequately address the “ready” portion of the IRC. I’ve requested the following edits be made to the article and wanted to post them here in case they are not made:

          By advertising the property for rent prior to starting your rehab, you have met the IRS’s “available” requirement (remember, to be “in service” it must be ready and available). Now all you have to meet is the “ready” part.

          What constitutes “ready” for rent? As always, it depends and can be a myriad of factors. If you are running a full-gut rehab, your rental will not be “ready” until substantially all of the rehab is complete. IRS standards also indicate that a Certificate of Occupancy is a great indicator of when a property is “ready” for rent. However, this will be up to you and your CPA to decide based on your facts and circumstances.

          Let’s say you need to rehab the kitchen in a new property. If you advertise it for rent prior to the rehab, you could potentially deduct the countertops, cabinets, painting, labor, appliances, and potentially even the flooring. If you rehab prior to advertising it for rent, you are forced to capitalize those costs.

          Thank you sir for pointing this out! Hopefully it will help clear up any future confusion.

  19. Natalie Kolodij

    I’m 100% with Steven on this one.

    I think you’re preaching something that’s not tested nor proven in real application. The cases cited are outdated at this point after the amount of revision in 2014 regarding tangible property regulations.

    There isn’t case law to follow yet regarding this theory and new law- someone has to trailblaze. I just hope BP members utilizing this could make them to person who new case law is based upon.

    I agree- Advertise early. Better to help your stance. My issue comes with the definition of a unit and how easily this can be broken apart, expensed, be de minimus compliant, ect.

    I know that you’ve prefaced with the “COULD POTENTIALLY”- but I’ve literally already had a client reach out and ask about this because you’ve thrown an aggressive, guidance needed, pretty controversial (You’re the only CPA/EA out of 8 including my self who feels this is audit sustainable) strategy to the masses and now it’s going to be very easy for a lot of people to shoot themselves in the foot trying to apply this.

    • Brandon Hall

      Those cases have set precedent still cited in court which is why I used them.

      Unfortunately I think I did a poor job of communicating the point of the article which is that without advertising your property, you are not placing it into service. The idea is that if you advertise it early on, you then need to demonstrate that the unit is “ready” for rent but you can most certainly make certain repairs after justifying the readiness and deduct those repair items (i.e. Painting). Versus getting the unit to 100% and then placing it into service by advertising (and thereby eliminating any flexibility).

      The post comes off as aggressive because I didn’t adequately explain the readiness part which was not my intention. Doing this will simply allow for flexibility in how we treat costs by advertising early on.

      I agree with both you and Steven in that you cannot do this and expect to write off major components. But take a property that doesn’t need a full gut and can easily place a tenant in the as-is state – you can advertise that unit for rent and make modifications that are potentially deductible. There is plenty of case law to support the theory.

      • Steven Hamilton II

        If you are planning a rehab or to replace a furnace, putting the property in service does not change that. We still have improvement issues. Replacing carpet with wood flooring or 20 year old cabinets with brand new ones is an improvement over the old features. Granite countertops instead of laminate is a great example. That is an improvement.
        Trust me you don’t want to be the test case. And the cost to defend it will be substantial. You are making changes in contemplation or planning to do one it can be a very fine line. If you place a tenant and then fix a water heater yes it will most likely be an expense; however to wait on replacing an inoperable furnace until you have it listed does not mean the property is ready and available. That is where the preaching in the article is misleading.
        Believe me when I say this ain’t my first rodeo.

  20. Natalie Kolodij

    “It’s about flexibility. We’re not writing off the entire rehab, that would be ridiculous. But we are providing ourselves with flexibility to write off components of the rehab that we would not have otherwise done.”

    I think this needs better emphasis in the article. We both know what clients are going to hear/take away from this is – I was advertising it now I can just expense my whole new kitchen. I fear this was a pandoras box sitch.

