Improvement

Article Dean Dorton

If last year your business made repairs to tangible property, such as buildings, machinery, equipment or vehicles, you may be eligible for a valuable deduction on your 2016 income tax return. But you must make sure they were truly “repairs,” and not actually “improvements.”

Why? Costs incurred to improve tangible property must be depreciated over a period of years. But costs incurred on incidental repairs and maintenance can be expensed and immediately deducted.

What’s an “improvement”?

In general, a cost that results in an improvement to a building structure or any of its building systems (for example, the plumbing or electrical system) or to other tangible property must be capitalized. An improvement occurs if there was a betterment, restoration or adaptation of the unit of property.

Under the “betterment test,” you generally must capitalize amounts paid for work that is reasonably expected to materially increase the productivity, efficiency, strength, quality or output of a unit of property or that is a material addition to a unit of property.

Under the “restoration test,” you generally must capitalize amounts paid to replace a part (or combination of parts) that is a major component or a significant portion of the physical structure of a unit of property.

Under the “adaptation test,” you generally must capitalize amounts paid to adapt a unit of property to a new or different use — one that isn’t consistent with your ordinary use of the unit of property at the time you originally placed it in service.

Two safe harbors

Distinguishing between repairs and improvements can be difficult, but a couple of IRS safe harbors can help:

1. Routine maintenance safe harbor. Recurring activities dedicated to keeping property in efficient operating condition can be expensed. These are activities that your business reasonably expects to perform more than once during the property’s “class life,” as defined by the IRS.

Amounts incurred for activities outside the safe harbor don’t necessarily have to be capitalized, though. These amounts are subject to analysis under the general rules for improvements.

2. Small business safe harbor. For buildings that initially cost $1 million or less, qualified small businesses may elect to deduct the lesser of $10,000 or 2% of the unadjusted basis of the property for repairs, maintenance, improvements and similar activities each year. A qualified small business is generally one with gross receipts of $10 million or less.

There is also a de minimis safe harbor as well as an exemption for materials and supplies up to a certain threshold. Contact us for details on these safe harbors and exemptions and other ways to maximize your tangible property deductions.

Article Dean Dorton

Question:

If you spend money to change a capital asset used in your business this year, then is the expenditure a capitalized improvement or an expensed repair?

Answer: 

Under the new Tangible Asset Regulations (TARS), you must capitalize all betterment, restoration, and adaptation expenditures as improvements to the unit of property (UOP). The regulations define these three terms as follows:

  1. A betterment is an expenditure that:
  • Corrects a material condition or defect that existed prior to acquisition or arose during production of the UOP,
  • Results in a material addition to the UOP, or
  • Results in a material increase in strength, capacity, productivity, efficiency, quality or output of the UOP.
  1. A restoration is an expenditure that:
  • Replaces a component of a UOP,
  • Repairs damage to a UOP,
  • Returns UOP to its ordinarily efficient operating condition if it deteriorated to a state of disrepair and is no longer functional for its intended use,
  • Rebuilds UOP to a like-new condition after the end of its ADS class life, or
  • Replaces major component or substantial structural part of UOP.
  1. An adaptation is an expenditure that adapts a UOP to a new or different use that is not consistent with the taxpayer’s intended ordinary use of the UOP when originally placed in service by the taxpayer.

Otherwise, the expenditure is a repair, and you can expense it in the current year.

Contact your Dean Dorton advisor or Faith Crump at fcrump@deandortonstg.wpenginepowered.com or 502.566.1025 if you have any questions.

Article Dean Dorton

This week concludes our six-part email series on the new tangible asset regulations which are generally effective for tax years beginning after 1/1/14 and impacts any taxpayer with capitalized assets or supplies.  The following is a summary of the five areas we previously discussed which may impact you.

De minimis Safe Harbor Rule
The de minimis safe harbor rule allows taxpayers to annually elect to expense certain expenditures, if a written policy is in place at the beginning of the tax year, when you spend less than a certain dollar amount on tangible property.

Materials & Supplies
Through the materials and supplies rules, incidental items meeting certain criteria may accelerate deductions by expensing items in the current year, rather than maintaining an inventory and deducting when used. Non-incidental (inventoried) items  are required to be capitalized and deducted when used or consumed, not necessarily in the year acquired.

