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Capital Improvements Vs Repairs: Are They Both Tax Deductible?

If you own a home or any kind of property, repairs are inevitable. You might even decide to make some improvements to it as the years go on, like adding a deck out front or changing your roof to be more storm-resistant. What you may not know is that these “capital improvements” can actually be tax deductible. Whether you’re a homeowner or rental property owner, any remodeling projects you’re considering to increase the value of your property may be eligible for deductions. We’ll break down which improvements and repairs can be deducted from your taxes and answer questions like is painting a capital improvement and how does the IRS classify repairs vs improvements. We’ll also discuss how rental property improvements can be depreciated.

Table of contents

Key takeaways...Read more

The capital improvement tax deduction...Read more

Is painting a capital improvement?...Read more

Capital improvements vs repairs...Read more

Depreciating capital improvements...Read more

What is the de minimis safe harbor rule for rental property?...Read more

How does the leasehold improvements depreciation work?...Read more

Save these tax documents when depreciating capital improvements...Read more

Key takeaways

Capital improvements can be taken as a tax deduction using depreciation by homeowners and rental property owners.
Repairs can be deductible if classified as a business expense.
The leasehold improvements depreciation allows a lessee to make changes to the leased property and claim it on their returns if they pay for it.

The capital improvement tax deduction

Capital improvements not only increase the market value of your property but also extend its lifespan. Additionally, they enable your home to adapt to changing circumstances, making it more versatile and accommodating for your lifestyle. The IRS has a list of capital improvements, which include a broad range of renovations. Some capital improvement examples are adding an extra living space, creating a home office or incorporating green technologies.

Infographic entitled Capital Improvements Examples taken from the IRS list of capital improvements.

Some capital improvements can be tax deductible, in a way. While you can’t deduct the expenses itself, you can deduct home improvement costs from the capital gain you’d earn if you ever sell your home. This can, in turn, reduce your capital gains taxes. Remember that the capital improvement tax deduction for your home can only be claimed once the property has been sold. Home improvements can increase the “cost basis” of your home, which is just a fancy term for its purchase price and its associated fees. When you sell a home, you might have to pay capital gains taxes based on the gap between the sale price and the cost basis. So, by making capital improvements, you can lower this tax burden since it raises the cost basis of the home.

Is painting a capital improvement?

Painting is generally not considered a capital improvement example. Capital improvements typically involve more substantial and permanent changes to a property, while painting is often considered a regular maintenance or cosmetic upgrade rather than a capital improvement. It's an expense incurred to maintain the property's appearance and protect it from wear and tear, but it doesn't typically increase the property's value or become part of the cost basis for tax purposes.

Capital improvements vs repairs

It can be difficult to distinguish between capital improvements vs repairs. While they may have similar characteristics, repairs aren’t usually tax deductible. To clear things up a bit, the IRS has come up with a bunch of rules that explain how you can figure out the difference between them. An expense can be classified as an improvement if it falls under any of the following categories:

Adaptation
Betterment
Restoration

If you change your property to serve a new or altered function that doesn't align with its original intended use, the costs associated with these alterations can be considered as adaptation expenses, and you can write them off. You would generally have to depreciate this type of expense. For example, if you lower the countertops in a kitchen to make it more accessible for a family member in a wheelchair. An expense is considered to be a "betterment" if it deals with a significant issue or flaw in the property. It involves making a substantial addition to the property, like physically enlarging or extending it. Or, it noticeably enhances the property's capacity, productivity, or overall quality and is at least semi-permanent. A “restoration” expense brings a property that was falling apart back to its normal working condition. It can also make an old property look brand new after it's lived its useful life. Replacing a big part of the property or fixing some damage to the property also counts. Repairs can include minor fixes like:

Painting a room
Fixing a broken window
Filing a hole in the wall
Replacing a smoke detector

You can’t usually deduct these from your taxes. However, any repairs stemming from a natural disaster can be written off if you itemize your personal expenses on your income taxes. The disaster has to be federally recognized, though. Additionally, repairs made to rental properties can be tax-deductible, as they count as a business expense. So, if you’re an Airbnb host and need to replace some cracked floor tiles in the kitchen of your property, you can deduct that cost from the rental income you receive. You should report it on Schedule E and then on Schedule 1 as an income adjustment. You can also use a 1099 tax calculator to find business deductions to write off.

Infographic entitled IRS Guide To Repairs vs Improvements listing the differences between the two expenses.

Repairs can also be tax deductible if they’re part of a capital improvement project. Suppose you're in the process of renovating your kitchen, which involves more than just installing new cabinets. You also have to address a persistent issue with a leaky faucet. Usually, the expense of repairing the faucet wouldn't qualify for a tax deduction. However, if the kitchen renovation project is considered a deductible capital improvement, the faucet repair cost may become eligible for deduction. Apart from making capital improvements to increase the cost basis of your property, you can also deduct capital improvements made for medical purposes. For example, if you're making home improvements to support your health (or your spouse or kids), there's a chance you can use them to catch a break on your taxes. So, what home improvements count? You can deduct things like adding handrails, ramps, widening a room entrance or hallway, anything that makes life easier and safer for someone with health issues. Say you add a chairlift to your home to help your elderly parent. If this addition boosts your home’s value, you can deduct the increase from the cost of the project. The difference can be counted as a medical cost and can be deducted from your taxes, too! Make sure the cost exceeds 7.5% of your AGI, though.

