Timing for New Construction and Renovations

Construction and renovation change the study picture in useful ways. Records are often better, and components are easier to identify, but there are timing questions to manage.

New construction

For a newly built property, contractor invoices and pay applications provide actual costs by trade. That can make allocation more direct than estimating from a lump-sum purchase price. The study can often be started during construction, with a final update at completion. The placed-in-service date, generally when the building is ready for its intended use, marks when depreciation begins. See Year of Acquisition: Why Timing Matters for a Study.

Keep construction contracts, change orders, lien waivers, and draw schedules. Ask the contractor to provide cost breakdowns by category if possible. These become evidence.

Costs that belong in the basis

Many costs incurred to build or acquire the property become part of its basis: land preparation, permits, design fees, and certain financing costs incurred during construction depending on the rules. How to treat them is a question for your preparer, and the study should allocate indirect costs across components in a reasoned manner. See What a Cost Segregation Report Should Contain.

Renovations of an existing property

If you buy a property and renovate it, you have two categories of cost: the purchase price and the improvements. The improvements may include items that belong in shorter recovery periods and items that are structural. Some renovation costs might be currently deductible repairs instead of capital improvements, depending on the facts. Whether a cost is a repair or improvement is a separate tax question worth discussing with your preparer.

Replacing existing components

When you replace a component, such as a roof or flooring, the remaining basis of the old component may be recoverable if it can be identified and treated as disposed of. This is often called a partial disposition. A study can help identify the components and their basis. See Partial Dispositions, Replaced Components, and Studies.

When to time the study

Options include:

• After completion. Simple, with final costs known.
• During construction. May allow early planning and better cost capture, at the price of updates.
• After a renovation phase. Useful if the work will happen in stages.

If a large renovation is planned soon, doing a study before and again after can be inefficient. Discuss the plan with your provider to decide whether to wait.

Timing relative to tenants

Site inspections in occupied properties may require notice and coordination. Renovations that displace tenants may affect when the property is considered placed in service for the improved portion.

Land improvements

New construction often includes site work such as paving, drainage, fencing, and landscaping. These are often classified as land improvements with a 15 year period. Capturing them accurately can matter. See Land Improvements and the 15 Year Class.

Rules that apply

The rules for bonus depreciation depend on when property is acquired or placed in service. For self-constructed property, the rules may look at when construction began. Verify with your preparer what applies to your project. See Bonus Depreciation: Rules as Currently Understood (Verify).

Coordinating with the preparer

Share the project schedule with your preparer so the study and return timing line up. If the project crosses year end, plan which costs and which placed-in-service dates fall in which year. See Tax Year-End Timing and Study Deadlines.

Renovation scenarios in words

An owner buys a dated duplex and replaces flooring, appliances, fixtures, and paving over six months. Each item has its own invoice. A study performed after the work can allocate the purchase price to the old components, and the renovation invoices to the new. The owner may also identify old components that were removed, if the purchase price study allocated some cost to them. This is a place where good documentation pays off.

Another owner builds a small commercial building. Contractor draws show separate line items for sitework, foundation, framing, mechanical, electrical, and finishes. A study can use these directly and can classify site work and specialized items using the actual costs.

A third owner plans a multi-year unit renovation program. Each year's work is small, and a study for each year would be costly. The owner might do one study for the acquisition and a lighter analysis for each year's renovations, in consultation with the preparer.

Repairs versus improvements

Renovation work must be sorted into repairs, which may be deducted currently, and improvements, which are capitalized. Rules distinguish them based on whether the work betterments, restores, or adapts the property. A study focuses on capitalized costs, and your preparer decides the repair question. Ask early, since the classification affects both the study scope and the return.

Coordinating with lenders and contractors

Lenders sometimes require cost documentation for construction loans, and the same documents help the study. Ask your contractor early for a schedule of values that separates major trades and site work, since a detailed breakdown saves analysis time. If you use a general contractor, ask whether subcontractor invoices are available. When change orders alter scope, keep them, because they affect final costs. Photographs at key stages, such as before walls are closed, help identify components that will later be hidden.

Next steps

Continue with What an Engineering-Based Study Typically Includes to see how fieldwork and cost review fit together.