What Is Capital Expenditures?

What Are Capital Expenditures?

Every rental property has two types of expenses. There are the regular, ongoing costs like fixing a leaky toilet or replacing a broken light switch. Those are operating expenses or repairs. Then there are the big-ticket items that come along every few years and cost thousands of dollars. Those are capital expenditures.

The IRS draws a clear line between the two. If the expense repairs something to its previous condition, it is a repair. If it improves the property, makes it more valuable, or extends its useful life, it is a capital expenditure. This distinction matters because it changes how you handle the cost on your taxes.

A repair is fully deductible in the year you spend the money. A capital expenditure gets depreciated over its useful life, which could be 5, 15, or 27.5 years depending on what it is. That means you cannot write off the full $12,000 roof repair in the year you paid for it. Instead, you deduct a portion of it each year over the depreciation period.

How CapEx Works in Practice

Let us say you own a duplex and the 20-year-old furnace finally dies in January. You pay $6,500 for a new high-efficiency furnace installed. That $6,500 is a capital expenditure because you are replacing a major building system with something that will last 15-20 years.

On your taxes, you would depreciate that furnace over its IRS-defined useful life. For residential rental property improvements, most building systems depreciate over 27.5 years, but certain assets like appliances and HVAC equipment can qualify for shorter depreciation periods (5-15 years depending on classification). Your CPA can help you pick the right schedule.

Now compare that to a $250 repair to fix a leaking pipe under the kitchen sink. That is a repair expense. You deduct the full $250 in the current tax year. Simple.

Common CapEx Items and Typical Costs

Here are the major capital expenditures most landlords will face and what they typically cost:

• Roof replacement: $8,000-$15,000 for a single-family home, $15,000-$30,000+ for a small multifamily
• HVAC system: $5,000-$10,000 per unit depending on system type
• Water heater: $1,200-$2,500 installed
• Kitchen renovation: $8,000-$20,000 depending on scope
• Bathroom renovation: $5,000-$12,000
• New windows: $300-$800 per window installed, $5,000-$15,000 for a whole house
• New flooring: $3,000-$8,000 per unit for quality LVP or hardwood
• Parking lot repaving: $3,000-$10,000 depending on size
• Exterior painting: $3,000-$8,000 for a single-family home

Real Example: CapEx Budgeting for a 4-Unit Building

You own a 4-unit building built in 1995. Each unit rents for $1,300/month, giving you $62,400 in annual gross rent. You set aside 8% for CapEx reserves, which is $5,000 per year going into a separate savings account.

In year one, nothing major breaks. Your reserve grows to $5,000. In year two, the water heater in Unit 3 fails. You spend $2,200 on a new one. Reserve balance: $7,800. In year three, you need to replace the roof. Cost: $22,000. You have $12,800 in reserves, so you cover $12,800 from savings and finance the remaining $9,200.

This is exactly why CapEx reserves matter. Without that $12,800 saved up, you would be financing the entire $22,000 roof, and your cash-on-cash return would take a massive hit.

CapEx vs. Repairs: The Gray Area

Sometimes the line between a repair and a capital expenditure gets fuzzy. Here are some examples that trip landlords up:

Replacing one section of a roof after storm damage? That is probably a repair. Replacing the entire roof? Capital expenditure.

Fixing a broken dishwasher? Repair. Replacing it with a new one? Capital expenditure, and you should track the appliance depreciation separately.

Repainting a unit between tenants? Repair and maintenance (regular turnover cost). Repainting the entire exterior of the building? Could go either way, but if it is part of a larger renovation project, it is likely CapEx.

When in doubt, talk to your CPA. Getting this classification wrong can trigger an audit or cost you deductions you deserved.

How to Budget for CapEx

Step 1: Assess your property's age and condition. A brand-new construction might only need 3-5% of gross rent set aside. A 1970s building with original systems needs 10-15%.

Step 2: List major systems and their remaining life. Roof has 10 years left? You have 10 years to save for a $15,000 replacement. That is $1,500/year or $125/month into reserves.

Step 3: Open a separate savings account. Label it "CapEx Reserve" and do not touch it for operating expenses. This money is for big-ticket items only.

Step 4: Fund it monthly. Transfer a fixed amount every month, just like paying a bill. Most landlords set aside $200-$400 per unit per month depending on property age.

Step 5: Track it in your NOI calculations. CapEx is not included in NOI (since NOI only covers operating expenses), but smart landlords track it separately to understand true property performance.

Common Mistakes

Not budgeting for CapEx at all. This is the most common mistake new landlords make. They look at their net operating income and think that is their profit. But a $10,000 roof replacement will wipe out months of cash flow if you have not been saving for it.

Confusing CapEx with repairs on your taxes. Claiming a $15,000 roof as a current-year repair deduction is a red flag for the IRS. Get it right or pay a CPA to categorize your expenses properly.

Deferring CapEx too long. Putting off a roof replacement to save money often leads to water damage that costs far more than the roof itself. A $15,000 roof today prevents $40,000 in water damage repairs next year. Read more about the risks of deferred maintenance.

Not factoring CapEx into purchase analysis. When buying a property, inspect major systems and estimate upcoming CapEx. A "cheap" property with a failing roof, ancient HVAC, and original plumbing is not cheap at all.

Frequently Asked Questions

What counts as a capital expenditure for a rental property?

Capital expenditures include new roofs, HVAC system replacements, kitchen renovations, new windows, adding a parking lot, or any improvement that extends the useful life of the property beyond one year. Routine repairs like fixing a leaky faucet are not CapEx.

How do I deduct CapEx on my taxes?

Capital expenditures are depreciated over their useful life rather than deducted in the year you spend the money. A new roof is depreciated over 27.5 years for residential property. A new appliance is depreciated over 5-7 years. Consult your CPA for exact schedules.

How much should I budget for CapEx each year?

A common rule of thumb is 5-10% of gross rental income or $200-$300 per unit per month set aside into a CapEx reserve fund. The exact amount depends on the age and condition of your property. Older buildings need larger reserves.

Is CapEx included in NOI?

No. Net operating income only includes operating expenses like property taxes, insurance, maintenance, and management fees. CapEx is tracked separately. However, smart investors calculate "NOI after CapEx reserves" to understand true cash flow.