Property owners need to know the difference between repairs and capital improvements, which can save them money on taxes. This guide explains what counts as a capital improvement and how it affects property taxes.
What Is a Capital Improvement?
A capital improvement is a permanent change or repair made to a property that increases its value, extends its lifespan, or changes its use. Unlike regular repairs that keep the property in good shape, capital improvements create lasting value and usually involve a significant investment.
For property tax purposes, capital improvements must generally meet three criteria:
The improvement must add value to the property
The improvement must have a useful life of more than one year
The improvement must be permanent
What Qualifies as a Capital Improvement?
The main difference between improvements and repairs is whether the work transforms the property's value and purpose or restores it to its original condition.
Capital improvements for residential properties can include:
Adding new spaces like bathrooms, bedrooms, decks, or garages that expand your home's size and function
Installing new siding or security systems that boost protection and appearance
Upgrading kitchens with built-in appliances or redesigning layouts
Adding central air or new plumbing systems that improve comfort
Installing insulation in attics, walls, or floors that cuts energy costs
For commercial properties, capital improvements can include:
Building expansions
Major space redesigns
Complete HVAC or electrical system replacements
Full roof replacements
Total parking lot renovations.
What Doesn't Qualify
Simple repairs that restore a property to its original condition don't count. For example, fixing a broken windowpane is a repair, but installing a new window is an improvement. Patching part of a roof is a repair, but replacing the entire roof is an improvement.
Tax Benefits of Capital Improvements
The cost basis is the original purchasing price of a property plus any closing costs paid by the buyer and the cost of capital improvements.
Property owners can increase their property's cost basis when they make qualifying capital improvements.
This becomes significant when selling the property.
For example, if someone purchases a house for $300,000 and later completes $50,000 in capital improvements, their new cost basis would be $350,000.
When selling for $550,000, their taxable gain would be $200,000 rather than $250,000, potentially reducing their capital gains tax liability.
Property Tax Appeals
Capital improvements typically increase a property's assessed value, which can lead to higher property taxes. Property owners should understand which improvements trigger reassessment so they can plan effectively and prepare for potential appeals.
These include, but are not limited to, the following:
Adding new spaces like bathrooms, bedrooms, decks, or garages that expand your home's size and function (residential)
Upgrading kitchens with built-in appliances or redesigning layouts (residential)
Building expansions (commercial)
Complete HVAC or electrical system replacements (residential and commercial)
Full roof replacements (residential and commercial)
Total parking lot renovations (commercial)
At Ownwell, we've helped many owners appeal their property taxes by demonstrating that certain improvements shouldn't have resulted in the substantial value increase determined by the assessor.
Special Tax Considerations for Commercial Properties
Commercial property owners should know how taxes apply to improvements and repairs. They can usually deduct the repairs and maintenance costs as expenses in the same year they pay for them.
However, they need to handle capital improvements differently.
Owners must use depreciation to spread the costs of these improvements over their useful life. This means the tax benefits from capital improvements come over several years instead of being an immediate deduction.
Documenting Capital Improvements
Good documentation is essential for tax benefits:
Keep all receipts, contracts, permits, and before/after photos
Create separate files for each project
Record when work started and finished, with all costs
Save records for at least seven years after selling, but a complete bathroom remodel counts as an improvement.
Homeowners should keep detailed records, including receipts, contracts, photos, permits, and inspection certificates, in case tax authorities question their claim.
Commercial property owners should plan their improvements with taxes in mind. They should consider the fiscal year and how depreciation impacts their annual taxes.
Consider cost segregation studies that identify components eligible for faster depreciation. These can change certain elements' 39-year depreciation schedules to 5-, 7-, or 15-year schedules, creating bigger tax benefits sooner.
Moreover, the improvement costs against potential tax savings over time should be analyzed before making significant investments. Lastly, consider the energy efficiency credits, possible property tax increases, and how improvements affect property value and rental rates.
Take Action on Your Property Tax Situation
Understanding capital improvements is key to managing property taxes effectively. Whether you've recently completed projects or are planning future ones, knowing the tax implications can save thousands over time.
Ready to ensure you're not overpaying after making capital improvements? Visit Ownwell to learn how our experts can help owners with property tax appeals and exemptions.
Ownwell can help homeowners apply for homestead exemptions for the current year and retroactively for up to two years.