  21. Curt Smith

    Thanks Brandon, Natalie, Steven, thanks evenly among all 3 of you. Why should I bother following up the recent past with a comment? A mouse zigging between the legs of giants? Because I think the zeroing in on what is an important help to us landlords, Brandon’s point, that got lost in miss-firing on the regs: advertise and document advertising and if a few other qualifiers,, then you may deduct as expenses the SAME types of things that would be expensable as they are AFTER a tenant moves in. My take away and the reason why I’m posting is to end on a simple note:

    – given advertising early and doc that date
    – given that the house is actually habitable at some date (sans some nicities as the latest paint color and nice flooring etc). An inservice date may still mean: it may get some more work after that date…
    – Costs that are after the advertise date AND after the habitable date (the real inservice date) that meet the SAME qualifiers as what is expensable after a tenant moves in are expensable during this period as well.
    – IE all same catagory (paint) is on one invoice and that invoice is <=$2500 you can expense this cost in the year of inservice and NOT have to add to the cost basis (27.5yrs).

    This is __THE__ big wow for me. I used to capitalize into the cost basis (27.5yrs) every single expense, every nickel,,, which I bet Steven and Natalie would agree (with Brandon) that a bunch of costs prior to the tenant moving in, but after advertising and after a date where its habiable are expensible.

    I even suspect we can agree that the filter for what is expensible is the SAME filter we have learned to use (in recent years) to expense costs when its rented. Schedule E trained us to think in terms of repairs vs improvements. What I didn't realize is that the same logic can be used prior to the first renter moving in (but after an inservice date, the date its habbitable).

    I also bet that, prior to us non-CPA landlords hearing of this no CPA would have advised me of expensibility of paint of a new purchase rehab that was going to be rented!!! Its my view that until Brandon mentioned this concept, most tax prep folks (which includes me) monolithically view purchase + rehab = cost basis = 27.5 yr depreciated deduction over time. Brandon broke my thinking re monolithicly treatment of all rehab expenses!! Thanks to all 3 of the tax reg contributors.

    • Brandon Hall

      Thanks Curt – you are right (along with Natalie and Steven) that I did not adequately explain how we achieve “placed-in-service” and that my article is misleading (not intended, I promise). I suppose I had a massive brain fart in detailing everything. My overall point was meant to be rather simple: if you advertise up front, you give your CPA/EA/tax pro the flexibility (not 100% guarantee) to write off certain costs associated with your rehab. And that I stand by 100% given various Court ruling, Rev Procs, and PLRs.

      Something else interesting is happening – CPAs and EAs are messaging/emailing me mad that their clients are calling them up asking about the BARRRR method. But I actually think this is a GREAT thing because the tax pros (1) get an opportunity to share their interpretation, and (2) get an opportunity to proactively advise their clients.

      Because like you, too many CPAs/EAs/tax pros simply will never mention it to their clients without prodding. Thus, there is no critical analysis around these items costing their clients thousands of dollars.

      Does it work every time? No way. But getting it all out on the table provides for a productive conversation. CPAs/EAs/tax pros who shut it down completely without asking themselves “how can I make this work for my client” are approaching it the wrong way.

      • Steven Hamilton II

        It’s poor because you are giving false information and a mis-interpretation of the law and rulings. We could go back and forth. Problem is an agent sees you did 5k of work on it after your listed placed in service date… You’re in a bad place.

        How much audit representation experience do you have? Not enough. Until you’re actively working audit cases and know how to do proper research to derive a fully documented opinion. You’re reading it wrong as you don’t know how to work the moving parts.

        The problem is what it says is one thing people only read half and comprehend less especially with tax.

  22. Frank Schwarz

    I love this idea and just need to wrap my head around a couple of things.
    If I buy a house that is lived in, BUT needs paint, carpet, and maybe a bathtub surround and minor electrical fixes (all separate trades) and I advertise the property as available BEFORE I do the work (in theory) I’d be ok to deduct these things.
    I could argue the “livable” and “ready” aspect because someone was living in it already and I’m just getting it freshened up for new tenants. Correct?
    I know every situation is unique, but overall is this what is meant?
    Also… if a renter moves into my unit and then the electric box fails and the repair/replace is $1500 I should be able to take this deduction because it is in service and rented. It’s not a “get ready” job then. Correct?