Depreciating capital improvements

According to the IRS, improvement expenses have to be capitalized and written off throughout the property or asset’s useful life. So, can building improvements be depreciated? Yes, improvements to buildings, like adding a parking lot or revamping the lobby, are considered to be a capital improvement and therefore tax deductible. Let’s use a real-life example. Say you’re a landlord who owns a residential rental property. You decide to make significant improvements to your property to increase its value and attract more tenants. You spend $30,000 on renovations, including upgrading the HVAC, installing a new roof and completely remodeling the kitchen and bathroom. These improvements are considered capital expenditures and, therefore, can be depreciated. The standard depreciation period for residential rental property is 27.5 years, so you calculate the annual depreciation expense.

30,000/27.5 = $1,090.91/year

So, for each year, you can deduct $1,090.91 as depreciation on your federal tax return. This is why it's essential that you make the distinction between capital improvements vs repairs, as it can have a significant impact on your taxes.

What is the de minimis safe harbor rule for rental property?

If you’re struggling to understand how to differentiate between capital improvements and repairs, the IRS has a solution, and it comes in the form of the “de minimis” safe harbor rule. Instead of being depreciated, rental property improvements under $2,500 (per invoice) can be deducted in the year it was incurred. This lets you take minor expenses as tax deductions without needing to track them over a longer period of time.

Infographic entitled De Minimis Safe Harbor Rule for landlords taking the rental property improvements depreciation.

How does the leasehold improvements depreciation work?

Leasehold improvements are any modifications made to a rental property to meet a specific tenant's requirements. It's important to note that the costs for these improvements can be covered by either the landlord, tenant or shared between the two. Similar to how rental property improvements depreciation works, leasehold improvements can also be depreciated, usually with the MACRS (Modified Accelerated Cost Recovery System) method, by whoever foots the improvement project bill. Imagine you’re a small restaurant owner who leases a commercial space for your business. The space you rent is pretty basic and doesn't meet the needs of your restaurant. So, you decide to invest in leasehold improvements. You hire some contractors to make significant changes to the rented space. These improvements include building custom kitchen counters, installing professional-grade appliances, and upgrading the plumbing and ventilation systems. You also invest in creating a dining area with new fixtures, flooring and lighting. The lease agreement specified that you are responsible for the leasehold improvements, which become part of the leased space. Over the years, you depreciate the cost of these improvements on your returns over the useful life of the capital improvements. Not all changes count as leasehold improvements. If an upgrade applies to only one tenant, it doesn’t count for anyone else, even if they're in the same building. Things like sprucing up the exterior of a building, such as landscaping or fixing the parking lot or roof, can’t be claimed. And even upgrades on the inside, like a new elevator or a super-efficient HVAC system, don't make the cut either. Why? Because these changes don't really make life better for just one tenant – they improve the building itself.

Save these tax documents when depreciating capital improvements

Taking the capital improvements tax deduction involves maintaining good records throughout the tax year. This is a good practice regardless of whether you’re paying income taxes or self-employment taxes.

Infographic entitled Records You Need For The Capital Improvement Tax Deduction listing the documents to save for the depreciation deduction.

You’ll need to save most of these documents until you’ve fully written off the capital improvement expense. In other words, you’ll need to keep it until the end of your property’s useful life. Keep the following documents:

Receipts and invoices of the improvements: They should also detail the costs, the date of the expenses, and the nature of the improvements.
Contracts: If you hired contractors or professionals to carry out the improvements, keep copies of those contracts or agreements.
Permits and Approvals: If the improvements require permits or approvals from local authorities, keep copies of these documents to show that all the work was legal and conducted in compliance with the regulations.
Before-and-After Documentation: Photographs or any visual records of the property before and after the improvements to show the impact of the improvement.
Financial Records: Bank statements or canceled checks
Depreciation Schedule: Keep a record of the depreciation schedule you use for the improvements, including the depreciation method (like MACRS) and the recovery period (e.g., 27.5 years for residential rental property).
Tax Returns: Copies of the tax returns in which you claim the depreciation deductions
Correspondence: To be extra careful, keep any correspondence with tax authorities or professionals related to the capital improvements and/or depreciation deductions

If you’re a business owner, you can use FlyFin and get unlimited tax support from CPAs who can guide you through these depreciation deductions. A.I. can also find business expenses that you can write off, and built-in tax calculators can total your estimated taxes and SE tax liability.

Office Supplies Tax Deduction

Office supplies are tax deductible for self-employed individuals and can be reported under the office expenses category on Schedule C.