When you spend money to repair, update or improve your rental property, there will come a time when there is a choice. Is this a repair expense? That means it’s immediately deductible. Or is this an improvement that needs to be capitalized as an asset? That means you depreciate it over time.
Most people would rather have the repair expense. If you later sell the property at a gain, you’ll need to recapture the depreciation you expensed from the improvement and pay tax on it. If that improvement was instead considered a repair, you don’t need to recapture it.
Repair expenses mean less tax in the future. And for many people it also means less tax now. This depends on how much your adjusted gross income is and whether you could be considered a real estate professional.
In general, if you repair something that is more than 50% of the cost of that “component” or more than 50% of the physical area, it is considered an asset. Also, if the repair enlarges or substantially improves the property it needs to be capitalized.
You need to track expenses by the components such as HVAC, electrical, structure, etc. and then make the decision on whether to deduct or capitalize based on the circumstances of each group of expenses.
After the regulations were released, the IRS later modified them with two important safe harbor elections.
If your real estate property is worth less than $1 million, you can claim an exemption from the more onerous rules. Additionally, if the individual invoice is less than $2,500, you can treat it as a repair and not a capitalized asset.
This last one, invoices that are less than $2,500, is especially powerful with some advance planning