How to account for Cap- Ex

Question

I am looking for guidance on how to account for the Cap-Ex on my rental properties. Unlike the rental deposit that is required to be on a separate account, I am not sure what to do with the cap-ex. I know I should account for this, but do I actually pull it out of the account and hold it separately? How does it, if at all, show up on taxes: is this part of profit, expenditure, or can it go unrecorded just like the rental deposit? I will greatly appreciate if someone can share best practice with the money I am saving for capital expenditure.

Eric Fernwood · Answer

Hello @Patience Echem,

A comment on how much you should set aside for maintenance. The amount depends on the property, local climate, and the type of construction materials used. While I can’t give you an exact number for your property, I can walk you through how to estimate it. The figures I’ll use here come from averages of the 570+ rental properties we’ve delivered in Las Vegas. Because Las Vegas is in the Mojave Desert, with less than four inches of rain a year and no hard freezes, our maintenance costs are much lower than in other parts of the country. Below is typical of our rental properties (click to enlarge).

Provisioning for Major Costs

To calculate a maintenance provision, the standard approach is to base it on the remaining life of major cost components. For example, water heaters in Las Vegas typically last about 12 years on average. However, I've seen them fail as early as six years or continue working beyond 18 years. Useful life is only an educated guess. Use national averages as your guide when making estimates.

In our market, the two most significant costs are air conditioner compressors and water heaters. Tile roofs typically last decades, and in more than 17 years across 570+ properties, we’ve only had to replace the underlayment once. The rest are all minor repairs.

Here are typical costs (for Las Vegas) and useful lives:

Water heater age is easy to determine, since the manufacture date is stamped on the unit. Keep in mind it may have sat in a warehouse for a year or two before installation, so the date isn’t exact but the best we have in most situations. Air conditioners are harder because some parts may have been replaced, but using the manufacture date is usually a good starting point.

Calculate the remaining useful life by subtracting years in service from the useful life:

Calculate monthly provisions as follows:

• AC compressor: $2,500 ÷ 16 years ÷ 12 months ≈ $14/month
• Water heater: $1,500 ÷ 3 years ÷ 12 months ≈ $42/month

Total monthly provision: about $56

You may have more high cost items, like roof replacement.

Base Maintenance

In addition to major components, you should plan for routine repairs—things like dripping faucets, slow drains, or minor fixes.

Across the properties we manage, the five-year average for these base-level repairs is about $400 per year. It won’t be exactly $400 each year—one year could run $1,000, while another might be nothing.

In my experience, monthly cash flow is usually enough to cover these base repairs, so a separate provision often isn’t necessary.

Patience, I hope this helps you calculate a maintenance provision.

Julius V. · Answer

Hey @Patience Echem - Capex is different from deposits because it’s not something you set aside in a separate account...it’s a tax/accounting treatment issue. Best practice is usually to keep a reserve account for Capex so you’re financially prepared for big-ticket repairs or improvements (roof, HVAC, renovations), but from a tax standpoint, you don’t expense those savings when you set them aside.

On your taxes, Capex only comes into play when you actually spend the money on an improvement. At that point, it gets capitalized and added to your property’s basis (rather than deducted all at once like a repair). Then you recover it through depreciation over time.

Most tax accountants handle this really smoothly. They just add the Capex to your basis and depreciation schedules. So the “holding” of the money is really just an internal reserve for you; the IRS only cares when you actually spend it.

If you’re working with a tax professional, they’ll likely have systems already set up to track this for you, so you don’t have to worry about misclassifying it.

Gregory Schwartz · Answer

We keep a CapEx cushion of about $5k per unit in our operating account. It's not an interest-bearing account, so technically that money could be put to better use in a high-yield savings account earning 3–4%. But either way, when a CapEx project comes up—like replacing stairs at a fourplex—we just redirect what would have been an owner draw back into the business until the cushion is replenished.

The bookkeeper/CPA handle the rest, haha.

Ashish Acharya · Answer

@Patience Echem

When accounting for CapEx on rental properties, you don’t need to hold the funds in a separate account, but it’s helpful to track them separately for planning purposes. CapEx must be capitalized and depreciated over 27.5 years for residential properties, and it’s not immediately deductible. Depreciation is reported on Schedule E (Form 1040), and bonus depreciation allows immediate deductions for qualifying property, such as appliances, but structural improvements like a new roof must be depreciated over time. While you don't need a separate account for CapEx funds, it's important to track your expenditures and the date placed in service for accurate depreciation.

Properly tracking and capitalizing your CapEx ensures you comply with IRS requirements and maximize your tax deductions. Depreciating these expenses over time can reduce your taxable income, while bonus depreciation offers an opportunity for larger, immediate deductions on certain assets. Staying organized and consulting with a tax professional will help you manage these deductions effectively.This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

Basit Siddiqi · Answer

Budgeting is great as it allows you to determine whether a project is worth moving forward or not. 'Reserves' such as vacancy and cap-ex may not hit you in year 1 but they will be seen as you own the property for a couple of years.Budgeting for a reserve is not a tax deduction. However, you can expense / capitalize it once you have to pay for it.Best of luck!

Josh Lewer · Answer

@Patience Echem -

Arn Cenedella · Answer

@Patience Echem

Cap ex costs get added to your basis in the property.

Investors or their tax professionals should keep a chart updated annually with current basis for each property.

Purchase price plus non recurring closings costs is original basis.

Each year basis is adjusted.

Original basis less depreciation plus cap ex items equals new basis.

William Whitley · Answer

Hello,

I actually operate a bookkeeping company just for real estate investors. CapEx is not expensed out in one year like general repairs and maintenance is expensed out.

For my clients' books, I have 4 asset categories for rental properties...5 actually but one is a contra account.

1. Land, 2. Building 3. Closing Costs (for purchase and refinances), and 4. CapEx. The 5th is Accrued Depreciation.

When you spend money on CapEx it goes in that asset account and adjusts your basis.

Your CPA or tax professional would then have a depreciation schedule based on your adjusted basis (buildings and capex), which becomes a depreciation expense to you for the tax year. Each year's depreciation expense goes into the accrued depreciation account.

If/when you sell the property, the total sale price less selling expenses is part of the equation in factoring your capital gains. From that you deduct your adjusted basis (land, building, closing costs, and CapEx). The difference between your sale price less selling expenses and your adjusted basis is your total capital gain, but you have to account for recapture of depreciation. The total capital gain less accumulated depreciation is your capital gain. There is a tax for the capital gain and a tax for the recapture of depreciation.

I hope that is helpful.

All the best!

Michael Murphy · Answer

If you are talking about your capex reserves (i.e. the cash you have set aside to handle future capex) you can hold them in whatever account you want.

For the accounting, you would just show the cash balance that you have set aside on your balance sheet.  Nothing would happen prior to the funds actually getting spent when needed for capex.  If it is true "capital expenditures" then it gets capitalized and added to your balance sheet.  You have to determine the useful life of the capital asset and then depreciate it over time.  If it is a "repair" then it gets expensed.  The IRS has rules on when to classify it as a capital expenditure versus a repair.

Patience Echem · Answer

This has been most helpful. I like the details and the specificity to the individual property. This is good since my rentals are at different ages and levels of maintenance. Until now I was just using the 10% of the rent as capex.

How to account for Cap- Ex

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