What You Need to Know About Tax Deductible Improvements

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.

Keep in mind that the 2017 Tax Cuts and Jobs Act made big changes to the U.S. tax code that will take effect in 2018. Though the IRS Rules on Renting Residential and Vacation Property remain mostly the same, some of the tax law changes will affect vacation rental owners.

Deductions can get complicated, and the regulations spurred by the new law are still getting hammered out, 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 “101 Ways to Stay Off the IRS Radar.” A qualified tax advisor also can help you navigate the new law and figure out what it means for your vacation rental.

To make sure you’ve got everything in order for taxes, 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, several 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.

The new tax law makes record keeping even more important if you take out a home equity loan to improve your vacation rental. In the past, a homeowner could deduct interest on a home equity loan of up to $100,000, but that will no longer be allowed unless you can prove to the IRS that you used the loan solely to make improvements to the home. So, save every receipt for that bedroom addition, kitchen remodel, or pool installation.

“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. The new tax law increases the depreciation period slightly. (See details below.)

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% 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% of the time, you’d be able to deduct 80% of the depreciation on the remodel, Wheeler says.

Under the old law, improvements to vacation rentals were depreciated over 27.5 years, and the new law extends that to 30 years.

Under the old law, if you divided the $20,000 spent by that number of years, you get $727 per year. Take 80% of that, and you would be able to deduct $582 annually over the depreciation period, Wheeler says.

Under the new law, dividing the total by 30, you’ll be able to deduct $666 per year for an identical project. Take 80% of that, and you’ll be able to deduct $532 a year over the new depreciation period.

Overall, that change to the new tax law should not have a huge impact on vacation rental owners, Wheeler says.

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

It’s also important to get guidance from your tax professional on whether to depreciate improvements at all, Wheeler says. If your expenses are high enough, you and your advisor might choose not to depreciate so you can instead use that expense to reduce your capital gains taxes on the profits when you sell your vacation home in the future, he says.

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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