If you’re still working on your tax filing for this year or looking ahead to next year’s, you want to understand what the difference is when it comes to deducting a capital improvement on your home versus what constitutes a repair. These are two separate distinctions in the world of tax filing that can have an impact on the value of your deduction.
Here’s what you should know.
What is a Capital Improvement?
To qualify as a capital improvement a renovation to your property has to be one that improves the “useful life” of the home. This is an improvement that will add durability and value to the property across a wider period of time – not just a convenient aesthetic upgrade. Improvements can include a wide range of functional assets that will increase the durability and value of the home.
Here are a few examples:
Additions – such as an added bedroom, bathroom, or even an in-ground pool
Replacements – like a roof, plumbing, electric, or flooring
Renovations – updating a kitchen or bathroom with modern fixtures and appliances
How do I deduct a capital improvement on my taxes?
Because capital improvements build your property value over time, you can’t deduct the full value of the improvement all at once. Instead, deductions need to be made on a depreciation schedule, which tracks the added value of the improvement to your home as it decreases over time.
What this means is that for each year that the improvement adds value to your home, you can deduct a fraction of that value on your tax claims.
For example, if the improvement cost $10,000 and will be of value to your property for a period of 5 years, you can deduct $2,000 per year for those 5 years. This is straight-line depreciation, which distributes the depreciated value evenly across the depreciation schedule. Then, depending on your tax rate, you will see a fraction of that expense in savings each year.
What is a Repair?
The IRS defines a repair differently than an improvement in that a repair does not have to add substantial value to a property or increase its durability. Repairs mostly consist of the needed maintenance you will complete in order to maintain functionality of the property, and chances are you will be deducting these on your tax forms much more often than improvements.
Repairs typically cost much less than improvements, though replacing a broken appliance can be expensive and is still considered a repair.
Here are more examples of repairs:
Painting – putting a new coat in even one room can constitute a repair
Fixing broken appliances – updating old appliances is typically considered a repair rather than an improvement
Conducting usual maintenance – like touching up walls or replacing damaged tiles or floorboards
How do I deduct a repair on my taxes?
Unlike capital improvements, repairs won’t depreciate. The full worth of the repair is immediate, so you can deduct the full value of the repair in the tax year that you made it.
For example, if this repair cost you $10,000, you can claim that entire amount as an expense. Then, depending on your tax rate, you will receive a fraction of that back in tax savings. If your tax rate is 28%, that’s a savings of up to $2,800, making the needed repair not so costly in the long run.
Should I make improvements or repairs? Which is more beneficial?
Every property and tax situation are different, so there is no blanket statement on whether improvements or repairs to your property will be more beneficial to you from a tax standpoint. However, repairs can be deducted in full the year they are made, which can save you money faster. For long-term added value, improvements are what you want to make.
If you are looking to save every last dollar so that you have enough left after your taxes are paid to get by, you want to focus on property repairs rather than improvements. Some property owners make use of a tax loophole when wanting to save money in a given tax year. They will have tenants living in the unit, then make fixes along with upgrades that might otherwise be categorized as improvements. This allows the landlord to defend these upgrades as repairs made for tenant satisfaction.
But despite the lack of immediacy, there are tax benefits in making improvements as well. For a reliable source of tax savings over the next few years while your improvements will be effectively adding value to your property, home improvements are the way to go. You might worry about market changes or instability, but a depreciating home improvement will save you tax dollars over the course of years, making them a useful investment – all other benefits aside.
All told, deciding whether to make improvements or repairs to your property during a given tax year ultimately comes down to your financial situation. For faster savings, make repairs. For reliable savings over time, make the improvements you’ve been considering. And always consult a financial professional when making these decisions to keep your assets working for you.
For more information on property management and real estate investment, contact 208.properties today.