Repairs vs. Capital Improvements Worksheet
Download REI Grove’s repairs vs. capital improvements worksheet to track rental property expenses, separate repairs from improvements, and organize records before tax season.
Key Takeaways
- Repairs and capital improvements are both common rental property expenses, but they are treated differently for tax purposes.
- Repairs generally restore something to its original or usable condition, while capital improvements increase property value, adapt it to a new use, or prolong its life.
- By using this worksheet, rental property owners can keep clearer expense records and make tax preparation easier for themselves and their tax professionals.
- REI Grove’s worksheet organizes expenses into two main categories: repairs and capital improvements.
Comparing Repairs and Capital Improvements in Real Estate
Investing is all about managing your money. The most successful investors and rental property owners are organized and knowledgeable about where their money is going and how it is used in their business.
Tax deductions are a vital tool in the money management process. While it's always a good idea to hire a tax professional to take advantage of all the deductions you can, you must first categorize your spending to help that professional help you.
So, where do you start? A critical part of preparing for tax season is deciding which expenses are repairs and which are capital improvements. This is because these expenses are classified and treated differently on your tax return: repairs can be deducted in the same year they were incurred, while improvements must be depreciated as capital over time.
What's the Difference Between Repairs vs Improvements?
Rental property owners incur many expenses throughout the year, including the following and more:
- New drywall
- Plumbing
- Roofing
- Pipes
- Security systems
Some of these expenses are repairs and some are improvements.
While differentiating between these terms may seem unnecessary for everyday purposes, it's important to know what actions fall under each category come tax season.
By tracking how much money is spent in each of the following categories, you can clearly distinguish the operating and capital expenditures related to your investment property and avoid an IRS audit.
What Does the Repairs vs. Capital Improvements Worksheet Cover?
REI Grove’s repairs vs. capital improvements worksheet is organized into two expense-tracking sections. Each section gives rental property owners space to record the date, expense, and amount for each item, then calculate a total.
This worksheet includes:
- Repairs
- Capital improvements
- Expense dates
- Expense amounts
Section 1: Repairs
Repairs and Maintenance
Rental property repairs and maintenance are both types of operating expenses. They are classified and treated similarly on your tax return.
Repairs
Repairs are necessary to restore a system or asset to its original condition. You probably know examples of repairs already— repairing holes in the wall, replacing faulty wires, or filling cracks in windows or doors all fall under this category.
Repairs typically do not increase the value of the residential rental property. Instead, repairs simply restore the property's systems to their previous working state.
Maintenance
When you hear the term "maintenance," think prevention. You conduct maintenance on certain aspects of your property to prevent the damage or decline of certain systems. Landlords should be conducting annual inspections on their properties and perform regular maintenance of major systems like plumbing, HVAC, and electric. Routine maintenance expenses could also include lawn care, repainting, or snow and leaf removal.
Classifying Repairs and Maintenance
If you want to be sure that your repair or maintenance expense is truly an operating expense, you can verify that it meets the IRS criteria for operating expenses:
- Ordinary and necessary
- Current
- Directly related to rental activity
- Reasonable
Ordinary and necessary expenses are expenditures that help your rental business in one way or another. For example, insurance, supplies, and advertising fees all could count as ordinary and necessary expenses.
Current expenses are those that benefit your rental business for less than a year. The expense must be something that you use often until it is used up or otherwise made obsolete before the year ends. You can consider preventative maintenance or cleaning fees as current expenses since the benefits likely won't last beyond a year.
Operating expenses must also be directly related to rental activity, and not something bought for personal use. If you use your office for both personal and rental activities, you can only deduct a portion of the office rent from your taxes since it is not directly related to rental business. Similar rules apply for personal property that you occasionally use for your rental business.
Finally, the expense must be reasonable in amount. Any expense is considered reasonable unless there is a significantly cheaper way to achieve the same result.
The operating expenses formula amounts to the total of all your rental property expenses that meet the above criteria. There are more technicalities on these rules set out by the IRS, so be sure to do more research or consult a tax professional before instating these rules on your taxes.
Section 2: Capital Improvements
What are capital improvements?
A real property capital improvement extends the life of an asset or improves its value. In contrast to repairs, they typically involve adding new components, renovating extensively, adapting the property to a new purpose, or significantly prolonging the life of your property.
For example, entirely replacing the fencing on a property could be considered a capital improvement because you're permanently improving its value. Additionally, if you were to install central air-conditioning in a property that did not have it previously, that's a capital improvement. Adding AC improves the value of the property.
