Having to make repairs to my rental properties can be expensive.
Knowing that I am able to deduct this expense from my taxes makes it a little easier to swallow.
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?
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.”
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
|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|
|Genenal 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)|
Finally, Official Guidance
As of January 1, 2014, the IRS has released official guidance regarding deduction and capitalization of expenditures related to tangible property, which add to and clarify 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 definitively be capitalized and depreciated over multiple years.
Heating & Air Conditioning
- Heating system
- Central air conditioning
- Duct work
- Central humidifier
- Filtration system
Lawn & Grounds
- Retaining wall
- Sprinkler system
- Swimming pool
- Storm windows, doors
- New roof
- Central vacuum
- Wiring upgrades
- Satellite dish
- Security system
- Attic, Wall, Floor Insulation
- Porch / Patio
- Septic system
- Water heater
- Soft water system
- Filtration system
- Built-in appliances
- Kitchen modernization
- Wall-to-wall carpeting
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
- Investopedia – Depreciation
- Federal Register – Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property
- Final Regulations Now Available for Repairs vs. Capital Improvements