Home repairs and home improvements differ in treatment when filing your taxes and trying to get the most out of the tax benefits that IRS offers to American homeowners. This article is not meant to be a substitute for the advice of a professional accountant.
But having a general understanding of the tax deduction differences between home repairs and home improvements will make any discussion with an accountant about your possible ways of minimizing your property taxes more productive.
3 Types of Tax Benefits
The NTUF estimates that up to 60% of homeowners overpay on property taxes. To know if you’re one of them, you need to understand how property taxes are calculated and what can be done to reduce the amount.
There are a few ways available to homeowners for reducing their property tax. If you want to learn about all of the most common ways, they are explained in this guide How to Lower Your Property Taxes.
But here we will discuss in detail the easiest and most popular of them—tax exemptions. Read on to learn about their types and which ones work in which situations.
A tax deduction reduces the amount of taxable income. For example, if your taxable income is $75,000 at a tax rate of 25%, you will owe the IRS $18,750. If you have $10,000 of qualified tax deductions, the tax on $65,000 would be $16,250—for a savings of $2,500.
A tax credit reduces the amount of taxes you pay. As an example, the government offers you a tax credit of 30% of the cost of a solar panel system you installed. Let’s assume it’s $3600. And let’s say your full liability for the year is $18,750. The tax credit is deducted from this amount which reduces your taxes for the year to $15,150.
The full purchase price of an improvement, such as the replacement of an HVAC system, cannot typically be deducted in the year of installation. As a general rule, the deduction is apportioned over 27.5 years. But in some cases, the depreciation can be accelerated—depending on the type of improvement that the government wants to encourage.
Difference Between Home Repairs and Home Improvements
As a general rule, when you fix something that breaks in a property, the IRS considers it as a home repair. Repairs “do not add significant value to the property or extend its life,” according to the IRS definition in their 1040 Schedule E Instructions.
If you break a window with a rock while mowing your yard, replacing the sash is considered a home repair.
Refinishing the floor in your living room because of pet damage is considered a home repair.
Replacing the dishwasher that quit functioning is viewed as a home repair.
By contrast, a home improvement adds value to the property or extends its life. Commonly called “capital improvements”, upgrades to your rental house or personal residence potentially increase the price that you will be able to ask for the property when selling it. For example, kitchen remodeling and home additions are among the most popular capital home improvements.
Using the above examples, if the broken glass was only one of many problems with the windows, you might decide to replace all of them. The IRS would treat the replacement as a home improvement.
If you choose to replace the damaged wood floor with porcelain tile that simulates wood, you would add value to the property. Hence, you have made a capital improvement.
Instead of replacing the broken dishwasher, if you decide to remodel the entire kitchen, you have chosen to make a home improvement.
With few exceptions, home improvements don’t qualify as tax deductions for your personal residence in the same year when they were made. And home repairs don’t qualify at all.
Through 2021, the Bipartisan Budget Act of 2018 allows a 30% tax credit for specific energy-efficient improvements. For example, 30% of the cost of a solar hot water heater can be deducted from your tax liability for that year. You can also deduct 30% of the equipment cost and labor for solar electric equipment from your tax liability for the year of installation.
There’s no limit on the deduction. And if the deduction exceeds your tax liability, you get a credit toward future taxes.
For fuel cell property, the deduction is capped at $500 per half-kilowatt of power capacity. For example, installing a 4-kilowatt fuel cell would result in a $4,000 tax credit.
Other home improvements allow you to get a deferred deduction taken at the time of the sale of the property. Many homeowners selling their houses choose to make upgrades just before the sale to increase the asking price and get a tax deduction as a bonus.
Please note that installing a security system does not provide any deductions, as stated in the Publication 529 (2018), Miscellaneous Deductions on the website of IRS, section “Nondeductible Expenses”. This applies if you are only protecting your personal property, but you can get a deduction if you need it for a home office.
However, you still can get the expenses for other safety improvements deducted when selling your home. These include installing metal window guards, replacing doors with stronger models, and similar.
The tax rules change when a portion of your home is rented out. The entire house is then subject to the same tax rules as a stand-alone rental—even the part that is not rented.
For example, you rent the efficiency apartment above your attached garage to a college student. It has a separate HVAC system. When the heat pump serving the main house quits working, you call in an HVAC contractor. If the unit can be fixed, it’s a repair. If the system has to be replaced, it’s an improvement.
Repairs made to a rental property are tax-deductible in the year of the repair. With few exceptions, improvements made to a rental are depreciated for up to 27.5 years.
Please note: from a tax perspective, repairing something is usually better than replacing it. In the short term, the tax benefit is greater for repairs than for improvements.
If a portion of your house is used exclusively for business purposes, it can be treated as a home office on your taxes. Repairs made to the home office can be deducted, and improvements can be depreciated—but only for the home office space. For example, if the electronic equipment in your office creates excessive heat, installing a window air conditioner would be considered an improvement that could be depreciated.
Beginning in the 2013 tax year, a standard home-office deduction (based on allowable square footage) is available. This deduction factors repairs and depreciation into the multiplier. So a separate deduction for repairs and depreciation is not available when using this standard deduction.
Please note: don’t red-flag your tax return with a suspicious-looking home office deduction. The small amount of tax savings on a home office is not worth the risk.