THE FINAL TREASURY REPAIR REGULATIONS
In the later part of 2013, the IRS released the Final Treasury Regulations (“Regulations”) governing repair and capitalization issues under Internal Revenue Code (“IRC”) Section 263. The effective date of the Final Regulations are for tax years beginning after January 1, 2014. Accordingly, we are approaching the first filing season where the Regulations have gone into effect. The Regulations are complex and the subject of a lot of discussion among tax professionals. This article could not hope to totally cover all the rules contained in the Regulations so you are advised to discuss these issues with your tax professional to ascertain how they impact your business.
The Regulations govern when taxpayers can currently deduct the costs of acquiring, maintaining, repairing, and replacing tangible property, and when those costs must be capitalized and depreciated over time. These Regulations replace the 2011 temporary regulations and made some improvements to the temporary regulations.
There are five main areas of concern with the Regulations: (i) materials and supplies; (ii) repairs and maintenance; (iii) capital expenditures; (iv) amounts paid for the acquisition or production of tangible property; and (v) amounts paid for the improvement of tangible property.
Generally, the costs of materials and supplies are currently deducted in the tax year first used or consumed. “Materials and supplies” means tangible property used or consumed in the taxpayer’s business that is not inventory and that is: (i) a component that is acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer, but is not acquired as part of any single unit of tangible property; (ii) fuel, lubricants, water, and similar items that are reasonably expected to be used in 12 months or less; (iii) a unit of property with an acquisition or production cost of less than $200 (higher under the de minimis safe harbor); or (iv) identified by the IRS in published guidance. Materials and supplies are subject to the de minimis safe harbor discussed below.
Routine maintenance can also be currently deducted under the Regulations. Under the routine maintenance safe harbor, an amount paid is deductible if it is for recurring activities that the taxpayer expects to perform to keep a unit of property in its ordinary efficient operating condition. The maintenance is routine only if, at the time the unit is placed into service, the taxpayer reasonably expects to perform the maintenance activity more than once during the class life of the unit of property. The Regulations expand the routine maintenance rules to buildings and its structural components. However, a maintenance activity is only covered for buildings if the taxpayer reasonably expects to perform such maintenance more than once over a ten year period.
The Regulations also allow taxpayers to elect out of expensing repair and maintenance costs and treat them as capitalized expenditures subject to depreciation on its books and records. Taxpayers must elect to capitalize these costs on its tax return and once elected it cannot be revoked.
The Regulations provide a de minimis safe harbor to acquire or produce tangible property. The de minimis safe harbor allows the current deduction of the cost for the acquisition or production of a unit of tangible property. Under the Regulations, if a taxpayer has an applicable financial statement and a written policy in effect before the expense is incurred, they can deduct up to $5,000 of the cost of an item of property per invoice. Without an applicable financial statement and written policy governing the expensing practices, the de minimis amount is $500 per invoice. This de minimis safe harbor has to be elected by attaching a statement to your tax return. An applicable financial statement is one that is required to be filed with the SEC, a certified audited financial statement or a financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the IRS or SEC). Accordingly, each taxpayer should make the de minimis safe harbor election and make sure their accounting policy is set forth in a written document effective as of the start of the tax year.
Lastly, the Regulations still require the capitalization of amounts paid to improve a unit of tangible property. A unit of property is improved if amounts are expended by a taxpayer that result in a betterment to the unit of property, a restoration of a unit of property, or adapt a unit of property to a new or different use. The Regulations adopt a safe harbor for small taxpayers with buildings. The Regulations provide for an annual safe harbor election for buildings owned or leased by a taxpayer with an unadjusted basis no greater than $1 million. However, the taxpayer must be a small taxpayer with average gross receipts of less than $10 million. Under the safe harbor, taxpayers are not required to capitalize improvements if the total amounts paid for repairs, maintenance, improvements and similar activities for the year do not exceed the lesser of $10,000 or two percent of the unadjusted basis of the building. Amounts deducted under the de minimis safe harbor for repairs and maintenance count toward the $10,000 ceiling.
The above represents a brief overview of the repair Regulations. As illustrated above the repair Regulations require annual elections attached to your tax return, require a written policy governing the expensing of tangible property, and may require an applicable financial statement. Business owners are advised to discuss these issues with their tax professionals and make or adopt the appropriate elections and written policies effective as of the beginning of tax year 2014.
– Jason W. Harrel is a Partner at Calone & Harrel Law Group, LLP who concentrates his practice in all manners of Taxation, Real Estate Transactions, Corporate, Partnership and Limited Liability Company law matters. He is a certified specialist in Taxation. Mr. Harrel may be reached at 209-952-4545 or jwh@caloneandharrel.com