The IRS taxes the rental income you receive if you own a house and rent it to another party. But the IRS also recognizes that property owners spend a good deal of their own money to keep their rentals in acceptable shape, and some of the costs associated with renovations on a rental house are deductible. Throughout the year, save your receipts and copies of contractor invoices from every expense associated with your rental. The sum of the qualified expenses, including repairs, is deductible from the amount of rent money you receive. Be aware, however, that the way you classify your expenses can make a big difference in how the IRS lets you deduct your expenses.
Repairs are deductible in the year you incur the expense. If the roof on your rental house springs a leak and you have to pay a roofing contractor $1,500 to fix the problem, you can deduct the entire $1,500 from the total of the rent money you receive that year. To qualify as a repair, the work should return the rental house to the condition it was in before the need for the repair arose. To file taxes for rental income, you’ll need to fill out IRS form Schedule E – Supplemental Income and Loss.
Improvements, which also fall under the heading of renovations, are not deductible in the year you incur the expense. Instead, the IRS allows you to depreciate the cost of the improvements over a longer period. Tax codes are subject to yearly changes, but as of 2011, the IRS allows you to depreciate improvements over 27.5 years. Wrongly classifying a repair as an improvement can keep you from deducting the whole cost of the renovation project. Improvements are capital expenses, because they increase your capital equity in the rental. Capital expenses must be depreciated, not deducted.
Getting the Right Classification
It makes a big difference, tax-wise, whether you classify a renovation as a repair or an improvement, so assess the expense carefully. A repair keeps the rental house in good operating condition, but the intent of a repair is not to add to the value of the house. Since many repairs do add to the value of the house, classifying the expenses correctly can be confusing. If the renovation returns your rental house to the condition it was before the renovation was necessary, classify the expense as a repair. If the renovation substantially prolongs the useful life of the house, if it makes the house substantially more useful or if it adds substantially to the value of the house, it’s an improvement. The key word is “substantially.” Using the roof example, if you could fix the leak for $1,500, but you choose to install a new roof for $9,000, the new roof would be an improvement, not a repair.
Labor and Materials
Rental owners often do their own repairs to save money. When you hire a contractor to fix something on the rental house, you can deduct the entire expense. If you do the work yourself, however, you can only deduct the cost of the materials, you may not deduct a labor cost for yourself.
The cost you pay to maintain the rental house in good operating condition is deductible on Schedule E. Both maintenance and repair costs are fully deductible, but you must list them separately. A maintenance cost is an expense you incur to keep something from breaking. A repair is an expense you incur to fix something after it breaks.
A tax credit isn’t a deduction but it can save you money. Tax credits are subtracted from the amount of taxes you owe, after calculating your income taxes. IRS-offered tax credits can change from year to year, so call the IRS or a tax accountant to see if any credits are currently available. If your rental house is historic or if it qualifies as housing for low-income renters, you might qualify for a tax credit of up to $1,000 as reimbursement for rehabilitation costs you incur in the year for which you’re filing your taxes.
- NOLO – Every Landlord’s Tax Deduction Guide, Eighth Edition; Stephen Fishman, J.D.
- IRS: Capitalization v. Repairs Audit Technique Guide
Glenda Taylor is a contractor and a full-time writer specializing in construction writing. She also enjoys writing business and finance, food and drink and pet-related articles. Her education includes marketing and a bachelor's degree in journalism from the University of Kansas.