Whether a company can spend or must capitalize on the difference between a repair and an improvement when it comes to many of the expenditures related to tangible property. New, final IRS regulations, IRS T.D. 9636 provides guidance to assist companies in making this determination.
Advantages of expensing
Sections 162 and 263 of the Internal Revenue Code (IRC) dictate that costs incurred for the acquisition, production or improvement of tangible property are capitalized rather than expensed. (Tangible property includes buildings, machinery, equipment, vehicles and other real and personal property.) However, the IRC sections allow for the cost of incidental repairs and maintenance of tangible property to be expensive.
It is necessary to depreciate and deduct capitalized property over a period of up to 39 years, whereas expensed property can generally be deducted in the current year. Expensing, therefore, is generally preferable in most situations to capitalization.
Maintenance expenses
To make it easier to distinguish between repairs and improvements, the final regulations include a safe harbor covering routine maintenance of property (including buildings). It is possible to spend and immediately deduct recurring activities dedicated to the use of property and keep it in an efficient operating condition.
These activities include inspection of property, cleaning and testing, and replacement of parts that are worn or damaged. Routine operations are those that your company reasonably expects to perform more than once during the “class life” of the property, as defined by the IRS. This is defined as more than once every 10 years for commercial buildings.
Meanwhile, when performing routine property maintenance, non-inventory materials and supplies used can be expensed and deducted if they are:
- Acquired components to maintain, repair or enhance a tangible property unit,
- The reasonably expected consumption of fuel, lubricants, water or similar items in one year or less,
- Property units with a useful life of a year or less,
- Property units with an acquisition or manufacturing cost of $200 or less or less,
- Properties identified in future regulations as materials or supplies.
Incidental materials and supplies can be deducted when they are purchased, for example, office and cleaning supplies. But only after they are first used or consumed can non-incidental materials and supplies be deducted. These include things like small parts of the engine, saw blades, fuel and motor oil. When they are disposed of, rotable, temporary and standby emergency spare parts, meanwhile, are deductible. Or, you can choose to treat and capitalize on them as depreciable assets.
Identifying units of property
The final regulations require you to identify the relevant “unit of property” (UOP) of a building when it comes to commercial buildings when distinguishing repairs from improvements.
A commercial building and its structural components are treated as a single UOP by the final regs. All work carried out on a building must be capitalized if, when applied to the building and its structural components as a whole, the level of improvement results in improvement, restoration or adaptation.
However, they treat certain construction systems (including HVAC, plumbing, electrical and elevator systems) as separate UOPs that must be individually evaluated for purposes of cost vs. capitalization. This will potentially make it harder to deduct certain costs. Consider a system for HVAC, for instance. If work performed on an HVAC system is determined to be an enhancement to the system, even if it is not an enhancement to the building itself, the expenses for that job must be capitalized.
For small companies with gross receipts of $10 million or less, the final regs contain a safe harbor. These companies can choose to spend and deduct repair, maintenance, improvement and similar expenses (rather than capitalizing) if:
The initial cost of the building is 1 million dollars or less, and
The total amount of these expenses does not exceed $10,000 or 2 percent of the adjusted basis of the building for the tax year, whichever is less,
Furthermore, the final regs include a restoration test stating that an amount paid to replace a major component of a UOP is an amount paid to restore that property. In determining if money spent on replacement constitutes a restoration, there is a new definition for use.
Effective date
Tax years beginning on or after Jan. 1, 2014 are covered by the final regulations. You will be impacted by the final regs if your company owns or leases tangible property and incurs expenses related to it. If you have questions regarding your particular situation, contact us.
If you feel overwhelmed and need help with your HVAC Repair Near Me Memphis, give us a call.
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New York, NY 10016
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