What You Need to Know about Tax Deductible Improvements

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Making an improvement to your vacation rental home can offer a win-win: your home gets spiffed up and you get an extra tax break.

But before you head to the hardware store, consult a designer or hire a remodeling crew, make sure you know the nuts and bolts of vacation home tax deductions.

The tax benefits you’ll get depend on a variety of factors, including whether and how much you visit the home for personal use, whether you’re making a repair or an improvement, what items you purchase for the home and how much you spend.

Deductions can get complicated, so it’s important to hire a tax pro with experience in vacation rental properties, says Abby Eisenkraft, a federally licensed tax professional and author of the forthcoming book, “101 Ways to Stay Off the IRS Radar.”

It’s also crucial to keep good records, including a log of your visits to the home and detailed receipts for all improvements, especially if you pay cash to a contractor, Eisenkraft says. You’ll need these records if you get audited, she says.

For example, a few years ago, Eisenkraft handled an audit for a client who had put a new bathtub in a vacation rental. The client produced a receipt, but the slip of paper did not include the address where the work was done. The IRS made the case that, without an address on the receipt, it was impossible for the taxpayer to prove that the bathtub had been installed at the rental home.

“It’s hard to fight [the IRS] when your records are sloppy,” Eisenkraft says.

Vacation rental repairs vs. improvements

The first question to ask when you’re spending money on a project at your vacation home is whether you’re making a repair or an improvement. The distinction matters because the IRS allows you to deduct the cost of a repair outright on that year’s income taxes while the cost of an improvement must be depreciated over time.

A repair is simply fixing something that’s been broken or damaged. Examples of repairs could include: replacing a shattered windowpane, having a plumber repair a broken toilet or patching a hole in a wall.

In contrast, improvements add value to your property. The IRS offers a chart that lists projects that count as vacation rental improvements, including:

  • Adding on a bathroom, bedroom, garage, deck, patio or porch
  • Doing a bathroom or kitchen remodel
  • Getting new storm windows or doors
  • Putting on a new roof
  • Upgrading the electrical wiring or plumbing
  • Hooking up an alarm system
  • Adding better insulation
  • Putting in a swimming pool
  • Having the grounds landscaped
  • Installing a new hot water heater or furnace

In general, the IRS defines an improvement as something that “results in a betterment to your property, restores your property or adapts your property to a new or different use.”

The ins and outs of deducting improvements

One issue that commonly trips up vacation rental owners is confusion about how to take deductions for improvements when they use the home for part of the year, says Bob Wheeler, certified public accountant and CEO of RWWCPA.com. Some people who stay in their vacation rental for personal reasons mistakenly think they can deduct 100 percent of their expenses.

“If you’ve got a beach house and you spend time there, along with renting it out, you’re going to have to prorate your expenses,” Eisenkraft says.

Here’s an example of how an improvement deduction might work on your taxes in that scenario:

Say you rent out your vacation home 80 percent of the year and relax there with your family the rest of the time. This year, you shell out $20,000 to do a big kitchen remodel, with new cabinets, granite countertops and tile flooring.

Because you made an improvement, rather than a repair, you’d depreciate the cost of the remodel. Because you stay at the place for personal use 20 percent of the time, you’d be able to deduct 80 percent of the depreciation on the remodel, Wheeler says.

Improvements are depreciated over 27.5 years. So, if you divide the total spent by that number of years, you get $727 per year. Take 80 percent of that, and you can deduct $582 annually over the depreciation period, Wheeler says.

However, the calculations get a little more complicated if part of your costs involved purchasing appliances. Appliances can be depreciated over a shorter time period, Wheeler points out.

The bottom line on improvements and taxes

Making an improvement to your rental home makes sense if the project is strongly needed or desired and you have the cash flow to pay for the project without taking a loan, Wheeler says.

It’s also worth considering if the specific improvement–for example, a fancy new kitchen or a gorgeous pool–would lure in renters, improve your occupancy rate and help you make more money.

However, don’t do a remodel or another home project mainly to save on taxes, Wheeler recommends.

“It’s not that big of a deduction,” he says.

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