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To Deduct or Not to Deduct…
Anita S. Wescott

In December, 2011, the IRS issued temporary regulations intended to set new standards for capitalizing or deducting dollars spent on tangible property.  These regulations were originally effective for years beginning on or after January 1, 2012, but the effective date has been postponed to tax years beginning on or after January 1, 2014.  Taxpayers have the option to apply the temporary regulations to tax years beginning on or after January 1, 2012.

Consistent with prior regulations, the new regulations center on a “unit of property.”  A “unit of property” is determined by the functional interdependence standard. Guidelines of particular interest for those involved in real estate include the following:

  1. Each building and its structural components is considered a single unit of property.
  2. Key building systems (like HVAC and plumbing) are separate from the building structure.
  3. Leasehold improvements are a separate unit of property.

Taxpayers are required to capitalize improvements made on a unit of property based on relevant facts and circumstances.  Improvements are divided into three categories: betterments, restorations and adaptations.  Changes have also been made to reporting the retirement of a structural component of a building.

Routine maintenance remains deductible in the current year.  Maintenance includes work that does not result in increased capacity, productivity, efficiency, strength or quality.

A de minimis rule allows materials and supplies to be deducted in the current year if the items are less than $100 and are expected to be consumed in 12 months or less.  Also, a de minimis expensing rule allows a taxpayer to deduct amounts paid to acquire property that would otherwise be capitalized if the taxpayer has an Applicable Financial Statement, written accounting procedures for expensing property under certain dollar amounts and treats the expenditure on the financial statement in accordance with the written policy.  An overall ceiling limits the amount that a taxpayer may deduct under the de minimis rule.

Also included in the temporary regulations are examples intended to clarify the treatment of roofs.  Replacement of an entire roof or a significant portion of a roof that has deteriorated over time is classified as a restoration and must be capitalized.  Replacement of shingles damaged in a storm or the cost of fixing a leaky roof (even if significant) may be considered a repair.  The treatment is based on specific facts and circumstances in a particular case.

Finally, if these new regulations differ significantly from the way repair and replacement costs have been handled in the past, it may be necessary to request a change of accounting method (Form 3115) with the 2012 tax return filed.  Most changes are automatic under Revenue Procedures issued in 2012, but guidelines should be followed to request the change.

The IRS is under pressure to clarify and simplify implementation of the regulations when they are issued in final form.  The de minimis rules, dispositions and routine maintenance are potential areas under IRS consideration for revision.

While this guidance is meant to simplify reporting dollars spent on tangible property, this area is increasingly complex.  Our goal is to help you maximize your deductions, so give us a call to discuss any questions you may have or contact me at [email protected].

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