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.

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image Planning Reminder
Repairs and Improvements
What if repairs and improvements are unconnected and not part of an overall improvement program? Assume you repair the floors of one story and improve another story by putting in new windows. You probably may deduct the cost of repairing the floors provided you have separate bills for the jobs. To safeguard the deduction, schedule the work at separate times so that the two jobs are not lumped together as an overall improvement program.
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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).


EXAMPLES
1. The cost of painting the outside of a building used for business purposes and the cost of papering and painting the inside are repair costs and may be deducted. A change in the plumbing system is a capital expenditure that must be depreciated under MACRS (42.13).
2. Campbell owned a one-story house that she rented to a tenant. She paid $8,000 to repair the roof after the tenant complained of leaks. The contractor she employed removed the existing layers of roof and replaced them with fiberglass and asphalt; no structural changes were made. The Tax Court allowed Campbell to deduct the full amount of the payment to the contractor as an ordinary and necessary repair because the roof replacement merely restored the property to a leak-free condition and did not add to the value of the home.
The Tax Court also allowed an owner of a commercial building with a leaky roof to fully deduct the $52,000 cost of stripping the roof layers, replacing them, and spraying the new ones with foam to prevent future leaks. These were repairs intended to keep the property in working condition and did not extend the life of the building.
3. You buy a dilapidated business building and have it renovated and repaired. The total cost comes to about $130,000, of which $17,800 is allocable to the repairs. The cost of the repairs is not deductible because the entire project is a capital expenditure. When a general improvement program is undertaken, you may not separate repairs from improvements. Both become an integral part of the overall betterment and are a capital investment, although a portion could be characterized as repairs when viewed independently.

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.

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