Many property owners think repair and improvement are somewhat similar. However, the Internal Revenue Service (IRS) says otherwise. As per the IRS, repair involves restoring the property to an operating condition. It does not increase its value or extend its life. On the other hand, improvement means investing in changing the look or adding extensions to the home for aesthetic and more functional purposes.
It is important to know the difference between the two to take advantage of all possible tax deductions, breaks, credits, etc., that can save you money.
What is Rental Property Repair?
Repair is done to keep the property livable and in compliance with the legal requirements. Thus, ensuring all the structural components are in good condition. No matter if you have a small or large property, repairing it when needed ensures its livability. The IRS suggests making timely repairs to ensure everything is in place.
Repair is done to restore the property's condition to its original form. The process involves identifying and fixing any issues to make the condition habitable for tenants. Repair expenses are deducted from the rental property income the year the repair was made.
What is Rental Property Improvement?
When something needs to be changed and does not involve minor or major fixing, it is known as an improvement. Rental property improvements involve improving or enhancing the overall property beyond its original condition. It is mostly done to increase the value of the property and functionality. For example - most homeowners turn their basement into a functional living room to relax or turn their garage into a workspace.
Or, we can say improvement includes making changes to the property to change the structure or look. Additionally, in some jurisdictions, home improvements may be exempted from sales tax and receive advantageous tax status. The expenses of home improvement fall under the category of capital expenditure.
Rental Property Repair vs. Improvements: What's the Difference?
Here's a table of differences showing the comparison between repair and improvement to help understand and classify each change done to the home -
| Repairs | Improvements |
| Replace damaged parts of the roof. | Involves replacing the roof. |
| Refinish hardwood floors. | Involves installing new flooring. |
| Adding a fresh coat of paint to light up the room. | Repainting the home’s interior and exterior. |
| Repair damaged pipes or sinks. | Installing a new plumbing system. |
| Repair a few damages in the electrical wires or system. | Upgrade or install a new electrical system. |
| Replace or make adjustments to the broken air duct, ceiling fan, AC, water heater, etc. | Installing a new HVAC system, in addition to heating and ventilation. |
| Mend a few cracks or damage to the doors and windows. | Replacing the door and windows with a new one. |
IRS Rules of Property Improvement
Under the IRS regulation, whenever a property undergoes an improvement, it must follow the rules as mentioned below -
Betterment
An expenditure is considered for betterment if it -
-
Improves any defect in the property before it was acquired.
-
Leads to property extension, such as the addition of a new room.
-
Results in the increase in durability, productivity, and strength.
Adaptation
An expenditure is considered for adaptation if it -
-
Modifies the building for a new or different use.
-
Remodifies the property (floor or walls) for sale.
Restoration
An expenditure is for restoration if it -
-
Rebuild the property to match its original condition.
-
Replace major components of substantial structural parts of the property.
-
Returns the property to its original state after a certain event (natural or manmade).
What Are the Tax Implications for Rental Property Owners?
It is important to understand the tax implications of rental property improvement and repair. It increases the tax benefits and profits.
Tax Deductible for Rental Home Repairs
Rental home repairs are tax-deductible, but they should not qualify as home improvements. According to the IRS, the work done to fix a flaw or damage to the property to keep it in good working condition qualifies for repair. It may include fixing a leak, repairing a cracked window, repairing pipes, etc. Repair costs can be claimed the same year they take place, which reduces the overall tax liability. Rental repair tax can be deducted using any one of the forms below -
| Entity Type | IRD Form And Line For Reporting |
| Individuals | IRS Form 1040 Schedule E, Line 14 |
| Partnership And S-Corp (S Corporation) | IRS Form 8825 Line 10 |
Tax Deductible for Rental Home Improvement
Home improvement is not tax deductible. Certain work done, such as - painting, updating carpeting, replacing appliances, etc., are not tax deductible. These are qualified as non-necessary actions that are mostly done to maintain or increase the aesthetic of the home. As these do not tend to improve the habitability, they cannot be claimed.
| Notes | Property owners should let the capital improvement cost amortize for 27.5 years. It may not offer immediate benefits, but it reduces tax income every year. You can report depreciation beginning in the year your rental property is put into service or when any improvements were made by utilizing IRS Form 4562. One of the following forms will receive the rental depreciation recorded on Form 4562: |
| Entity Type | IRD Form And Line For Reporting |
| Individuals | IRS Form 1040 Schedule E, Line 18 |
| Partnership And S-Corp (S Corporation) | IRS Form 8825 Line 10 |
What Does the IRS Consider a Unit of Property (UOP)?
