At the end of 2013, the IRS released final regulations that answered the question: “When should costs be capitalized, and when should they be expensed?”
In general, you can immediately deduct expenses if they are ordinary and necessary to carrying on a trade or business. But certain costs — specifically, the costs incurred to acquire, produce, or improve tangible property — may need to be capitalized. By capitalizing costs, you are spreading those tax deductions over a number of years rather than taking a large deduction in the year you made the cash outlay. Treasury Decision (TD) 9636 provides guidance to taxpayers on when these types of costs must be capitalized and when they can be expensed. Though there are many facets of this IRS guidance, the most impactful provision may be the one that allows taxpayers to deduct the cost of repairs. Routine maintenance and repairs are not considered improvement costs and are therefore fully deductible.
A year after TD 9636 was released, the IRS published another document: TD 9689. This guidance addresses how partial dispositions of depreciable tangible property should be reported on your tax return. The partial-disposition election lets taxpayers recognize a loss on a disposition of only part of an asset rather than waiting to recognize that loss until the entire asset is disposed. For example, if the taxpayer replaces the roof of a building, the partial-disposition election may let them recognize a loss on the disposition of the roof while they continue to depreciate the rest of the building.
Why are we talking about this now?
The repair regulations may be old, but they are still relevant to taxpayers today, and that’s for one main reason: the Tax Cuts and Jobs Act.
The TCJA, which was passed at the end of 2017, limits certain tax deductions. It’s possible that making elections under TD 9636 and/or TD 9689 could help reduce the impact of these limitations.
Bonus Depreciation Phaseout
Thanks to the TCJA, Section 168(k) bonus depreciation is set to phase out starting in 2023. The phase-out percentages for the next few years are as follows:
|
Year Asset is Placed in Service |
Bonus Depreciation Percentage |
|
2022 |
100% |
|
2023 |
80% |
|
2024 |
60% |
|
2025 |
40% |
|
2026 |
20% |
|
2027 |
0% |
Now that asset costs are no longer eligible for a 100% bonus depreciation deduction, taxpayers may be more interested to see if property costs could be deductible under the 2013-era repair regulations. Here are the decisions they would be trying to make (in 2023):
-
- If considered an improvement, they would be required to capitalize the asset costs, but they could immediately deduct 80% using bonus depreciation.
- If considered a repair, they could immediately deduct 100% of the costs under TD 9636.
This determination will become even more important as the bonus depreciation percentages drop over the next few years.
Section 163(j) Interest Limitations
The TCJA limited the amount of interest businesses could deduct to roughly the following:
Business interest income
+ 30% of adjusted taxable income (ATI)
+ Floor plan financing interest
The ATI component of the calculation required taxpayers to add back and recalculate certain depreciation deductions, including bonus depreciation—but only in tax years prior to 2022. We won’t get into the specifics of the calculation, but in tax years 2018 through 2021, taxpayers may have seen a tax benefit by foregoing the elections under TD 9636 and TD 9689. In other words, they may have seen a financial benefit if they:
-
- Capitalized amounts that would have otherwise been fully deductible as repairs under TD 9636, or
- Waived the partial-disposition election under TD 9689 and chose to postpone their loss, instead.
Because the depreciation addback/recalculation requirement for ATI has been phased out as of January 1, 2022, taxpayers may not see the same benefits by waiving the elections under these repair regulations in 2022 or 2023.
What are some concerns?
If you want to make changes under either of the repair regulations, you need to know whether an accounting method change is required. Fortunately, when dealing with the repair regulations, a change of accounting method isn’t typically necessary; most are annual elections you make when filing your tax return. If an accounting method change is required, you’ll likely still be in the clear. In general, you cannot change your accounting method for the same item more than once in a five-year period. If you had adopted TD 9636 or TD 9689 in 2014 or 2015, that five-year period has long since lapsed.
It's also wise to simply look at the repair regulations with a fresh set of eyes. Since they were released, your business may have made changes that impact how these elections would affect your tax position. Perhaps you have net operating losses that you didn’t have back then; perhaps you expanded into a new industry or acquired a business. Your tax advisor can help you determine if any changes you’ve undergone in the past decade should have an impact on your decision to utilize the opportunities in the repair regulations. Reach out to your Meaden & Moore advisors if you want to learn more about how these regulations can help you.
