Can Landlords Deduct Remodelling Expenses for Rental Property?

Are you a landlord contemplating renovations for your rental property? If so, you might be wondering, “Can I deduct my rental property remodeling expenses?” The good news is that, yes, you can deduct these costs! However, there are important details to keep in mind to ensure you do so correctly and in compliance with IRS regulations.

In this article, we’ll explore the essentials of deducting remodeling expenses for rental properties. We’ll also share valuable tips to streamline the process and help you make the most of your deductions come tax season. 

Let’s dive in! 

Related Article: Real Estate Taxes, Income, and Deductions - What Landlords Need to Know

Can You Deduct Renovation Costs on The Rental Property?

The short answer is yes, sometimes. You can deduct renovation costs on your rental property so long as they are not improvements to the property. While minor renovations (like a fresh lick of paint) qualify as maintenance or repairs and can be deducted in the year they occur, major improvements must be depreciated over time rather than deducted all at once. 

Additionally, if the remodeling expenses occur before the property is placed in service then all renovation costs, minor or not, are classified as improvements by the IRS and will need to be added to the property cost basis and depreciated.

Here's how IRS distinguishes between major (capital improvements) and minor renovations (repairs and maintenance):

Major Renovations

Major rental property renovations add value to a property and, for tax purposes, are classified as capital improvements. These enhancements significantly upgrade the property, extend its lifespan, or notably increase its value.

Unlike regular expenses, capital improvements cannot be deducted in the current tax year; instead, they must be depreciated over time. This means you can spread the costs across several years, allowing you to claim a portion of these expenses in both the current and future tax years.

For residential rental properties, you will depreciate these capital improvement costs over 27.5 years (unless using an accelerated depreciation schedule), while for commercial properties, the period extends to 39 years.

Examples of Capital Improvements

Here are some common examples of capital improvements:

• Replacing a roof
• Adding or expanding a bathroom or bedroom
• Constructing a deck or patio
• Upgrading heating or cooling systems
• Enhancing the electrical system
• Resurfacing parking areas
• Installing a swimming pool

Minor Renovations

In contrast, minor renovations consist of smaller repairs and maintenance tasks that do not substantially enhance the property. For tax purposes, these are categorized as repairs and maintenance and can be deducted in full in the year they occur. Common repairs might include fixing a roof leak, painting walls, repairing appliances, or replacing flooring. 

For more detailed information, refer to IRS Publication 527. Additionally, be sure to keep a separate record of your capital improvements apart from your regular expenses.

How to Deduct Remodeling Expenses for Rental Properties

If you're looking to deduct remodeling expenses for your rental property, you'll need to first determine if it qualifies as a capital improvement or as maintenance or repair. This can be tricky sometimes, so if you're unsure talk with your CPA.

If it does qualify to be deducted in the year it occurs you next need to: 

• itemize these costs on your tax return (Form 1040 Schedule E) and,
• keep receipts or other documentation to support your claims. 

Generally, you can deduct expenses related to repairs on your rental property from your income tax. However, it's important to note that these expenses should be for current repairs that do not enhance the property's overall value.

To maximize your deductions and minimize your tax liability, maintaining meticulous records is essential and the easiest way to keep your rental property accounts up to date is to use purpose built software like Landlord Studio.

As always, investors should consult with a tax advisor to gain a clearer understanding of which remodeling expenses are rental property renovations tax deductible based on their circumstances.

Related Article: Capital Improvements vs. Repairs and Maintenance: Rental Accounting 101

Understanding ‘Placed In Service’

Understanding the distinction and timing of when their property is "placed in service" can help landlords optimize their tax deductions and compliance with IRS guidelines.

Essentially, the term "placed in service" refers to the point at which a rental property is made ready and available for rent - usually, this is when the rental listing goes up and you start looking for tenants.

Any repairs or improvements made to the property before it is placed in service are treated at capital expenditures, whether they are large or small. And, you can start depreciating the property (using an adjusted cost basis that includes the value of any improvements) from the placed-in-service date.

Depreciating Rental Property Renovations and Remodels

While routine repairs and minor remodeling expenses can often be deducted in the year they occur, capital improvements - such as major renovations, structural upgrades, or adding new amenities - must be depreciated over their useful life.

