Wendy Landrum and Scott Johnson,
The Daily Record Newswire
As year end approaches, there are new tax rules that affect every business entity and may necessitate accounting method changes. One of these tax rules is repair and maintenance regulations, and like most tax rule changes, it provides an opportunity for additional deductions for taxpayers, but may also result in additional tax liability.
In September 2013, the IRS and Treasury Department released the final regulations providing guidance regarding the deduction and capitalization of expenditures related to tangible property (commonly referred to as the repair and maintenance regulations).
The final regulations affect all taxpayers that acquire, produce, or improve tangible property, especially real estate owners with substantial property portfolios. The repair regulations generally permit these property owners to deduct expenses for repair and maintenance costs that keep property in efficient operating condition and may also provide substantial tax savings opportunities to property owners.
Capitalization standards
The starting point in determining whether an expenditure is an "eligible repair cost" is identifying what unit of property the capitalization standards apply to. The unit of property for building property is each building and its structural components and is further broken down into the building structure and eight systems: HVAC, electrical, plumbing, gas distribution, elevators, escalators and building security.
An improvement to a unit of property or to the building structure and/or systems, results when one or more of the following capitalization standards is met and the expenditures may not be treated as a deductible repair cost: betterment, restoration or adaptation.
Betterment results if an expenditure:
- Fixes a material condition or defect at acquisition or production.
- Results in a material addition or expansion.
- Is reasonably expected to materially increase the productivity, efficiency, strength, quality, or output.
Restoration results from any of the following:
- Recognition of a loss on component.
- Gain/loss on sale of component.
- Basis adjustment as a result of a casualty loss.
- Return to former operating condition - no longer functioning.
- Rebuild the property to like-new condition after class life.
- Replacement of a major component/substantial structural part.
A major component is defined as a part or combination of parts that performs a discrete and critical function in the operation of the unit of property. A substantial structural part is defined as a part or component of parts that comprises a large portion of the physical structure of the unit of property.
Because the discrete and major functions from building to building are similar, the regulations provide a list of the major components within each building structure/system.
Adaptation, the final capitalization standard, is the adaptation of a unit of property to a new or different use inconsistent with the intended, ordinary use of the building for example, converting a warehouse to office space.
Electing to follow book capital improvement costs
The intent was to reduce uncertainty in applying the subjective capitalization standards and reduce administrative burden. Taxpayers may now elect to follow their book capitalization policy for improvement costs to avoid any differences for tax treatment.
This election is helpful for companies that:
- Are in net operating loss positions or don't need additional deductions.
- Don't want book/tax differences.
- Have a fixed asset system that makes implementation of the changes difficult.
'Routine maintenance safe harbor' for building property
The routine maintenance safe harbor includes the recurring activities that the taxpayer expects to perform to keep the building structure or system(s) in its ordinary efficient operating condition. The taxpayer must reasonably expect to perform the activities more than once during a 10-year period, beginning at the time the building structure or system(s) is placed in service.
'De minimis safe harbor election'
Under the new de minimis safe harbor, a taxpayer may follow its book minimum capitalization policy if there is a written accounting procedure in place at the beginning of the taxable year and the policy includes a specified dollar amount that does not exceed a per invoice or per item cost as substantiated by the invoice. The dollar amount ceiling is $5,000 per item for taxpayers with an applicable financial statement and $500 per item for those without.
Effective date
The final regulations generally apply to taxable years beginning on or after Jan. 1, 2014; however, certain provisions only apply to amounts paid or incurred in taxable years beginning on or after that same date.
Most companies will likely need a repair and maintenance cost review and a change in accounting method to comply with the final regulations.
Most companies will need to make at least one election - de minimis safe harbor, election to capitalize book repair costs for tax, small taxpayer safe harbor, etc. - which should be analyzed on an annual basis.
Companies needed a written financial accounting policy in place by Jan. 1, 2014 in order to conform to the new de minimis safe harbor rules.
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Wendy Landrum and Scott Johnson are with the Baker Tilly Virchow Krause LLP accounting firm. Any viewpoints and advice are those of the authors.
Published: Wed, Dec 03, 2014
