As your property management company, we want to bring an important issue to your attention but while reading this article, please remember we are not dispensing tax advice. For that, we urge you to talk to an expert on tax law and investment property if you need to determine the fine line between a repair and improvement.
As an investor, you want to take advantage of as many tax deductions as possible to increase the return on your investments. Maintenance on your property is a viable tax deduction. However, there is a difference between how you can use repairs and improvements in your tax returns. The Internal Revenue Service has defined the difference between repairs and improvements in Pub. 527 and the following two paragraphs provide a very general outline of their definitions.
A repair is what you do to maintain the property. The list of possible repairs is extensive; examples are fixing leaks or faulty electrical, replacing a broken window or lock, cleaning, carpet cleaning, and touch-up painting. During the course of the tax year, you can deduct repairs on your income tax statement.
An improvement adds to the value of your property, prolongs its useful life, or adapts it to new uses.
Instead of deducting an improvement during the current tax year, you must capitalize and depreciate them over time. Here are typical examples of improvements.
- Complete flooring replacement
- Complete roof replacement
- Complete replacement of an air-conditioning and/or heating system
- Major remodeling, such as the renovation of a bathroom, kitchen, or other major building projects
- Additions such as a deck, garage, porch, patio, or family room
The size of the expenditure can trigger a closer look by the Internal Revenue Service to determine whether it is a repair or an improvement. This is not a universal rule but simply common sense, making it even more important to be able to justify the cost of the item in the event you have an audit. There can be a gray area of whether something is a repair or an improvement.
The timing of any maintenance that takes place on a property is also crucial. If you contract any work that takes place before any attempt to rent, consider it an improvement, not a repair. However, the consensus of tax advisers is that if you have the property on the rental market while doing normal repairs, you can deduct them as ordinary maintenance. The key here is to document that you actively marketed the property while repairs are taking place. Otherwise, all repairs before establishing the property as a rental are improvements to capitalize and depreciate.
A natural disaster also may affect the types of expenses you may claim. Again, the definitions of a repair or replacement still apply, as well as if you market the property for rent and/or will continue to offer it for rent. If you are fixing the property to sell, you change the use.
Keep thorough records of all repairs and/or improvements. Again, the best course of action is to consult a reliable tax consultant. They can also advise you of how long you need to keep the records for any possible audits.