Tax Deduction for Electrical Service Upgrade on a Rental Property

Electrical upgrades are deductions covered by the IRS.

Real estate investors have significant tax advantages when preparing their tax returns. These generally result from the upgrades or repairs they do on their rental properties each year. In some cases, these deductions are greater when the upgrades result in greater energy efficiency. In other cases, deductions are simply made to account for the increased upkeep of the property. Rental property owners can take advantage of Internal Revenue Service provisions in this area.

Repairs

As a property owner, you may take tax deductions on rental property if you are making a repair to the property that results in its upkeep. The IRS distinguishes between repairs and upgrades and this affects the way you are allowed to treat the expense on your taxes. Generally, repairs can be deducted from your income, which, in turn, reduces your adjusted gross income and thus your tax liability.

Improvements

Improvements and upgrades to rental property are in a separate category. The IRS treats upgrades and improvements as an asset that is depreciated over its lifetime. This means that an electrical service upgrade that adds value to the rental property must be depreciated and cannot be deducted. The exception to this rule would be where the existing electrical system is no longer functioning or poses some kind of fire hazard and must be replaced. In such cases, an upgrade may fall under the repair classification.

Depreciation

Depreciation of rental property and its upgrades is a complicated process. The IRS provides information regarding property depreciation in Publication 946. Depreciation is a form of deduction, but differs from a straight deduction in that it is not done all at once. Instead, using the IRS's formulas for depreciating property, upgrades are deducted in small portions each year, based on their life expectancy. Liberty Tax Service notes that improvements that make up a component of the building, like its electrical system, have a life expectancy that is the same as the building itself. Residential building are expected to last 27.5 years, while commercial buildings will have either a 39- or a 31.5-year life expectancy.

Limits

Should your electrical service upgrade qualify as a deduction because of the need to replace a faulty system, there may be limits to the amount you may deduct from your taxes. This depends largely upon whether your rental income is passive or non-passive. Non-passive deductions occur when your primary business or the majority of the work that you do is in rental property. When this is the case, your repairs are fully deductible with no limits. Passive income occurs when your rental property is not your primary income source. In this case, your deduction limit is capped out at $25,000 in a given tax year.

References

• The Tax Incentives Assistance Project: General Information
• Internal Revenue Service: Topic 414 - Rental Income and Expenses
• Liberty Tax Service: Rental Property
• Internal Revenue Service: Publication 946 (2010), How To Depreciate Property
• Internal Revenue Service: Reporting Rental Income, Expenses, and Losses