Real Estate Investing Guide: The Difference Between Capital and Current Expenses

I recently published a blog post about managing rental income as a property manager/investor. However, there’s a lot more that goes into financial management of a rental property. It’s not just about collecting rent and covering the mortgage. In fact, there’s a whole list of other expenses you should be aware of before you dive into property management. Here’s what you need to know.

What Are Capital and Current Expenses

The good thing about owning rental properties is that you can deduct any reasonable expenses you incur to earn rental income and save money on taxes. As long as you can prove that an expense is tied to the property and that there’s a logical reason behind it, that amount can be deducted against your rental income. Managing your expenses properly will help you cut down your tax payments.

If you want to play the tax game right, you should be familiar with the two basic types of expenses. These are:

• current expenses

• capital expenses

Current Expenses Explained

Current expenses are recurring expenses that provide a short-term benefit. For example, a current expense is the cost of repairs you make to keep a rental property in the same condition as it was when you acquired it. 

What might be confusing here is that property renovations can fall into both categories, depending on the outcome of the renovation. However, this is really simple to understand. If the property is going to remain in the same condition as it was when you bought it, the cost of that renovation process falls into the category of current expenses. Anything that drastically changes the condition of the property is considered a capital expense.

Capital Expenses Explained

As for capital expenses, they provide a benefit that usually lasts for several years. For example, costs to change the roof on property are capital expenses. Thus, capital expenses provide a long-lasting benefit and they include the cost of acquiring the property and also the cost of improving it upon purchase. 

For example, if you choose to buy an older property that needs lots of renos, the amount of money you invest to renovate it is going to be classified as a capital expense. Other costs that fall into the capital category include the costs of selling the property such as real estate commissions. One thing you should keep in mind when it comes to capital expenses is that they are deducted over a multi-year period. 

An Overview of Capital and Current Expenses

It is important to treat your real estate ventures as a business. As any real business does, you have to keep track of your capital and current expenses, since these can benefit you in the long run. Don’t forget that current expenses include the necessary and on-going costs that keep your investment afloat, such as rent, utility bills, quick fixes, inventory, and supplies. 

On the other hand, you are likely going to be making asset purchases that fall into the category of capital expenses. Luckily, these expenses can be reduced from your taxable income each year. That way, the more you invest into the property, the less you’re going to pay for taxes, which pays out in the long run. 

Other expenses you can deduct from your taxable income include:

• Prepaid expenses

• Advertising

• Insurance

• Interest and bank charges

• Office expenses

• Professional fees (includes legal and accounting fees)

• Management and administration fees

• Repairs and maintenance

• Salaries, wages, and benefits

• Property taxes

• Travel

• Utilities

Estimate Capital Expenditures in Time

One thing you should keep in mind is that current expenses and capital expenditures are accounted for differently. You might want to consult an accountant before diving into these reports on your own. 

My best advice would be to always estimate capital expenditures ahead of time so you will know what you’re getting yourself into. Make sure to do the math before investing to understand what your profit estimate would be and, more importantly, what expenses you are going to be dealing with. 

When calculating the estimate, consider the costs of repairs, vacancy periods, and property management fees. Don’t forget to include the big ticket items that might have to be replaced, such as plumbing systems, roofs, appliances, or even driveways.

Once you get a better idea of what you’re getting yourself into, you will feel more confident to step forward and turn your rental property investment into a success.