You may have heard that it is better for rental property expenses to be classified as a repair rather than an improvement. This is because repairs are deductible in the year their cost was incurred, while improvements must be prorated over the life of the asset. Often repairs versus improvements are simply an issue of timing. But capitalizing an improvement and depreciating it over a period of years (generally up to 27.5 for a residential rental property and 39 years for nonresidential property) can make a significant difference in your federal tax bill, and thus in your bottom line.
For example, say that Vanessa spends $7,000 on a fix-up.
- If classified as an expense, this will be an immediate $7,000 deduction.
- If classified as an improvement with a class life of 27.5 years, Vanessa can only claim $255 per year over the next 27.5 years. Given the expected inflation, in today’s dollars those totaled deductions will end up being worth only about $3,750.
As you can see, when dealing with business expense deductions, repairs are worth about twice as much as expenses.
It is important to understand how the IRS decides what can be classified as a repair vs improvement, especially since they could decide to reclassify your deduction if they do not agree with you.
The IRS Capitalization v Repairs Audit Technique Guide defines that repairs do not add significant value to the property or extend its life. Repairs are reasonable in amount and are necessary to keep the property in good working condition. Common repairs include repainting a room, fixing leaks, replacing a broken window or toilet, or replacing cracked floor tiles.
On the other hand, improvements materially increase the value of the property, substantially prolong the useful life, or adapt the property to a different or new use. Remodel upgrades generally fall into this category, as does putting on a new roof (rather than replacing a few damaged shingles).
So remember, money spent to make a property last longer or increase its market value is generally an improvement. If the money spent does not add to the life or increase the current value of the property, it is a repair.