Unit of Property: Building Systems
The new rules for building systems places the building components into nine different units of property to determine whether an expenditure is a capitalized improvement or a deductible expense.  These components include HVAC, electrical systems, plumbing, escalators, elevators, fire protection & alarm, security, gas distributions or other structural components.

Unit of Property: Non-Building
To determine whether property is subject to capitalization or expense, you must look at the Unit of Property rules.  For non-building property, you must determine if the components are functionally interdependent, and placing one component in service is reliant on placing other components in service.

Repairs vs. Improvements: 3 Tests
The new regulations implement three new tests to determine whether expenditures related to a unit of property should be capitalized or expensed. The three tests are the betterment test, the restoration test, and the adaptation test. If the expenditure meets any of the tests, the cost should be capitalized as an improvement to the unit of property.  All three tests must be done in succession before determining that expensing the cost is appropriate.

Additional guidance was also released that allows for a late partial disposition election in 2014 to claim  a loss on the cost of the component that was replaced, removed or disposed of in prior years.

As the new regulations are complex, we highly recommend that you address these required changes prior to year end and assess any planning opportunities available.

If you would like additional information or have questions, please contact Allison Carter at alcarter@deandortonstg.wpenginepowered.com or Faith Crump at fcrump@deandortonstg.wpenginepowered.com or by calling 502-589-6050.

View Faith Crump’s Bio

Article Dean Dorton

The new Tangible Asset Regulations (TARS) implements three new tests to determine whether expenditures related to a unit of property (UOP) should be capitalized or expensed. The three tests are the betterment test, the restoration test, and the adaptation test. If the expenditure meets any of the tests, the cost should be capitalized as an improvement to the UOP.  All three tests must be done in succession before determining that expensing the cost is appropriate.

A betterment is an expenditure that does the following:

  • Corrects a material condition or defect that existed prior to acquisition or arose during production of the UOP
  • Results in a material addition to the UOP
  • Results in a material increase in strength, capacity, productivity, efficiency, quality or output of the UOP

A restoration is an expenditure that does the following:

  • Replaces a component of a UOP
  • Repairs damage to a UOP
  • Returns UOP to its ordinarily efficient operating condition if it deteriorated to a state of disrepair and is no longer functional for its intended use
  • Rebuilds UOP to a like-new condition after the end of its ADS class life
  • Replace major component or substantial structural part of UOP

An adaptation is an expenditure that adapts a UOP to a new or different use that is not consistent with the taxpayers intended ordinary use of the UOP when originally placed in service by the taxpayer.

What this means to you: By applying each of these tests, you will determine if you can accelerate your deductions by expensing the items in the current year, or if you will be required to depreciate the items over the useful life.

If you would like additional information or have any questions, please contact Allison Carter at alcarter@deandortonstg.wpenginepowered.com or 859-425-7645, or Faith Crump at fcrump@deandortonstg.wpenginepowered.com or 502-589-6050.

View Faith Crump’s Bio

Article Dean Dorton

This is the first in a six-part series of emails that will provide an overview of the new tangible asset regulations that were finalized in late 2013.  These are generally effective for tax years beginning after 1/1/14; as we approach year-end, there may be planning opportunities or required changes due to these new regulations.

These regulations impact ANY taxpayer that has capitalized assets or supplies, so almost everyone will be impacted somewhat by these rules.  In general, there are five areas that will impact most taxpayers:

  1. De minimis safe harbor rules
  2. Materials & supplies
  3. Unit of Property: functionally interdependent
    1. Building systems – now a separate structural component and what that means
  4. Unit of Property:
    1. Non-building
  5. Repairs vs. improvements – 3 tests

We will summarize each of these areas over the next five weeks, and hopefully provide guidance on potential action items that need to be addressed prior to year end.

Also of note:  Additional guidance was issued recently which has extended the ability to take a late partial disposition election in 2014.

What this means to you:  If you own a building that has recently had renovations or improvements, you may be eligible to claim a loss on the cost basis of the component that was replaced, removed or disposed of in prior years.

If you want additional information or have questions, please contact Faith Crump at fcrump@deandortonstg.wpenginepowered.com or 502-56050.

View Faith Crump’s Bio