The IRS recently finalized regulations that help distinguish capital expenditures from supplies, repairs, maintenanceand other deductible expenses. These regulations affect virtually every business that acquires, produces, or improves tangible property and will likely change the way these items are accounted for on your tax return and books. These changes can be taxpayer friendly from the standpoint of providing guidance for accelerating deductions for certain tangible property sooner than you would have previously.
Capitalization Threshold
The new regulations provide guidance on the dollar amount a taxpayer should use when determining whether a fixed asset purchase should be capitalized. For most taxpayers, the IRS has now stated that this amount is up to $500. This amount is per item, not per invoice. For taxpayers that receive audited financial statements, the amount, when included in the company’s written accounting policies, can be as much as $5,000. This increased amount does not include taxpayers that receive compiled or reviewed financial statements.
For example, in the case of the $500 threshold, a company purchases a new table and eight new chairs for a conference room. The total invoice cost is $2,200, however the cost is itemized as follows: Table (1)- $600 Chairs (8) - $1,600. The table exceeds the $500 threshold and should be capitalized and depreciated. The chairs, however, have a unit cost of $200, and under the new regulations, can be expensed in the year purchased.
Repairs and Maintenance
In the past, some repairs and maintenance costs have been capitalized, and depreciated over their estimated useful life, due to their relative cost or due to the lack of guidance from the IRS. The new regulations help to define what is a routine maintenance item and thus should be expensed in the year incurred.
Buildings – If the maintenance occurs, or can be reasonably estimated to occur, more than once during a ten year period, the IRS says this is routine maintenance and should be expensed as incurred.
For example, replacing the carpet in a rental house can be costly, and generally exceeds the capitalization threshold. Depending on tenant turnover, this maintenance can occur several times during a ten year period. Based on the new regulations, replacing the carpet would be expensed in the year incurred for this taxpayer.
Equipment – If the maintenance occurs, or can be reasonably estimated to occur, more than once during the class life, the IRS says that this is routine maintenance and should be expensed as incurred. The class life is the estimated life assigned to a particular fixed asset for tax purposes. An example of class life would be five years for a vehicle.
Building Repairs and Maintenance Threshold
The new regulations provide a safe harbor amount for building repairs. This is an amount provided for “small businesses” to exempt testing individual repair costs from the rules listed above. The guidance says that a taxpayer can expense building repairs as long as, in total, they do not exceed the lesser of $10,000 or 2% of the cost of the building. If the building cost is more than $1 million or the previous three year average revenue exceeds $10 million, this safe harbor does not apply.
It will be good practice, going forward, to have separate expense accounts for building repairs and equipment repairs. This will help improve accuracy, and compliance with the new regulations.
Materiality – Building Improvements
The new regulations include a consideration of materiality when determining whether a capital expenditure is a betterment to a building. Replacements of 30% or less are considered immaterial in respect to improving a building, and thus, are eligible for immediate expense.
For example, a building has four HVAC units and one needs to be replaced. Prior to these new regulations, the cost of the replaced HVAC unit would be capitalized and depreciated over the life of the building (27.5 years or 39 years). Under the new regulations, the 25% replacement is not a material betterment and the cost of the new HVAC unit can be expensed when incurred.
If you would like to discuss this further to determine how this will impact your business, please do not hesitate to contact us.
Ryan Doss, CPA, joined BatesCarter in 2009, specializing inTax. Ryan brings experience in individual and business tax returns as well as commercial compilations and reviews.
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