Repair Regulations / Repair vs. Capitalization Review
On September 13, 2013, the IRS issued final regulations that provide guidance on the treatment of amounts paid to acquire, produce, or improve tangible property under sections 162(a) and 263(a) of the Internal Revenue Code. These regulations modify and supersede the temporary regulations that were issued on December 23, 2011. In addition, the IRS also released proposed regulations for dispositions of tangible property under Section 168. Even though a formal 6-month period for comments will allow taxpayers to provide feedback, these final and proposed regulations are effective for tax years beginning January 1, 2014.
The regulations are commonly known as the Repair Regulations or the Tangible Property Regulations. They are applicable to businesses in all industries that acquire, produce, replace or improve tangible property. Since the new regulations mostly affect real property, they can provide significant benefits even if a cost segregation study has already been performed. Application of the new regulations requires an in-depth understanding of various tax cases and “circumstances” that must be met.
IRS procedures allow you to apply these rules retroactively and claim any missed deductions using Form 3115. Correcting these errors is considered an Automatic Change of Accounting Method and does not require amending any returns.
Who Can Benefit?
Generally, anyone that has incurred significant costs for renovations to their existing property in the last 15 years is an ideal candidate. The original improvements should be placed in service for at least one year before renovations occur. KBKG recommends a formal study if at least $500,000 or more is spent on renovations.
Significant Changes to Rules
Whether building expenditures are capital improvements or repair expenses.
The IRS outlines numerous subjective factors that must be considered when deciding if the building expenditure is an improvement or a repair expense. KBKG engineers will help you determine when it’s appropriate to expense things such as windows, roofs, HVAC, plumbing and electrical based on your unique situation.
Write-off structural components of buildings when retired or demolished.
Structural components of a building include items with a long tax life (generally 39, 27.5 or 15 years) such as lighting, roofs, HVAC systems, interior and exterior walls, etc. The new regulations allow you to assign a value
to those items and write them off when replaced.
Example: Client acquires an office building for $5M. Five years later the client spends $1M to remodel the second floor. KBKG engineers perform an Asset Retirement Study and identify $450,000 of 39-year life items that were removed during the remodel. This might include things like lighting, drywall, doors, floor coverings, acoustical ceilings, and more. Client claims $400,477 of additional deductions on the current return.
“Plan or Rehabilitation Doctrine” is now obsolete!
Under the old rules, you had to capitalize any routine repair work that was performed at the same time as other major improvements. If you did not expense repair work done in the past under the old regulations, you are now able to claim those missed deductions without amending tax returns.
Example: Four years ago, a client capitalized all $4M of “renovation” costs to their building. KBKG engineers find that $300,000 was used to replace certain windows, asphalt patchwork, painting, roof tiles, some plumbing fixtures and one HVAC unit. KBKG determines all these costs are repair expenses. Client files Form 3115 and claim an additional $266,985 of deductions on the current return.
Retirement of Structural Components is a Permanent Tax Savings
Read our case study involving a $5M building. » View Case Study