If you rent out a house for profit, you can write off your expenses. Even if you haven't rented the house out when you start fixing it up, the money you spend is still a valid deduction. Federal tax law, however, limits how much you can claim and whether you can claim it this year or must wait.
A lot depends on whether the IRS decides your renovations are repairs or improvements. Repairs are anything that keeps the property in good operating condition: If making the property fit to live in requires that you fix leaks, replace a few washers on the taps or repaint the walls, all those costs are write-offs. You subtract the costs from your rental income for the year on Schedule E, or -- if you provide renters with what the IRS considers "substantial services" -- on Schedule C.
Improvements are renovations that make the house substantially more valuable or add years to its life span. Patching a hole in the roof is a repair; replacing the roof is an improvement. You can write off improvements, but you have to depreciate the cost over several years instead of claiming it all in one year. If you make repairs as part of a major makeover of the house, the entire job counts as one big improvement and you can't deduct the repairs immediately.
Passive or Active
Even if you don't feel like a "passive" landlord while you're pounding in nails or splashing on paint, in the eyes of the IRS you may be. If you're a real estate professional running a rental company or you provide your tenants with benefits such as maid service, you "materially participate" in managing the property. If you don't provide any services beyond repairs, maintenance and trash pickup, you're passive: Your tenants are paying for the house, not your services.
If you don't earn enough in rent to cover the cost of your renovations, the passive/materially participating difference affects how much of the loss you can write off. If you materially participate and your rental business is in the red, you can deduct your losses from your non-rental income. If you're passive, you can only write it off against other passive activities, such as another, more profitable rental. If you don't have any passive income from which to deduct the loss, you must carry the red ink over to next year instead.
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