Repairs vs. Improvements

When you figure your profit or loss from operating the rental property each year, you can deduct the cost of repairs to the rental property. However, any improvements that were made must be depreciated over the improvement’s useful life. How do you distinguish a repair from an improvement?

• Repairs - A repair keeps your property in good operating condition and does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, and replacing broken windows are examples of repairs. However, if the repairs are part of an extensive remodeling or restoration of your property, the whole cost is an improvement.
  
  
• Improvements – An improvement will add to the value of the property, prolong its useful life, or adapt it to new uses. If you make an improvement to a property, the cost of the improvement must be capitalized. The capitalized cost can generally be depreciated as if the improvement were separate property.

There are also special rules that allow routine maintenance to be expensed rather than capitalized and depreciated, where a taxpayer reasonably expects to perform the routine maintenance expenses more frequently than once during a ten-year period. Small taxpayers, those with $10 million or less average annual gross receipts in the three preceding tax years, can elect to currently deduct, rather than capitalize amounts paid during the tax year for repairs, maintenance, improvements, and similar activities performed on an eligible building that does not exceed the lesser of $10,000 or 2% of the building's unadjusted basis.

In addition, there is a partial disposition election that allows a taxpayer to report gain or loss on the disposition of a partial asset such a roof, AC system, etc. However, if the partial disposition election is made, the replacement must be capitalized, even if otherwise deductible.

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