Capital Improvements on Rental Property: BAR Test and Depreciation

Capital improvements on rental property are costs you cannot deduct in the year you pay them. Instead, you add the cost to the property’s basis and recover it through depreciation over a set number of years, and the depreciation you claim is later recaptured when you sell. Repairs work the opposite way and come off your rental income in full the year of the expense. Classifying each job correctly is the whole game, because getting it wrong means either overpaying now or facing corrections and penalties later.

What Counts as a Capital Improvement

A repair keeps the property in normal working condition without meaningfully changing its value or lifespan. Painting between tenants, fixing a leaky faucet, patching a driveway crack, replacing a broken window pane — all repairs, all fully deductible in the year paid.¹

A capital improvement goes further. It materially increases the property’s capacity or quality, adapts the property to a different use, or restores a major component. Replacing an entire roof, gutting and rebuilding a kitchen, installing central air where none existed, or converting a garage into a rentable apartment all qualify. Those costs get added to basis and recovered through annual depreciation.²

Most disputes happen in the middle. Replacing one failing appliance is usually a repair. Replacing every appliance in a unit as part of a broader upgrade tips into improvement territory.

The BAR Test for Borderline Jobs

When the answer isn’t obvious, the IRS applies the BAR test: if the work is a betterment, an adaptation, or a restoration, you capitalize.¹

A betterment fixes a pre-existing defect or materially increases capacity, efficiency, or quality. Installing a high-efficiency HVAC unit with significantly more cooling capacity than the old one is a betterment. An adaptation changes what the property is used for, like turning a residential unit into commercial office space. A restoration replaces a major component or returns the property to like-new condition after deterioration, like replacing an entire roof or all the windows in a building.

One detail changes a lot of outcomes: the BAR test is applied separately to the building structure and to each major building system — HVAC, plumbing, electrical, fire protection and alarm, gas distribution, elevator, escalator, and security — not to the building as a whole.¹ Replacing a single water heater is a repair to the plumbing system. Replacing all the plumbing throughout the building is a restoration of that system and must be capitalized.

Safe Harbors That Let You Deduct Anyway

Three annual elections let you skip the BAR analysis for qualifying costs and deduct the expense in the current year.

De Minimis Safe Harbor

If an individual item or invoice falls below a dollar threshold, you can expense it regardless of whether the work would otherwise be an improvement. Most individual landlords, who do not have an applicable financial statement, can expense items up to $2,500 per invoice or per item. Taxpayers with an applicable financial statement get a $5,000 threshold.¹

Small Taxpayer Safe Harbor

Designed for smaller portfolios, this lets you deduct repair, maintenance, and improvement costs up to $10,000 per building per year if your average annual gross receipts are $10 million or less, the building’s unadjusted basis is $1 million or less, and total improvement spending stays below the lesser of 2% of unadjusted basis or $10,000.³

Routine Maintenance Safe Harbor

Recurring work you reasonably expect to perform more than once during the building’s first ten years of service qualifies as routine maintenance and can be deducted immediately. Inspecting, cleaning, testing, and replacing worn parts with comparable replacements all fit. This safe harbor can even cover work that would otherwise be a restoration, as long as it is genuinely recurring.¹ It does not cover betterments. Upgrading beyond the original condition must be capitalized no matter how often you do it.

How Long You Depreciate an Improvement

Once an expense is capitalized, you recover it through straight-line depreciation over a period that depends on what was installed.

Residential rental building and structural improvements: 27.5 years. A new roof, kitchen renovation, or bathroom addition on a rental house or apartment building follows this schedule.²
Nonresidential (commercial) real property: 39 years for the structure and structural improvements.⁴
Land improvements such as fences, driveways, sidewalks, and qualifying landscaping: 15 years.⁴
Appliances, carpeting, and furniture in a residential rental: 5 years.²
Office furniture and fixtures: 7 years.⁴

Each improvement runs on its own schedule, separate from the original building. A $20,000 roof placed in service in June 2026 begins a fresh 27.5-year period from that date, independent of when you bought the property. Tracking each component matters when you later replace it or sell the property.

When You Can Accelerate the Deduction

The One, Big, Beautiful Bill permanently reinstated 100% bonus depreciation for qualified property acquired after January 19, 2025.⁵ Bonus depreciation lets you write off the full cost of eligible property in the year it is placed in service. The catch: it only applies to property with a recovery period of 20 years or less.

For a residential rental landlord, that rules out the building structure and structural improvements, which sit at 27.5 years. What does qualify are the shorter-lived components: appliances and carpeting at 5 years, office furniture at 7, land improvements at 15. A cost segregation study can pull portions of a larger renovation into those shorter-lived buckets and accelerate a meaningful share of the depreciation.

