Differentiating Repairs from Capital Improvements to Real Estate by Angie Adames, CPA
Posted on August 13, 2020
by
Angie Adames
There is no doubt the tax laws concerning real estate are complex. One of the more common challenges faced by owners and investors is distinguishing between property repairs and capital improvements. While both can provide tax benefits, an incorrect classification could have significant impact on the amount of taxes you owe.
The U.S. tax code defines repairs as one-time expenses incurred to keep a property maintained and in good operating condition. This can include fixing appliances, air conditioning or a roof leak; cleaning and repainting a rental unit; replacing a few broken windows or tiles; or other activities that do not increase the property’s value. The IRS considers this work to be ordinary and necessary activities required in the general course of carrying out a business and, therefore, allows property owners to immediately deduct the full cost of those repairs in the year they are incurred.
By contrast, capital improvements, including replacing a roof, installing new plumbing or wiring systems, and/or replacing all the windows in a building, can materially increase a property’s fair market value, prolong its useful life or even change the way it is used (i.e. converting a residential building to office space). Under the tax laws, the costs of improvements are considered separate from the property and must be capitalized and depreciated over its useful life, which is 27.5 years for residential property and 39 years for all other types of real estate.
While repairs can be written off much faster than capital improvements, property owners cannot blindly characterize work as a repair because they need a deduction in that particular year. Instead, they should consider the following questions:
- Does the work increase the value of the property?
- Does the work prolong the useful life of the property?
- If the answer to either question is no, will the work result in any future benefit?
As simple as this sounds, it is important to remember that the tax code is complex and constantly evolving with new exceptions to the general rules. Most projects will not fit neatly into one category or the other. There will be a lot of gray areas for which a tax accountant should be consulted to not only plan for a repair or improvement but also to support taxpayers’ claims for deductions or capitalized costs. For example, property owners should keep invoices and receipts for repairs separate from those for capital improvements and consider the timing of those activities to maximize the intended tax benefits. Whether individual repairs are minor fixes or part of an overall plan to renovate and improve a property is another important factor to consider when determine if expenditures can be treated for tax purposes as repairs or capitalized expenditures.
About the Author: Angie Adames, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she provides tax and business consulting services to real estate companies, manufacturers and closely held entities. She can be reached at the firm’s Miami office at (305) 379-7000 or info@bpbcpa.com.
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