Owning investment property like rental units bestows varied benefits on the owner, including tax advantages. Landlords can deduct mortgage interest, operating costs, property taxes, and even repairs. The investment in the building is deductible over time as depreciation and repairs that qualify as improvements are depreciated rather than deducted.
Deduction versus Depreciation
From a tax perspective, you can recoup the cost of repairs to a rental property more quickly than improvements. You can deduct a repair expense from income in the year you make the payment. In contrast, the cost of an improvement to a rental property is added to the basis and depreciated over as much as 27.5 years.
Determining the difference between a repair and an improvement is usually straightforward:
Replacements are often considered improvements. For example, if you repair the heating and air conditioning unit of a rental, that is a deductible repair expense. If you replace the system, that is an improvement that most likely will need to be depreciated, not deducted. Similarly, if you repair a leaking roof, that is a deductible expense, but if you replace an entire roof, that is likely an improvement.
Upgrades are almost always improvements rather than repairs. If you replace a cracked tile in the kitchen, that is a repair, but if you replace the entire floor, that is an improvement, and you will need to use depreciation to recoup the cost.
What's the Value of a Deduction?
The advantage of a deduction is that it reduces the income from the property, and that reduces the amount of money on which you owe taxes. For example, suppose you rent out a house for $2,000 a month, and last year it was occupied every month, so you collected $24,000. If you pay $5,000 in property taxes, $3,000 in mortgage interest, $1,000 in property interest, you can deduct those amounts from the income received. Let's say you spend $2,000 for the following repairs:
$800 for a plumber
$500 for a locksmith
$700 for a broken window
You can also deduct the $2,000 as current year costs, reducing income by that amount. If you had spent $2,000 entirely on one improvement item (like new cupboards in the kitchen), you would instead depreciate the cost over 27.5 years, which means each year you would see a reduction in income of only $72.
What About Maintenance?
Maintenance and upkeep are deductible like repairs. If you pay for the gardener and the pool service, those costs are deductible business expenses. Similarly, when you send a professional to service, clean, and calibrate the air conditioning system (preventive maintenance to avoid repairs) or inspect for and prevent pests like termites, rodents, or other intruders, those charges are deductible expenses. Almost anything that you pay for to attract, obtain, and retain tenants is deductible. That includes advertising, checking credit and background information, property management, and lease processing. You can also write off travel expenses to and from your rentals (within reason) and legal and financial charges related to the properties.