capital improvements vs. repairs

Every landlord must carry out regular maintenance and repairs to keep their rental properties habitable. Fixing a faulty faucet, AC unit repair, or painting the property are all part of a landlord’s job description.

In contrast, capital improvements boost the property value, or extend the life of the property. Capital improvements also go by the terms capital expenditures (CapEx) or capital expenses.

Many real estate investors like to classify most of the work done in the property as regular repair and maintenance to maximize their landlord tax deductions. As much as it sounds like a good plan in minimizing the property or rental income tax dues, false tax deduction claims can land you in hot water with the IRS.

So put on your accountant hat, because all landlords need to understand rental property repairs versus capital improvements for filing tax returns and taking deductions. 

 

Repairs vs. Improvements vs. Maintenance

As you update your rental property, here’s what you need to understand about deductible repairs vs. capital improvements, and where maintenance fits in.

 

Maintenance

Maintenance is any job done on the property to resolve existing degeneration or prevent damage. Preventative or standard maintenance work is simple. The aim is to keep the property original and functional.

Substitutes or replacements of property components that are past their useful life fall under maintenance. Anything more than that ceases to be routine maintenance work.

Routine servicing of the air conditioning condenser counts as maintenance.

 

Repairs

Property repair is any work that’s done to fix damage or deterioration. Continuing the example from above, calling an HVAC professional to fix a broken line in the air conditioning condenser counts as a repair.

Repairs aim to reinstate the property to the condition it was in before the damage occurred. However, some damage can’t be fixed through repair but replacement.

In this case, the work is sometimes considered a capital improvement and treated differently when filing tax returns.

 

What Are Capital Improvements?

This is defined as any work done to better the state of the property beyond the original condition. Not only do capital improvements increase the property value, but also extend its expected life.

Capital improvements also raise the income-generating capability of the property. They can include additions, extensions, or changes in the character of the property (i.e. through remodeling or renovations). Replacements, even when the original components are damaged beyond repair, are capital improvements.

To differentiate between capital improvement vs. repairs or maintenance work, you just have to consider whether the job increases the property value beyond the original or simply restores it to the value it was in before the damage or change occurred.

Maintenance jobs can end up being capital improvements when the damage is extensive because a simple repair won’t suffice in fixing the problem. For instance, treating termite damage to the joists can become a capital improvement if you end up replacing many joists and structural components. In this case, you should list the expense as a capital improvement as opposed to repair or maintenance work.

If you buy a fixer-upper, while following the BRRRR method of rental investing, you must depreciate the initial renovation costs. You add them to the rental property cost basis to reduce your capital gains taxes when you are ready to sell.

Replacing the air conditioning condenser counts as a capital improvement.

(article continues below)

rental property loans comparisonWhat do lenders charge for a rental property mortgage? What credit scores and down payments do they require?

How about fix-and-flip loans?

We compare the best purchase-rehab lenders and long-term landlord loans on LTV, interest rates, closing costs, income requirements and more.

Types of Capital Expenditures

Capital expenses are categorized by the IRS to minimize confusion in filing tax deduction claims. As you try to define repairs vs. capital improvements, the latter include:

Betterments: These expenses improve the property’s condition or value by increasing its strength, quality, or capacity. Betterments also result in an expansion of the property or fixing a pre-existing flaw.

Improvements: Any expense incurred in the process of improving the condition of an investment property should be capitalized. Improvements are changes done to adapt the property to a different or new use. Restoration of properties also falls under capital improvements.

Restoration: Rebuilding a property to restore it to the original condition or after damage due to casualty loss is classified as restoration capital expense. Also, replacements that involve a significant part of the property structural aspect fall under restoration.

Adaptation: If you alter a major component of the property for new use, that counts as a capital improvement.

 

Tax Consequences of Repairs vs. Improvements

“Fascinating as this lesson in semantics is, why should I care in the slightest?”