  23. Larisa G.

    Brandon, great article, as always!!! But what about the situation when you are going to sell your rental SFH house, that was rented for several years, and you need to perform some repairs or improvements before sale? Should you advertise a house for sale before repairs in order to classify both repairs and improvements as expenses in the year of sale, as long as they are itemized below $2500 per item? It does not even make sense to capitalize improvements in the year of sale anyway, correct? What do you think?

    • Brandon Hall

      I would assume the house is already in service. If you are going to sell it though, it won’t matter as you’d just be increasing you basis (which reduces capital gain) in the year of the sale. Net net notna big difference either way.

      • Larisa G.

        Of course the house was in service for several years. But I did not understand regarding basis though. How would you show improvements in your accounting for that house in the year of sale- as capitalized improvement or repairs? Or you just adding it to basis without showing as either repairs or improvements?

    • Brandon Hall

      It depends on whether your rental is in a state of readiness. If you have a signed rental agreement and you’re 2 months out from your scheduled rehab completed date, I’d say no. If you’re a couple of weeks out, I’d say yes.

  24. Larisa G.

    Brandon, Of course the house was in service for several years. But I did not understand regarding basis though. How would you show improvements in your accounting for that house in the year of sale- as capitalized improvement or repairs? Or you just adding it to basis without showing as either repairs or improvements? You need to show it on your accounting books somehow, correct?

  25. Mary White

    Excellent article! We purchased a 4-plex this year with new flooring, paint, etc needed for each unit and are renting each one out as soon as it’s ready. We’ve also been advertising the other units and lining up tenants to move in the moment the painting is done. Are all expenses after the first tenant moved in operation costs? We had all major repairs (new roof) done before anyone moved in, but are still painting the exterior, working on landscaping, and touching up the last unit. Also does flooring cost get split up by unit? We paid $6000 for all of our vinyl plank flooring. Can it be applied $1500 at a time for each individual unit or is it a depreciation item?

  26. John Murray

    Rental property IRS start up rules are tricky. I always have my CPA (passive income expert) give me the skinny. The $5K rule and same geographic region rules as well as the official start day I take from my CPA. My CPA knows the skinny. I just keep working hard and when I get audited I’ll fall on the sword and plead ignorance.

  27. Andrew R.

    Wondering about the ethical implications here. RE: advertising a home or apartment as “ready and available” when in fact is it clearly not ready or available, and then itemizing smaller costs to try to disguise the extent of the work being performed. Sounds like cheating. Thoughts?

      • Nathan Letourneau

        I agree there is nothing wrong with “coming soon” and trying to advertise your property early. The disagreement is on the “tax break” and using the “advertisement” as the “ready” date. The difference with builders is they are not getting a tax break based on when they post the advertisement. It’s when they sell the property. They don’t sell the property until it is finished (or at least 99% there). No mortgage company would lend on a property if there were no paint, trim, cabinets, and if it did not meet the minimum national and/or local codes. I think that is a more reasonable determination of when a property is “ready”.

        • Brandon Hall

          Nathan you have missed my point as well, the advertisement date is NOT the “in service” date – it provides us with greater flexibility of determining what the in service date actually is.

          If you advertise post-rehab/repairs, you are definitely capitalizing all costs period. The point that I’m trying to make is that if you advertise prior to the rehab begging completed, you can deduct costs such as painting. There is case law to support it (cited in earlier comments).

          I’m not advocating for deducting the entire rehab. I’m advocating for deducting certain costs that would normally be considered operating costs associated with a rental property.

          Andrew was questioning whether you can advertise pre-rehab. My point is yes, you can advertise at any time. I didn’t say builders are deducting any of this costs (builders capitalize costs to inventory anyway). Please don’t make my comments something they are not.

