The IRS recently issued lengthy and complex temporary regulations relating to business repairs and capital improvements. These new regulations cover expenses paid to acquire, produce or improve tangible property. They are generally effective for tax years beginning after 2011.
Basic premise: In general, repairs incurred by a business operation are currently deductible, while improvements must be capitalized and written off over time. But it is often difficult to distinguish a “repair” from an improvement for tax purposes.
As a rule of thumb, a repair keeps the property in good operating condition over its intended useful life. Conversely, an improvement extends the useful life of the property, increases its value or adapts it for a different use.
The new regulations generally follow proposed regulations issued in 2008 with a few key revisions. Here’s an overview of the main points:
Repairs: Under the new regulations, it is clarified that a business may deduct amounts paid to repair and maintain tangible property as long as the payments do not have to be capitalized under the tax law.
Materials and supplies: The definition of materials and supplies is expanded to provide an optional method of accounting for rotable and temporary spare parts. This includes a “de minimis election” for certain materials and supplies.
Rentals and leased property: The cost of erecting a building or making a permanent improvement to leased property is treated as a capital expenditure. However, leasehold improvements must be depreciated or amortized under the applicable depreciation period, rather than the lease term.
Payments to acquire or produce tangible property: The new regulations retain the rules in the proposed regulations for capitalizing amounts paid to acquire or produce units of tangible property. These include requirements to capitalize acquisition and production costs, as well as amounts paid to defend and perfect title to property. Furthermore, the new regulations explain the treatment for moving and reinstallation costs, transactional costs and the de minimis rule.
MACRS property: The rules for accounting for property under the Modified Accelerated Cost Recovery System (MACRS) are revised under the new regulations. They spell out the method for determining gain or loss on the disposition of MACRS property.
Payments to improve property: The new regulations keep simplified conventions for determining a unit of property and establishing whether such units have been improved. They also retain a “routine maintenance safe harbor” and an optional regulatory accounting method. But be aware that the regulations modify the way in which standards must be applied to a building and its structural components. Finally, the regulations include numerous other technical changes in this area.
As mentioned above, the new regulations are complex. Consult a professional tax adviser for application of the rules.