With the 2014 implementation of the final repair regulations, the IRS hopes to reduce decades of controversy with taxpayers surrounding the determination of whether to deduct an expenditure as a repair or capitalize it as an improvement. Although the final repair regulations are expansive and complex, they have generally been well-received by tax practitioners and taxpayers, as they reduce much of the ambiguity that surrounded the deduct vs capitalize decision.
Perhaps most significant, the regulations provide a three-part test for determining whether an improvement to a unit of property (the asset) has occurred. If the expenditure does not fall within the regulations' definition of a betterment, adaption or restoration of the unit of property, it will generally be expensed as a repair or maintenance.
To comply with the regulations, taxpayers must be able to define the asset (unit of property) against which improvements are measured. For example, the new regulations provide that a building and its structural components comprise a single UOP, with nine separate “building systems” (think HVAC, Plumbing, and Electrical). No longer can a taxpayer measure an expenditure against the building as a whole to determine whether a capitalizable improvement has occurred.
Although many businesses will incur costs to comply, the regulations provide taxpayers with various elections and safe-harbors to consider with the 2014 tax filing and beyond. Below is a brief summary of some of the opportunities the regulations provide which may impact your business.
Late Partial Disposition Election
The regulations provide a mechanism by which taxpayers can write-off the remaining basis of a component of an asset which has been disposed of in prior years. For example, if the roof of a building was replaced in 2009 and the taxpayer capitalized the replaced roof, it is permissible to extract the basis of the original roof (likely included in the cost of the building), and take a loss deduction for the remaining basis of the original roof.
De Minimis Safe-Harbor Election
Taxpayers with an audited financial statement can elect to not capitalize or treat as a material or supply amounts paid for a unit of property up to $5,000 per invoice (or per item as substantiated by the invoice). The taxpayer must have a capitalization policy in place as of the beginning of its tax year to utilize the safe-harbor. A lower threshold amount of $500 is available to taxpayers who do not have an audited financial statement.
Routine Maintenance Safe-Harbor
Allows for the current deduction of recurring type activities expected to be performed to a building or building system to keep it operating efficiently. An activity is considered routine if the activity is reasonably expected to be performed more than once during the 10-year period beginning at the time the structure or system is placed in service. A similar definition is available for non-building property.
Safe-Harbor for Small Taxpayers
Allows for the current deduction of amounts paid for repairs, maintenance and improvement costs to a unit of property (i.e. building) with an unadjusted basis of $1M or less. For this provision a small taxpayer is defined as one with average gross receipts of $10M or less in the previous three years. Additional rules apply.
Compliance with the regulations is mandatory for tax years beginning on or after January 1, 2014 and will impact every business who has depreciable assets or materials and supplies. Most businesses (and individuals with rental or business income) will be required to file a Form 3115 Change in Accounting Method with their 2014 return to adopt certain provisions of the new regulations. Consideration should be given to opportunities and exposure areas such as how your business accounts for materials and supplies. The new regulations provide that non-incidental materials and supplies are not deductible until used or consumed and detail special rules for rotable, temporary and emergency spare parts.
How We Can Help
Meaden & Moore can provide you with guidance and assistance to identify opportunities and implement a compliance plan to mitigate exposure. We can assist you in reviewing fixed asset schedules to identify previously capitalized assets which may now be deductible under the new improvement standards and provide you with a practical approach to filing the required Form 3115. Please contact us to discuss your situation.