  28. Paul Halphen

    The debate is a good one. It is illuminating to hear the different sides.

    The point about a CO being a sign of readiness is interesting when thinking about commercial applications.

    Every single company has to have a CO to operate their business within a piece of real estate in our area. Sure seems like that is the standard nationwide. Certainly the building is still considered ready to rent when tenant turnover occurs? The CO has no influence on its “readiness” in that application with respect to the landlord.

    Whole bunch of scenarios to consider whether to capitalize or expense:
    1) Abandoned building needs major items like roof and walls (may have active CO, may not)
    2) Building is a shell ready to rent and improvements are made with no one in mind (may have CO, may not)
    3) Tenant specific improvement requests paid by landlord for a 5 year lease
    4) Tenant specific improvement requests paid by tenant in lieu of higher rent
    5) General improvements to commercial property less than 2,500 ( may have CO, may not)
    6) General improvements to commercial property more than 2,500 (may have CO, may not)

    Can we ask for a pretty diagram/flow chart?

  29. Nancy Bachety

    This is way more valuable than “tuition” at most colleges. I must have read your posts on this Brandon because I did just what say here: advertised on Craigslist, answered emails and they’re all time-stamped. Reading trumps tv.
    And I found the tone of a couple of replies disappointing. Countering and pointing out legalities, specifics and even errors can always be done respectfully. You were humble and polite.

  30. Jennifer B.

    While I believe that the excellent debate within this article’s comments is ironing out the details, I wanted to point out another situation for consideration.

    There is one straightforward example that comes to mind for making use of the “in service” application for expenses. In some cases, a tenant-requested expense that would have otherwise been considered an improvement can actually be a tax benefit for the landlord.

    For example, we advertised a house for rent (and was completely ready for move-in) that did not contain a fence, and nowhere in the advertisement did it mention a fence. We signed a lease with the tenant in the house’s current state (fence-less), and then afterwards they realized that they would really like a fence for the yard, so they asked for one. Some landlords might think, “absolutely not, you rented the house without a fence, you aren’t going to get a fence”. A more advantageous way to think of it from the Landlord’s perspective is that because the house was ready and available in its current state, this fence can be deducted in the current period so long as it is under the $2500 threshold utilizing the de minimus rule. I am not one for spending money for the sake of getting a deduction, but in this situation I realized I could potentially get a future rent increase out of this!

    In this situation, it would likely cause an IRS auditor to think, “hey, the Landlord advertised a property without a fence (showing proof that the landlord was not planning on putting in the fence), the house was rented in its current state without even a discussion of a fence, and the landlord didn’t incur the expense until after the tenant moved in (in which case, it is clearly in service)”.

    This idea might make landlords reconsider tenant-requested expenses that would have otherwise been considered upgrades depending on the timing.

  31. So, we started a renovation back in August upon acquiring a HUD property. We actually did advertise it for rent immediately, however we took it down after a couple of weeks because the amount of calls and inquiries coming in was unreal and since we knew it would not be ready for move in till November we thought we would just put it up for rent in Oct once we were ready to show it to folks and take applications. We have put about $15k into it and have very little left. We obviously didn’t know about this strategy, and would like to use it if possible. I assume the plumbing and drywall work would have to be considered a get ready expense? But we have purchased cabinets, and paint, done deck repair, installed new tile in the bathrooms and kitchen and are refinishing hardwood floors. The add originally said available Nov 1, so would that shoot us in the foot for this strategy? How about the fact that we took it down?

  32. Ndy Onyido

    Given the number of comments that this article has generated is a testimony to the fact that it touched many nerves thereby expanding the conversation, evolving into different scenarios and perspectives.
    And this is the best part of this forum; stimulate sufficient interests to generate more perspectives.

    Further to @Larisa G, if i purchase a property that has been vacant for say 3 years with an intent to do a full rehab and flip, at what point in time do I advertise it?