It is important to understand what the property consists of, as it helps to determine if the work done is improvement or repair. As per the IRS, these elements are known as Units Of Property (UOP). A component's repair is more likely to be deductible than an improvement that needs to be depreciated if the UOP is higher.
As per the IRS, the building must be divided into nine different UOPs. This includes one building and eight separate structures, and improvement to any of these must be depreciated.
The Entire Building (UOP 1)
The entire building and its components are considered a single UOP, which includes -
-
Fire escapes.
-
Sprinkler system.
-
Windows and doors.
-
Roofs and chimneys.
-
Stairs, escalators, and elevators.
-
Electric wiring and lighting fixtures.
-
All central air conditioning or heating system components.
-
Walls, partitions, floors, and ceilings, in addition to any permanent coverings on them such as - paneling or thinning.
Building Systems (UOP 2-9)
In addition to the elements mentioned above, here are more components of the home that must be depreciated -
-
HVAC (Heating, Ventilation, And Air Conditioning), which includes motors, boilers, compressors, furnaces, chillers, pipes, ducts, radiators, etc.
-
Plumbing systems, which include water and sanitary sewer collecting equipment, pipes, drains, bathtubs, sinks, valves, toilets, and site utility equipment for waste and water distribution.
-
Fire protection and alarm systems, including sprinkler heads, sensory devices, sprinkler mains, associated pipes and plumbing, smoke and heat detectors, fire escapes, emergency exit doors, fire fighting equipment, visual and audible alarms, alarm control panels, etc.
-
Security systems include doors and windows, security cameras, entry and access systems, related junction boxes, motion detectors, recorders, monitors, etc.
-
Gas distribution systems such as pipes and other equipment, that is used to distribute gas to and from the property line and between buildings.
Safe Harbors to Detect Repairs and Improvement
As a property owner or landlord, you can use three "safe harbor" rules to bypass the repair-improvement conundrum. Here are three safe harbor rules set by the IRS -
Safe Harbor for Small Taxpayers
The SHST (Safe Harbor For Small Taxpayers) permits property owners to deduct repair, maintenance, and improvement costs for rental buildings. It is only applicable for properties valued at $1 million or less, along with a deduction limit of $10,000 or 2% of the building's unadjusted basis, which is determined separately for each rental property owned.
The election can be made by attaching a statement to your income tax return for the taxable year in which the qualifying amounts are incurred.
Routine Maintenance Safe Harbor
The routine maintenance safe harbor allows certain expenses to be fully deductible in a single year, even if they appear to be classified as improvements requiring depreciation. Routine maintenance, such as - inspections, cleaning, testing, and replacing worn-out parts, is done to ensure the building is in livable condition.
To qualify for this, it is important to ensure that the maintenance is reasonably expected to occur more than once every ten years. However, this excludes betterments, repairs for deteriorated properties, and restorations. If a property owner is claiming maintenance safe harbor, they don't need to make elections. It is automatically applied if they meet the criteria.
De Minimis Safe Harbor
Labor de minimis safe harbor helps landlords deduct any low-cost property items used in their rental business, no matter if the items would be considered as repair or improvement. It can also be used for personal property and for the components that come under deduction parameters. Landlords can deduct $2,500 per item as per the invoice.
To elect Section 1.263(a)-1(f) de minimis safe harbor, attach a statement with your name, address, and Taxpayer Identification Number to file a federal tax return, including extensions.
Conclusion
Repair and improvements are two huge expenses that property owners and landlords have to bear. Understanding the tax codes and other implications, as mentioned above, can help you save money and comply with the IRS terms and conditions.
