Step 5 Restoration Guidelines (And The Wiggle)

By Jason Watson, CPA
Posted Monday, March 30, 2026

Now that you have survived the betterment and adaptation tests, you have arrived at the gray waters of restoration. Under the Tangible Property Regulations, you must capitalize an expenditure as a restoration if it replaces a “major component or substantial structural part” of your Unit of Property (UoP), as defined in Step 2 previously. Yeah, got it, now what?

Welcome to the jungle (aka, the Wiggle).

But how do you define “major” or “substantial”? Is it dollars? Is it physical size? The IRS refuses to give us a bright-line percentage, but they do give us a zillion examples. Let’s look at a famous one found in Treasury Regulations Section 1.263(a)-3(k)(7):

Example 25: Not replacement of major component or substantial structural part; windows. U owns a large office building… The building has 300 exterior windows that represent 25 percent of the total surface area of the building. In Year 1, U pays an amount to replace 100 of the exterior windows that had become damaged… Therefore, the replacement of the 100 windows does not constitute the replacement of a major component or substantial structural part of the building, and U is not required to treat the amount paid as a restoration…

Yawn. There are a total of 31 examples like this if you cannot get enough. But keep this specific 100-windows out of 300 total ratio in mind as we look at the maze.

The 33% Heuristic

When you are dealing with discrete, countable components within a system (like windows, doors, or individual condenser units), you can use physical math.

On one hand, the 100 out of 300 is a very specific percentage (33.3%). On the other hand, the IRS explicitly states that a hard bright-line rule does not exist. Regardless, practitioners use the 33% mark as a highly defensible barometer. Why? At the end of the day taxes become binary- yes or no? In other words, we must choose.

What if you need to replace an HVAC unit? In a single-family rental property, the HVAC system generally only has one component. Replacing it means replacing 100% of the system, which commonly triggers a restoration (capitalize). However, if you have an apartment building with 10 rooftop HVAC units all tied together as a system, and you replace 2 of them, you are only replacing 20% of the UoP. That falls well below the 33% barometer and can often be treated as a repair!

Sidebar: Using the window example, if you replaced all 300 windows at once, it would absolutely be a capital improvement. However, if you replace 100 each year for three years, you might be able to call it all routine maintenance/repairs. Spreading things out helps with cash flow and maximizes immediate deductions. This is a potential win-win, but don’t break out the bubbly quite yet. Substance? Form? Gaming the system? The IRS will look at the series of events holistically and could label it a wholesale improvement based on the overall facts and circumstances.

The Continuous System Dilemma

Counting windows and HVAC units is reasonably easy. But what happens when you are dealing with a continuous system like plumbing or electrical where the components aren’t easily countable? How many feet of wires does your rental have?

To have a reasonable tax position when you argue that what you did was not material or substantial, consider the following:

• Physical Segmentation (The Baseline): This is the most objective metric. If the building has 1,000 linear feet of plumbing supply lines and you replace 150 feet, you have a physical metric to point to (15%). Because 15% is well below our 33% heuristic, it leans heavily toward an expensed repair. Clearly this is a bit laughable since knowing the total amount of plumbing is silly, but it illustrates the math at any rate.
• Relative Cost and Value (The Fallback): Often, physical segmentation is impossible to calculate without ripping open the walls. In these cases, use value as a proxy. Compare the cost of the replaced portion against the estimated replacement cost of the entire system. If the total plumbing system would cost $50,000 to replace, a localized $5,000 repair falls well below the threshold of replacing a “substantial structural part.” Keep in mind that replacing an entire plumbing system is significantly more costly as a retrofitted renovation than as a new-build. This actually works to your advantage, as it inflates the replacement value (your denominator) and keeps your repair percentage lower.
• Qualitative Function (The IRS Suit Argument): This is where the rubber meets the road. Even if a replaced portion represents a tiny percentage of the total system’s physical footprint or value, capitalization might still be required if the component performs a discrete and critical function within the system (UoP).

On the qualitative function nonsense that is not taxpayer friendly, consider these bookends-

• Main Sewer Line: This is a critical choke point. If you replace the main sewer line connecting the rental property to the city system, it is usually a capital improvement (restoration), regardless of the cost relative to the whole system.
• Branch Lines: Conversely, if you replace the branch lines servicing the second-floor bathrooms, this is generally a repair. The system can still mostly function without those specific lines, meaning they do not hold the same critical functional weight as the main.

In practice, function often beats percentage.

If your expenditure survives the qualitative function test and falls below the 33% heuristic, congratulations: you have successfully navigated the gauntlet and you have a strong position to expense the repair!

No Bright Lines

When the IRS first proposed these rules, CPAs, tax attorneys, and industry groups flooded them with comment letters practically begging for a quantitative safe harbor on what constitutes the replacement of a “major component or substantial structural part.” Why not? As we just mentioned, we all like binary situations- Yes or No, and certainly not the Maybe So.

IRS declined.

Here is exactly how the IRS addressed it in the Final Tangible Property Regulations Preamble regarding Betterments and Restorations:

Several commenters requested that the final regulations provide a bright-line test for determining whether an amount results in a material increase in capacity, productivity, efficiency, strength, quality, or output… The IRS and the Treasury Department decline to adopt a bright-line rule for this purpose. Because of the inherently factual nature of the betterment inquiry and the varied nature of the property and situations… a single bright-line test would be inappropriate.

Regarding Restorations (specifically replacing a “major component”), they said the exact same thing:

The final regulations do not adopt a bright-line percentage… The IRS and the Treasury Department believe that a quantitative threshold for major components would be difficult to apply and would yield inappropriate results in many cases.

They ruled that determining a major component will forever remain a subjective “facts and circumstances” test based on qualitative function and relative size. To help taxpayers, if you can call it that, they pumped the regulations full of those 31 highly specific examples (like Example 25: the 100 out of 300 windows). More is not always better.