If you own your own home or income property, you know that hearing the word “repair” can send chills down your spine. Repairs are expensive—but the potential tax deductions can make all the difference. But what if something falls into the category of improvement? Understanding the difference is important.
A repair is typically a fix needed to ensure that the property remains habitable and in excellent working condition. Price matters much less, but (for repairs) generally falls under the $500 mark.
Repairs are great because they’re deductible. They rarely, however, add significant value to the property and do not generally extend the life of the home.
As the name suggets, improvements are a more significant undertaking. Unlike repairs, they increase property value and extend the life of the home. Categorically, they’re a capital expense and must be capitalized and depreciated over many years, which means that only a small portion can be deducted from every tax year.
If something takes a lot of time, labor, or cost, it likely falls into the improvement category. Adding or upgrading items in your property probably falls into the improvement category as well. Improvements add long term value, while repairs focuse on the curent year.
When you sell your home or property, it will be important to know the cost of improvements, as well as their depreciation. Keep copies of records, receipts, and tax returns on file to make this easy.
For tax purposes, let’s look at the categories that define capital expenses.
Improvments: you have to capitalize any expense you pay as an improvement to your rental property—anything that adds value by betterment, restoration, or adaptation.
Betterments: expenses that make your property better include fixes for things on the property, expansions, increases to capacity/strength/quality.
Restoration: expenses for restoration are those such as replacing substantial strutural things, repairs to damage, rebuilding to restore like-new condition.
Adaptation: expenses that alter your property in a way that is not necessarily intended when you began using it as a rental.
If you’re still confused, simply check with the IRS. The website offers a fairly comprehensive look at what counts for what category, lest you make a mistake. Remember that common sense (and the wisdom of the internet) go a long way toward helping you as you prepare to improve or repair your income property.
And, you can always go the way of Jason Hartman and invest in the help of a property manager and investment adviser who will help you sort it all out!
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The Young Wealth Team