Reporting Repairs for Military Landlords: Capitalize or Deduct

Due to PCS moves or intentional real estate investing, many military members become landlords at some point in their careers. While owning rental property can build long-term wealth, it also introduces new tax responsibilities — especially when it comes to repairs. The key question is whether those costs should be capitalized and depreciated over time or deducted immediately, a distinction that can significantly affect your tax bill.

Military Landlords and Home Repairs

The VA loan provides eligible service members and veterans a low-cost home-buying option. And, when military members move after buying a home, they often decide to become a landlord. Rather than sell recently purchased homes, they convert them into rental properties. Alternatively, many military members opt for a more deliberate real estate investing track, buying rental properties in every duty station.

Regardless of how you acquired your rental properties, being a landlord comes with one inevitable challenge: home repairs. Through wear and tear or just downright neglect, you’ll eventually need to pay to fix something at a rental property.

New landlords typically believe that if they repair something, they can deduct this from their taxes. But, the tax treatment isn’t always so clear cut in the eyes of the IRS. Depending on what sort of work you complete, you’ll either 1) capitalize the costs, or 2) deduct the costs. Both of these options will have different impacts on your taxes, and we’ll discuss these differences in the next section.

Capitalize vs. Deduct: What’s the Difference?

When you capitalize a cost, you spread the tax benefit out over time. The expense is added to your property’s basis and depreciated, typically over 27.5 years for residential rental property under MACRS.

For example, replacing a roof for $25,000 is considered a capital improvement. Instead of deducting the full $25,000 in the current year, you would depreciate it over 27.5 years — about $909 per year.

When you deduct a cost, you receive the full tax benefit immediately. Routine expenses, like a $500 HVAC maintenance service, can generally be deducted in the year they’re paid.

While deductions provide faster tax savings, you must follow IRS rules to determine which treatment applies.

When Must You Capitalize Repairs?

The IRS requires you to capitalize costs if they improve the property. An improvement occurs when work:

• Adapts the property to a new or different use
• Betters the property
• Restores the property

Betterments

You must capitalize costs that materially increase the property’s value, capacity, efficiency, strength, or quality, or correct a significant defect. The IRS does not strictly define “material,” so landlords must apply reasonable judgment.

Restorations

Capitalization is required when you:

• Rebuild the property to like-new condition
• Replace a major component or structural part
• Return the property to working condition after it has fallen into disrepair

Adaptations

If you modify the property for a new or different use that wasn’t intended when you placed it in service, those costs must be capitalized.

When Should I Deduct Repairs?

From the thorough guidance regarding capitalized improvements, it may seem like the IRS doesn’t want you to deduct anything. But, IRS rules clearly state that routine maintenance qualifies as a deductible expense. In particular, you are not required to capitalize as an improvement, and therefore may deduct, amounts that meet all of the following criteria:

• Amounts paid for recurring activities that you expect to perform;
• As a result of your use of the property in your trade or business;
• To keep the property in its ordinarily efficient operating condition; and
• You reasonably expect, at the time the property is placed in service, to perform the activities:
  • For building structures and building systems, more than once during the 10-year period beginning when placed in service, or
  • For property other than buildings, more than once during the class life of the unit of property.

IRS Safe Harbor Rules

But, even with that guidance on routine maintenance, military landlords may question whether a certain cost qualifies as a deduction or an expense. Recognizing this potential for confusion, the IRS has created “safe harbor” rules that, if followed, let landlords deduct all costs under certain monetary thresholds.

Specifically, the IRS’ Safe Harbor Election for Small Taxpayers states that: “You are not required to capitalize as an improvement, and therefore may be permitted to deduct, the costs of work performed on owned or leased buildings, e.g., repairs, maintenance, improvements or similar costs, that fall into the safe harbor election for small taxpayers. The requirements of the safe harbor election for small taxpayers are”:

• Average annual gross receipts of $10 million or less; and
• Owns or leases building property with an unadjusted basis of less than $1 million or less; and
• The total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property doesn’t exceed the lesser of-
  • Two percent of the unadjusted basis of the eligible building property; or
  • $10,000

For most military landlords, this safe harbor effectively allows you to deduct up to $10,000 in costs annually, regardless of whether those costs would normally qualify as capital improvements or deductible repairs.

Final Thoughts

As with most tax issues, the IRS doesn’t make figuring out whether to capitalize or deduct repairs easy. But, by following the above guidance and safe harbor rules, military landlords can A) maximize their current year tax deductions, while b) complying with IRS rules on capital improvements. Having said that, if unsure how to treat a certain rental property cost, you should seek the advice of a tax professional.