Final Comprehensive Repair/Capitalization Regulations Take Effect: Theory Becomes Practice

Posting by Kelly Lopez

The IRS released the much anticipated “repair and maintenance” regulations for Sections 162(a) and 263(a) in September of last year, providing guidance regarding the deduction and capitalization of costs related to tangible property. The final regulations replace the temporary regulations issued in 2011.

Much was written about these changes when they first came out, however, since these regulations will affect virtually everyone who has a business (as most businesses have tangible property) and just took effect at the beginning of 2014, we wanted to remind you of some of the regulation’s highlights.

Capital Expenditures

De Minimis expense rule
Taxpayers are required to capitalize amounts paid to acquire or produce tangible property. However, the new regulations provide a de minimis exception, allowing the taxpayer to deduct certain amounts that would otherwise require capitalization. In order for this exception to apply, taxpayers MUST have a written capitalization policy. The de minimis amounts are as follows:

  • A taxpayer with an applicable financial statement can deduct items as long as the amount per invoice (or item) does not exceed $5,000.
    • An applicable financial statement is one that is required to be filed with the SEC, a certified financial statement that is accompanied by the report of an independent CPA, or a financial statement (other than a tax return) required to be provided to the federal or state government or any federal or state agency (other than the IRS).
  • Taxpayers who do not have applicable financial statements can deduct expenditures for tangible property costing $500 or less per invoice (item).

The $500 and $5,000 limits are all or nothing: if the cost of an invoice exceeds the applicable limit, then no portion of the cost is deductible under the de minimis safe harbor. The final regulations include an “anti-abuse rule,” which specifically prohibits the “componentization” of an item of property in order to get the invoice totals below these limits.

There are two key components to this provision: one is the fact that taxpayers must make an annual, irrevocable tax return election and attach it to a timely-filed tax return (including extensions) in order for this safe harbor to apply. Furthermore, once the election is made, it applies to all amounts. Second, taxpayers must have written accounting procedures indicating capitalization thresholds, which must be in effect on or before the first day of the taxable year.

Materials and Supplies
The final regulations expand the definition of deductible “materials and supplies” to include units of property with an acquisition cost of $200 or less. This is an increase from the $100 limit established by the temporary regulations for items that are expected to be consumed in 12 months or less. The final regulations allow the IRS the flexibility to change this threshold without having to amend the regulations in the future. Generally, non-incidental materials and supplies are deducted in the year that they are used or consumed. This provides a safe harbor for items under $200 to be expensed when paid, even if they are non-incidental in nature.

Repairs and Maintenance
The temporary regulations included a safe harbor that allows certain routine maintenance to be a current deduction rather than capitalized and depreciated, as long as the taxpayer reasonably expects to incur these expenses more than once during the “class” life of the property. The final regulations have expanded this safe harbor to allow expense for routine maintenance activities on a building and its structural components. For a building or structure system, the taxpayer must reasonably expect to perform the maintenance more than once during the 10-year period that begins when the building/structure system is placed in service.

Improvements
The final regulations continue to require the capitalization of costs incurred to improve a unit of property. The regulations define three types of costs that are within this category: betterment, a restoration, or an adaptation of the unit of property to a new or different use.

The final regulations also include a safe harbor election for “small taxpayers” with buildings. The safe harbor allows small taxpayers to deduct the smaller of $10,000 or two percent of the unadjusted basis of the building.

The final repair and maintenance regulations are very complex and include a wide variety of subjects. The topics covered in this blog were some the more talked-about points covered by these rules. Please consult your tax accountant to determine how they apply to your particular business and tax circumstances.

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