Take Advantage of New Tax Break for Repairs and Maintenance and Capitalized Assets

In most cases, IRS makes our lives more difficult by having to guess whether an expenditure should be classified to repairs and maintenance or “capitalized” which means moved out of an expense deduction and moved to an assets which has to be depreciated.

For most of my career as a Phoenix CPA who has been a partner and owner of Phoenix tax CPA firms, most CPAs have used $500 as the decision whether an expenditure should be expensed as repairs and maintenance or capitalized and depreciated. These new IRS regulations clears up what is expensed and what has to be capitalized. Of course, capitalizing an expenditure does not mean you cannot deduct the expenditure in the current year. We still have Section 179 depreciation!

CPA tax clients can be frustrated when patching a hole in a portion of the roof had to be written off over 39 years. The exciting point of the new repairs and maintenance regulations is that now fixing the roof can be written off as a repair and maintenance! For example, if the cost of a building is less than $1 million (let us use $950,000) and $9,000 is spent on the repair of the roof, the entire $9,000 can be expensed. Why? Because $9,000 passes the rule that the lower of 2% of the building cost or $10,000 can be deducted.

What is good about the new IRS regulations is that they decided to print 140 examples of when an expenditure should be capitalized or expended!

I recently had a situation faced by a client whose fact pattern exactly matched the IRS example!

Our firm does not perform audits of financial statements so the examples that discuss how to treat expenditures related to companies whose financial statements are audited by a CPA firm is not relevant. However, for those of you who have audited financial statements, you could write off large amounts of repairs just because your firm had a financial statement audit by a CPA firm.

One important take away from the new regulations is that if you have a written policy adopted by your company, you can deduct a larger amount of dollars to repairs and maintenance instead of having to capitalize as a fixed asset IF revenue is “not distorted”. Whether revenue is or is not distorted is a judgment call which I think the IRS would have difficulty disputing!

All of my tax CPA clients are going to be asked to adopt a written policy:

The IRS issued new regulations on repairs. For businesses (including rentals) there are safe harbors that will allow a business to write off certain small cost items immediately instead of capitalizing them and depreciating them. To do this, the business must have an accounting Capitalization Policy in place BEFORE JANUARY FIRST, 2014.

What I found most refreshing is that for a change the IRS wrote the regulations in simple English!

 

Key takeaways:

Tangible Property Regulations Issued

Guidance affects all taxpayers who acquire, produce or improve tangible property

The IRS issued Treasury Decision 9636, which included 222 pages of guidance regarding the deduction and capitalization of expenditures related to tangible property. Tangible property in a business is anything that can be touched. Three major changes that go into effect January 1, 2014, include the following:

 

1.What I got out of these regulations is to not be too “piggy”. You have heard of the saying that pigs get fed but hogs get slaughtered. If your company has $450,000 in revenues and you decide to write off $45,000 expenditure as a repair and maintenance instead of capitalizing and depreciating, the IRS will consider this distortion of income and will kick out the deduciton.

2.Materials and Supplies
The definition of materials and supplies has been expanded to include property (not including inventory) that has a cost of $200 or less. For example, if a business purchases a printer for $175, the business can generally deduct the cost instead of capitalizing and depreciating over five years.

3.Repair or Improvement
To determine whether an expense may be deducted as a repair or must be capitalized as an improvement the business may use their financial accounting policies as a guideline, up to $5,000. Small businesses without audited financial statements may adopt an internal policy for non-tax reasons to expense property less than $500.

4.Improvements to Buildings
Qualifying small businesses have the option of applying the improvement rules to an eligible building property if the total amount paid during the taxable year for repairs, maintenance, improvement and similar activities performed on the eligible building does not exceed the lesser of $10,000 or two percent of the unadjusted basis of the building.

5.A routine maintenance safe harbor for buildings now allows taxpayers to deduct repairs that may have otherwise been capitalized if they can reasonably expect to perform the repair activity more than once in a 10 year period.

6.Taxpayers may now elect to capitalize repair and maintenance items that are capitalized for financial statement purposes.

7.This is an annual election to capitalize and depreciate the costs. It applies to all amounts paid for repairs during the tax year. This election reduces the administrative burden of tracking differences between financial statement accounting and tax accounting.

8.A de minimis safe harbor was added to allow for the deductibility of items under certain dollar thresholds depending on whether the taxpayer has applicable financials statements or not. If taxpayers have an applicable financial statement they may deduct up to $5,000 per item. If a taxpayer does not have financial statements, the amount is limited to $500.

9.A specific capitalization policy must be in effect for the tax year. The definition of an improvement has been redefined and clarified. Improvements to property must be capitalized if they constitute a betterment, a restoration or an adaption of that property.

10.The improvement rules must be applied separately now to buildings, their building structure and certain major building systems as defined in the regulations.

11.Removal costs related to property are not capitalized as an improvement if the taxpayer realizes a gain or loss on disposition. If no gain or loss is realized, the taxpayer deducts the removal costs if they directly benefit the unit of property. Otherwise, the removal costs are considered an improvement.

12.A small taxpayer safe harbor provides relief to taxpayers if their original building cost was under $1,000,000 and their average annual gross receipts are under $10,000,000.

13.A small taxpayer does not need to capitalize improvements if total annual costs are less than the smaller of $10,000 or 2% of the original building cost The definition of the betterment test has also been redefined. There are three tests to determine if a cost is a betterment and thus an improvement. A cost is for a betterment if it: corrects a material condition or defect Is for a material addition or a material increase in the capacity or space of the property Is reasonable expected to materially increase the productivity, efficiency, strength, quality or output of the property

14.The implementation of these final regulations needs to start now due to the January 1, 2014 effective date. However, in most cases it may be beneficial to elect for 2013.

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009
Email: jeff@jbrookswa.com