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Routine Repairs vs. Capital Expenditures (CapEx)

February 24, 2015 by Marco Santarelli

For some residential investors, capital expenditure terminology — CapEx for short — is unfamiliar.  Capital expenditure reserves are common in the commercial real estate sector but lesser known in the residential real estate space.

CAPITAL EXPENDITURES

A capital expenditure is something you can capitalize over a certain time period.  It adds to or upgrades a property’s physical assets.  It is typically a one-time major expense.

Examples of capital expenditures include a new roof, appliance or flooring.  A capital expenditure could also include installing a new heating and air conditioning system or doing a major overhaul of an existing HVAC system.  The same goes for extensive new plumbing or major electrical work.

If you are painting multiple properties, that could be classified as a capital expenditure, but routine painting upon move-out is just that, routine.  You won’t be able to tap your capital expenditure reserve to pay for run-of-the mill maintenance.

MAINTENANCE AND REPAIRS

Repairs such as move-out painting, touch-up painting, or patching a wall or floor fall into the routine category.  The cost of routine maintenance is typically covered by an investor’s annual operating budget, not from the capital expenditure reserve.

The easiest way to identify routine maintenance is to ask yourself if the repair is something that tends to be reoccurring.  Examples include repair of existing appliances, cleaning the carpets or patching a worn section of flooring.

Some repairs could be conceivably paid for from either the capital expenditure fund or the operating fund.  Look at whether the expense is “major” to determine whether it qualifies to be paid for from capital expenditure reserves.

For example, if you need to replace multiple sinks or toilets, that would come from the CapEx reserves, but if you only need to replace one sink or one toilet, that would come out of your annual operating budget.  If you need to replace one light fixture, expect to pay for that from your operating budget.  If you need to replace multiple light fixtures, the expense could come from the CapEx fund.

The following table summarizes many of the factual considerations used by the IRS.  These factors, although not exhaustive, should be considered in your analysis to distinguish between capital expenditures and deductible repairs:

CapitalRepair
Improvements that “put” property in a better operating conditionImprovements that “keep” property in efficient operating condition
Restores the property to a “like new” conditionRestores the property to its previous condition
Addition of new or replacement components or material sub-components to propertyProtects the underlying property through routine maintenance
Addition of upgrades or modifications to propertyIncidental repair to property
Enhances the value of the property in the nature of a betterment
Extends the useful life of the property
Improves the efficiency of the property
Improves the quality of the property
Increases the strength of the property
Increases the capacity of the property
Ameliorates a material condition or defect
Adapts the property to a new use

Hopefully these examples give investors a clear idea of the difference between capital expenditures and routine maintenance.

Filed Under: Financing, Property Management, Real Estate Investing, Rehabbing

About Marco Santarelli

Marco Santarelli is an investor, author, Inc. 5000 entrepreneur, and the founder of Norada Real Estate Investments – a nationwide provider of turnkey cash-flow investment property.  His mission is to help 1 million people create wealth and passive income and put them on the path to financial freedom with real estate.  He’s also the host of the top-rated podcast – Passive Real Estate Investing.

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