Capital Expenses for Real Estate Investors

Bonus Module

Capital expenses, or CapEx, are significant costs related to maintaining or improving your rental properties.

These expenditures, while not frequent, play a crucial role in the long-term success of your real estate investments.

We’ll explore how to distinguish CapEx from regular maintenance, how to budget for these expenses, and the importance of incorporating CapEx into your deal analysis to ensure accurate projections and planning.

Table of Contents

Included below:

• Capital Expenses for Real Estate Investors

• CapEx versus Maintenance

• Traditional Maintenance vs Capital Expenses

• Maintenance

• Capital Expenses

• Separate Maintenance and CapEx?

• Paint and Carpet/Flooring

• Impact of Price/Rent on Maintenance %

• Not Just Paint and Carpet/Flooring

• You Must Do Your Own Due Diligence

• Maintenance and Capital Expenses

• Instructions for Maintenance and CapEx Estimator for Rental Properties - Basic™ Spreadsheet

• Shortcomings of BASIC Version

• Advanced Version

• Overrides for Each Expense and Instructions

• Override for Expense Account

• Results

• Identify Deficits

• Where To Enter Them on The World’s Greatest Real Estate Deal Analysis Spreadsheet™

• Why A Starting Balance?

• Not Reserves

• Capital Expenses Show Up in Cash Flow

• Cash Flow Isn’t Everything

• Compare New Construction to Resale

• Portfolio Planning

• Can You “Time” Maintenance and Capital Expenses?

• Selling Before Major Expenses

• Buying After Major Expenses

• New Roof vs 10-Year-Old Roof at Purchase

• Alternative to Saving for Capital Expenses

• Insurance Claims

• Home Warranty

CapEx versus Maintenance

As a real estate investor, it’s important to distinguish between maintenance and capital expenses, especially when analyzing deals.

These are both costs you’ll incur to keep your property operating as a rental, but from a tax perspective, they are treated differently.

To keep it simple:

• Maintenance costs tend to be smaller, regular expenses—like fixing a leaky faucet or replacing a broken window—that keep the property functioning.

• Capital expenses (CapEx), on the other hand, are usually larger improvements or replacements—like a new roof or replacing an HVAC system—that extend the life or value of the property.

For tax purposes, the IRS separates the two.

According to Internal Revenue Code (IRC) Section 162, maintenance expenses can be written off in the year they are incurred, while capital improvements must be capitalized and deducted over time. Safe Harbor allows you to write off expenses under $2,500 (per invoice or item) in the year you take them, up from $500 before January 1, 2016. This means you don’t need to capitalize these smaller expenses. If you have audited financial statements, the threshold is even higher at $5,000.

In short, anything under $2,500 can often be treated like a regular maintenance expense, even though it may seem like a capital improvement.

For anything above $2,500, it’s considered CapEx and will need to be deducted over time.

As always, check with your CPA for specific details related to your situation.

Traditional Maintenance vs Capital Expenses

When it comes to analyzing deals, real estate investors typically make their own distinction between what counts as maintenance and what falls under capital expenses.

While we’ve covered the tax perspective earlier, here we’ll focus on how investors might categorize these costs when running their numbers.

Maintenance

Maintenance expenses are the smaller, routine costs you’ll face while managing your rental property.

They’re often related to keeping things in working order and handling the normal wear and tear that happens over time.

Here are some examples:

• Small Turnover Expenses - Costs associated with preparing the property for the next tenant.

• Wear and Tear That Can’t Be Billed Back to Tenant - Natural aging of materials like flooring or paint.

• Repairs to Items That Break - Fixing issues like a malfunctioning toilet or a broken window.

• Service Calls - Hiring plumbers, roofers, HVAC technicians, electricians, handymen, or landscapers for minor repairs or upkeep.

Capital Expenses

Capital expenses are the larger, less frequent costs that improve the property or extend its useful life. These are typically major replacements or renovations.

Investors often categorize the following as capital expenses:

• Replace Roof and/or Gutters - A major overhaul that protects the structure.

• Replace AC and/or Furnace/Boiler - Significant system upgrades for heating and cooling.

• Kitchen/Bathroom Remodels - Large-scale renovations that increase property value.

• Replace Windows - Often necessary to improve energy efficiency and comfort.

• Replace Driveway - A major exterior improvement.

• Replace Appliances - Upgrading or replacing aging refrigerators, stoves, or dishwashers.

• Replace Water Heater - A critical part of the property’s infrastructure.

• Exterior Paint - A full refresh of the property’s exterior.

Separate Maintenance and CapEx?

When analyzing deals using The World’s Greatest Real Estate Deal Analysis Spreadsheet™ (TWGREDAS) or the Real Estate Financial Planner™ software, you may wonder whether to separate maintenance and capital expenses.

The short answer is—you could.

Both systems provide separate fields for tracking maintenance and capital expenses for those who want to distinguish between them. However, some investors choose to combine these costs for deal analysis. When it comes to taxes, though, you’ll still need to follow the $2,500 Safe Harbor rule.

• Maintenance - We calculate this as a percentage of Gross Operating Income (GOI). This means that as rents go up and your GOI increases, the amount you set aside for maintenance rises proportionally. It keeps maintenance costs tied directly to your property’s income.

• CapEx - We handle CapEx differently. It’s calculated in dollars, not as a percentage of income. This is the amount you should be saving each month for major future expenses—like replacing a roof or an HVAC system—regardless of what your rent is. In TWGREDAS, CapEx is adjusted for inflation over time using the CapEx Appreciation Rate in the Overrides tab.

This separation allows you to plan and adjust for both ongoing maintenance and big-ticket replacements while keeping your analysis accurate and realistic.

Paint and Carpet/Flooring

When analyzing deals, one common question for real estate investors is whether repainting the interior and replacing carpet or flooring should be considered maintenance or a capital expense.

Some investors choose to categorize these costs as maintenance when evaluating their deals. After all, they are recurring expenses that happen during tenant turnovers, typically every few years.

Including paint and carpet as a maintenance expense can lead to—what might seem like—abnormally high maintenance percentage when analyzing deals.

Let’s look at an example to explain what I mean.

Impact of Price/Rent on Maintenance %

When analyzing deals, it’s important to remember that the price of your property and the rent it generates can significantly impact your maintenance percentage.

Let’s look at how this works with paint and carpet/flooring replacement as an example, keeping in mind that these costs and frequencies can vary—slightly or significantly—based on your specific property.

Assumptions

• Tenant turnover happens every 2.5 years (though it could be slightly shorter or longer).

• You replace paint and carpet/flooring every two tenant turnovers, or about every five years (but this could happen more or less frequently).

• You’re using the most basic and least expensive materials:

  • Paint: $2/sq ft (but costs may vary slightly).

  • Carpet/Flooring: $3/sq ft (again, this could be a bit more or less).

For a 1,600 sq ft, three-bedroom property, here’s the estimated cost to repaint and replace the flooring every five years: