Before you get excited, there are no tax savings from improvements you make to a property you rent.
You: But the title—
Sorry, but that refers to rental properties you own.
You: Now how could I possibly own the property if I am renting it?
If you’re the landlord.
You: I knew that.
There are many tax benefits available to those who own rental properties. As an important example, most modifications you make to your rental property result in tax savings of one kind or another.
You: How so?
Whether the changes you make to the property are considered improvements or repairs. Whereas repairs may be immediately tax deductible, improvements must be depreciated over time.
You: What’s the difference?
What’s the difference between improvements and repairs? Or what’s the difference between an immediate tax deduction and depreciation over time?
You: Actually, both.
Improvements vs. Repairs
Like they sound, repairs don’t make any permanent changes to the property; they simply put the property back to a previous state. Said another way, repairs don’t add to the value of the rental property. Consequently, expenses such as the cost for a plumber to go fix a toilet or for an electrician to replace a circuit are textbook examples of repairs. But, so too, are far more expensive costs, like the expense of painting your property or fixing up part of a roof where it might be leaking (again).
On the other hand, expenses you incur which increase the life of the property or add value to it are considered improvements. Replacing the whole roof, for example, is an improvement. Although you wouldn’t necessarily think of a new roof as immediately increasing the value of the property, it certainly increases the expected useful life of it and consequently is considered an improvement. Obviously, additions and similar major upgrades are considered improvements as well.
Tax Deduction vs. Depreciation
Repair expenses may be immediately tax deductible from rental income. This means you’ll reduce your taxable income from the rent you collect by the exact amount of the repair expense. On the other hand, costs for improvements must be depreciated or divided over their useful life. As a result, improvements add to the amount you can already depreciate related to your rental property on an annual basis.
You: What does that mean?
Say you decide to add a new piece of furniture to the property. Furniture typically has a five-year life, at least according to the IRS (that you and your tenants might have completely different opinions is not relevant). If the price of the furniture is $500, you can depreciate $100 a year for five years. Since a couch is not a repair, you cannot immediately expense it.
Between improvements and repairs, there’s plenty of tax savings opportunities if you’re in the mood to get to work (and to spending) this summer.