Rental Accounting: Capital Expenses vs. Operating Expenses

Running a real estate business takes a lot from you, with your biggest worry being the stress of managing the financial expenditures.

Proper accounting of both operating and capital expenses - CapEx and OpEx can help landlords maximize their ROI, optimize tax benefits, and prevent costly surprises. Similarly, misclassifying these expenses can lead to missed deductions, cash flow challenges, or even scrutiny from the IRS. 

This guide clarifies the differences between CapEx and OpEx, their tax implications, common pitfalls, and how tools like Landlord Studio streamline expense management.

Capital Expenses vs. Operating Expenses In Real Estate

Understanding the distinction between capital expenses (CapEx) and operating expenses (OpEx) is essential because they both needed to be treated differently at tax time. Vest case scenario getting this wrong can lead to missed expenses and overpaid taxes, worst case could lead to an IRS audit and fines. 

Below we detail the main differences between CapEx and OpEx with examples. 

Capital Expenses (CapEx) in Real Estate

Capital expenses in real estate, also known as capital improvements, are larger investments in the property that either enhance or increase the value of the rental. 

Common examples of CapEx for real estate investors, whether dealing with single-family rental (SFR) homes or multifamily buildings, include significant renovations like reroofing, upgrading electrical or plumbing systems, and installing new windows or doors. Additionally, investors may choose to modify the interior layout of a unit to make it more appealing to prospective renters. 

Capital improvements then can have a significant influence on the property's long-term value and also increase rental rates you can demand for the property increasing overall profitability.

Because of the long term value these improvements add, the IRS does not allow landlords to deduct capital improvements in full in the year they occur. Instead, they needed to be added to the cost basis of the property and depreciated over what the IRS deems the improvements ‘useful life’. 

These costs can accumulate quickly so it's vital for real estate investors to meticulously track the cost of capital expenditures as well as the associated depreciation schedules.

Capital Expense Tax Treatment Example

Sarah, a real estate investor, replaces the roof on her rental property for $12,000. Since this is a capital improvement, she cannot deduct the full cost in the year of the expense. Instead, the IRS requires her to add it to the property’s cost basis and depreciate it over 27.5 years (for residential properties).

• Annual depreciation deduction: $12,000 ÷ 27.5 = $436 per year
• Sarah can deduct $436 each year instead of the full $12,000 at once.

Certain assets, like appliances, may have a shorter depreciation period; under the Modified Accelerated Cost Recovery System (MACRS), appliances can be depreciated over just five years.

How Can Landlord Studio Help?

Tracking capital expenses (CapEx) manually can be overwhelming, especially when managing multiple properties. Landlord Studio simplifies the process, ensuring that every improvement is accurately recorded and depreciation schedules are easily maintained.

• Separate CapEx from OpEx – Avoid misclassifying expenses by clearly distinguishing between regular repairs and capital improvements.
• Track Capital Improvements by Property – Assign CapEx costs to individual properties, ensuring precise financial records for tax reporting and ROI analysis.
• Generate Tax-Ready Reports – Instantly generate financial reports that break down CapEx and depreciation, making it easy to maximize deductions and comply with IRS regulations.
• Go Paperless with Receipt Storage – Digitally store and attach receipts for every capital improvement, ensuring organized records and audit readiness.

With Landlord Studio, you can streamline capital expense tracking, improve tax efficiency, and make informed investment decisions—all from one easy-to-use platform.

Operating Expenses (OpEx) in Real Estate

Operating expenses on the other hand are costs associated with the day to day operation and management of your property. The boundaries can become blurred sometimes especially when considering repairs and maintenance. When does a repair become and improvement (for example)?

As a general rule though, repairs and maintenance return the property to the condition it was previously in whereas a capital expense increase the property’s value beyond that original value.

Accurately differentiating between the two is essential, because operating expenses can be deducted in full in the year they occur, dramatically reducing your tax bill for the year.

How Can Landlord Studio Help?

Landlord Studio also makes it super easy to categorize, track, and report rental property operating expenses accurately, ensuring you never miss a deductible expense.

• Automate Expense Tracking – Link your bank accounts to automatically import and categorize transactions, saving time and reducing manual data entry.
• Attach Receipts Digitally – Digitize receipts and store them securely within the app, eliminating the hassle of lost paperwork and making tax time stress-free.
• Simplify Tax Deductions – Ensure every eligible OpEx is accounted for, helping to minimize your taxable income and maximize your savings.

