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Real Estate Repairs vs Improvements

Repairs fix something broken. Improvements add value to the property.

When calculating an annual tax bill for a rental property one of the most common mistakes made by investors is to not properly deal with capital improvements to a property vs. repairs or maintenance. Elsewhere on this site we have talked about depreciation and changes in basis on a property but this is a good point to drive home with an additional example.

The thought behind what makes an improvement to a property different than a repair is that an improvement theoretically increases the value of a property whereas a repair simply keeps it in working condition. A repair could also be said to return a property to a prior condition as it was before the item needing repair broke. Improvements, on the other hand, include things like a new roof, new carpets, new appliances, new additions, a remodeled kitchen, etc. Repair items generally are things like a repaired roof (vs. a new one), small sections of damaged carpet replaced, paint, repairs to existing plumbing or electric, repairs to appliances and so forth. Generally we can think of "adding" or "replacing" (improvement) vs. "fixing" (repairs). Repairs are usually of a smaller dollar amount as well, but not always.

Why this difference is important to us is that repairs are treated as a direct expense of the rental property and improvements are not. If we spend $500 to repair something then that is an expense that comes off of our rental income at tax time. If we buy a $500 stove for our rental unit, that is not deductible in the year purchased. The $500 spent on the new appliance gets deducted over the life of the item, in the case of a new stove - five years. Again, even though we spent the $500 this year we only get to deduct the purchased item over its five year useful tax life, approximately $100 per year in this example.

There are methods to "accelerate" this depreciation to a shorter time frame in a lot of cases but the principle remains the same. Repairs are a true expense and therefore deducted from this year's income. Improvements may be paid for this year but are deducted over the tax life of the improvement.

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Disclaimer -- Legal and tax information is not legal or accounting advice.

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