The IRS has released final "repair" regulations governing when taxpayers must capitalize and when they can deduct their expenses for acquiring, maintaining, repairing and replacing equipment. These new regulations are effective for tax years beginning January 1, 2014.
De Minimus Rule
Amounts less than $5,000 per item can be expensed for tax purposes as long as they are expensed on audited financial statements. Taxpayers without audited financial statements can expense with a limit of $500 per item.
Maintaining a written capitalization/expense policy is required by the new regulations and it may now be beneficial for your business to obtain a financial statement audit in order to qualify for higher limits.
Unit of Property (UOP)
All guidance in the new regulations is first based on what constitutes a UOP. A UOP is based upon a functional interdependence standard. For property other than a building, all components that are functionally interdependent comprise a single UOP.
The UOP for buildings consists of each building and its structural components unless such component is a building system. HVAC, plumbing, electrical, and the like are considered building systems that are separate from the building structure, and to which the improvement rule must be applied.
Costs to "improve" equipment must be capitalized. "Improvement" applies if the costs incurred betters, restores, or adapts the property to a new or different use. There is a routine maintenance safe harbor in the new regulations for recurring activities that taxpayers expect to perform more than once during the life of the property. Buildings and their structural components are safe harbored if recurring activities are performed more than once in a 10 year period.
Materials and Supplies
Materials and supplies are non-inventory and non-depreciable items with a cost of $200 or less which are generally expensed when used, unless they are incidental. If they are incidental, taxpayers may expense when purchased if these items are not tracked when used.
Restorable, temporary, and standby emergency parts all fall under the materials and supplies regulations. Taxpayers now have several alternatives which may be elected and must be accompanied by a written expense policy.
New IRS repair and capitalization regulations require taxpayers to evaluate whether they need to or should change their tax methods of accounting in order to comply. Below is a summary of elections available to taxpayers:
• Optional method for restorable parts
• Election to capitalize and depreciate restorable parts
• The De Minimus rule
• Routine maintenance safe harbor
• Optional regulatory method
• Safe harbor for small taxpayers
• Optional capitalization method
• Election to recognize gain or loss on "partial disposition"
• General asset account election
With the New Year in full swing, now is the time to take action. Contact Osborne Rincon in order to maintain compliance and maximize tax savings brought upon by the biggest change to repair and capitalization regulations in over 25 years.