Real estate investors who wait until the final weeks of the tax year to reconstruct their property spending risk losing the details that determine how those costs are treated on their returns, according to CostSegRx, an engineering-based cost segregation firm.
“Property owners should really document all of their capital improvements and expenses throughout the year,” Brian Kiczula of CostSegRx said. “It’s not just at the year-end.”
The stakes go beyond tidy bookkeeping. When a CPA or cost segregation professional reviews an owner’s spending, they typically apply the BAR test, which asks whether each cost is a betterment, an adaptation, or a restoration. Costs meeting one of those definitions generally must be capitalized and depreciated, over 27.5 years for residential rental property, 39 years for commercial property, or shorter lives of 15, 7, or 5 years depending on the asset. Costs that fail the test usually fall into repairs and maintenance, which can be deducted in the year incurred. Without records, there is no reliable way to sort a cost into the right bucket.
In CostSegRx’s experience, the gap almost always comes down to individual receipts and a clear description of the work performed. Some owners keep every receipt in a cloud folder and track each improvement, with dates, in a spreadsheet. Others know roughly what they spent over the year but cannot say how the money divided among new flooring, windows, lighting, or a bathroom remodel. Many contractors bill in lump sums without breaking out each component, leaving owners without the detail their tax preparers need.
For owners in that position, CostSegRx uses construction cost estimating, rebuilding the contractor’s costs from the owner’s description and images of the property so each improvement can be classified. The firm recommends simple habits going forward: save each receipt or invoice, note what work was done, record the completion date, and photograph the finished improvement.
Timing matters for owners who bought and renovated in the same year. If renovations were finished before the property went into service, an original cost segregation study may need adjustment. If the property went into service first and a major remodel followed, the tax preparer would typically receive two separate fixed asset schedules, one for the acquisition and one for the remodel. The same approach applies when a property is bought one year and renovated the next, a pattern CostSegRx sees often with hotels.
Disorganization is common among landlords, and CostSegRx says it does not mean the opportunity is lost. The firm recently completed a study on a multi-year renovation of three buildings—a restaurant, a boutique bed and breakfast, and a group of shops—without the owner’s original construction data. As long as an owner can document that improvements were made, a study can usually still be done.
The practical takeaway is to stop treating documentation as a year-end task: keep records as work happens, share them with a CPA, and ask early how renovations will be classified.
