Rental Improvements: Tax Tips for the Highest Deductions

When it comes to tax season, landlords have a lot to think about.

Many landlords leave taxes to an accountant or tax preparation software without bothering to learn specifics. As a result, those landlords lose hundreds of dollars every year. By neglecting to learn about rental tax deduction basics, you might miss profitable deductions and limit your potential tax return.

One tax concept all landlords should understand is how the IRS treats rental improvements. 

Unlike repairs, improvements are not currently deductible in a given year. Instead, they must be depreciated slowly over time.

However, if certain conditions are met, you may be able to deduct your improvements as you would any other operating expense. The key is understanding the tax code and qualifications.

Here are the basics for dealing with rental improvements next tax season.

What are Rental Improvements?

Rental improvements are different than typical everyday repairs. They include any type of maintenance you perform that constitutes a betterment, adaptation, or restoration of property.

Betterments increase the base value of your property. Adaptations add to or change your property in some way, and restorations significantly prolong the useful life of the property.

If your maintenance meets the criteria for a betterment, adaptation, or restoration, it’s considered an improvement for tax purposes.

If you want to sell your property, and make some improvements in your home to get a higher price – consider learning more about the tax implications of selling a house.

How Are Improvements Treated by the IRS?

The tax code requires rental improvement expenses to be depreciated over several years—27.5 for residential real estate.

This contrasts with repairs, which are fully deductible in one year. Repairs are considered everyday operating expenses of your rental business, while improvements are larger investments and therefore considered capital assets.

Deductions are almost always a better deal than depreciations. However, you should learn about depreciation for when you do perform improvements.

Benefits of Preventative Maintenance

To make the most of your tax return, preventative maintenance is crucial. This is because preventative maintenance is always fully deductible each year. 

Furthermore, preventative maintenance sustains the condition of your properties, helping you keep tabs on appliances and building systems. With regular preventative maintenance, it’s more likely that you’ll only need to do repairs throughout the year instead of major improvements. This means you can deduct more of your expenses more frequently rather than waiting for large improvements to depreciate.

Applying the Safe Harbors

Once you’ve identified a project as an improvement, the default option is depreciation. However, before you list it on Schedule E, find out if the expense qualifies for any of the three safe harbors.

The safe harbors allow you to fully deduct improvements that would otherwise have to be depreciated if certain conditions are met. Here is more information about the three safe harbors.

Safe Harbor for Small Taxpayers

The Safe Harbor for Small Taxpayers (SHST) is designed to help small landlords manage the operating costs of their businesses. Under this safe harbor, you may deduct almost any building-related cost so long as you meet three criteria:

  • Size Limit – The value of your improvements must be less than $1 million for each building
  • Expense Limit – Your total annual expenses for maintenance must not exceed either $10,000 or 2% of the unadjusted basis of the building
  • Income Limit – You must not make more than $10 million during the last three tax years

Routine Maintenance Safe Harbor

The routine maintenance safe harbor allows you to fully deduct recurring expenses you need to keep a building and its systems in working condition. For example, inspections, cleanings, or part replacements are all examples of routine maintenance.

The only qualification for this safe harbor is that the maintenance must be something you reasonably expected to do at least twice every ten years. If you’re unsure whether an expense passes the ten-year rule, consider general industry practices or the manufacturer’s recommendation.

De Minimis Safe Harbor

The de minimis safe harbor allows you to deduct small expenses regardless of whether they are technically repairs or improvements. The only qualification is that the expense be less than $2,500 per item.

You can always use the standard regulations for repairs and improvements if you’re unsure about applying the safe harbors. However, the safe harbors are usually better because they help you deduct more and save money. 

If keeping track of the amount and nature of all your expenses sounds tedious, try using the expense tracking feature on property management software. The software allows you to organize your financials and even auto-generate forms as you prepare for tax season.

Improving Your Property and Tax Skills

Cultivating your tax skills and knowledge is a valuable investment of your time. While it’s never a bad idea to hire a tax professional, especially if you are a large landlord, understanding the basics of the tax code for real estate owners can help you achieve the largest tax return possible.