Maybe it starts with a leaky ceiling. Or perhaps a leaky faucet. Sometimes, you simply notice that the walls could use a another coat of paint. Home improvement for your rental real estate investment is inevitable. At some point, your property will require maintenance. Will you be able to deduct the cost of that maintenance on your tax return? The simple answer is yes, however, the issue at hand is not a matter of ‘if’, but rather of ‘when’.
The IRS differentiates between repairs and capital improvement. A repair is maintenance that returns the home to its original state. Replacing missing roof shingles, fixing a pipe, and fixing up the HVAC are all examples of repairs. Capital improvements, on the other hand, refer to work that increases the value of the home or prolongs its useful life. They are the big ticket items, such as replacing the roof, installing a new HVAC, and erecting a fence. See here for more examples of capital improvements.
Classification of your improvement as a repair or capital improvement can have massive tax implications. The reason is that repairs are normally fully deductible against the rental income in that year. Improvements, however, must be capitalized and depreciated over 27 ½ years. A simple example helps to illustrate the point.
Tom’s roofer explains that the shingles need work. A lot of work. He offers to patch up the shingles for $2,000. Alternatively, he could replace the entire roof for $10,000, which will last 20 years. At first glance, it seems to make sense for Tom to spend the extra money, replace the roof, and not worry about it for the next couple of decades. But let’s analyze the options.
Spending the $10K will give Tom a brand new roof. But his tax deduction in the year of replacement is a nominal $364 for the next 27.5 years (10,000 / 27.5). Whereas the patch up job would give him a $2,000 deduction in that year. It would take 5 replacements to equal the cost of a new roof. In the meantime, the full $2k is deductible each time. The lesson here is that sometimes, from a tax perspective, repairing is sometimes better than replacing. However, this is just looking at this through the tax perspective. There might be other considerations like cash flow so be sure to analyze everything involved.
Understanding the nuances of rental real estate improvements can be complex. Of course each situation is different and in order to reap the tax benefits for your unique situation, it is always advisable to contact your CPA.
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