9.3 Distinguishing Between a Repair and an Improvement
Maintenance and repair expenses are not treated in the same way as expenses for improvements and replacements. Only maintenance and incidental repair costs are deductible against rental income. Improvements that add to the value or prolong the life of the property or adapt it to new uses are capital improvements. Capital improvements may not be deducted currently but may be depreciated (42.13). If you make improvements to property before renting it out, add the cost of the improvements to your basis in the property.
A repair keeps your property in good operating condition. For example, repairs include painting, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows. However, putting a recreation room in an unfinished basement, paneling a den, putting up a fence, putting in new plumbing or wiring, and paving a driveway are all examples of depreciable capital improvements (42.13). Putting on a new roof is generally a depreciable capital improvement; however, the Tax Court has allowed current deductions for roof replacements intended to prevent leaks; see Example 2 below.
Planning Reminder
Repairs may not be separated from capital expenditures when both are part of an improvement program; see Example 3 below.
IRS regulations distinguish repairs from improvements.
At the end of 2011 the IRS released temporary regulations that attempt to clarify the standards for distinguishing deductible repairs to buildings and structural components from expenses that must be capitalized as improvements subject to depreciation. For example, replacing a roof is treated as an improvement to the building unit that must be capitalized. An improvement to a building system, such as to the HVAC (heating, ventilation, air conditioning), plumbing, electrical, fire protection or security systems, also must be capitalized. The regulations apply to expenses in taxable years beginning on or after January 1, 2012 (Treasury Decision 9564, 12/27/11).
Normal maintenance or major improvement?
Normal maintenance expenses were distinguished from major improvement costs in a case involving a major hotel where improvements and maintenance were generally done at the same time. The operators of the hotel capitalized the cost of the improvements but claimed expense deductions for the cost of painting and repapering rooms. The IRS disallowed the deductions, claiming they were part of the improvement program. The operators claimed that the papering and painting were normal and usual maintenance work required to keep the hotel in first-class condition. The Tax Court disagreed and sided with the IRS. However, on appeal, the appeals court allowed the deduction. The “rehabilitation doctrine” does not apply where it can be shown that repairs are part of a normal range of ongoing maintenance. Here, the painting and papering only served to maintain the first-class status of the hotel. The fact that the work was done under a general improvement plan did not defeat the deduction. Any commercial enterprise, such as a hotel, that annually spends large sums of money on replacements and repairs must do so under a detailed plan and budget.