‘Repair’ or ‘improvement’: Don’t paint yourself into a tax corner

QTA Consultants, Ltd./Renata Bliumaite

There’s more than just semantics involved when you’re talking about the tax treatment of “repairs” for a business building versus “improvements.” On one hand, the cost of repairs made by your business is currently deductible. On the other, the cost of improvements must be capitalized and written off over time via depreciation deductions.

Strategy: Separate repairs from improvements when work is done on the building. For instance, don’t lump standard repairs with a major renovation. If that occurs, it will take longer to write off the cost of the repairs. As a recent case shows, the burden of proof is on you to show that renovation expenses should be deducted currently instead of being capitalized. (Gay, TC Memo 2007- 87)

What’s the difference? It’s sometimes hard to tell the tax difference between a “repair” and an “improvement.” However, in a pinch, you can rely on this rule of thumb:

• A repair keeps the property in good operating condition over the course of its intended useful life. For example, replacing a broken window or fixing a leaky faucet is obviously a repair.

• An improvement extends the useful life of the property, increases its value or adapts it for a different use. A good example is putting a new roof on the building. If the cost of the work amounts to 25% or more of the original cost, it will probably be classified as an improvement.

Caution: There’s usually no tax problem when deductions are claimed for isolated repairs. But suppose you’re planning to renovate, remodel or expand the company building. It might seem like a good idea to make minor repairs to the building at the same time. After all, the workers will already be on the premises. Unfortunately, if all the work is done at the same time, the repairs may be included as part of a general betterment plan or rehabilitation plan.

Result: The IRS can say that the entire cost—including the portion specifically devoted to repairs—must be capitalized and depreciated over time. Depending on the situation, you can opt to accelerate or delay the repairs so they don’t coincide with a general betterment plan or other planned improvements. Allow enough time between jobs—for instance, a couple of months—to show that the repairs and improvements aren’t part of the same overall plan. Personal residence repairs are not deductible— period. And you can’t add repair costs to your basis either. But the cost of capital improvements is added to your basis. When you sell the home, the increased basis can reduce any taxable gain on the sale.

Tip: For this reason, it’s better to lump home repairs with improvements—the opposite of the usual strategy for business buildings.