The IRS has released final regulations outlining when business expenditures must be capitalized as opposed to currently expensed as routine repairs and maintenance. The final regulations make substantial changes to the temporary regulations that have been in place since 2011. These regulations will affect all taxpayers that acquire, produce or improve tangible property.

The final “taxpayer-friendly” and “simplified” regulations do not come without a cost, as the new law consists of over 200 pages of rules and regulations that will be a challenge to implement for most businesses. The implementation will be further complicated by a fast approaching January 1, 2014 effective date. Businesses can elect to implement these changes prior to the effective date and retroactively to 2012.

The final regulations have changed the following 5 general sections within IRS code sections 162 & 263:

1. Materials & Supplies

2. Repairs and maintenance

3. Capital expenditures

4. Acquisition of tangible property

5. Improvements to tangible property

Materials & supplies: Items used or consumed in the business operations that are not inventory, a component that is purchased and used to maintain or repair tangible property can be expensed as consumed. Expensed materials & supplies also include items that have a useful life of 12 months or less and items costing less than $200.  

Repairs and maintenance: An amount paid is deductible under repairs and maintenance if it is for a recurring expense, one that the taxpayer expects to incur to keep the property in operating condition. The new regulations have been expanded to include “routine maintenance” on a building and its structural components such as the heating and air conditioning systems, plumbing, electrical and fire/security systems. The building maintenance must be reasonably expected to recur more than once within a 10 year period. The regulations also allow for “dispositions” of structural components that occurs before the disposition of the entire building. For example, if you install a new roof you can “dispose” of the old one. The only problem is how do you determine the cost of the old roof? The regulations have not yet addressed this issue, but the IRS has promised to provide clarifications soon.

Capital expenditures: The final regulations allow taxpayers to make an annual election to opt out of expensing repair and maintenance costs. The election applies to all amounts paid that the taxpayer treats as capitalized expenditures on its books and records.

Acquisition of tangible property:  The regulations have added a de-minimis safe harbor when acquiring or producing real or personal property. A taxpayer who prepares an applicable financial statement may deduct up to $5,000 of the cost of an item, the taxpayer must have written accounting procedures in effect as of the beginning of the tax year. Taxpayers who do not have an applicable financial statement may elect to expense up to $500 per item. Taxpayers must attach a statement annually to their Federal tax return in order to use the de minimis rule.  

Improvements to tangible property: The final regulations require capitalization of amounts paid to improve tangible property, including betterment to the property and/or a restoration or adaptation of the property for a new or different use.

So what steps should be taken now and in the future? In certain circumstances it would be wise to put these procedures into place before 2014 and possibly amend returns for 2012. Generally anyone that has incurred costs to their building structure may benefit by filing a form 3115 “Application for Change in Accounting Method” in order to claim any missed deductions. This effectively accelerates your deduction into the current year instead of depreciating it over several years.   

Virtually every business must comply with these very complex rules that will require significant time and talent to assure compliance. The tax professionals at Dermody, Burke and Brown are here to assist you every step of the way.

The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.