Capital Improvements vs. Repairs and Maintenance: What All Landlords Should Know

If you’re a property owner or landlord, understanding the difference between capital improvements vs. repairs and maintenance might feel a bit stressful come tax season.

And that’s before getting into the question of learning how to classify expenses.

You’ll probably ask yourself a few questions, including:

So, are certain expenses tax-deductible on an annual basis, while others aren’t? Or, some expenses lower my tax burden after the property is sold or refinanced, but others won’t? What does it all mean?!

While confusing at times, navigating expense classifications and tax implications is an essential skill you’ll need while sorting through your receipts and invoices. We understand how complicated these topics can feel, so we’re here to simplify them.

To help you make sense of every expense, we will:

• Explain the difference between capital improvement vs. repairs and maintenance
• Define and give examples of each type of expense
• Help property owners learn how to classify each type of expense
• Analyze the tax implications of each classification
• Explore how to use software to stay on top of repairs and maintenance

What is the Difference Between Capital Improvements and Repairs and Maintenance?

Capital improvements are any alteration or addition that permanently raises a property’s value. Maintenance and repairs, on the other hand, are any work that brings a property back to its original state and helps retain its value.

How each expense is ultimately classified will determine whether it’s annually tax-deductible or instead increases the property’s cost basis and associated annual tax depreciation, thereby lowering an owner’s future capital gains tax. We’ll explore each scenario further in the following sections.

Understanding Capital Improvements

Again, a capital improvement is any permanent upgrade, alteration, or addition that increases a property’s value or lifespan. Such costs are classified separately from routine maintenance and repairs that don’t increase property value.

Capital Improvement Examples

• Adding a room or a bathroom
• Renovating a bathroom or kitchen
• Installing a deck, patio, pool, or hot tub
• Upgrading or replacing the plumbing, wiring, or HVAC
• Finishing an unfinished bathroom or attic
• Installing a new roof or windows

Capital improvements are tax-deductible as depreciation expenses yearly. Plus, they add to the property’s “cost basis,” which is the original purchase price, plus any improvement costs incurred during ownership. If and when the owner decides to sell the property, they’ll be subject to a capital gains tax, which is determined by calculating the difference between the selling price and the owner’s cost basis and then taxed at the applicable capital gains tax rate.

Understanding Repairs and Maintenance

Repairs and maintenance encompass all expenses incurred to keep a property functioning as intended. If a given expense isn’t meant to raise a property’s value but instead helps restore it to its previous condition, it falls under the umbrella of repairs and maintenance.

Repairs and Maintenance Examples

• Refinishing worn-out flooring
• Fixing a leaky toilet, faucet, or pipe
• Repainting walls or touching up blemishes
• Cleaning air conditioning and heating systems
• Replacing or repairing a broken garbage disposal
• Routine landscaping and upkeep

Unlike capital improvements, repairs and maintenance expenses are tax-deductible in the year you pay for them and can thus be written off on annual taxes. However, these expenses cannot increase the property’s cost basis and won’t lower the owner’s tax burden once you sell the property.

How to Classify Capital Improvements, Repairs & Maintenance

Not every repair or improvement to a given property is easy to classify. Some expenses may fall into a gray area, leaving property owners, managers, and landlords seeking clarification on whether their expenses qualify as improvements or repairs.

Let’s say a homeowner hires a handyperson to repair a hole in their property’s drywall. The worker then discovers that the insulation behind the drywall is outdated and moldy. As a result, the homeowner asks the handyperson to remove and replace all the insulation with a newer, more efficient type that will lower the property’s heating bills over the long run.

In this example, what started as a routine maintenance request to restore a property’s value (repairing a hole in the drywall) turned into a much larger capital improvement project that increased the property’s value (replacing the insulation).

While the owner may have originally planned on deducting the repair expenses from their annual taxes, the scope of the maintenance changed, and the money spent was no longer eligible to be written off as a standard expense on the owner’s annual tax returns. Instead, the homeowner will depreciate the expense over a period of time as defined in the IRS’ Modified Accelerated Cost Recovery System, or MACRS.

If ever in doubt about expenses incurred while putting work into your property, ask yourself the following:

Did the expense in question help retain the property’s value or raise it? 

• If you spent money to retain the property’s value, you’d generally classify the expense as repairs and maintenance.
• If you spent money to raise the property’s value, you’d generally classify the expense as a capital improvement.

Tax Implications of Capital Improvements and Repairs & Maintenance

As we explained earlier, capital improvement expenses aren’t tax-deductible like typical repair expenses. They do, however, count towards a property’s cost basis and will lower an owner’s tax burden if and when they decide to sell.

And, while value-adding capital improvements aren’t directly tax-deductible, they (as part of the physical property) will depreciate and lose value over time, allowing owners to claim higher annual depreciation deductions on their taxes.

Unlike capital improvements, repairs and maintenance expenses are tax-deductible but cannot be added to the property’s cost basis. Since these routine repairs don’t increase the home’s value, they won’t lower the property owner’s tax burden if and when the owner decides to sell.

Additionally, repairs and maintenance are not considered depreciable expenses and cannot be treated as such.

For more information on depreciation regarding taxes, refer to pages 16-20 on the IRS’s “Selling Your Home” document. Also worth noting, residential rental real estate is subject to special depreciation recapture rules as both residential and commercial rental property is generally classified as Section 1250 property.

Tips to Maximize Tax Deductions

• Track every expense: To stay on top of your expenses, use rental accounting software to organize all maintenance and improvement receipts and invoices to ensure you don’t miss any deductions or additions to your property’s cost basis.
• For short-term tax benefits, maximize repairs and maintenance: Focus on spending money to meticulously repair and maintain your property if you want to lower your annual tax burden.
• For delayed tax benefits, maximize capital improvements: Focus on spending money to upgrade your property and raise its value if you want to lower your capital gains tax burden once you sell.
• Seek professional help if you need help classifying expenses: Nobody wants to get in hot water with the IRS, so if you’re having trouble classifying property expenses, hire a knowledgeable tax professional to help you navigate your options.

TurboTenant’s Role in Property Maintenance and Repairs

You’re in the right place if you’re a landlord searching for a more hands-off approach to maintenance and repairs.

TurboTenant empowers tenants to create detailed maintenance requests. From the tenant portal, tenants can submit maintenance issues, complete with notes and images, so you’re both on the same page. With this tool, you’ll always have a single place to track maintenance requests across all your properties.

Check out some reviews and sign up today to see how TurboTenant can enhance your property management experience.

Disclaimer: This blog is for informational purposes only and is published by TurboTenant. It is not legal, financial, or tax advice. Laws and regulations for landlords vary by state and locality and may change over time. Always consult a qualified attorney, accountant, or local housing authority before making decisions related to your rental property. The publisher and authors assume no responsibility for actions taken based on the information provided.