Improvement or Repair?

Capital Gains tax is usually not an issue when a person is selling their primary residence, because of the existing exemptions. Owners of investment property need to keep track of any expenditure that could lower their tax obligations in the future. Tax will be owed on the gain at the sale, which is the difference between the basis and the sales price. It sounds easy, but it is not always easy to determine the base amount.

The basis is the amount spent on purchasing the property, plus the amount spent on improving it.  Improvements can be deducted as depreciation on a tax return, so the depreciation needs to be subtracted from the amount spent on improvements. The cost of a repair may be deducted in full that year, but an improvement expenditure gets added to the basis of the property, (but can be deducted as depreciation over the years).  

But what is an improvement, and what is a repair?

The IRS considers it an improvement if the expenditure is to better the property, restore the property, or adapt the property to a new or different use. Everything else would be considered a repair.

When calculating the gain on the sale of investment real estate, the basic rule is that you can deduct what has not been deducted already.  For example, if a window was broken and replaced, that expenditure would likely be a repair and deducted as an expense for that tax year.  If a house has new windows installed, that would likely be a betterment of the property and considered an improvement. If the taxpayer has claimed depreciation on the new windows as a tax deduction, then the basis is only increased by the amount spent on the windows minus the depreciation claimed already.  

Anyone investing in real estate should have a CPA or tax professional advising them. At closing, we cannot give tax advice to buyers or sellers. As an investor, have these numbers ready at closing so you know your tax liability for the sale. 

John C. Bennett is a real estate closing attorney and owner of Origin Title and Escrow, Inc.. Since 2003, Origin Title has handled real estate transactions – purchases, refinances, reverse mortgages – quickly and professionally. There will be no surprises, nothing misunderstood. Title searches are thorough and well-reasoned, to avoid unpleasant surprises later down the road. Calculate your closing costs in Georgia or Florida using our calculator or contact Origin Title using this form.