How Are Real Estate Repairs and Improvements Handled?

Jul 13, 2022

Real estate is tricky and is usually treated much different than a typical business. This is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

In this post we are going to specifically be discussing the difference between repairs and improvements and why it is important to you in your rental property journey.

At a very basic level, real estate repairs you expense immediately as they occur and improvements are capitalized and depreciated.

What Are Real Estate Repairs and Maintenance?

Basically repairs and maintenance are things that keep your property in normal operating condition. These items do not materially add value to your rental or prolong the life of the property.

Think of things like: painting, repairing flooring, fixing leaky plumbing, repairing appliances, etc.

The great thing about repairs and maintenance is that you can expense them immediately and you do not have to worry about depreciation (or depreciation recapture).

What Are Real Estate Improvements?

Improvements add value to your property or prolong the life of the property. Improvements go further beyond repairs.

Think of things like: additions (deck, new room, etc), entire room renovation, new windows, new appliances, landscaping, etc.

If an item falls under an improvement you need to capitalize the costs for that and then depreciate which would also make it subject to depreciation recapture should you sell the property.

The tax law has three main types of improvements:

  • Betterment: Increase the property's value, efficiency, strength or quality. 
  • Restoration: Return property to ordinary condition after its fallen into a state of despair or afters its class life.
  • Adaption: Converting property into something different (new use).

How Do I Turn Spending Into Repairs vs Improvements?

As discussed above in general we would rather have our spending classified as a repair vs an improvement because we can expense it right away without having to worry about depreciation and we also avoid depreciation recapture in the event of a sale.

However, it is not always 100% clear on how the spending should be treated so here are some ideas.

  1. Separate Repairs from Improvements
    • Request separate invoices for repairs vs improvements and ensure the contractor is labeling it as repairs.
    • Use separate contracts and/or contractors for repairs vs who you use for improvements.
  2. Repair vs Replace When Possible
    • Examples Include:
      • Repair flooring in your rental vs replacing it all. 
      • Repair windows vs replacing and putting in all new windows.
      • Etc.
  3. Use Similar Materials as the Prior When Repairing

The IRS also has a few safe harbors that help make this determination easier. With-in our Tax Minimization Program we dig deeper into these as they are a little lengthy to include in the discussion here. These include:

  • De Minimis Safe Harbor for Tangible Property
  • Safe Harbor for Routine Maintenance
  • Safe Harbor Election for Small Taxpayers

At the end of the day we need to be sure we are fully analyzing the spending on rental properties and ensure we are treating it properly. Generally stating we would prefer repairs (expense immediately) over improvements (depreciate over time).

Again, this is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

We also have a full section in our Tax Minimization Program specific to strategies around rental properties!

 

The Time Is NOW To Start Paying Less In Taxes. Join Our Tax Minimization Program (w/ Stress Free Bookkeeping Training)!

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  • Library of Tax Strategies, Implementation Guides, Videos, Downloads, etc.
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