The WOW Factor of Kitchen/Bath Upgrades
Second in a Series of 2 Articles
In last month’s issue of the Residential Investor Connection we introduced a mindset … “Don’t fall in love with your investment.” To revisit that idea, you can and should respect as well as protect your asset without feelings of emotional attachment.
The point is that your residential rental property should not be afforded the same rigorous standards that you likely apply to your own home. Face it (no slur intended), tenants view the residence as temporary and will not treat the rental unit with the same quality of care they would exhibit toward their own property.
Very few renters will notice or appreciate “above and beyond” efforts on your part to improve the rental unit. Their concern is a functional, comfortable living space that is consistent with the rent they pay.
So as you approach the need for renovations, upgrades or improvements be critical … but remain objective. Your concerns should reflect the above tenant expectations with an eye to your expenses, potential return on investment (ROI) and tax considerations.
Repairs vs. Improvements
There are distinct differences between “repairs” and “improvements” to your rental property. Not only are there descriptive differences, e.g. the extent of work-effort and materials required, there are tax implications as well.
Repairs: The word “maintenance” immediately comes to mind when discussing repairs. These are the upkeeps that are ordinary, necessary and reasonable in cost that are required to keep the property both habitable and in working condition. Taking a page from the IRS code, repairs are defined as those that “do not add significant value to the property or extend its life.”
Examples of repairs are typically those where the objective is to restore an item or structural element to its original, or at least, serviceable condition. Here are a few that will likely qualify as repairs vs. improvements: smoke detector replacement, floor refinishing, plumbing repair, roof patching, repainting and replacing broken windows.
Back to the IRS for a moment. The cost of repairs to rental properties that conform to the above are generally fully deductible in the year incurred as ordinary business expenses. Be sure to consult the IRS or your tax advisor to decide what deductions are applicable to your specific situation.
Improvements: Improvements and its synonym, renovations, enhance or change the function of your property, or the property value. Typically improvements are significant enough in scope to extend the useful life of your property. Likewise, there is usually considerably more cost involved than would be experienced with repairs.
Virtually any major renovation will be termed an improvement. Examples include: kitchen or bath renovation, new or replacement HVAC system, roof replacement and room addition.
And now a word from the IRS. Expenses for improvements generally must be “capitalized”. That means that the expenses incurred may not be deducted immediately. Rather the deductions must be spread out over some period of amortization.
Many residential rental investors are inclined to maximize the immediate deductibility of repairs to improve annual net cash flow from the property. Often, the benefits of tax deductibility “this year” can make the difference between losing money and earning a profit on your rental property.
Caution: While the line between “repairs” and “improvements” may sometimes be a bit blurred, be sure to consult the IRS or your tax advisor to decide what deductibility applies to your circumstances.
The WOW Factor of Kitchen/Bath Upgrades
Whether seeking to rent or buy a house, people look first at kitchens and baths. Both of these rooms have a special place in the minds of prospective tenants and buyers alike. More than any other room, these address comfort, hygiene, and peace of mind when they are attractive, functional and up-to-the-minute.
Given the priority value placed on kitchens and baths by prospective residents, improvements typically result in two additional immediate values to you, the investor. First, appraisers will assure you that the asset value of your property will increase. Second, you will be able to realize increased rental rates in the range of 10% – 30% or more.
A residual benefit is savings in maintenance when aging appliances and fixtures are replaced. And finally, don’t forget that Uncle Sam is your financial “partner” in allowing for depreciation expense deductions on your tax return.
A word of caution to motivate planning before you jump into renovation. There are variables that determine what combination of improvements in kitchens and baths produce the biggest bang for your investment buck. Projecting what percentage of rent increase will be realized from a renovation is often more art than science.
If you have prior experience in the market served by your rental property, you will start with a definite advantage. That said, whether experienced or not, it’s important that you closely examine the variables that impact rents before committing to a major upgrade effort. Among others, those variables include: the age of the building, location, tenant profile and competitive offerings – each of which may vary widely from property to property.
In the next issue of the Residential Investor Connection, we’ll take a close look at alternative upgrade materials to better ensure that you enjoy maximum value with minimum expense. Oh, and to remind you, “Don’t fall in love with your investment.”