The IRS released final regulations dealing with when taxpayers are required to capitalize and when they can deduct expenses for acquiring, maintaining, repairing and replacing tangible property. All businesses that own fixed assets will be affected in some manner and are required to comply with these new regulations as of January 1, 2014.
There are four basic areas which are impacted by the new regulations: (1) materials and supplies; (2) repairs and maintenance; (3) amounts paid for the acquisition or production of tangible property; and (4) amounts paid for the improvement of tangible property.
Materials and Supplies
Materials and supplies are those tangible items used or consumed in the taxpayer’s business operations and are typically expensed when they are consumed. These can include: (1) components acquired to maintain, repair, or improve a unit of property (UOP); (2) fuel, lubricants, water and similar items that are reasonably expected to be consumed in 12 months or less; (3) a UOP that has a useful life of 12 months or less; (4) a UOP with an acquisition or production cost of $200 or less; (5) or an item identified by the IRS in published guidance.
Routine Repairs and Maintenance
Taxpayers often capitalize costs that may be eligible for immediate expensing as repair and maintenance costs. The new regulations make clear that costs of certain routine maintenance need not be capitalized.
Under the routine maintenance “safe harbor,” the amount paid is deductible if it is for recurring repairs and maintenance that the business expects to perform to keep the UOP in its ordinary efficient operating condition.
Repair and maintenance costs are considered routine only if the business expects to perform these activities more than once during the MACRS alternative depreciation system class life of the property. For buildings and their structural components, maintenance can be expensed only if the taxpayer reasonably expects to perform the maintenance more than once over a 10-year period.
Asset Acquisition or Production
Taxpayers are generally required to capitalize amounts paid to acquire or produce a unit of real or personal property. Under the new regulations, the IRS has provided a de minimis exception to this general rule. Taxpayers with an applicable financial statement (AFS) may deduct up to $5,000 per invoice or item purchased. Taxpayers without an AFS may expense up to $500 per invoice or item purchased. For all taxpayers, amounts paid for property with a useful life of 12 months or less may be expensed. In order to apply this de minimis exception, you must (1) have a written capitalization policy in place as of January 1, 2014; (2) treat these expenses in the same manner on your tax return and financial statement; and (3) elect this treatment annually by including a statement with your tax return.
In general, the new regulations require taxpayers to capitalize amounts paid to improve a UOP. A UOP is considered improved if the amounts paid for activities performed result in a (1) betterment; (2) restoration; or (3) adaptation of the UOP to a new or different use. It is important to consult your tax advisor when making this determination.
The new regulations also include guidance pertaining to casualty losses, asset disposals, and favorable safe harbor rules for small taxpayers.
It is important to take action to comply with these new regulations. Taxpayers should analyze capitalization policies to determine compliance with the new standards, including having an adequate written policy for repairs and determining whether it is advantageous to make certain annual tax elections and/or file accounting method changes to conform to the new rules.
These issues are complex. There is no one-size-fits-all answer for every business. Your trusted tax advisor can provide specific guidance for your industry and your unique business situation.