If you’re about to acquire, produce or improve real or tangible personal property, and then turn around and use the property in a trade of business for income, stop right there. Under the Internal Revenue Code, you’re required to capitalize certain amounts of money you invested into the property.
While the IRS guidance on capitalization for the acquisition or production of new assets has not historically been controversial, there has been significant disagreement between taxpayers and the IRS in the past relating to repair and maintenance- type expenditures for existing property they already own. Examples include routine reconditioning and replacement of worn parts and repairs to buildings (e.g. roofs, HVAC units).
What Is Considered “Property”?
The main reason for this disagreement is due in part to the lack of a good definition of “property” for purposes of evaluating expenditures and their impact on it. For example, repairs made to a leaky roof could be expensed under a certain set of facts or could be capitalized under another. The primary issue is how extensive the repair was and whether you looked at the entire building as the property being repaired – in which case the roof repair was likely expensed – or only the roof itself as the “unit of property.” The IRS often disagreed with taxpayers on the treatment of these types of expenditures.
To add insult to injury, if a repair cost the amount that is required to be considered “capitalization” (e.g. a roof replacement), you were not allowed to write off the remaining cost of the roof you just replaced. Under the old rules, it was common for a building owner to depreciate two or more roofs at the same time.
How You May Benefit From These Capitalization Regulations
After considerable input from the tax professional community, the Department of Treasury issued revised final regulations regarding capitalization versus expensing, which generally are effective for tax years beginning Jan. 1, 2014. The full impact of these final regulations are too numerous to fully discuss here. However, there are some important, favorable changes taxpayers should know about.
- The IRS has revised and expanded the de minimis safe harbor election with regard to corporate purchases otherwise required to be capitalized. For the first time, the de minimis election allows you to legally follow your financial statement methodology for to determine whether to capitalize or expense asset purchases subject to a per-item maximum. The maximum amount depends on whether you have audited or reviewed financial statements.
- With regard to buildings, the IRS now allows a write-off of certain repair or improvement costs, not to exceed $10,000, that otherwise would require capitalization under the regulations. To qualify, you must have more than $10 million in average annual gross receipts and the total building cost can’t exceed $1 million.
IRS regulations related to capitalization can be complex and at times, difficult to understand. If you’re getting ready to purchase a new building or improve your building for business purposes, contact Rea & Associates. Our team of Ohio tax professionals stands ready to help you fully understand the scope of these final IRS regulations and determine the impact these regulations may have on you.