The IRS and taxpayers have long disputed whether to classify certain expenditures as either deductible repairs\supplies or as assets that have to be capitalized and depreciated. In attempt to resolve these controversies, the IRS released the final repair and capitalization regulations. These new rules are in full effect for the 2014 tax year and require all taxpayers that acquire, produce or improve tangible property to comply in their current year tax returns. While these regulations have some pitfalls, they present numerous opportunities. Below is a list of ten items every taxpayer should consider under the new rules:
- De Minimis Safe Harbor – A new rule allows taxpayers to immediately deduct certain small-dollar capital expenditures that may have required capitalization under previous rules. This rule requires that the taxpayer have a depreciation policy and follow it for book and tax. Generally, the safe harbor amounts are $5,000 if the taxpayer has “applicable” (i.e. generally audited) financial statements and $500 if not.
- New Improvement Rules – The repair regulations clarify the rules as to what can be immediately deducted. For example, a installing a new roof membrane, replacing one of three furnaces in a building, or remediating asbestos are generally immediately deductible expenses.
- Routine Maintenance Safe Harbor – This new rule allows a taxpayer to immediately deduct certain building costs if the taxpayer expects to perform the activity more than once within a ten-year period. Examples may include repainting a hotel lobby or replacing an escalator handrail. A similar rule applies to personal property as well.
- Small Taxpayer Safe Harbor – Certain taxpayers meeting the definition of a “small taxpayer” and owning buildings with basis of less than $1M may be able to make an election allowing them to immediately deduct certain costs that would otherwise require capitalization.
- Demolition costs – Under prior law, taxpayer were required to capitalize removal costs into the basis of the new asset. Now, taxpayers can immediately deduct such costs. Taxpayer should request that contractors separately state removal costs on invoices, and then immediately deduct such expenditures.
- Supplies – New rules clarify the definition of supplies and when taxpayers can deduct them. For example, anything less than $200 or is expected to be consumed within 12 months can be treated as a supply. If the taxpayer does not maintain inventory or consumption records of the supply, they can be immediately deducted when purchased. Otherwise, they are deducted when consumed.
- Review Past Expenditures – The new regulations allow taxpayer to review their fixed assets for items that qualify as repairs expenses that can be immediately deducted. Resealing of a parking lot and HVAC repairs are often capitalized but can be written off. Conversely, taxpayers who were overly aggressive in immediately deducting capital expenditures should review their prior year repairs registers as well as their current year capitalization policies.
- Partial Dispositions – Prior to the repair regulations, there was no clear guidance that allowed taxpayers to deduct costs of removed building components, such as an old roof, HVAC system, or windows. The new rules allow taxpayers to take losses on the undepreciated basis of assets removed or disposed of. For the 2014 tax year only, the IRS allows a simplified approach to write-off disposed building components that were removed prior to 2014. You must act now!
- Cost Segregations are more relevant – Cost segregation studies accelerate the timing of deductions by reclassifying personal property and land improvements, which have favorable tax attributes, from building costs, which have poor tax attributes. Cost segregations are also helpful in quantifying the costs of removed components since tax payers are allowed to take losses on them.
Conclusion – Many provisions of the repair regulations require filing of additional tax forms and making elections.