Anyone who owns a house knows that it will periodically require work to keep it in good condition. This work can often end up being very expensive.
The IRS allows business owners and investors to deduct as a business/investment expense the full cost of this work if it determines that it is an ordinary repair. However, if the IRS determines that the work amounts to an improvement or that it extends the useful life of the property, it will not allow an immediate deduction and instead requires the work to be capitalized.
This has caused a lot of controversy between the IRS and taxpayers trying to determine what qualifies as an ordinary repair and maintenance and what is an improvement that must be capitalized.
Recently, the IRS issued new regulations to attempt to clarify the issue. If you are a business owner or an investor who owns any property that occasionally requires repairs, you need to know about the IRS's new repair regulations that took effect on January 1, 2014.
As a general rule, you are required to capitalize:
- The cost of purchasing new property (e.g. buildings or equipment);
- The cost of making permanent improvements to buildings; or
- The cost of restoring property that has already been fully or partially depreciated to its original condition (essentially extending the useful life of the property).
What do you mean by capitalizing the cost?
As I mentioned before, if an expenditure is deemed to be an ordinary repair then the full cost of the repair may be expensed in the year that the cost is incurred. However, if it is not deemed to be a repair it has to be capitalized.
If a cost is capitalized, it is transformed from being an expense into being a depreciable asset. This asset is then depreciated (expensed) over the useful life of the asset. The useful life of the asset is determined based upon what the asset is. For example, a residential building is depreciated over 27.5 years while an "improvement" is depreciated over 15 years and office furniture is depreciated over 7 years.
Most people would prefer to deduct the entire cost of the work required to keep their property in good condition right away instead of over a number of years, so most taxpayers would prefer to have the work classified as a repair.
There are 3 safe harbors with the Internal Revenue Code Regulations that, if met, allow a taxpayer to treat their expenditures as repairs. These safe harbors are:
- The de minimis safe harbor;
- The small taxpayer safe harbor; and
- The routine maintenance safe harbor.
These safe harbors will be the subject of my next several blog posts.
If you have any questions about the IRS's new repair regulations, please send me an e-mail.