The definition of capital improvements vs. repairs to a rental property matters because of how you deduct the costs on your tax return.

Landlords can deduct 100% of the costs of repairs and maintenance, in the year when they occur. However you can’t deduct the cost of capital expenditures all at once – these must be depreciated over time. Spread over 27.5 years, to be precise. Read up on how rental property depreciation works for a more thorough explanation.

Hire an accountant well versed in real estate investments and tax laws, to maximize your deductions and depreciation. Also, keep excellent records of all repair and maintenance expenses. Save your receipts, invoices, and other paper trails of all repairs, maintenance, and CapEx so you can prove them to the IRS in the event of an audit.

 

Final Thoughts

Every landlord should know how to categorize capital expenditures vs. repair work. The IRS won’t overlook blunders in your tax returns just because you are a new landlord.

Bear in mind that the line between repairs vs. capital improvements sometimes gets blurry. If you replace all your outdated windows with new energy-efficient modern ones, that counts as a capital expense, since it prolongs the usable lifespan of your rental property. If the neighbor’s son throws a baseball through one window by accident, replacing that one window is clearly a repair.

But what if you replace a few windows each year, as they become exceptionally old and crusty looking?

When the line gets blurry, talk to your accountant. They’ll tell you to have an argument ready for the IRS in case they challenge you on it, but often you can get away with deducting all of the cost this year.

 

What do you find confusing about repairs vs. improvements to rental properties?

 

 

More Real Estate Investing Reads:

FREE Webinar: Open $250K in Credit Lines for Investing

On Wed. 3/23/22 at 2pm & 8pm EST, Deni & Brian are hosting Fund&Grow for a free webinar to show you how to open up to $250,000 in unsecured business credit lines for real estate investing.

Free Background Check

Run a FREE housing & identity check!

Credit, criminal, eviction reports also available.

Want to create passive income?

 

We’ll email a series of videos in our free course,

to help you start earning income from rentals.

[mc4wp_form id=”501″]

Privacy Policy: Your info will never be shared or sold to a 3rd party. Even if Dr. Evil offers us 1 million dollars 🙂

Rental ROI Ebook

Want to earn more from your rentals?

 

Download our free Ultimate Guide to Higher ROI and be dazzled by the charming wit, disarming frogs and invaluable tips for higher profits and less work.

 

[mc4wp_form id=”501″]

Free Mini-Course: Passive Income from 2-4 Unit Multifamilies

Free Mini-Course: Passive Income from 2-4 Unit Multifamilies

 

Ready to build passive income from small multifamily properties?

Over the next week, we'll email you a free series of videos, so enter your best email and let's get started!

You're in! Check your email to confirm, and you can email us directly at [email protected] with any questions :-)

Free Webinar: Earn 15-50% on Passive Real Estate Syndications

LIVE masterclass on Tues. 10/25 @ 8pm EST

Your seat is reserved! Check your email to confirm.

Inside a group real estate investment

Here's a quick video breakdown of a past group investment — and how it's performed since our Co-Investing Club invested in it in early 2023.

You got it! Check your email for the link, and some other fun freebies.

Ready to Build Passive Income?

Ready to Build Passive Income?

 

We'll email you the course videos over the next week, so enter your best email!

You're in! Check your email to confirm.

Ditch Your Day Job: Free 8-Video Course

 

Our brand new course on how to reach financial independence and retire early (FIRE) with rental properties is open for one week from Oct. 23-30!

You're in! Check your email for the link, or click here for the 1st video!

How do group real estate investments work?

If you want the cash flow, appreciation, and tax benefits of real estate without hassling with loans or landlording, learn how to invest passively. 

Awesome! Check your email :-)

learn private equity real estate investing

Hack the Rich: 7 Secrets We've Learned from Private Equity Real Estate

In a live online meetup, we'll be sharing and discussing 7 secrets we've learned from the rich over the last few years of investing in private equity real estate syndications.

Awesome! Check your email :-)