Is Substitution a Capital Expenditure? - An Expert's Perspective

Capital expenditures, also known as improvements, can include major projects such as replacing carpets, lighting, landscaping, pool decks, security systems, exterior painting, and more. For instance, replacing a car battery is considered a repair, while replacing a transmission or engine is a capital expenditure. When investing in a company car, it is important to keep these differences in mind to increase the value of the car and property. Once your property is in service, you must decide whether each repair and maintenance expense should be classified as an ordinary expense or capital improvement to be capitalized and depreciated. Common capital expenditures for real estate assets such as rental properties and commercial real estate include renovations and major repairs.

Examples of major repairs that improve and maintain the property include replacing the roof, windows, or siding. A capital expenditure is intended to upgrade the component to a like-new condition or extend its useful life. The purchase of certain equipment for use in a real estate investment company is also considered a capital expenditure. It is essential to differentiate between repairs and capital improvements, as there is a fine line between them. Painting, wallpapering, and redecorating are not capital improvements; however, substantial repairs to a house may be.

Generally speaking, the IRS does not consider work that restores something to its original condition, no matter how extensive, to be a capital improvement. For example, fixing a leaky roof by replacing a few shingles is not a capital improvement; however, if the entire roof is replaced, it is. Structural improvements such as replacing the foundation of a house are also considered capital improvements. The CRA folio provides an example of the difference between replacing a spark plug and replacing an entire engine of a vehicle. Replacement cost refers to the amount of money that must be spent currently to replace an essential asset such as real estate with another of equal or greater value.