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December 20, 2023 | read

Accounting for Repairs, Replacements and Rowdy Tenants

Brandon Hall

Let’s face it, owning real estate isn’t all profit and glamour. Headaches happen: broken AC units, tenants who smash a window or punch a wall, refrigerators that need replacing—we’ve seen it all! But, how do you file these expenses come tax time? Here we explain how accounting works when dealing with repairs and replacements.

IRS Clarification of Capital Improvements Versus Deductible Repair Expenses

Back in the day, real estate CPAs were left in the dark, so to speak, by the IRS, not having been provided a clear distinction between what constituted a capital improvement, and what constituted a repair expense. We just used our best judgement. Which seemed to work just fine, until one day, in 2014, the IRS decided to throw us a bone and provide guidelines that detailed these distinctions. Now, it is quite easy to determine what counts as a capital improvement vs a repair expense, making accounting much simpler. Great!

So, what’s the distinction?

Capital improvements include anything that is, “Fixing a defect or design flaw, creating an addition, physical enlargement or expansion, creating an increase in capacity, productivity or efficiency, rebuilding property after the end of its economic useful life, replacing a major component or structural part of the property or adapting property to a new or different use.”

Deductible repair expenses, on the other hand, would be, “improvements that keep property in efficient operating condition, restore property to previous condition, repairs incidental damage or maintains underlying property through routine maintenance.”

So, replacing single-pane windows with double-paned energy efficient ones? You just performed a capital improvement. Tenant takes a baseball bat to the bedroom door (it happens!), and you patch up the door, with the same or similar materials used to construct the door? That’s a repair.

Accounting for Ordinary Repairs

Another way to look at this is to think of ordinary repairs versus major or extraordinary ones. Ordinary repairs count, obviously, as repairs. Make them, as needed, instead of replacing property outright. Patch, mend and fix, using the exact or similar materials as what the asset was constructed of—most things can be repaired several times before they need to be completely replaced, so take advantage of the rental property tax deductions.

They should be expensed when they are incurred, and then charged to a maintenance allowance account. As revenue expenditures, they should be expensed in the period where the repair occurred, and then they can be deducted come tax time, which makes you and your CPA happy campers come tax time.

I’d like to take a moment and make two points here, regarding maintenance allowance accounts, and repairs in general. As any good scout knows, it’s better to keep things simple, and always be prepared. So, for every rental unit you have, I’d advise you to place $100 in your maintenance allowance account. You won’t need $100 for every unit every month, but it’s an easy, no-brainer way to save money for those months when tenants go haywire, or everyone’s furnace goes kaput simultaneously. Better safe than sorry!

Accounting for Major and Extraordinary Repairs

Major and extraordinary repairs are capital improvements. Capital expenditures are recorded as an increase to the fixed asset account. If an improvement increases the useful life of the asset (fancy weather-resistant shingles on a roof, for example), you should decrease the accumulated depreciation account to record the value of the extraordinary repair expenditures.

Remember, improvements are not immediately tax-deductible: you have to wait for depreciation, which can be two decades or more. We’ve discussed Section 179 deductions (for energy efficiency and tax savings), which are not for assets in or on rental units, so forget those when considering this sort of accounting. The rule of thumb: you should improve things if it will increase the value of an asset, or if the asset can no longer be repaired, but you shouldn’t just replace and improve willy-nilly. Got it?

How The Real Estate CPA Can Help

Still a little confused? It’s alright, that’s what we’re here for! The team has been helping real estate investors like you for years—we’ve seen it all, done it all and answered it all. We want to help you make your real estate investment the best investment it can be, and that starts with streamlined accounting systems and maximum tax deductions. Let’s get started—give us a call, and we’ll schedule you an appointment!