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California rental properties, relates to Rent control and Schedule E

RSO Buildings and Your Schedule E: The Deductions LA Landlords Keep Missing

by Stephen Morris CPA, MBT, CCIM

When the city caps your rents, every deduction you miss comes directly out of your pocket.

Many RSO owners have returns prepared by generalists who have never encountered a SCEP invoice or a soft-story retrofit bill, and it shows.

Here is where money is often missed on a rent-stabilised property’s Schedule E.

Repairs Versus Improvements: The Biggest Lever

Repair something, and you may be able to deduct the cost in the current year.

Improve something, and you may have to depreciate the cost over as long as 27.5 years.

The line between the two is where much of the tax planning sits, and the rules provide several tools that may allow more costs to be treated as current deductions:

  • A de minimis safe-harbour election, which may allow items costing up to $2,500 per invoice or item to be expensed
  • A routine-maintenance safe harbour
  • A small-taxpayer safe harbour for qualifying buildings

Used deliberately, these provisions can convert part of your capital spending into current deductions.

Used carelessly, they are often overlooked.

LA-Specific Costs and Their Treatment

RSO registration fees, SCEP inspection fees and city business taxes on rental activity are generally deductible operating expenses.

A soft-story seismic retrofit usually falls into a different category. It is generally treated as a capital improvement and depreciated rather than deducted immediately.

However, this type of project may contain shorter-life components that can be identified separately. Breaking those components out from the beginning may create meaningful tax savings over the life of the property.

Tenant Buyouts: Do Not Guess

Cash-for-keys payments are common under the RSO, but their tax treatment can be complicated.

Depending on why the payment was made and what happens to the unit afterwards, the cost may be:

  • Deductible immediately
  • Capitalised and recovered over time
  • Treated differently according to the surrounding facts

Owners make mistakes in both directions.

This is worth reviewing before the payment is made, because the way the agreement is structured may affect the tax treatment.

The Passive-Loss Reality

Capped rents combined with legitimate deductions often mean that a building reports a paper loss.

Whether you can use that loss against other income in the current year depends on the passive-activity loss rules.

A limited allowance may be available to some smaller landlords, although it phases out as income rises. Real estate professional status can materially change the position.

Even when a loss cannot be used immediately, it is not necessarily lost.

The unused loss generally carries forward and may be released when the property is sold, reducing the taxable impact of the eventual exit.

Are My RSO Registration and SCEP Fees Deductible?

Yes. They are generally treated as operating costs of the rental property.

Can I Write Off My Seismic Retrofit This Year?

Generally, no.

A seismic retrofit is usually treated as a capital improvement and recovered through depreciation.

The planning opportunity lies in identifying the individual components, assigning them the correct recovery periods and establishing when they were placed in service.

Is a Tenant Buyout Deductible?

Sometimes it is deductible immediately; in other cases, it must be recovered over several years.

The answer depends on the facts.

Structuring the payment correctly before it is made is far better than trying to correct the treatment afterwards.

My Building Shows a Loss Every Year That I Cannot Use. What Is the Point?

Unused passive losses generally accumulate and may be released when you sell the property.

They are deferred, not necessarily lost, and they may make the eventual tax cost of your exit lower than expected.

Own an RSO Building?

Have us review last year’s Schedule E.

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