When renting or leasing a property, it is very likely that you will incur expenses, including regular expenses, such as repair and maintenance expenses, or capital improvements. Even if you decide to get a home warranty, understanding the difference between the expenses that may be incurred and their tax implications is important.
Repair and maintenance costs refer to expenses incurred from work done to fix existing damage or prevent an asset from deteriorating. Repairs and maintenance are targeted at getting an asset to its original state for optimal working conditions.
On the other hand, capital improvements refer to expenses incurred when work to improve the overall condition and appearance of a property is done. Capital improvement generally seeks to optimize the value, function, and lifespan of a rented or leased property.
Understanding Capital Improvements
Capital improvement refers to an overall improvement or permanent change to a property that improves its appearance and value. In other words, a property’s appearance is changed or something is replaced. For example, a garage can be converted into an additional bedroom or living space. Another example on a smaller scale is discovering leaky taps and replacing them rather than repairing them.
According to the Internal Revenue Service (IRS), capital improvements must exceed more than a year of completion and exhibit durability. Capital improvements vary as individual homeowners and multi-property owners can improve infrastructure.
It is important to note that capital improvements always work to increase the value of a property. As such, always ask yourself if a repair or maintenance will improve the overall value of a property or keep it at its original value.
Understanding Repair and Maintenance Expenses
Repair and maintenance expenses refer to costs incurred from repairing or servicing an asset to ensure they remain in good working condition. Repair and maintenance are usually one-time expenses and include painting, servicing HVAC systems and air conditioners, repairing a plumbing issue, and replacing a broken window or cabinet door. It even includes payment made to a professional to inspect and maintain certain appliances.
Can Repairs and Maintenance Be Capitalized?
Based on Generally Accepted Accounting Principles (GAAP), repair and maintenance expenses must be recorded and reported on your financial statements at the time incurred.
Because repairs and maintenance only enhance efficiency and do not improve the value or prolong the lifespan of an item, the expenses should not be capitalized. However, repair or maintenance can be capitalized when an item's parts are repaired or purchased at above $5000 as this increases its value. In such cases, all details of the repaired or replaced parts must be reported in the financial statement.
Tax Consequences of Capital Improvements vs. Repairs & Maintenance?
According to the IRS, special tax treatments are often granted to capital improvements. Since capital improvement increases the value of a property, the IRS will not let you deduct the entire expense for improvements in a single year. Since capital improvements depreciate gradually, you might be required to track and deduct the improvement cost over a period.
In the case of maintenance and repairs that do not improve the overall value of an item or property, the IRS considers such costs to be expenses. This means landlords can deduct all of these costs in a single year.
It is important to always be prepared with detailed records of repairs, maintenance, and capital improvements in the event of an audit.
Key Differences Between Capital Improvements and Repairs & Maintenance
The key differences between capital improvements and repair and maintenance rely on two major factors: their classification and tax implications. These differences are outlined below.
Repairs and Maintenance
Classification:
- Restores property to its original condition
- Repairs property to restore its normal operating condition
- Preserves property through routine maintenance
Tax Implication:
- The IRS allows landlords to deduct all repair and maintenance costs in the same calendar year
Capital Improvements
Classification:
- Improves the lifespan of the property
- Adds value to the property or item
- Makes the use of the property flexible
- Enhances efficiency, capacity, or productivity
Tax Implications:
- The IRS will not allow you to deduct the entire cost of the improvement in one tax year
Final Thoughts
Understanding the difference between repairs and maintenance and capital improvements is quite tricky. This is why you must keep track of all your expenses and record them in your financial statements.
A professional tax consultant or property manager can help you when facing tax issues related to capital improvements or repairs and maintenance. You can also keep an eye out for some good home warranties that could help out with repairs and maintenance as the need arises. Start by checking out companies like Choice Home Warranty and First American Home Warranty.
