Before you make changes to your rental property, you need to first figure out if the change is a repair or an improvement. You need to know this because each has its own tax handling, which will have an effect on your bottom line:
- Repairs are a major rental property deduction and keep the rental property in an efficient operating condition, according to the IRS instructions for Schedule E. A repair is a routine maintenance expense that restores the property; it doesn’t add value to the property or extend its useful life. You can usually write repairs off in the current year.
- Improvements add value or extend the useful life of a rental property. You can’t immediately deduct improvements to your rental property. Instead, you’ll depreciate them over 27.5 or 39 years.
We’ve made a table to help you figure out which category your costs might fit into.
Repair | Improvement | |
|---|---|---|
Roofing | Replace damaged shingles | Replace roof |
Flooring | Refinish hardwood floors | Install new flooring |
Painting | Put a fresh coat of white paint on the walls to brighten the rooms | Repaint the inside and outside of the home after a natural disaster |
Plumbing | Replace a broken toilet | Install a brand-new plumbing system |
Electricity | Install light switches | Upgrade the circuit-breaker |
Heating & cooling | Replace a ceiling fan | Install a new heating, ventilation, and air conditioning (HVAC) system |
Windows | Replace broken window | Replace window unit |
How To Decide if It Is a Repair or an Improvement
To figure out if a cost is for a repair or an improvement, you need to look at the specific facts and circumstances of the cost. To help you decide, follow these steps.
Step 1: Decide if an Exception Applies
Decide if an expense is for materials and supplies or if it falls into one of the safe harbors listed below. If an improvement falls into one of the exceptions, it can be deducted as a repair.
Routine Maintenance Safe Harbor Election
This lets rental property owners expense repairs that they generally make routinely rather than capitalizing those repairs as improvements. This safe harbor is helpful for people who own rental homes, restaurants, or hotels and need to fix their property often to keep it in good shape.
If you are claiming the routine maintenance safe harbor, you do not need to make an election; if you meet the criteria, it is automatically applied. This safe harbor is meant to cover most of the typical repair and maintenance costs that taxpayers deduct.
De Minimis Safe Harbor Election
This allows you to deduct small-dollar costs for buying or producing property that would have to be capitalized. Generally, you can expense up to $2,500 in costs without worrying about whether they are repairs or improvements.
To make this election, you should attach a statement titled “Section 1.263(a)-1(f) de minimis safe harbor election” to the timely-filed original federal tax return, including extensions for the taxable year wherein the de minimis amounts are paid. The statement should include your name, address, and Taxpayer Identification Number, as well as a statement that you are making the de minimis safe harbor election.
Sample Election
Section 1.263(a)-1(f) De Minimis Safe Harbor Election
Richie Rich
1040 Golden Drive, Anytown, NY 10001
123-45-6789
I hereby elect to make the de minimis safe harbor election under Sec.1.263(a)-1(f).
Small Taxpayer Safe Harbor Election
Under this election, you are not required to capitalize as an improvement the costs of work performed on owned or leased buildings that fall into the safe harbor election for small taxpayers. The requirements of the safe harbor election for small taxpayers are as follows:
- You have average annual gross receipts of $10 million or less
- You own or lease building property with an unadjusted basis of less than $1 million or less
- Your total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property doesn’t exceed the lesser of:
- Two percent of the unadjusted basis of the eligible building property; or
- $10,000
- You make the election to use the safe harbor for each taxable year in which qualifying amounts are incurred.
You can make an election for this safe harbor by attaching a statement to your income tax return for the taxable year.
Ryland Richie owns a hotel located at 123 Diamond Avenue, Anytown, New York 10001. The following applied during the 2022 tax year:
- Gross receipts for 2019: $8 million
- Gross receipts for 2020: $5 million
- Gross receipts for 2021: $10 million
- Repairs in 2022: $9,000
Since Ryland had average annual gross receipts of less than $10 million and spent less than $10,000 on repairs during the tax year, she can make the Small Taxpayer Safe Harbor Election under Section 1.263(a)-3(h)(5).
