Maintaining your rental property is a given. From minor repairs to major renovations, these repairs and improvements can be deducted from your taxable income. The key is knowing the difference between a repair and an improvement. Repairs can be fully deducted in the year you experienced it. Improvements, however, must be depreciated over multiple years.
Repairs: This includes expenses that maintain your property in its current condition. For example, let‘s say high winds blew off a section of your roof, and the accompanying rain leaked in, creating water damage in the family room of your rental.
You must replace the missing shingles or tiles, and water damage. It may include new drywall/paint in a portion of the family room. All of this is returning the home to its condition before the storm hit, and therefore a repair.
Improvements: On the other hand, what if the lost shingles reveal an issue in the entire roof, or at least enough of it that rather than repairing the storm-damaged section, your wisest choice is to replace the roof. Now you have increased the life expectancy of the roof and the value of your property, which is classified as an improvement. Likewise, inside –perhaps it makes more sense to gut the room and replace all the drywall, rather than the damaged section. Once again, you have stepped up from repair to improvement.
The definition between repairs and improvements can sound simple, but it can get complicated. While cost can be an indicator, it‘s not the bottom line. For example, repairing those damages from the storm might be somewhat costly, but still a repair. On the other hand, let‘s say you replace the kitchen flooring that had been in the property for years and needed to be updated. It may cost less than the roof and water damage, but it would still be an improvement.
One way to ensure you are classifying expenses correctly, is to use the BAR acronym. The IRS defines improvements as anything is a –
Betterment
Adaptation
Restoration
Betterment – anything that makes your rental better – including fixing a pre-existing condition. (remember the roof damage that revealed a more serious issue involving the entire roof). Making your home better would also include any activity that expands the size (for example, a room addition or even a carport) or improves your property’s quality, quality, or capacity.
Adaptation – alters the property from when you purchased it. For example, let‘s say you purchased a two-story single-family home. You closed off the stairway from the inside, then added an exterior door to access stairs from the outside and created an upstairs and downstairs unit. You have now adapted the original use of the property.
Restoration: Substantial structural repairs that improve the value of your rental (remember drywalling the entire family room vs. the water-damaged section). It also includes items such as flooring, new windows, replacing your HVAC system. While these aren‘t structural, they do increase the quality and value of your property.
To help you understand the difference between repairs and improvements, here are some examples.
The glass in the exterior door cracks
Repair: replacing the glass and repainting the door – even putting on a new handle
Improvement: Replacing the entire door and frame
An appliance is malfunctioning
Repair: Paying a service to fix the issue
Improvement: Replacing the appliance
A toilet keeps running, and the plumbing is leaking beneath it
Repair: You replace the leaking pipe and the toilet and repair the water damage
Improvement: You replace all the bathroom plumbing, including the sink and shower.
Be sure to keep all your receipts for both repairs and improvements. When you decide to sell the property, depreciated items must be documented.
The IRS is not entirely merciless. Safe Harbor rules have been established to help property owners bypass the repair vs. improvement scenario and deduct specific improvements in certain situations as repairs. We will discuss these in our next article. Remember, as a property management company, we are merely providing a helpful overview. For specific details regarding your taxes, consult your tax accountant. Meanwhile, if you need any assistance with your rental properties, the team at Rentals America is ready to help. We offer a variety of services and can customize a package that‘s right for you.
About Rentals America
Rentals America provides full-service property management for residential rental properties. Our team is completely dedicated to property management and we’re here to help landlords navigate the rental market.
