Once you own a rental property, you can continue to build wealth. However, most investors just focus on income and forget about costs. Underestimating expenses is one of the biggest mistakes that you can make as a property owner. To avoid that mistake, you need to be aware of the major costs of rental property ownership. Read this guide, and we will help you understand them.
What are Capital Expenses for Rental Property and How They Work
Understanding what capital expenses for rental property investments are is essential for landlords who want to plan long-term maintenance and maximize tax benefits. Capital expenses (or CapEx, for short) are significant expenditures made toward improvements or replacements on your rental property. Capital expenses are different from your day-to-day repair costs. They’re larger expenses that help keep your property safe, livable, and profitable in the long run.
Repairing a faucet vs. replacing your entire plumbing system? Make sure you know the difference.
One good way to understand capital expenses: Repairs simply keep your property up. Capital expenses improve it.
Capital expenses and repairs impact your budget differently. They’re also treated differently on your taxes. According to the IRS, landlords can’t deduct capital expenses the same way we can deduct day-to-day operating costs.
When you pay for a capital expense, you gradually deduct its cost over the years. This spreading out of deductions is known as depreciation.
You can depreciate residential rental property at a rate of 3.636% per year. This may not sound like much, but $3,636 is much better than $0 every year. Learn more about how depreciation works by checking out IRS Publication 527.
Understanding the difference between repairs and capital expenses is crucial. Throw them together, and you’ll have a headache when tax season rolls around, and your budget might suffer.
Capital expenses don’t occur every month. They pop up every few years, and they’re often expensive. Think $10,000 for a new roof, or $5,000 to $12,000 for a new HVAC system.
If you spend $10,000 on a new roof, that could be two or three months’ worth of rent wiped out instantly.
Common Examples of Capital Expenses Landlords Should Know
Understanding what qualifies as a capital expense will help you determine how much you should budget for them in advance. Here are the expenses landlords will encounter most frequently:
Roof replacement – Asphalt roofs last anywhere from 20 to 30 years. When you have to replace a roof, you are looking at a substantial bill of $8,000 to $15,000 or more, depending on the size of your property.
Heating and air conditioning system – HVAC systems are bound to wear out eventually. A full replacement of your HVAC system is one of the most frequent (and costly) CapEx projects you will come across.
Water heater – These only last about 8–12 years. Water heater replacement is clearly a capital expense, especially when it’s replaced as part of an overall upgrade.
Windows and doors – Replacing old, drafty windows or broken doors can improve energy efficiency and tenant satisfaction. This type of home improvement qualifies as capital.
Flooring – Whether it’s hardwood floors, tiles, or carpeting – if you replace all the flooring as part of a large upgrade, it counts as a capital expense. Spot fixes do not.
Appliances – If you provide appliances to your tenants, replacing these may fall into the CapEx category if done during a major upgrade. Think refrigerators, washers, and dryers.
Kitchen and/or bathroom upgrades – Giving your kitchen or bath a makeover to make the space feel more modern counts as a capital improvement.
Electrical and plumbing – Replacing or greatly upgrading your electrical wiring or plumbing system counts as CapEx. Both of these improvements increase your property’s value and keep your tenants safe.
Ask yourself: Does this expense improve my property’s value and last for more than one year? If so, it’s probably a capital expense. Your property manager can help you with this as well. Experienced Atlanta property managers can help landlords reduce vacancy rates by marketing rental homes effectively, screening tenants thoroughly, and handling maintenance requests promptly.
Why Understanding Capital Expenses Matters for Investors
Investors lose money on properties not because they chose a bad investment. They lose money because they failed to plan for capital expenses.
You can’t put off replacing a roof that started leaking. You can’t tell your tenants to tough it out without AC in the middle of summer, and don’t think you can rent it out as-is. Tenants will only live in safe, habitable conditions.
The point is, when that repair or replacement comes due, you have to pay for it, whether you’re prepared or not.
That’s why savvy investors create a CapEx reserve fund. You fund it monthly, just as if it were another expense of owning the property. Then, when a big-ticket repair comes due, you pull from the fund.
Let me explain why this makes a big difference for your investment profits:
- It protects your cash flow. An unforeseen expense can wipe out months, or even a year’s, worth of profit. A reserve fund insulates your cash flow.
- It allows for better investment analysis. If you factor in CapEx at the start, you’ll have a realistic idea of how much the property will actually earn. Some investors falsely inflate their returns by ignoring CapEx.
- You can plan for taxes. Knowing which expenses are considered capital expenses and which are classified as repairs can help you claim every deduction while avoiding the IRS.
- It can prolong the long-term value of your property. By keeping up with capital expenses, you’ll keep your property attractive to potential tenants and help maintain its value.
- You can avoid a forced sale. Too many investors let things go until they have to sell the property just to “stop the bleeding.”
One trick I use is to track the age of every major system. When was the last time you replaced the roof? How old is the HVAC? If you know these things, you can plan for the future. You’ll have time to save up for that repair or replacement when you know it’s coming.
Final Words
Capital expenses are inevitable when you own rental property. They don’t mean you did something wrong. They’re just part of the game. The landlords who have problems are the ones who avoid them. The landlords who succeed are the ones who plan for them.
Let’s start preparing for them by creating a CapEx reserve fund, tracking the ages of your major systems, and understanding the difference between a repair vs. a capital improvement. Once you learn to master these expenses, your investment will become much more dependable.
