Long-awaited repair regulations clarify and expand how purchases, repair and improvements of equipment, buildings and other capital property are depreciated for tax purposes.
The recently released standards in the current regulations – the fourth and final reiteration of the regulations – replace temporary regulations that were issued in 2011. The new regulations become effective Jan. 1, 2014.
One significant rule that did not change is the retirement area that allows deductions for building components that are removed. If you have renovated a building, it would be to your benefit to have a retirement study done to determine what assets were demolished for accelerated depreciation and permanent tax savings upon the sale of the property.
The final regulations create a $5,000 safe harbor protecting businesses from penalty. Businesses that have a financial accounting policy that expenses purchases of $5,000 or less will be able to elect and use the safe harbor. Companies that have a policy that exceeds $5,000 can still follow that policy, but it will be up to the examining agent to determine whether the policy results in “a clear reflection of income.”
In several areas, the new regulations in Treasury Decision 9636 allow businesses to follow their financial accounting policies without analyzing the fact-based tests that are in the tax rules.
For example, a de minimis expensing rule may allow a company to follow its accounting policy in expensing items that fall below a certain threshold.
In determining whether a business has a deductible repair or a capital improvement, the final regulations allow an annual election to follow the financial accounting.
But the IRS is limiting the applicability of these rules for smaller businesses. To elect to follow financial accounting policy, the business must have an “applicable financial statement,” a term that includes one of the following:
- Financial statement filed with the SEC
- Certified audited financial statement
- Financial statement filed with a state or local government
Businesses without an applicable financial statement are limited to a $500 threshold, instead of $5,000.
The final regulations permit a qualifying small business to elect not to apply the improvement rules to an eligible building property – if the total amount paid during the taxable year for repairs, maintenance, improvements and similar activities performed on the eligible building does not exceed $10,000 or 2 percent of the unadjusted basis of the building, whichever is less.
The eligible building property includes a building unit of property that is owned or leased by the qualifying taxpayer, provided the unadjusted basis of the building unit of property is $1 million or less.
Materials and supplies are deductible when used or consumed, according to the new regulations. There is an optional method to account for rotable spare parts – which is cumbersome – but the regulations allow the taxpayer to elect to capitalize and depreciate rotable, temporary or standby emergency spare parts to minimize that burden.