Are you a rental property owner wondering about the tax implications of repairs and capital improvements? Look no further as we dive into the nitty-gritty details of how these expenses are taxed differently and why understanding the difference is crucial for maximizing your deductions and minimizing your tax liability. 

In this article, we will define repairs vs. capital improvements, explain the tax treatment of each, and give examples of how to distinguish between the two. By the end of this article, you will better understand how to handle repairs and capital improvements on your rental properties and ensure you’re making the most of your tax deductions.

Understanding the Taxation of Repairs

Repairs on rental properties are considered deductible expenses as they are considered ordinary and necessary business expenses. This means that you can write off the cost of repairs on your taxes in the year they were made. 

Some typical repairs that are typically eligible for this deduction include painting, fixing a leaky roof, repairing damaged floors or walls, and fixing appliances or other systems that are part of the rental property. 

It’s important to note that the repairs must be made to keep the rental property in good working condition and should not add value or prolong the property’s life. Additionally, repairs should be something other than capital expenses that improve the property and should be considered only to maintain the property in its current condition.

Understanding the Taxation of Capital Improvements

On the other hand, capital improvements are not immediately deductible and must be capitalized and depreciated over time. This means that the cost of capital improvements cannot be written off in the year they were made but instead must be spread out over several years as a depreciation expense. 

This is because capital improvements are changes that add value to the property or extend its useful life. Some examples of capital improvements include building an addition, installing a new HVAC system, upgrading electrical or plumbing systems, and installing new windows or a new roof. 

The depreciation period for these capital improvements is generally 27.5 years for residential rental property and 39 years for nonresidential rental property. It’s essential to keep records of all capital improvements made to the rental property, including the cost, date of purchase, and useful life, as these will be needed to calculate the depreciation expense for tax purposes.

The difference between home repairs vs. capital improvements

It’s important to understand the difference between repairs and capital improvements because they are taxed differently.

Repairs are routine maintenance to keep a property in good working condition. Rental property owners make these expenses to keep their property in the same condition as it was before, and they don’t add value or prolong the life of the property. Examples of repairs include fixing a leaky faucet, patching a hole in the wall, or replacing a broken window.

On the other hand, capital improvements are changes made to the property that add value or prolong the life of the property. These are expenses that are made to improve the property and make it more valuable. Examples of capital improvements include building an addition, installing a new HVAC system, or upgrading the electrical system.

Examples of how to Distinguish between Repairs and Capital Improvements

How To Determine if an Expense is a Repair or a Capital Improvement?

Determining if an expense is a repair or a capital improvement can be tricky, but there are a few ways to help make the distinction. 

One way is to consider whether the expense is maintaining the property in its current condition or if it’s improving the property and adding value. 

Another way is to consider whether the expense is fixing something that’s broken or worn out or if it’s adding something new to the property. For example, replacing a worn-out carpet with a new carpet is a repair, while installing new hardwood flooring would be a capital improvement.

How To Calculate and Claim Depreciation on Capital Improvements?

When it comes to capital improvements, it’s important to keep records of all expenses, including the cost, date of purchase, and useful life. This information will be needed to calculate the depreciation expense for tax purposes. 

The IRS has a set of rules for depreciating rental property, known as the Modified Accelerated Cost Recovery System (MACRS). Under this system, the depreciation period for residential rental property is 27.5 years, and for nonresidential rental property is 39 years.

When calculating depreciation, you will need to divide the cost of the capital improvement by the number of years in the depreciation period.

It’s important to consult a tax professional or an accountant to ensure that you properly report your repairs and capital improvements on your taxes. They can help you distinguish between repairs and capital improvements and guide you in calculating and claiming depreciation.

The bottom line

In conclusion, understanding the taxes surrounding repairs and capital improvements on rental properties is crucial for maximizing deductions and minimizing tax liability. As we have seen, the IRS treats repairs and capital improvements differently, and it’s important for rental property owners to understand the difference between home repairs vs. capital improvements. 

By understanding the tax implications and distinguishing between the two, rental property owners can ensure they are reporting their income and expenses correctly on their taxes. It is always advisable to consult a tax professional or an accountant for guidance and ensure that you’re taking full advantage of the deductions and depreciation available to you. 

Remember, the key is to understand the difference between repairs, which are considered routine maintenance, and capital improvements which are considered expenses that add value or prolong the life of the property.

Don’t let confusion about the tax treatment of repairs and capital improvements on rental properties cost you money. Reach out to the experienced real estate professionals at 302 Properties for guidance and ensure you take full advantage of all available deductions and depreciation.