    Thank you, Brandon for the article and to everyone that has contributed to this.

  33. Nathan Letourneau

    Like any investor, I’m all for taking any tax breaks and deductions I can, but what is suggested here is very questionable advice. Make sure you do your homework before utilizing what is recommended above.

    The one thing I fully agree with comes towards the end of Brandon’s article. It says, “be very careful who you take advice from” I suggest talking with other seasoned real estate investor CPAs/Tax attorneys/strategists/etc and see if they agree with what is said above. As you can see from the comments, so far none have agreed with what was said. That alone should speak volumes.

    Unfortunately, after reading this article from Brandon, I will now question all advice he gives. I know he has a ton of great advice (as I have read many of his posts and articles), but now when I read any new content from him, there will always be a voice in the back of my head questioning the legality/ethical-ness/validity of what he is saying.

  34. Deanna Opgenort

    Anyone dealt with the 2% limitation of the De Minimus Safe Harbor rule?
    In the newest version of Turbotax and the IRS publications it seems to say that if I spend more than 2% of the basis value of the house on TOTAL repairs & maintenance I can’t use the $2,500 per item write-off at all for that year!??!
    So, if the structure of my house is worth $50,000 I’ll be prohibited from using the de minimus safe harbor option for that year entirely if my TOTAL maintenance costs are more than $1,001 for the entire year (interestingly, no such restrictions are placed on my small business until I hit I think about $1million in income).
    So much for being able to get rid of all the paperwork. It looks like I’m back to the hassle of the 27.5 year depreciation on each shrubbery. SO annoying.
    If this is correct, could have some significant impact on the BARRR idea as well?

      • Deanna Opgenort

        Where on earth can I find the difference between the two different “safe harbors” spelled out? The only things I can find in either the IRS publications or TurboTax that mention Rental property seem to specifically PROHIBIT using the De Minimis Safe Harbor if the total repairs/maintenance combined exceed 2% of the basis value of the property.
        Do I need to declare the rental as a “business”?
        Taking small expenses as real-time current year deductions would be SOOOOO much easier – I could literally take the difference between the house account at the beginning of the year, the end of the year, subtract the principle paid off on the mortgage and be DONE.

        • Deanna Opgenort

          Finally found it!
          https://irs.gov/pub/irs-drop/n-15-82.pdf
          (Pub 2015-82). Published for tax year 2016, but “backward compatible” through 2014 if I read it correctly.
          It’s written in Gov’t standard of 500 words for every word actually needed, but it does (eventually) cover that the De Minimus Safe Harbor may be taken by someone without an “Applicable Financial Statement”, even if the the small tax payer situation applies. Why anyone would choose to take the lower “small tax payer” limits instead of De Minimus I have no idea, but there you have it.
          I’m much happier now.

  35. Michael Baum

    Great article! How would this apply to short term vacation rentals?

    We bought our first SRT this May and have spent the summer cleaning, painting, refinishing the deck and replacing the deck railings. Some flooring in the basement bunkhouse and we are nearly finished.

    Also, we had to furnish the entire thing. From furniture to linens to kitchen stuff. Everything for a nice lakefront vacation house to make it great for guests.

    We didn’t officially advertise it, just to friends and family and rented it only one weekend as a trial run.

    Plus most of the furniture we bought was used (nice stuff tho) from consignment shops and off Craigslist. Lots of receipts for all the new stuff (linens, dishes etc etc).

    Are we pretty much screwed on this? What needs to be amortized and what can be deducted now?

    • Brandon Hall

      I’d say in this situation that all costs will need to be capitalized and depreciated.

      Painting, flooring, deck work, structure work, drywall, etc will be depreciated over 27.5 years. Carpet, appliances, cabinets, and other personal property items can be depreciated over 5 years. Land improvements (such as planting shrubs) is depreciated over 15 years.

