What is a capital improvement?
Capital improvement is any permanent structure or other asset added to a property that adds to its value.
Capital improvement can be defined in a personal, business or municipal sense, as it is a term that broadly applies to any expense that is invested to improve the value of some asset.
According to the IRS, all capital improvements must have the following qualities:
- Must fix some defect or design flaw.
- Must substantially improve the value of a property.
- Must become a permanent part of the property so that removal would cause some impactful damage to the property.
- Must be added with the intention of becoming a permanent part of the property or asset.
Not only do capital improvements typically improve the livability of a home or the function of a commercial property, but they also add value to that property. One of the main draws of a capital improvement project is that it promises to be worth the expense put into it when considering matters of depreciation and/or sale.
A capital improvement differs from a repair because it adds value to property to put it into another value category altogether, whereas a repair simply keeps the property in its same condition. Repairs don’t add life or financial value to an asset.
Capital improvements are also tax deductible, while routine repairs are not. This provides incentive for property owners to perform capital improvements, since they pay off not only in the long run, but on near-future tax returns, as well.
Capital improvement example
If you own a home and add a significant addition, you add a capital improvement to your home. If this addition was a master bedroom suite that cost $20,000, you could expect to see this value reflected when you go to sell your home.
Assuming you purchased your home for $170,000, the $20,000 master suite addition would bring the value of your home to $190,000, assuming that no other capital investments were made throughout your period of ownership.