IRS Repair & Maintenance Regulations

Dennis Murphy, CPA

David Walter, CPAMay 15, 2014

• Background• Capitalization Standards

Betterment Restoration Adaptation

• Partial Disposition of Assets• Materials & Supplies• Safe Harbor Rules

AGENDA

NEW RULESOLD RULES TO

• Effective January 1, 2014• Five main areas affected by these final regulations:

Materials and supplies Repairs and maintenance Capital expenditures Amounts paid for the acquisition or production of

tangible property Amounts paid for the improvements of tangible property

• Nine individual structural components of a building

2014 AND BEYONDRULES & REGULATIONS

• A taxpayer must generally capitalize an amount that improves a Unit of Property (UOP) if the amount: Materially expects a betterment Restores the UOP to working use Adapts the UOP to a new or different use

• For all UOPs (other than buildings), all components of a piece of property that are functionally interdependent make up the single UOP Buildings are now split into nine structural components

• General Rule (writing off assets) A taxpayer is allowed to write-off the adjusted basis of an asset when a

new asset of the same type is capitalized

A BUILDINGCOMPONENTS OF

• Each of the following nine structural components of a building are each their own UOP HVAC (heating, ventilation, and

air conditioning) Plumbing systems – inside and

outside; including water, storm, and sewer systems and related fixtures

Electrical systems – inside and outside; including fixtures, wiring, and distribution

Escalators

A BUILDINGCOMPONENTS OF

Elevators Fire protection (sprinklers) and related

alarm systems Security systems – for the protection of

the building and its occupants Gas distribution system – inside

and outside Structural components (roof, walls,

floors, windows, doors, etc.)

• An expenditure results in capitalization under betterment if it is expected to: Correct a material condition or defect at the time of acquisition

or production (not having previous knowledge of the defect is not an excuse)

Result in a material addition to the UOP Result in a material increase in the capacity, productivity,

strength, efficiency, or quality of the UOP or the output of the UOP

BETTERMENT

REMODELINGMAJOR BUILDING

• Remodeling projects are broken down in to the nine Building Systems (listed earlier)

• Example: Should the following expenditures be capitalized or expensed? Building refresh (new paint, clean up, other cosmetic changes) Building refresh and limited improvements (replacing fixtures

throughout the building, etc.) Building refresh and substantial remodel (knock down walls

and reconstruct parts of the building)

• An expenditure results in capitalization under restoration if it: Replaces a disposed component Returns the UOP to its ordinary operating condition after the

property has deteriorated to a state of disrepair and is no longer functional

Rebuilding to like new condition after the UOP’s tax depreciation useful life ends

Replaces a major component or substantial structural part of the UOP

RESTORATION

• Example: Should the following items be capitalized or expensed? Entire roof Roof membrane All 20 sinks in a building Three of the 20 sinks in a building 200 of 300 windows in a building 30 of the 300 windows in a building Floors in the lobby Floors in all public areas

RESTORATION

• An expenditure results in capitalization under adaptation if: The adaptation is not consistent with

the taxpayer’s ordinary use of the UOP at the time it was originally placed in service

ADAPTATION

TANGIBLE PROPERTYIMPROVEMENTS TO

• If the new rules are a different treatment of assets (capitalization vs. expensing) than previously done, this will create the need for an accounting method change Form 3115 will have to be filed This may create a 481(a) adjustment Statistical sampling is allowed if an IRS prescribed method

is used Note for Form 3115: A statement has to be attached to the

form listing the adjustment amount for each property classification (i.e. 5 year, 7 year, or nonresidentialreal property)

ACCOUNT (GAA) RULESGENERAL ASSET

• The temporary regulations proposed the need to elect to place building components into General Asset Accounts

• The need for this election has been lifted with the final regulations

• Each component of a building will be evaluated on a combined basis (i.e. the treatment of the replacement of window(s) is determined on a combined basis) Need to evaluate the portion of the component that is being

replaced and determine if the replacement cost can be expensed (as repairs & maintenance) or if it is required to be capitalized

OF ASSETSDISPOSITION

• Partial disposition election – on retirement/replacement of structural components the component can be written-off

• Need to determine the adjusted basis of components that are disposed (in many cases this could be the difficult part) Original cost records and invoices Detailed building appraisal Qualified cost segregation report (best record) Temporary “companion” regulations have been issued to assist is

determining adjusted basis (Consumer Price Index)

• Materials and supplies – tangible property that is used or consumed (that is not inventory) and that is: A component acquired to maintain, repair, or improve a UOP Fuels, lubricants, water, and similar items reasonably expected to

be consumed in 12 months or less A unit of property that has an economic useful life of 12 months or

less A UOP that has an acquisition or production cost of $200 or less Items identified in published IRS Guidance (restaurant small

wares, etc.)

• Taxpayers need to change their general ledger definition of materials and supplies to agree with the IRS definition

MATERIALS & SUPPLIES

• The IRS has set “safe harbor” amounts for expenditures to determine what should be capitalized. This amount is dependent on the level of annual financials the taxpayer produces Audited/Government required financials - $5,000 per item limit Any other level of financials - $500 per item limit

• Having this policy in place (written) and operating under it will eliminate the IRS questioning expenditure items under examination

• This policy has to be the same for book and tax purposes (cannot be a tax-only policy)

DE MINIMIS RULE

SAFE HARBORROUTINE MAINTENANCE

• Routine maintenance (i.e. recurring expenditures) can be expensed as incurred, rather than continuing to capitalize and write-off these expenditures. Buildings – expenditure incurred more than once over a 10 year

period All other assets – expenditure incurred more than once over the

asset’s ADS life

• This is an annual election that has to be made to take the deduction

SAFE HARBORSMALL TAXPAYER

• A small taxpayer can elect to deduct expenditures on an eligible building, up to a certain limit Small taxpayer – Business gross receipts of $10M or less Eligible building – Original cost of building is $1M or less Expenditure limit – Annual repair and maintenance expenditures

for the building cannot exceed the lesser of $10,000 or 2% of the building’s unadjusted basis (original cost)

SAFE HARBORSMALL TAXPAYER

• This is an annual election that has to be made to take the deduction

• Expenditures claimed under the “Routine Maintenance Safe Harbor” are counted toward the expenditure limit

• For a lessee, the unadjusted basis is equal to total amount of rent paid over the lease term (including expected renewal periods)

FLOW CHARTCAPITALIZATION DECISION

MAINTENANCE COSTSCAPITALIZING REPAIR &

• Annual election can be made to opt out of deducting repair and maintenance expenditures and treat all costs as capital

• This election is made by attaching a statement to the taxpayer’s timely filed original tax return

• This election cannot be revoked• Why would you consider this option?

SPARE PARTSROTABLE & TEMPORARY

• Rotable - Parts that are installed on a UOP, removed and repaired or improved, and either reinstalled or stored for later installation

• Temporary – Components that are used on a temporary basis until new or repaired parts can be installed.

• General rule – a part should be capitalized and deducted in the year it is used

• Optional method election – can elect to capitalize and depreciate these parts

• Capitalization Standards• Materials & Supplies• Safe Harbor Rules• Taxpayer-Friendly Changes

CONCLUSION

QUESTIONS?

Dennis Murphy Jr., CPAManager

dmurphy@skodaminotti.com

440-605-7124

David Walter, CPASenior Manager

dwalter@skodaminotti.com

440-605-7188

www.skodaminotti.com

If you have any questions or need additional information, please contact: