Technical improvement versus repair of assets

What Exactly is a Repair and Where Does Technical Improvement Begin

According to Section 33 of the Income Tax Act, this refers to expenses on completed extensions, additions, and structural alterations, reconstructions, and modernizations of property, if they exceed the threshold of CZK 80,000 for an individual asset per tax period. While a repair is immediately expensed in the given tax period, a technical improvement increases the acquisition cost of the asset and is expensed gradually through tax depreciation.

In practice, this means that if you have a leased office building and you replace worn-out floor coverings for your tenants with new ones of similar properties, it is more likely a repair. However, if you reconstruct the entire electrical system in the same building, expanding its capacity for new server rooms and digitization systems, then it is a technical improvement.

Czech tax legislation distinguishes between reconstruction, which results in a change of purpose or technical parameters, and modernization, which is an expansion of the property's equipment or usability. However, the line between these two categories is very thin, and this is where the trickiest problems lie, and where entrepreneurs most often make mistakes.

Categorization of Investments and Assessment of Technical Improvement

In practice, you will face the first crucial decision point where you must determine whether the planned expenditures are indeed a technical improvement or a repair. Lawyers and financial experts agree that this requires a comparison of the property's original state with its state after the interventions. Therefore, if you own an industrial building and decide to reconstruct it, the first step must be a detailed survey and photo documentation of the existing condition.

According to the established case law of the Supreme Administrative Court, it is an operation that brings a significant qualitative or quantitative change to the existing asset. Specifically, these are situations where there is a change in the building's functionality, a change in technical parameters, or a structural and layout change. Other signs include an expansion of equipment, such as adding new devices permanently attached to the building, or structural modifications like an extension or addition.

Here is a practical example: the owner of an office building decides to insulate the facade and replace the windows to significantly increase energy savings.

This is a technical improvement because the technical parameters have changed, whereas replacing existing broken windows with new ones with the same parameters would be a repair. It is in these situations that many entrepreneurs do not realize that the decision on categorization effectively impacts their income tax for years to come.

If an entrepreneur were to correctly classify an expenditure of CZK 150,000 as a technical improvement instead of recording it as a repair, it would have major consequences. The tax expense would not be claimed immediately but would be spread over decades, and the income tax base would be significantly higher.

In reality, however, incorrect classification leads to an additional tax assessment and related penalties, which are difficult to explain to auditors from the Financial Administration.

When a Tenant or User of Property Carries Out a Technical Improvement

The situation becomes dramatically more complicated when a technical improvement is carried out on property that does not belong to the person performing it. Typically, this involves a tenant of an office building who adapts the leased space to their needs, which often leads to surprises during audits.

The Income Tax Act allows a tenant to depreciate a technical improvement on leased tangible property if key conditions are met. The technical improvement must be paid for by the tenant, they must have the landlord's written consent for depreciation, and the property owner must not increase the acquisition cost of their property by these expenses.

The principle is simple, but in practice, an essential detail in the lease agreement is often overlooked. The contract must explicitly state that the tenant will depreciate the technical improvement and that the landlord will provide the necessary data for the asset's classification.

The lease agreement must be formulated to explicitly state that the tenant will depreciate the technical improvement and that the landlord will provide the necessary information. Further complications await at the end of the lease, when non-monetary income may arise for the landlord, which must be taxed.

If the tenant has carried out a technical improvement and does not restore the leased premises to their original condition, a settlement problem arises. At the same time, the tenant cannot claim the tax residual value as a tax-deductible expense unless the expenses are reimbursed by the landlord.

If the tenant hands over the premises with the technical improvement free of charge, this may be considered a supply of goods or services from a VAT perspective. The lawyers at the ARROWS law firm regularly handle situations where entrepreneurs prepare lease agreements without legal supervision and later face tax consequences.

The result is a reassessment of tax positions and a penalty that could have been easily avoided with a properly prepared contract. This is precisely why it is important for companies to have their contracts prepared by experts. Write to us at consultation@arws.cz, and we will ensure your contract is secure.

VAT on Technical Improvements

This is where the problem expands into another dimension, as it involves not only income tax but also value-added tax. The ARROWS law firm handles situations where entrepreneurs correctly classify a technical improvement for income tax purposes but then run into problems with VAT.

If it is an administrative or industrial building, the standard rate of 21% applies, while for residential properties, a reduced rate may apply. For 2026, if construction and assembly work relates to a building for housing or social housing, the reduced VAT rate of 12% will apply.

But here comes another layer of complexity concerning the exemption on the sale of real estate. The sale of real estate is generally exempt from VAT after 5 years have passed since the first final building approval was issued or since its first use.

If you carry out a technical improvement on the property that is considered a substantial change, the five-year time test for VAT exemption may be reset. According to the VAT Act, a substantial change is considered an improvement where the costs exceed 30% of the building's value before the modification.

