The IRS has released final regulations on the tax treatment of expenditures related to tangible property, also known as the repair regulations. These final regulations replace the temporary regulations released in December 2011 and provide guidance on whether expenditures are deductible repairs and maintenance or capital improvements. Every taxpayer with business expenditures related to tangible property will be impacted by these new (and taxpayer friendly) regulations. Most provisions of the final regulations take effect for tax years beginning on or after January 1, 2014, so taxpayers should start looking at how they will be impacted by these new rules.
The basic rule in the regulations is that costs resulting in an improvement to a building structure, building system or other tangible property must be capitalized. This initially might make us think that every repair must be capitalized. However, the new regulations include several safe harbors that allow certain repairs to be expensed.
Routine Maintenance Safe Harbor
The first safe harbor is the “routine maintenance safe harbor” which allows expenses incurred to keep property in its ordinarily efficient operating condition to be expensed as routine maintenance. In addition, the costs of performing certain routine maintenance activities for tangible property other than buildings are allowed to be expensed if, at the time the property was placed in service, the taxpayer reasonably expected to perform the maintenance activity more than once during the property’s life. An example of this is replacing a gear on a piece of equipment if it is expected to replace the gear several times during the equipment’s life span. Another part of the safe harbor allows the costs of performing certain routine maintenance activities for buildings to be expensed if the maintenance activities are expected to occur more than once over a ten year period.
Another safe harbor under the new regulations is for Qualified Small Businesses (defined as a business with gross receipts of $10,000,000 or less). For buildings with an initial cost of $1 million or less, small businesses may elect to deduct repairs, maintenance and improvements, if such costs do not exceed the lesser of $10,000 or 2% of the adjusted basis of the property during the tax year.
De Minimis Rule
In addition to the safe harbors provided, there is a de minimis rule for expensing repairs. Taxpayers with an applicable financial statement (i.e., an audited financial statement) may rely on the de minimis safe harbor and expense amounts paid for property with an economic useful life of 12 months or less as long as the amount per invoice or item does not exceed $5,000. Taxpayers without an applicable financial statement (i.e., unaudited financial statement) may rely on the de minimis safe harbor and expense amounts paid for property with an economic useful life of 12 months or less as long as the amount per invoice or item does not exceed $500. This de minimis provision is a positive development because it is the first time we have concrete guidance on this issue.