repairs vs improvements

Understanding the difference between repairs and improvements is a common point of contention. This article gives a short explanation of what sorts of expenses belong in which category, and a brief explanation of their treatment for tax purposes.

It is important to realise at the outset that repairs are treated differently in your income tax return than improvements. Essentially, any repairs to an item or building are fully deductible in the year of expense. Improvements are also deductible, but must be depreciated throughout their useful life. Furthermore, the “useful life” of a building, for depreciation purposes, is 25 years. There is no precise determination on what constitutes a renovation, suffice to say that comprehensive 'repairs' to a building are likely to increase the buildings rent value, and are thus considered to be an improvement (renovation), and as such need to be depreciated.

An unfortunate illustration of this concept is the classic example of a landlord spending $25000, to renovate a property, expecting to claim the full expense as a tax deduction, only to find that the amount must be depreciated over 25 years. Such a deduction (though mythical) would produce a tax advantage of around $7,500 (in the 30% tax bracket). Many clients expecting that kind of refund on their renovations are disappointed to find that through depreciation, they can only claim $1000 per year, (thus a tax advantage of $300 in the 30% bracket).

In order to discern whether an expense or cost is a repair or an improvement, you need to consider the following questions:

  • Are you preparing the property to be rented, never having rented that property previously?
  • Have you completely replaced an object or item?
  • Do the changes resulting from the expense provide any different functionality from the previous amenities?
  • Do the changes resulting from the expense increase the market value of the property?

If you answered yes to any of the above then chances are your dealing with an improvement, or capital item, which needs to be depreciated over that item's useful life.