In December of 2011, the IRS issued comprehensive regulations regarding the deduction and capitalization of expenditures related to tangible property, i.e. the “Repair 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.
Blue Ray Engineering’s repair vs. capitalization study includes a complete analysis of the taxpayer’s buildings and improvements to determine appropriate Units of Property for capitalization and depreciation purposes. Our engineers will identify routine repair and maintenance expenses that may have been capitalized and depreciated incorrectly. Additionally, the details contained in a repair vs. capitalization study will enable taxpayers to write down structural assets that no longer exist. This analysis could result in a reduction in tax liability; generating tax refunds and ultimately improving cash flow.
What is the difference between a capital expense and repair expense?
A capital improvement is the addition of a permanent structural improvement, or the restoration of some aspect of property, that will either enhance the property’s overall value or increase its useful life. A repair expense restores a property to a sound state and does not add to the value of the property or increase its useful life. Simply, it keeps the property in operating condition. A repair may be taken as a deduction in the current year. By taking current deductions of previously capitalized repair and maintenance costs, taxpayers can realize immediate benefits. Although the concept of repair vs. capitalization is simple the implementation and development of supporting documentation requires access to a high-level of tax expertise and construction engineering experience.
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. Blue Ray Engineering recommends a formal study if at least $500,000 or more is spent on renovations.
What are the significant changes to the repair regulations?
Whether building expenditures are capital improvements or repair expenses. Given that every situation is different, the IRS outlines numerous subjective factors that must be considered when deciding if the building expenditure is an improvement or a repair expense. Blue Ray Engineering 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.
“Plan or Rehabilitation Doctrine” is now obsolete! Under the old Plan of Rehabilitation Doctrine, 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.