If you own rental properties or business real estate, it’s almost guaranteed that you’ll need to address building upkeep or upgrades at some point. Whether it’s fixing a leaky roof or installing a brand-new HVAC system, these projects can range from minor touch-ups to major overhauls. But while most owners focus on the cost, there’s another key factor to consider: How will these expenses affect your taxes?
The IRS makes a critical distinction between repairs, which can often be deducted immediately, and improvements, which must be capitalized and depreciated over time. Classifying expenses correctly can impact cash flow, long-term tax liability, and even future property sales.
Let’s break down the key differences, IRS safe harbors that can work in your favor, and strategies to help you maximize tax benefits while staying compliant.
Defining “repairs” and “improvements”
The IRS generally regards repairs as activities that keep a property operational without substantially increasing its value or extending its useful life. For instance, if your warehouse roof springs a minor leak and you patch it quickly, that patch is considered a repair. The same logic applies to fixing broken fixtures, replacing a cracked toilet, or patching a few damaged tiles. Because these actions merely restore the property to its previous condition, they’re typically deductible in the year you pay for them, providing an immediate tax benefit.
Improvements, however, usually involve significant changes that enhance a property’s value, extend its lifespan, or adapt it to a new use. Replacing a building’s entire roof rather than fixing a minor leak, installing a new HVAC system, or adding extra square footage to an office suite all qualify as improvements. These expenses must be capitalized and added to the property’s basis, then depreciated over time – often over 27.5 years for resident rental property and 39 years for most nonresidential property.
That said, certain nonresidential property improvements, known as Qualified Improvement Property (QIP), are eligible for 15-year depreciation under current IRS rules. QIP generally includes interior improvements made after a building is placed into service, such as expansion of the building, elevators, and escalators, and changes made to the internal structural framework.
While capitalizing improvements may offer long-term benefits – like raising the property’s basis and generating depreciation deductions – these benefits are spread out over many years. And when it comes to tax savings, the time value of money matters: a dollar deducted today is worth more than a dollar deducted decades from now. This principle makes properly distinguishing between repairs and improvements especially important when planning property projects.
IRS safe harbors: are there ways to deduct more now?
To simplify tax reporting, the IRS provides several safe harbors that allow certain costs to be deducted right away instead of capitalized. Here are three key ones that property owners should know:
De minimis safe harbor election
The de minimis safe harbor election rule lets you immediately deduct costs for tangible property up to a certain dollar limit:
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$5,000 per item or invoice for businesses with applicable financial statements (prepared in accordance with generally accepted accounting principles).
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$2,500 per item or invoice for businesses without audited statements.
If an invoice lists multiple individual items, and each one is under the limit, the total invoice amount doesn’t automatically disqualify you from using the safe harbor. For instance, if you receive an invoice for $15,000, but it covers 10 separate machines at $1,500 each, you can deduct the full $15,000 because each unit is under the limit.
However, you cannot break apart a single asset to qualify. For instance, let’s say your new HVAC system costs $12,000, and the invoice lists separate charges for the unit, installation, and wiring. The IRS would likely view this as one unit of property, not separate deductible purchases.
You also can’t apply the de minimis safe harbor rule selectively – if you use it for one type of expense, you must consistently apply it to similar purchases.
Small business safe harbor for building improvements
If your average annual gross receipts are $10 million or less, and your building’s unadjusted basis is $1 million or less, you may be able to deduct amounts paid for repairs, maintenance, and improvements. However, there is an annual expense limit. You can only use this safe harbor if the total amount paid during the year does not exceed the lesser of $10,000 or 2% of the property’s basis.
This safe harbor must be claimed annually by filing an election with your tax return.
Routine maintenance safe harbor
The routine maintenance safe harbor allows certain maintenance costs to be deducted immediately rather than capitalized—as long as they meet the IRS’s definition of “routine.” This safe harbor applies to costs incurred to keep a building, system, or unit of property in its original or efficient operating condition, but it cannot be used for expenses that improve or upgrade the property.
To qualify, the maintenance must be something the taxpayer reasonably expects to perform more than once over the class life of the property or system. For example, scheduled HVAC servicing or replacing worn-out parts with similar, commercially available components could qualify. However, maintenance performed immediately after a property or system is placed into service typically doesn’t count since wear and tear must result from actual use over time.
If you haven’t consistently expensed these costs in prior years, you may need to file a Form 3115 (Application for Change in Accounting Method) to start using this safe harbor. Once applied, the safe harbor remains in effect for all subsequent years unless the taxpayer later requests another method change. Unlike the de minimis safe harbor election, which must be made annually, this is a one-time election that continues indefinitely unless revoked.
Avoiding costly tax pitfalls
Even when you think you’re following the letter of the law, it’s easy to inadvertently lump repair and improvement costs into a single “to-do.” The IRS may view extensive work on a property as part of a broader “plan of betterment” if you perform repairs and improvements at the same time. Essentially, an auditor might look at the entire project and decide you’ve made a series of capital improvements, regardless of your intent to classify individual tasks as repairs.
For instance, if you replace the roof, repaint the building, and upgrade the HVAC in the same project, the IRS could decide the painting (which might have been deductible on its own) is part of a broader improvement plan – and require you to capitalize it.
To avoid this, consider the timing of your projects and space out repairs from major improvements when possible. Ask contractors to break down invoices so you can classify each expense correctly, and ensure you keep detailed records of every project.
Beyond these practices, it’s important to stay informed about the newest IRS regulations and safe harbors. They can change periodically, and you want to ensure you’re applying the rules correctly. Consulting with a tax professional is often advisable when your project straddles the line between repair and improvement. The upfront investment of expert advice is small compared to what you might save—or avoid losing—in the long run.
If you’re considering a complex project or want to ensure you’re maximizing deductions, contact our office, and we’ll discuss tax strategies tailored to your specific situation.
