Your tenant calls to let you know they’ve been using a bucket to catch the water dripping into their kitchen because of a leaky roof. You have to do something pronto, so you contact a roofing specialist, who will let you know whether you can get by with a repair or if you need a new roof. Either way, you’re going to shell out some cash.
Wouldn’t it be nice to deduct whatever you spend from your taxes? Rental property repairs and improvements can be expensive, so it’s comforting to know some deductions might be coming your way.
Whether or not something counts as a tax deduction hinges on how the IRS categorizes the repair. In the case of the leaking roof, if you simply repaired the leak, you could deduct the entire cost, but if you replaced the roof, you can’t deduct that entire expense right away; you’d do so over time.
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 case you’re not allowed to deduct the entire expense immediately.
The difference between repairs and improvements
Repairs
Repairs are usually one-off fixes that help keep the property habitable and in good working condition. Although the price is irrelevant, most of my qualifying repairs tend to cost less than $500.
Whether you’re fixing a hole in the wall or 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.”
Here’s a tricky scenario from landlord Scott Benson, who owns a four-unit building. He wasn’t sure whether his tuckpointing project, of removing and replacing rotting bricks and mortar on the external walls, would be a repair or improvement. The total job cost him $4,500, but only 75% of that amount is a possible deduction because three of the units are rentals. Can he deduct all 75% as a repair, or would he need to depreciate the expense over several years?
CPA Lisa Earnhart says that Benson could probably deduct all 75% of the cost as a repair. Why? “It’s similar to refinishing or resurfacing a wood floor and replacing some bad planks. That is a repair expense, but replacing the floor is capitalized as an “improvement.” Refinishing the bricks by tuckpointing where necessary, and replacing a few bad bricks would be a repair expense, but replacing the brick wall with a new brick wall would be capitalized,” she says.
Improvements
Anything that increases the value of the property or extends its life is categorized as a “capital expense” and must be capitalized as a long-term asset and depreciated over multiple years. You can deduct a small but even portion of these expenses in the current 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 if you’re 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. That’s why you can’t deduct the entire $20,000 kitchen renovation in a single year.
In the case of a kitchen renovation, it’s easy to accept it as an improvement instead of a repair. You get a fabulous new kitchen, which most likely means you could fetch more rent for the unit. But what about those gray areas, such as when the central heating and air-conditioning unit goes out? When you factor the unit’s age and condition, it might be beyond repair, meaning you’d have to buy a new one. This happened to Sandra Riffe, who doesn’t understand why she can’t deduct this cost as a repair.
“By replacing the unit, you weren’t fixing it,” says Lucas Hall, head of industry relations at Cozy and founder of Landlordology. “The IRS says that a new heating system is an improvement and, therefore, must be depreciated.”
And just how many years do you deduct the value of a heating and air system? The IRS guide says that appliances are depreciated over five years. If you use a tool like TurboTax, Lucas says, it’ll do the math for you.
Likewise, when you sell a property, you’ll need to know the costs of these types of improvements and how much each one has depreciated, because you’ll have to pay taxes on the depreciated amount. Figuring out these amounts should be easy to track, if you keep accurate records, receipts, and copies of tax returns.
Types of capital expenses
The IRS uses 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 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 considered 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.
Source: IRS Rental Income and Expenses
Landlord Robert Ward’s situation represents a great example of a betterment. The shower pan in his rental leaked. So he tore out the shower and replaced it for about $2,700. If the shower pan didn’t leak, Ward wouldn’t have replaced the shower. Was it a repair or a betterment?
Pamela Yi, CPA, says betterment. “Basically, if an item is a betterment, restoration, or adaptation of an asset, then that item should be capitalized. So I would list the shower repair on the depreciation schedule for the rental as “Bathroom #1 improvement, and it would have a recovery period of 27.5 years.”
Comparison of repairs and improvements
| Repairs | Improvements |
|---|---|
| Repairing a cracked foundation | Adding a structural addition, extra rooms, garage, etc. |
| Repairing a broken AC fan, replacing damaged/clogged air vent registers or air filters | Adding central air conditioning |
| Replacing a broken security camera | Installing a security system |
| Replacing a small area of carpet that was damaged, or having it professionally cleaned | Installing brand new carpet |
| Patching a leaky or damaged roof | Replacing an entire roof |
| Replacing a broken plumbing pipe, leaky faucet, or running toilet | Replacing all existing plumbing |
| Replacing an unsafe or improperly run section of electric wire, outlet, or light fixture | Replacing all existing electric wiring |
| Replacing a broken cabinet | Renovating a kitchen |
| Refinishing or resurfacing the wood floors, or replacing damaged planks | Replacing the wood floors |
| General painting | Painting as part of a larger restoration project or addition |
| Fixing appliances | Replacing appliances (fridge, stove, washer/dryer) |
| Replacing a broken door knob | Replacing all the door hardware in the house for cosmetic reasons |
| Replacing a few cracked tiles | Tiling the entire bathroom floor |
| Replacing the glass in a window frame | Replacing multiple windows (entire house) |
Official guidance
As of Jan. 1, 2014, the IRS released official guidance regarding deduction and capitalization of expenditures related to tangible property, which adds to and clarifies the existing understanding of deductible repairs and depreciable improvements mentioned above.
Examples of improvements
According to the IRS, the addition or upgrade of the following items must be capitalized and depreciated over multiple years.
Heating and air conditioning
- Heating system
- Central air conditioning
- Furnace
- Duct work
- Central humidifier
- Filtration system
Lawn and grounds
- Landscaping
- Driveway
- Walkway
- Fence
- Retaining wall
- Sprinkler system
- Swimming pool
Miscellaneous
- Storm windows and doors
- New roof
- Central vacuum
- Wiring upgrades
- Satellite dish
- Security system
- Attic, wall, and floor insulation
Additions
- Bedroom
- Bathroom
- Deck
- Garage
- Porch and patio
Plumbing
- Septic system
- Water heater
- Soft water system
- Filtration system
Interior improvements
- Built-in appliances
- Kitchen modernization
- Flooring
- Wall-to-wall carpeting
Additional resources
Want to learn more? Check out these articles and forms.
IRS Form Schedule E(pdf)
IRS Form 1040 Schedule E Instructions
IRS A Brief Overview of Depreciation
IRS Publication 946: How to Depreciate a Property (pdf)
IRS Rental Income and Expenses (If No Personal Use of Dwelling)
Wikipedia: Expenses versus Capital Expenditures
Final Regulations Now Available for Repairs vs. Capital Improvements
In conclusion
Conscientious landlords, who make repairs and improvements to their properties, should take every tax advantage available. It’s important, however, to understand the correct ways to go about it. If you have questions, it’s always wise to speak with a professional tax advisor.