Classifying Capital Improvements
For identifying capital improvements, the IRS provides the BAR rule as a helpful tool. BAR stands for betterments, adaptations, and restorations. Any expense that falls into one of these categories is a capital improvement:
- Betterments add value to the property by correcting defects, expanding it, or increasing its strength.
- Adaptations change the property to a new or different use.
- Restorations significantly prolong the life of the property, returning to like-new condition.
Additional Considerations
There are a few more things to look out for when classifying which expenses fall under which category.
Some maintenance and repair projects may snowball into capital improvements. For example, maybe you begin a project thinking you're repairing a simple roof leak only to find out that you will have to replace the entire roof. At that point, a full roof replacement is classified under capital improvements—a new roof increases the value of the property.
If you end up fixing a building system or enlarging the building's capacity and end up improving the energy efficiency of that building, the repair becomes a capital improvement according to the IRS. Capital improvements also include reconstruction of a building once it has reached the end of its economic life.
Repairs vs. Capital Improvements Worksheet at a Glance
| Category | Repairs and Maintenance | Capital Improvements |
|---|---|---|
| Purpose | Restore or maintain existing property components. | Improve, expand, adapt, or significantly restore property components. |
| Effect on Property Value | Generally does not increase property value. | Generally increases property value or extends useful life. |
| Examples | Patching walls, fixing wiring, cleaning, inspections, lawn care, repainting. | New roof, kitchen renovation, new fencing, central air installation, additions. |
| Tax Treatment | Typically treated as operating expenses. | Typically treated as capital expenditures. |
| Recordkeeping | Track date, expense description, amount, and total. | Track date, expense description, amount, and total. |
Tax Implications
Your rental property expenses must be properly categorized on your tax return each year to be compliant and avoid an audit.
As mentioned, repairs and maintenance are operating expenses. Improvements are classified as capital expenditures. The IRS has published rules on their website laying out the technicalities and guidelines for these processes.
Repairs and maintenance can be deducted from your taxable income in the same year you incurred them. However, improvements cannot be deducted for the year they were conducted. Improvements must be depreciated over the lifespan of the improvement (the size of these depreciation deductions depends on the type of improvement). If you have questions about capital improvements vs repairs or the technicalities and steps required for depreciation of an improvement over its recovery period, consult a tax professional.
Conclusion
Extending the life of your property should be one of your main considerations as a rental property investor. Repairs, maintenance, and capital improvements all increase your tenants' satisfaction as well as your potential for a higher ROI. However, all these expenses must be properly categorized to take advantage of relevant deductions and save the most on your taxes, which pairs well with REI Grove's tax prep checklist.
Download REI Grove’s Repairs vs. Capital Improvements Worksheet to help you navigate this complex categorization process.
FAQs
What is a repairs vs. capital improvements worksheet?
A repairs vs. capital improvements worksheet is a tool rental property owners can use to track repair expenses and capital improvement expenses separately.
What does the worksheet include?
The worksheet includes sections for repairs and capital improvements. Each section lets users record the date, expense, amount, and total.
What is a repair in real estate?
A repair restores something to its original state or returns it to a basic, usable condition. Examples include patching a hole in the wall or replacing a few roof shingles.
What is maintenance in real estate?
Maintenance is routine upkeep that helps prevent damage or decline. Examples include inspections, lawn care, repainting, snow removal, plumbing maintenance, HVAC maintenance, or electrical maintenance.
What is a capital improvement?
A capital improvement increases the value of the property, adds new components, adapts the property to a new purpose, or significantly prolongs its life.
What are examples of capital improvements?
Examples include adding a sunroom, renovating a kitchen, replacing an entire roof, replacing fencing, or installing central air-conditioning in a property that did not previously have it.
How are repairs treated differently from capital improvements?
Repairs can generally be deducted as operating expenses in the year they are incurred, while capital improvements must generally be depreciated as capital expenditures over time.
What is the BAR rule?
The BAR rule refers to betterments, adaptations, and restorations. Expenses that fall into one of these categories may be classified as capital improvements.
What should landlords do if an expense is unclear?
Landlords should save documentation, review IRS guidance, and consult a tax professional if they are unsure whether an expense should be classified as a repair or capital improvement.
Why should landlords track repairs and capital improvements separately?
Tracking repairs and capital improvements separately can make tax preparation easier, support better financial records, and help landlords give clearer information to their tax professionals.