The IRS classifies residential rental property improvements under a 27.5-year depreciation schedule (unless using an accelerated depreciation schedule). This means that if you invest $50,000 in a full kitchen remodel or add a new roof, you cannot deduct the entire cost in the year of the expense. Instead, you would deduct a portion of the improvement’s cost each year over 27.5 years.

For example, if you remodel a rental property with $50,000 in capital improvements, you can deduct approximately $1,818 per year ($50,000 ÷ 27.5 years). This depreciation helps offset taxable rental income, making long-term renovations more financially manageable for landlords.

How to Track Rental Property Remodeling Expenses

A well-organized tracking system is essential for successfully managing your rental property expenses. There are a few ways you can track expenses associated with remodeling and maintaining your property including handwritten ledgers, spreadsheets, bookkeeping software, and specialized rental property management tools like Landlord Studio. Choosing the right system for you will make all the difference.

Option 1: Hand Ledgers

Handwritten ledgers may seem outdated, but they still offer value to many landlords. A ledger serves as a manual logbook where you can track rent payments and other expenses. Typically, it includes columns for debits and credits, account details, and transaction dates.

Pros

• Cost-effective: Minimal expenses involved.
• Flexible: Easy to customize entries.
• Accessible: Data is readily available without the need for technology.

Cons

• Manual entry required: This is incredibly time-consuming and dramatically increases the risk of errors.
• Requires accounting knowledge: Familiarity with double-entry accounting is beneficial.
• Vulnerability: Physical ledgers can be lost or damaged easily.
• No reporting: With physical ledgers, you don’t have the option to easily create reports, analyze data, or prepare tax documents.

Option 2: Rental Spreadsheets

‍Rental property spreadsheets are an excellent tool for consolidating all your financial data in one place. Property owners can effortlessly track monthly costs, property taxes, and outstanding expenses. You can create a custom spreadsheet or utilize an online template.

Most spreadsheets allow you to input details such as the property's market value, purchase price, monthly and annual expenses, and more.

‍Pros

• Highly customizable: Adaptable to your specific needs.
• Formulas for calculations: Simplifies math tasks.
• Easy for small portfolios: Easy to manage if you only have one or two properties.

Cons

• Complex expenses can be challenging: Difficulties may arise when tracking intricate financial situations.
• Manual data entry: Increases the chance of mistakes and is very time-consuming.
• Error-prone: Small errors can lead to major inaccuracies and are incredibly hard to spot.
• No reporting: No reporting options to dig into your numbers or prepare tax documents.
• Don’t scale: As your portfolio grows so does your accounting complexity. This can lead to errors, missed expenses, overpaid taxes, or even trigger an audit.

Option 3: Landlord Software

While general accounting software like QuickBooks or Xero can be used for rental property bookkeeping, they come with notable limitations, they are hard to set up and easy to make a mess of unless you’re already an expert. 

Additionally, these platforms lack features specifically tailored for real estate investors who need to monitor remodeling expenses related to their properties, find and screen tenants, and collect rent (amongst other tasks).

This is where purpose-built property management and accounting software like Landlord Studio comes in. Landlord Studio combines intuitive tools for tracking income and expenses on a property-by-property basis with customizable reporting and a suite of features to help landlords streamline every aspect of their rental property management, from finding tenants to managing maintenance to filing taxes. 

Final Words: Deducting Rental Property Remodeling Expenses

Understanding how to treat and track minor renovations (like fresh paint and fixing leaks) vs major property improvements as well as key terms like placed in service and depreciation are vital if you want to maximize your deductions and stay compliant with IRS tax regulations.

Landlord Studio is a property management and accounting software designed to make this easier with default expense categories in line with IRS requirements. 

Landlord Studio has a built-in property maintenance tracker, so you can stay on top of jobs and manage contractors. Plus, digitize receipts and log expenses as they occur to ensure nothing gets missed. For larger capital improvements you can use the recurring expense feature to track your depreciation expenses. 

Finally, you can instantly generate a range of customizable reports to dig into the numbers when you need to and prepare your finances for tax time.

Create your free Landlord Studio account today and see how the right rental accounting software can help you save time, maximize deductions, and increase ROI.

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