Capital improvements to property and repair costs to property are both tax deductible, but they're handled differently. Improvements have a much greater impact on the value of your property than repairs, so they're depreciated when you file your tax return. The cost of repairs can often be deducted in the tax year you pay for them.
It is important to understand what qualifies as making a capital improvement to your investment property and what instead qualifies as making a repair or minor upgrade so you claim the correct tax break.
Key Takeaways
- A repair is essentially maintenance that brings an asset back to working condition but doesn’t improve on its condition beyond the quality or usefulness that existed before the work was done.
- The full cost of a repair can be deducted in the year you make it.
- A capital improvement involves extensive work at a more significant cost that adds to an asset’s useful purpose or extends its useful life.
- The cost of an improvement is divided up over the number of years you expect the asset to remain useful. You can deduct that percentage of the overall cost each year.
Deducting Capital Improvements
A capital improvement is a property update that extends the “useful life” of the property. This is defined as the period of time during which the asset serves a useful purpose. Wear and tear can factor in because an asset might be more useful and accomplish more initially than after years and years of use.
Improvements are usually more extensive than repairs and they usually involve greater cost. They include adding something to an existing building, such as a room or a wing, or making major upgrades to features that already exist. They might also adapt the asset to a new use. Improvements aren't just short-term fixes. They add value to the property for years to come.
Examples of Capital Improvements
- Adding an addition
- Adding central air conditioning
- Installing a security system
- Installing brand new hardwood flooring
- Replacing an entire roof
- Replacing all existing plumbing
- Replacing existing electric
- Renovating a kitchen
- Renovating a bathroom
- Replacing all windows
- Adding a deck
- Building an in-ground pool
Deducting Repairs to Your Investment Property
A repair is simply necessary maintenance that keeps the property in habitable and working condition. It doesn't add significant value to the property or extend its life.
An asset is generally restored to its previous good condition when it's repaired. It's not improved upon. Repairs can usually be completed for a reasonable amount of money. Replacement of broken appliances is usually also considered to be a repair.
Examples of Property Repairs
- Refinishing a Wood Floor
- Repainting a Room
- Repairing a Roof
- Repairing Existing Plumbing
- Repairing Existing Appliances
- Replacing a Doorknob
- Replacing a Window
- Replacing a Broken Smoke Detector
- Replacing Rotted Floorboards
- Replacing Cracked Floor Tiles
- Updating Old Appliances
How To Deduct Improvements on Your Tax Return
You can deduct the cost of improvements made to your investment property, but you can't deduct the full value of the improvement in the year it's made.
Note
An improvement adds value to your property for years to come, not just in the current year, so you can't take the deduction all at once.
Improvements must be capitalized and depreciated according to a set depreciation schedule. The schedule used depends on the particular asset. You must divide the cost of the improvement over the useful life of the improvement and then take an annual deduction based on the given year's expense. You would typically use the Accelerated Cost Recovery System (ACRS) if you acquired the asset and put it in service before 1987. Otherwise, use the Modified Accelerated Cost Recovery System (MACRS).
An Example of Deducting an Improvement
Let's say you've made a $5,000 improvement to your rental property. You must deduct it over a set depreciation schedule. We will use a depreciation schedule of 10 years. We'll assume there's no salvage value so it will be worth nothing after this 10-year period. We'll use straight-line depreciation so the cost will be spread out evenly over the 10 years.
You can deduct $500 each year ($5,000 divided by 10) for the next 10 years. So your taxable income is lowered by $500 each year when you file your taxes.
How To Deduct Repairs on Your Tax Return
You can deduct the full cost of a repair in the tax year that the repair was completed because it's merely intended to restore the asset to its previous condition. The deduction would be subtracted from the rental income received in the same period.
Note
Losses incurred by repairs can sometimes be carried over to subsequent years so consult with a tax professional if you find yourself in this situation.
An Example of Deducting a Repair
Now let's say that you performed a repair on your rental property that cost you $5,000. You can deduct the entire expense in the current year because it's a repair. That lowers your taxable income by $5,000.
Improvements vs. Repairs: Which Is Better?
The decision to deduct the cost of work as an improvement or repair will depend on your needs and on the nature of the work.
Some landlords need to maximize all immediate write-offs because their livelihoods depend on their yearly rental incomes. Being able to classify an expense as a repair would be beneficial in this case because it would maximize your after-tax dollars in the given year. But extending the life of the depreciation for several years by classifying the expense as an improvement could be beneficial if you don't need additional deduction in that first year.
And, of course, it depends a great deal on the nature of the work that's been done. Many improvements simply don't qualify as repairs. You're not permitted to classify them as such so you can take the entire deduction in the year you spend the money.
Note
One option isn't necessarily better than the other. An improvement, such as adding an addition, adds value to your property, but the entire cost of a repair, such as fixing a roof leak, can be immediately deducted on your taxes, leaving more money in your pocket.
As for costs that fall into a gray area between being classified as improvements or repairs, it really depends on how comfortable you and your accountant are with defending your claim against IRS scrutiny.
Frequently Asked Questions (FAQs)
How do you describe improvements vs. repairs on a rental property?
Ask yourself a simple question: Did the work you paid for make the asset better and more serviceable than it was before? Or did it merely restore it to working condition? It's a repair if you've merely fixed it so it works again.
How do you deduct repairs on a rental property?
Repairs on a rental property are deducted on IRS Schedule E as expenses. The schedule must be filed with your tax return. It tallies up all the rental income you received and subtracts your expenses from the total. The balance is your taxable income from your rental business.
