Whenever you fix or replace something in a rental unit or building you need to decide whether the expense is a repair or improvement for tax purposes. Why is this important? Because you can deduct the cost of a repair in a single year, while you have to depreciate improvements over as many as 27.5 years. For example, if you classify a $1,000 expense as a repair, you get to deduct $1,000 this year. If you classify it as an improvement, you'll likely have to depreciate it over 27.5 years and you'll get only a $35 deduction this year. Unfortunately, telling the difference between a repair and an improvement can be difficult. In attempt to clarify matters, the IRS has issued lengthy regulations explaining how to tell the difference between repairs and improvements. Implementation of these rules was delayed but they became effective on January 1, 2014. For more details on current vs. capital expenses refer to the article Current vs Capital Expenses. If You are a Landlord

Maximize your tax deductions, including how to deduct repairs and losses, depreciate improvements. Check out Every Landlord's Tax Deduction Guide » Under the new IRS regulations, property is improved whenever it undergoes a: Think of the acronym B A R = Improvement = Depreciate.ideas to hide hvac unit If the need for the expense was caused by a particular event--for example, a storm--you must compare the property's condition just before the event and just after the work was done to make your determination. 1.5 ton ac unit wattsOn the other hand, if you’re correcting normal wear and tear to property, you must compare its condition after the last time you corrected normal wear and tear (whether maintenance or an improvement) with its condition after the latest work was done. pioneer air conditioner split units

If you’ve never had any work done on the property, use its condition when placed in service as your point of comparison. An expenditure is for a betterment if it: An expenditure is for a restoration if it: You must also depreciate amounts you spend to adapt property to a new or different use. A use is “new or different” if it is not consistent with your “intended ordinary use” of the property when you originally placed it into service. To determine whether you’ve improved your business or rental property, you must determine what the property consists of. The IRS calls this the “unit of property” (UOP). How the UOP is defined is crucial. The larger the UOP, the more likely will work done on a component be a deductible repair rather than an improvement that must be depreciated. For example, if the UOP for an apartment building is defined as the entire building structure as a whole, you could plausibly claim that replacing the fire escapes is a repair since it doesn’t seem that significant when compared with the whole building.

On the other hand, if the UOP consists of the fire protection system alone, replacing fire escapes would likely be an improvement. New IRS regulations require that buildings be divided up into as many as nine different UOPs: the entire structure and up to eight separate building systems. An improvement to any of these UOPs must be depreciated. As a result, more costs will have to be classified as improvements, rather than repairs. The entire building and its structural components as a whole are a single UOP. A building’s structural components include: For example, replacement of a building’s roof is an improvement to the building UOP. In addition, the following eight building systems are separate UOPs. An improvement to any one of these systems and must be depreciated: Example: A landlord purchased an apartment building five years ago for $750,000. This year he spends $5,000 to fix wiring in the electrical system. Under the old IRS rules, the $5,000 likely would be considered a repair because it is relatively small compared to the overall cost of the building, which was treated as a single UOP.

Under the new rules, the electrical system is a separate UOP. This means that the $5,000 must be compared with the cost of the electrical system alone, not the cost of the whole building. This makes the expense seem much more significant and likely to constitute an improvement. For the latest IRS rules on repairs and improvements, see IRS Bulletin 2012-14, Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property. Having to make repairs to my rental properties can be expensive. Knowing that I am able to deduct this expense from my taxes makes it a little easier to swallow. The general rule is that the cost of “repairs” incurred to maintain your rental properties may be deducted from each property’s taxable income in a given year. However, some repairs are considered “improvements” in which you’re not allowed to deduct the entire expense immediately. Repairs vs. improvements, so what’s the difference? Repairs are usually one-off fixes that help keep the property in good working condition and habitable.

Although the price is irrelevant, most of my qualifying repairs tend to be under $500 in cost. Whether you’re fixing a hole in the wall, or a unclogging a shower drain, you can deduct the cost of these minor repairs from the current year’s tax liability. The IRS clarifies in the 1040 Schedule E Instructions that “repairs in most cases do not add significant value to the property or extend its life.” Anything that increases the value of the property or extends its life is categorized as a “capital expense” and must be capitalized and depreciated over multiple years. Meaning, you can only deduct a small but even portion of these expenses in the current tax year. Improvements, such as replacing a roof or renovating a kitchen, are usually more labor-intensive than repairs and typically cost substantially more. The good rule of thumb is that if you are adding a new item, or upgrading an existing item, then it’s usually considered an improvement. The assumption is that these improvements will add value to the property over multiple years, not just the current year – and thus why you can’t deduct the entire $20k kitchen renovation in a single year.

Likewise, when you sell a property, you’ll need to know the costs of these improvements and how much each one has been depreciated because you will have to pay taxes on the depreciated amount. This should be easy to track if you keep accurate records/receipts and copies of tax returns. The IRS uses the following categories to help define a capital expense. You are required to capitalize and depreciate the following: Source: IRS Rental Income and Expenses As of January 1, 2014, the IRS has released official guidance regarding deduction and capitalization of expenditures related to tangible property, which add to and clarify the existing understanding of deductible repairs and depreciable improvements mentioned above. According to the IRS, the addition or upgrade of the following items must definitively be capitalized and depreciated over multiple years. Attic, Wall, Floor Insulation Want to learn more? Check out these articles and forms. photo credit: Alan Cleaver, Karl Palutke via cc