For years, the IRS and taxpayers have sparred over whether certain expenses constitute “repairs” or “improvements.” The issue is important because repair costs can be deducted immediately while improvement costs generally must be capitalized for tax purposes and written off over several years.
Alert: At long last, the IRS has issued new temporary regulations on this subject. The new regs explain the tax treatment of expenses paid to acquire, produce or improve tangible property.
But these new regulations, a staggering 255 pages, are extremely complex in their own right.
Here’s the whole story: The basic rule is that the cost of repairs is currently deductible by a business. On the other hand, improvements must be capitalized and written off over time.
However, it’s often tough to tell a repair from an improvement. Generally, a repair keeps the property in good operating condition over its intended useful life. For example, replacing a broken window is obviously a repair. Conversely, an improvement, like adding a new wing to a building, extends the useful life of the property, increases its value or adapts it for a different use.
Rundown on the new regs
The new regulations generally follow proposed regulations issued in 2008, but with certain modifications. Here’s a quick rundown.
Materials and supplies: The definition of materials and supplies is expanded to provide an optional method of accounting for rotable and temporary spare parts. It also includes de minimis election for certain materials and supplies.
Repairs: The new regulations clarify that you can deduct amounts paid to repair and maintain tangible property as long as the payments don’t have to be capitalized under the tax law.
Rentals and leased property: The cost of erecting a building or making a permanent improvement to property that you lease is treated as a capital expenditure. Key point: Leasehold improvements must be depreciated or amortized over the applicable cost recovery period, not the lease term.
Payments to acquire or produce tangible property: The rules in the 2008 proposed regulations reflecting capitalization of amounts paid to acquire or produce units of tangible property are retained. This includes requirements to capitalize acquisition and production costs as well as amounts paid to defend and perfect title to property. In addition, the new regs clarify the rules for moving and reinstallation costs, transactional costs and the de minimis rule.
Payments to improve property: The new regs retain certain simplified conventions for determining a unit of property and establishing if such units have been improved. They also keep the “routine maintenance safe harbor” and an optional regulatory accounting method. Caveat: The regs also revise the way in which standards are applied to a building and its structural components, plus a slew of other technical changes.
Tip: These new regs are generally effective for tax years beginning after 2011. See a tax pro for more guidance.
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