Rental Improvements and Repairs: How these Affect a Landlord’s Taxes

Every landlord knows that improvements and repairs are highly important for enhancing the rental unit’s potential for renting and to retain existing tenants. However, many believe that improvements and repairs are both the same, which is a wrong conclusion. It is very important to understand the salient differences between improving a property and performing repairs because both affect a landlord’s taxes in an entirely different manner. Improvement and repairs both are necessary and need to be performed at some point but both have varying tax implications and impact the value of your property quite differently. So let’s understand the differences between improvement and repairs before you decide about repairing or improving the rental property.

Related: Make Property Repairs on a Regular Basis: Keep Your Tenants Happy

Improvement versus Repairs

Improvement means renovating the property in a way that the real estate becomes extended and its usefulness is increased. The reason is that improvement adds value to the property and it continues to increase its appeal for many years not for the current tax year only. Generally, landlords improve their real estate property by adding something new to it such as a new bedroom, storeroom, expanding a small room or constructing another floor altogether. It is also possible to improve a property by upgrading existing appliances or fittings such as kitchen cabinets, water pipes, electricity wiring, refrigerator and heating system, etc. Improvement may also refer to adapting the property to a new use. It is worth noting that improvements tend to be more laborious and intensive than repairs, and the expenditures involved are relatively much high in comparison to repairs.

Some notable examples of property improvement include: adding/upgrading central air conditioning, making an additional room/storage space or expansion of property, installing security system, adding hard wood flooring, replacing old carpets/windows/locks/doors/roof, replacing current electrical and water lines and piping and kitchen renovation, etc.

Repairing of property

Repairing is maintenance of the real estate that is required to keep a property in optimal working condition. According to IRS’s definition of repairs for landlords for tax purposes, these are actions that don’t add value to the property or extend its life. To ensure that the property remains habitable, the landlords must perform regular inspections and repairing is a mandatory part of the process. The expenditures involved are not as high as improvement costs and repairs don’t take a lot of time to be completed. On the other hand, improvements are time-consuming and the required duration relies upon the nature and extent of improvement.

Generally, repairs are understood for tax deduction purposes as restoring the life of an item so that it continues to remain in its previous good condition. For instance, general repairing job can include refinishing of wood floor, repainting or a particular area, roof and locks repair, maintenance of plumbing and appliances, replacing of old door knobs/windows/doors, repairing of broken smoke detector, replacement of rotted floorboards and cracked tiles.

Deducting Improvement Costs from your Taxes

You can deduct improvements from your taxes but full value cannot be deducted in the year when the improvement was carried out because of their usefulness and value adding feature. The effect of improvement is often long-term and not limited to the year when the improvement was conducted. This is why the full value is never deducted.

Improvements need to be capitalized and depreciated as per a pre-determined depreciation schedule. The depreciation schedule is different for every asset. Landlords are required to divide the improvement cost over its usefulness and generate the annual deduction according to the given year’s expenditures.

For instance, if you have carried out improvements worth $5,000 on your property then you need to deduct it over a pre-determined depreciation schedule supposedly of ten years. There should be no salvage value because the improvements’ impact will fade away after ten years and the depreciation will be evenly spread out over the ten years’ time, which means it will be a straight-line depreciation. Therefore, you can claim an expense of $500 per year for the next ten years. If you have a 28% tax rate then you can expect to save $140 in taxes.

Is it possible to deduct repairs from taxes?

Yes, it is indeed possible to deduct complete costs of the repair from taxes but it should be deducted the same year when the repairs were completed. For instance, if you performed repairs of $5,000 on your property then you can deduct the full expense of those repairs from the current year’s tax, if your tax rate is 28% then you can expect to save $1400 in taxes.

What Should You Prefer Improvement or Repair?

It is difficult to pick any one because both tasks are carried out with different perspectives and reasons. Improvement is conducted if the landlord wants to make the rental property more appealing and accommodating, so that it fetches higher rent or is sold at higher amount. Improvement is mainly an addition to the existing infrastructure or amenities at the property. Repairing is not conducted upon will but on demand, that is, a pipe is not changed unless it is broken or leaking. Similarly, landlord would not repair door knob unless it becomes faulty. A roof won’t be repaired if it is not leaking. The purpose of repair is not to add value but to retain the property’s existing value and condition. You can easily deduct repair costs from your taxes while this isn’t the case with improvements.

It is therefore, not possible to conclude which would be ideal for you for tax purposes because the situation and your requirements will determine whether your property will undergo repairing or improvement. Some landlords have to maximize all the immediate write-offs on their real estate because they depend upon their yearly rental income to make a living. In such a situation, opting for repair is more beneficial because it would then maximize the after-tax dollars for the landlord for the current year.

Conversely, if the landlord doesn’t need to perform additional deductions for the current year then it would be a better idea to extend the life of depreciation for several years by classifying the expense as an improvement.

We suggest that you must consult with the IRS or a certified accountant to be sure about the applicable landlord tax deductions on property repairs and improvement for your situation.

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