The new tangible property regulations in effect since 2014 mostly frustrate tax accountants and confuse small businesses and real estate investors. However, sole proprietors, businesses, and rental property owners can deduct expenses for repairs and maintenance of their property and equipment. The IRS tightened up the rules for how repairs and maintenance expenses can be deducted in 2014, but you can still do so and need to understand the basics or hire someone who does.
These regulations give bright lines and guidance on how and when to capitalize and how and when to expense repair and maintenance items. Since almost every building needs some repairs and maintenance each year, the ability to understand when items can be expensed and what items must be capitalized is extremely important. One way to ruin a very profitable year is to be audited by the IRS and told that costs were incorrectly expensed must be capitalized and the taxpayer penalized and charged with interest and penalties.
Repairs and maintenance costs, when appropriately evaluated need to be reviewed using a series of tests and principles:
- Routine Maintenance
- De minimis
- Small project
- The Three-Part ‘Improvement’ Test (BAR Test: Betterment, Adaptation, and Restoration)
- Unit of Property
- Materiality Test
- Distinctive functionality
Partial Asset Disposition Analysis on Capital Expenses
In addition, if a cost must be capitalized, then the rules require a Partial Asset Disposition (PAD) be done to remove the “retired” or disposed of asset from the depreciation schedule of the building. Let’s say you have a real estate investment, e.g. a small office building, that you’ve owned for 5 years, and now you need to replace the roof. Prior regulations had you capitalizing and depreciating the new roof over the usual depreciable life while also depreciating the costs of the old roof which was included in the original purchase of your office. In effect you are depreciating two roofs. The one that came with the original purchase, which is not in a trash heap, and the new one. Who wants to do that? Now you can value deduct the current market value of that old roof, and we’re not talking about salvage value here…..it is remaining, undepreciated basis.
USTAGI provides a Tangle Property Regulation Study that will test and categorizeall building improvements costs, repairs and maintenance to determine if they need to be capitalized or if they can be expensed. USTAGI includes partial asset disposition valuations in all Full Scope Cost Segregation studies. If you already have done a cost segregation study, USTAGI can do the valuation on any partial assets disposed of.
If you would like to know more, call or email US Tax Advisors Group, Inc. (USTAGI).