Written by Lucas Hall on February 19, 2014
Having to make repairs to my rental properties can be expensive.
The general rule is that the cost of “repairs” incurred to maintain your rental properties may be deducted from each property’s taxable income in a given year. However, some repairs are considered “improvements” in which you’re not allowed to deduct the entire expense immediately.
Repairs vs. improvements, so what’s the difference?
This damaged outlet needs repair
Repairs are usually one-off fixes that help keep the property in good working condition and habitable. Although the price is irrelevant, most of my qualifying repairs tend to be under $500 in cost.
Whether you’re fixing a hole in the wall, or a unclogging a shower drain, you can deduct the cost of these minor repairs from the current year’s tax liability.
The IRS clarifies in the 1040 Schedule E Instructions that “repairs in most cases do not add significant value to the property or extend its life. ”
An addition is an “improvement”
Anything that increases the value of the property or extends its life is categorized as a “capital expense” and must be capitalized and depreciated over multiple years. Meaning, you can only deduct a small but even portion of these expenses in the current tax year.
Improvements, such as replacing a roof or renovating a kitchen, are usually more labor-intensive than repairs and typically cost substantially more.
The good rule of thumb is that if you are adding a new item, or upgrading an existing item, then it’s usually considered an improvement.
The assumption is that these
improvements will add value to the property over multiple years, not just the current year – and thus why you can’t deduct the entire $20k kitchen renovation in a single year.
Likewise, when you sell a property, you’ll need to know the costs of these improvements and how much each one has been depreciated because you will have to pay taxes on the depreciated amount. This should be easy to track if you keep accurate records/receipts and copies of tax returns.
Types of Capital Expenses
The IRS uses the following categories to help define a capital expense. You are required to capitalize and depreciate the following:
- Improvements. You must capitalize any expense you pay to improve your rental property. An expense is for an improvement if it results in a betterment to your property, restores your property, or adapts your property to a new or different use.
- Betterments. Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property.
- Restoration. Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.
- Adaptation. Expenses that may be for adaptation include expenses for altering your property to a use that is not consistent with the intended ordinary use of your property when you began renting the property.
Comparison of Repairs and Improvements