Operating Expense Tax Treatment: Example

John owns a duplex and pays $250 to fix a leaking pipe in one of the units. Since this repair restores the property to its original condition and doesn’t improve its value beyond that, it qualifies as an operating expense.

• Tax impact: John can deduct the full $250 expense in the year it occurred, reducing his taxable rental income for that year.

Common Operating Expenses in Real Estate

Some common operating expenses you might encounter with a single-family rental home or a small multifamily building:

• Marketing and Advertising: This includes costs for online rental listings, 'For Rent' signs, and maintaining a website for the property or real estate business.
• Tenant Screening Fees: These are charges incurred for conducting background checks, credit reports, rental history assessments, and eviction checks on prospective tenants.
• Leasing Fees: If you hire a property management company, leasing fees typically equal one month’s rent for new leases and half a month’s rent for lease renewals with existing tenants.
• Property Management Fees: Property management fees usually amount to around 8%-12% of the monthly rent collected but can vary by company.
• Repairs and Maintenance: These costs cover necessary repairs to keep the rental property habitable, such as fixing leaks or patching carpets.
• Landscaping and Snow Removal: In single-family rentals, these may be tenant responsibilities, whereas in small multifamily buildings, they often fall on the landlord.
• Pest Control: This expense covers seasonal treatments for pests like termites, ants, scorpions, or spiders.
• Utilities: Costs for utilities such as water, sewer, and trash collection can be considered operating expenses when paid by the landlord in multifamily properties.
• Insurance Premiums: Homeowners and landlord insurance premiums are deductible expenses, even if included in your monthly mortgage payment.‍
• Property Taxes: These are fully deductible expenses associated with rental properties, regardless of whether they are part of your mortgage payment.‍
• HOA Fees: Annual dues paid to a homeowners association are common operating expenses for single-family rental homes.‍
• Professional Service Fees: Costs incurred for services from accountants, financial planners, or attorneys are generally deductible as operating expenses.

For guidance on reporting these operating expenses to the IRS during tax season, IRS Schedule E (Form 1040) serves as an excellent resource. Also, read our article on A Breakdown of your Schedule E Expense Categories to gain more insight. 

Common Mistakes Landlords Make With CapEx and OpEx

Here are some of the most prevalent mistakes we’ve noticed that  property owners or landlords 

Misclassifying Repairs and Improvements

One of the most common errors landlords make is confusing capital improvements with repairs. For instance, consider the following scenario:

• Mistake: A landlord categorizes a kitchen remodel (CapEx) as a simple repair (OpEx).
• IRS Guideline: Repairs are intended to restore functionality, while improvements enhance property value. Therefore, replacing a broken window pane is considered an OpEx expense, whereas installing energy-efficient windows qualifies as CapEx.

Overlooking Documentation

Neglecting to keep track of receipts and invoices can complicate the audit process. Maintaining thorough records is essential for justifying expense classifications during tax evaluations. Without proper documentation, landlords may struggle to defend their claims.

Ignoring Depreciation Schedules

Many landlords overlook the importance of claiming annual depreciation on their CapEx expenditures. This oversight can result in missed long-term deductions that could significantly improve their financial situation. Regularly reviewing and updating depreciation schedules is vital for maximizing tax benefits.

Short-Term Thinking

Some landlords may be tempted to deduct the full cost of CapEx expenses in the current tax year to lower their immediate tax burden. However, this approach can lead to penalties from the IRS due to incorrect classification. It’s important to adopt a long-term perspective when managing these expenses to ensure compliance and optimize financial outcomes.

Related Article: Common Rental Property Expenses Investors Often Miss

How Landlord Studio Helps with OpEx vs. CapEx Management

Landlord Studio's award-winning rental property accounting suite makes tracking and categorizing capital expenses (CapEx) and operating expenses (OpEx) correctly easy.

• Automated Expense Tracking – Link your bank account to auto-import transactions and categorize them correctly.
• Clear CapEx vs. OpEx Distinction – Easily separate improvements from repairs to avoid misclassification.
• Tax-Ready Financial Reports – Instantly generate reports that break down expenses and depreciation for tax filing.
• Paperless Record Keeping – Attach receipts digitally to every transaction for a complete audit trail.

Streamline expense tracking, ensure IRS compliance, reduce manual data-entry and errors, and ensure you never miss a deductible expense. Create your free Landlord Studio account today.