Expense or Repair?
The Distinctions are Not Always Clear… Here’s the Inside Scoop
Business owners know that it is often extremely expensive to acquire productive tangible property and to keep that property in sound, working order. Generally, federal income tax rules allow businesses to deduct the cost of acquiring and maintaining tangible property. However, historically there has been disagreement between business taxpayers and the IRS regarding when those costs are deductible for income tax purposes. The IRS allows owners to deduct the full cost of repair work that is deemed to be ordinary in nature. However, if the IRS concludes that repair work is actually an improvement or means to extend the life of the property, the work must be capitalized. The new repair regulations attempt to clarify the differences between deductible expenses and capitalized improvements.
Anything not deemed as a repair needs to be capitalized. The following typically need to be capitalized:
- Original purchase price of the tangible property
- Optional cost of permanent improvements to a building
- Restoration cost of property that had been partially or fully depreciated to original condition – in other words, the cost of extending the useful life of the property
Business taxpayers usually prefer to immediately deduct expenses related to business property. Capitalizing costs of property can delay tax deductions for several years depending on the depreciable life of the property. Most machinery and equipment is depreciable over 7 years, and buildings and building improvements are generally depreciated over periods as long as 39 years.
The good news is that the new repair regulations do offer the following “safe harbors” for businesses to deduct rather than capitalize certain costs:
- De minimis safe harbor amount rules that allow businesses to currently deduct purchased items costing less than $500 (or $5,000 per item if the business has an audited financial statement).
The treatment of these items must be the same for accounting books and tax purposes, and the business must make an annual election to use the de minimis safe harbor.
- Small taxpayer safe harbor for building improvements that applies to taxpayers with three preceding years of annual gross receipts of less than $10 million. The original purchase price of buildings must be under $1 million, the total cost of all repairs, maintenance, and improvements must be the lessor of $10,000 or 2% of the building’s basis. This also requires an annual election by the business.
- Routine maintenance safe harbor which allows for a full deduction of scheduled necessary routine maintenance of property during the depreciable life of machinery and equipment or during the first 10 years for a building.
Herbein can help you determine if these safe harbors are applicable to your business and how to take advantage of the favorable rules.
In our next edition, we’ll provide tips and key questions to ask to help get you moving in the right direction, from the start. For additional information on this topic please contact the author Barry D. Groebel at 610.378.1175 or firstname.lastname@example.org.