The dishwasher broke: again. This is the fourth time in two years your tenant has called to report this issue. It’s not the tenants; they are using it within common household guidelines, and you’ve had no other issues with your renters to suspect otherwise. The question is, do you repair it for the fourth time? Or do you replace it? And what are the tax consequences of each?
Repairing versus improving a rental property considerations go beyond initial cost considerations; it also can reduce or increase your tax burden. The Internal Revenue Service (IRS) offers guidelines to determine whether work done to real estate rental property is considered a repair or an improvement.
Repairs are defined as something that keeps property in working condition. Calling Handyman Fred out to fix the abovementioned dishwasher is considered a repair to the IRS. Repairs are a business expense and are fully deductable in the tax year the repair was made. Handyman Fred’s $100 charge for labor is $100 off your tax burden[u1] .
Improvements are generally defined as something that increases the overall value of the property. Examples include:
- expansion/new construction
- substantial rebuilding
It is considered a capital outlay by the IRS. The IRS applies different rules to expenses used to purchase or create something “having a useful life substantially beyond the tax year” according to Terry Myers, J.D. and Dee DeScherer, J.D. The IRS considers repairing the broken dishwasher to be a maintenance expense, and the expense is directly deductible against your profits in the current year. But Ripping out the old dishwasher and installing a new appliance is considered an improvement – and so falls under different rules. Handyman Fred charged you $500 for the dishwasher and installation. That $500 gets added to your tax basis in the property. Under MACRS rules, you normally depreciate the dishwasher over a period of five years.
Which Option to Choose?
Are you going to repair or are you going to improve your property? First, reflect on how long you are going to own this property. If you’re planning to sell, consider the following questions:
- Will you own it long enough to depreciate the
full value of the improvement?
- Will the new market value substantially increase
your capital gains taxes?
- Will you roll the property over into a 1031
exchange to avoid paying the capital gains taxes?
If you are planning to keep the property,
- Will the repair hold up long enough to keep from
being a headache to you and your tenant?
- Does not replacing the item cause additional
problems? For example, will a broken dishwasher cause water damage to the
subfloor, costing you even more in the long run?
- How does does the cost of repair or maintenance
compare to the replacement/improvement cost?
Note: Keep meticulous records and receipts for all work done to your property, whether repair or improvements. Every dollar you spend in improving the property adds to your tax basis in the property, which can pay off handsomely later when you eventually sell it. Contract with a tax attorney or a Certified Public Accountant (CPA). Let the professionals do the work you hire them for: By hiring a professional you are better able to correctly categorize the work done to your property and therefore take advantage of all possible deductions and depreciation.