Qualified Improvement Property Applies Only to Commercial

Interior improvements to a nonresidential building placed in service after the building itself are qualified improvement property (QIP), which carries a 15-year recovery period and is eligible for 100% bonus depreciation. Enlargements, elevators, escalators, and changes to the internal structural framework are excluded. QIP does not apply to residential rental buildings — interior improvements to an apartment building or rental house depreciate over 27.5 years with no QIP shortcut.

Section 179 Usually Won’t Help Individual Landlords

Section 179 expensing allows a business to deduct the full cost of qualifying assets in the year of purchase, with a 2026 cap of $2,560,000. But it requires the property to be used in an active trade or business, and the IRS generally treats an individual landlord’s rental activity as production of income rather than a trade or business. Owners of commercial rental property who actively run the rental as a business may be able to use Section 179 on certain improvements.

Replacing an Improvement: The Partial Disposition Election

When you replace an existing capital improvement, such as tearing off an old roof to install a new one, you can elect to recognize a loss on the old component’s remaining undepreciated basis. Without the election, that old basis stays on your books and keeps depreciating alongside the replacement, meaning you are depreciating something that no longer physically exists.⁶

You make the election on your timely filed return for the year of the replacement. No special form is required, but you do need to identify the disposed component, its original placed-in-service date, and its adjusted basis at disposal, then reduce the basis of the original asset. The disposed component and its replacement must be the same type of property, at the same location, with the same recovery period. If a replaced roof had $8,000 of undepreciated basis remaining, that $8,000 becomes a current-year loss instead of trickling out over decades.

Depreciation Recapture When You Sell

Every dollar of depreciation you claim on a capital improvement reduces your adjusted basis. When you sell, the IRS recaptures that depreciation at a rate of up to 25%, in addition to any capital gains tax on the profit itself.⁷

Suppose you bought a rental for $200,000 excluding land, added $30,000 in improvements over the years, and claimed $50,000 in total depreciation. Your adjusted basis is $180,000. Sell for $280,000 and the total gain is $100,000: $50,000 is unrecaptured Section 1250 gain taxed at up to 25%, and the remaining $50,000 is taxed at your long-term capital gains rate.

Recapture applies to depreciation “allowed or allowable.” Skipping deductions in prior years does not spare you from recapture. It just means you missed write-offs you were entitled to.

Passive Loss Limits on the Deductions Themselves

Depreciation from a capital improvement reduces your rental’s taxable income, but it is caught by the passive activity rules. For most individual landlords who are not real estate professionals, rental activity is passive regardless of hours worked.⁸

If depreciation and other rental expenses push you to a loss, that loss generally cannot offset wages or investment income. One exception: if you actively participate and your modified adjusted gross income is $100,000 or less, you can deduct up to $25,000 of passive rental losses against non-passive income. The $25,000 allowance phases out between $100,000 and $150,000 of modified AGI and disappears above $150,000.⁹ Unused losses carry forward and can offset passive income later or free up entirely when you sell the property in a fully taxable transaction.

Timing, Invoices, and Records

Depreciation starts when the improvement is placed in service — ready and available for use in the rental — not when you pay or when the contractor finishes.⁴ For a new furnace in an occupied unit, that is the day it works. For a major renovation on a vacant property, it is the day you first make the property available to tenants.

Invoices should describe the scope of work and tie each cost to a specific property and component. When a contractor performs both repairs and improvements in one project, the invoice needs to separate the costs. If it does not, the IRS will often capitalize the whole amount, and the burden is on you to prove otherwise.² Keep a depreciation schedule listing every capital improvement by description, cost, placed-in-service date, and recovery period. You will need it to calculate adjusted basis at sale and to support any partial disposition election.

Fixing Past Mistakes With Form 3115

If you expensed something that should have been capitalized, or missed depreciation you were entitled to, the fix is Form 3115, Application for Change in Accounting Method. Amending prior returns is not required. The form calculates a Section 481(a) adjustment that captures the cumulative effect of the error and applies it going forward.¹⁰

Most rental property corrections qualify as automatic changes: no advance IRS approval, no user fee. Attach the form to your timely filed return for the year of change and send a signed copy to the IRS National Office. A negative adjustment, where you were entitled to more deductions than you took, is claimed in full in the year of change. A positive adjustment, where you overclaimed, is spread over four years.¹⁰ Because recapture applies to depreciation “allowed or allowable,” catching up on missed depreciation through Form 3115 recovers years of write-offs you would otherwise pay tax on at sale without ever having deducted.

1
Internal Revenue Service. Tangible Property Final Regulations – Frequently Asked Questions
2
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
3
eCFR. 26 CFR 1.263(a)-3
4
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
5
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
6
Internal Revenue Service. Examining a Taxpayer Electing a Partial Disposition of a Building
7
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
8
Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules (2025)
9
Internal Revenue Service. Instructions for Form 8582 (2025)
10
Internal Revenue Service. Instructions for Form 3115 Application for Change in Accounting Method