  36. Caren Euster

    I think Brandon was trying to bring up a hopeful idea; and while the actual IRS rules seem to dash the hopes of expensing while not actually ready to be occupied by a renter, it brings up the interesting idea that you can get the basics done for ready Occupancy, then perhaps expense the augmentation;
    More/ better molding
    Shiplap
    Built ins
    Window treatments
    Paint of course
    Even make accessible- that would be repair
    Widen doorways
    Ramps
    Stair climber chairs
    Eliminate shower thresholds
    change faucets to handles
    And so on
    Perhaps these can be expenses after the C of O or whatever the ready signal is but before ir between rentals.
    Any way, ordered signs today!

  37. James M Smith

    Hey @Brandon, First off great article and one that we will definatly be following. We always put a for rent sign out front the day we buy a propety but never thought to take a timestamped photo as evidence. Good thing all our phones now store that data (time stamp and GPS location) for us.

    I do have a quick question. We purchased a property that was already occupied in April of this year. They moved out in September of this year. We are having to replace the carpet among other repairs. As I understand it this property was placed into service on the day we purchased since it was already occupied… so in this situation would we be held to the same scrutany as a traditional “BARRRR” for advertising to consider repairs opperating expenses that occured after tenant move out?

    Thanks again for your continued great articles!

  38. Justin R.

    Love your articles @Brandon – awesome.

    If it helps others, in 2015 I purchased and did a huge remodel of a vacant 5 unit building. I addressed this post’s topic by…

    (A) Renting out two of the units to very cheap, temporary (3 month) leases right away. I needed to wait for permits and such anyways, so I left these in tact.

    (B) Though I signed a contract with the Contractor for the whole project, I asked – err, forced – him to itemize on the invoices per trade AND per unit. The result was more accurate accounting and more favorable current deductions.

    There was still a big part of the expenses that needed capitalization since I changed floorplans around and did other structural stuff. But, I’d much rather pay long term capital gains than depreciation recapture wherever possible!

    And, to underline @Brandon’s underlying theme … asking a qualified CPA to help in these scenarios is well worth the cost and trouble to do so.

  39. scott w lamb

    I wish I would have known you 2 years ago. I had 2 apartments that I sold at once. I received a 5 bd/ 2bath house as a down payment for the apartments. (I had some health issues) I put 50K into the house and then sold it this 6/18/17. When it was all said and done I was hit with 58K dollar capital gains tax. NOT FUN. Never a dull moment!

  40. Brian Buxton

    Thanks Brandon! Awesome info! I just wish I had it about 8 weeks ago. Does this strategy apply to existing properties vs. new buys?
    I have a fully rented 3 unit that I’ve owned since Nov of last year. One of the tenants lease expired this past Aug and they moved out. I took the opportunity to fix up the apartment and spent about $5K on things like carpeting, vinyl flooring, paint, and appliances. No one item cost over $2500. I officially advertised the place about 1 week after the previous tenant vacated and I started work. We ID’d a new tenant quickly and they moved in on Sept 15th. I will show rental income for every month of the year, except Sept will only be for 1/2 the month.
    Technically, the apartment was empty for 2 weeks. Would the IRS consider this 2 weeks as the apartment being out of service? During the 2 weeks, the other 2 apartment were fully occupied so the house itself was certainly “in-service”. Any insight you can provide would be greatly appreciated!

    Thanks!
    Brian

  41. Katie Bond

    What does it look like to advertise a property in process? For example, my property ( a duplex) is currently completely gutted on both sides. The “before” photos are really horrible (like, you can’t believe someone was actually living there) and the current photos are of a completely empty space. So, at what point do I advertise? What am I advertising if it’s still in process? The premise makes sense but the implementation is a little unclear. Thanks!

  42. Rich Doan

    It appears that you can’t use the safe harbor election beyond 2% of the cost basis of the property (purchase price), up to $10,000, in total repairs and improvements. Is that correct? That would make the safe harbor election much less exciting as a way to deduct rehab expenses.

  43. Alex Ell

    Brandon,

    Very informative article! Thank you for posting.