She can make the election by attaching the following statement to her tax return.
Section 1.263(a)-3(h)(5) Small Taxpayer Safe Harbor Election
Ryland Richie
1040 Revenue Drive, Anytown, New York 10001
123-45-6780
I am hereby making the safe harbor election for small taxpayers under Section 1.263(a)-3(h)(5). The election applies to the eligible building property located at 123 Diamond Avenue, Anytown, New York 10001
Step 2: Determine if There Is an Improvement to a Unit of Property
If your expenditure doesn’t meet any of the exceptions above, you need to determine if the cost is for an improvement and therefore must be capitalized and depreciated. In general, property is improved whenever it undergoes a betterment, an adaptation, or a restoration. Let’s look at each.
Betterment
A betterment is any expenditure that improves your property by fixing a preexisting defect, enlarging, expanding, or increasing the capacity, strength, or quality of your property.
For example, you purchased a four-bedroom rental property with a collapsed ceiling in one of the rooms. After purchasing the home, you hired a contractor to fix the ceiling to enhance the quality of the property. This improvement would be considered a betterment because you fixed a material condition or defect that arose prior to the purchase of the rental property.
Adaptation
An adaptation is a significant change to the property, such as a physical enlargement, expansion, extension, the addition of a major part, or a significant increase in the capacity of the property.
Look at the same facts as above as an example. After fixing the ceiling in your new rental property, you decided you wanted to add another bedroom, so you called your contractor and asked him to build a fifth bedroom. This is an adaptation because the change made to your rental property made it bigger. You can now give out five bedrooms instead of four.
Restoration
Restoration costs might encompass anything from replacing a major structural component to fixing up your home after a fire or other disaster to bringing it back to its preloss condition.
Let’s consider the same facts as above. After one year of owning your rental property, a major storm occurred, and a bolt of lightning struck your property and destroyed the fifth bedroom that you had built in the previous year. You decided to repair the room and return it to its previously existing condition.
Step 3: Determine If You’ll Treat the Cost as a Rental Repair vs Improvement
Let’s summarize our determination of the tax treatment of your rental repair vs improvement:
Step 1 | Step 2 | Tax Treatment |
|---|---|---|
Qualifies for an exception | Not an improvement | Repair—unless you make a special election |
Qualifies for an exception | Is an improvement | Either an improvement or a repair |
Doesn’t qualify for an exception | Not an improvement | Repair |
Doesn’t qualify for an exception | Is an improvement | Improvement |
Tax Treatment of Rental Property Repairs vs Improvements
The full cost of a repair can be deducted in one year, but the cost of an improvement has to be depreciated over 27.5 years for residential rental buildings and 39 years for nonresidential buildings.
How To Deduct Rental Property Repairs
You can deduct your rental repairs using one of the following forms:
Entity Type | IRS Form & Line for Reporting |
|---|---|
Individuals (Passive Income) | |
Partnerships & S Corporations (S-corps) |
How To Deduct Rental Property Improvements
You can amortize the cost of your improvements over a period of 27.5 or 39 years. You’ll claim depreciation using IRS Form 4562 to report depreciation starting in the year your rental property is first placed in service, or when any later improvements are made. The rental depreciation on Form 4562 will be carried to one of the following forms:
Entity Type | IRS Form & Line for Reporting |
|---|---|
Individuals (Passive Income) | |
Partnerships & S corporations (S-corps) |
Frequently Asked Questions (FAQs)
Yes, you can ignore the facts and circumstances surrounding the expense and choose to capitalize all repair and maintenance costs as an improvement and recover the cost through depreciation. You must attach a statement to your return stating that you are electing to capitalize repairs.
If you happen to make an error on your tax return and misclassify a cost, you can correct the error by filing an amended tax return.
Bottom Line
Repairs and improvements are two of the largest expenses for landlords and property owners. Knowing how the tax code treats each can save you taxes and avoid an IRS headache in the future.