A practical case may arise when an investor owns an office building acquired 10 years ago and carries out an extensive reconstruction. If the reconstruction costs exceed the 30% limit, a substantial change to the building occurs, and the period is reset.

If the investor wanted to sell the building in 2027, the sale would not be exempt from VAT, even though the building is old. If an investor unaware of this rule proceeded incorrectly, they could face an unexpected VAT liability in the millions of crowns.

An expert tax strategy must therefore be prepared before you embark on reconstruction and sale. If you have any doubts, contact the ARROWS law firm at consultation@arws.cz – the lawyers at the ARROWS law firm will securely calculate the impacts for you.

Practical Examples of Categorization in Common Situations

To make everything clearer, let's look at specific practical situations that entrepreneurs encounter and that the lawyers at the ARROWS law firm handle.

The owner of an industrial building has a rusted metal roof and decides to replace it with a new, functionally similar covering, with costs amounting to CZK 680,000. This is a repair, as it involves restoring the building to a usable condition without changing its technical parameters or function. The expense is claimed in full in the given year.

A second case is an entrepreneur who decides to expand the electrical wiring in an office building with new circuits for air conditioning. Here, the key moment is completion, as the asset is included in depreciation only in the year the improvement is completed and put into use at its total value.

The owner of a building insulates the facade, including paints and insulation materials, and replaces the windows with new triple-glazed ones, whereas the original ones were single-glazed. In this case, it is a technical improvement because there has been a change in technical parameters leading to a reduction in energy consumption. The expense will be depreciated gradually and will increase the building's acquisition cost.

Another example is a building management company that decides to install a passenger elevator in an older four-story building for CZK 800,000. This is a technical improvement, as it is a modernization and structural alteration that expands the building's facilities.

These examples show how decision-making varies greatly in these cases, and the lawyers at the ARROWS law firm analyze such situations daily. If you have doubts about your specific situation, please contact consultation@arws.cz.

Depreciation of Technical Improvements

Now we come to other aspects that many entrepreneurs understand less, because the decision of whether something is a repair or a technical improvement is just the beginning. Once an investment is classified as a technical improvement, the question arises of how it will be depreciated, where we encounter the difference between tax and accounting depreciation.

Accounting depreciation reflects the actual wear and tear of an asset, while tax depreciation is strictly defined by the Income Tax Act and is governed by depreciation groups. A significant difference exists right from the start of depreciation, as accounting depreciation generally begins after the asset is put into use, but tax depreciation can be claimed for the entire period.

If you perform a technical improvement on an asset you are already depreciating, the acquisition cost or residual value is increased. For real estate, this often means extending the depreciation period, which can affect the company's financial plans.

If you perform a technical improvement on an asset you are already depreciating, the acquisition or residual value is increased. Let me give you a specific example with a car purchased in 2024, into which you install a special cooling device in 2026.

This is a technical improvement, so you increase the acquisition cost and continue to depreciate from the increased cost, which will affect the amount of depreciation in subsequent years. At this point, the situation becomes considerably more complicated and requires precise calculations.

A simple decision on categorizing an investment affects the company's tax position for years to come, which is why the lawyers at the ARROWS law firm can help you with this step.

Dependence of Categorization on Tax Audits

Here we come to the point that is most serious for many entrepreneurs: what happens when the tax office re-evaluates your asset classification during an audit. The lawyers at the ARROWS law firm have experienced it all and are familiar with the typical scenarios where auditors from the Financial Administration challenge classifications.

Auditors from the Financial Administration very often challenge classifications, and the burden of proof always lies with the taxpayer. How to discharge this burden of proof depends on the quality and extent of your documents.

The most important thing is to have sufficient documents that prove the technical condition of the asset before the intervention, the scope of the work performed, and the content of the supplier's invoice. Construction documentation is essential if it exists for the intervention. If you are unsure, there is a legal tool for your protection in the form of a request for a binding assessment from the tax administrator.

The tax administrator will issue a decision that is binding during an audit, provided you have stated truthful information in your request. Although it costs CZK 10,000 in administrative fees, this certainty is well worth it for investments worth millions.

The lawyers at the ARROWS law firm regularly prepare requests for binding assessments and are familiar with the necessary formal requirements. If you are considering this path, please contact consultation@arws.cz.

Conclusion

The distinction between a repair and a technical improvement seems simple on paper, but in reality, it is a complex legal and factual issue. Incorrect classification means an additional tax assessment, a 20% penalty on the assessed amount, late payment interest, and financial losses that could have been easily prevented.

The lawyers at the ARROWS law firm deal with this issue daily and have experience from thousands of cases. We know where the pitfalls lie and how to correctly assess borderline situations, with hundreds of companies in the ARROWS law firm's portfolio.

If you are unsure whether your investment is a repair or a technical improvement, the safest solution is to turn to experts. The experts at the ARROWS law firm will help you with legal advice and the preparation of documentation for a tax audit.

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