    Reading through the comments I did not see any questions about short-term rentals (i.e. Airbnb). Would the same rules apply to a short-term SFR rental if say the pictures were posted on Airbnb but the calendar was blocked during renovation? We live on the main floor of the house but plan on renovating the basement to make it Airbnb friendly.

    Thanks,
    Alex

  44. Andrew K.

    What are the chances the IRS will look at your advertisements, dig a little and see that your advertisement wasn’t sincere? After all if you advertise but in reality the kitchen/bathroom/bedroom is gutted, it’s not habitable.

    • Brandon Hall

      That’s where the “ready” part comes in to play. You can advertise at any time, but if your unit isn’t “ready” then you still can’t deduct your expenses. My point is that most investors only advertise when they are 100% done which ensures 100% of the costs incurred prior to that point are capitalized. So why not advertise early and potentially be able to write-off some of your costs?

  45. Jen Simbolw

    Hi @Brandon Hall! Thanks so much for this article, it is amazing! My husband and I are about to house hack using a fha 203k loan. We are moving into the first unit and will continue renting the second unit to the current Tennant. We are going to use the 203k loan to convert the house from oil to gas and to update her bathroom and and kitchen. We will then raise her rent $200 per month. How can we utilize this strategy to write off the updates and conversion as operating costs even though it’s already rented?

    Thank you in advance!
    Jen

  46. Randy Gerstner on

    Brandon,

    Thanks for thought provoking articles on BP. I haven’t seen anyone ask about how this would work in a house hack. If you live in a single family home with additional bedrooms for rent, is the home placed in service from a tax perspective if you advertise the rooms for rent? Would you need to show proof of rooms being rented in the past for it to work? I’m not sure what the IRS would think if someone tried to report rental deductions on their Schedule E without any rental income.

    Thanks for any thoughts around this.
    Randy

  47. Ben Byma

    Thanks for the article, definitely thought provoking. Here’s a question: can this strategy be applied to financing a major repair? For example, last night I got a quote for replacement windows to the tune of about $6k for a SFR I own that is currently rented. The salesman mentioned I could finance it with zero down payment. Normally I’m not a huge fan of financing stuff like that, but if I could finance the whole thing and write off what I pay on it every year, I wouldn’t have to tie up 6k. Or better to just have it invoiced by room or window for amounts below 2500 and pay it all now?

  48. James Piercy

    Hello Brandon,

    I tried to read through as many of the replies as possible to find a relevant answer for my question but failed to find one (maybe too many replies). I just purchased a duplex and both units are vacant and the property has been listed since the beginning of October. Upon purchasing, both electrical boxes have to be replaced for both units. The quote is for $3,200 (includes permitting, labor and parts). If for example, permitting and labor costs are under $2,500 and the remaining $700ish is in parts, can these be itemized and deducted?

    I read a comment about HVAC and if the total cost of everything going towards the job is over $2,500 it cannot be. Also, since these are for two different units (duplex with no shared walls – 2 different addresses) can the cost per unit be separated? Thank you!

  49. john akolt

    Thank you for the article. If I understand your article and looking at final tangibles regulations the key building systems are the plumbing system, electrical system, HVAC system, elevator system, escalator system, fire protection and alarm system, gas distribution system, and the security system. Does that mean as long as I don’t touch those systems as part of a bathroom/kitchen remodel (replacing existing items only) I can break the costs up into separate components (cabinets, shower, etc) each under $2500 and make the de minimus election?

    In your experience, along similar lines of expensing/shortening depreciation periods, do you find cost segregation studies to be beneficial versus the cost of preparation on small projects (4 units or less)?

  50. Jeff Hug

    Awesome information. I’m definitely saving this information for when I decide to go for a BARRRR strategy (mid next year). Anyone else want to call it BARRRF (finance) just for fun? “I BARRRFed 8 times this year. Try BARRRFing today!”. The kid in us never leaves…

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