The start of 2014 marked the effective date of the IRS’s final version of its repair regulations.
These regulations govern when businesses must capitalize or deduct expenses related to acquiring, maintaining, repairing and replacing tangible property.
For many businesses, the final regulations are likely to offer tax-savings opportunities, according to Nathan Clark, a senior tax director at BDO, depending on what the company was doing previously.
“There are some rules that, for many people, will be more relaxed for the de minimis expenses,” he said. “There is a provision for small taxpayers. There are new rules around when you can claim a disposition of property, which is new. All of these things add up together for many taxpayers to offer tax savings opportunities.”
Clark provided two common examples that are clarified under the new regulations, but noted there are plenty of other examples.
“Let’s say you are a manufacturer and you have a piece of machinery, and annually you are going to perform some type of routine maintenance, just like we would do with our cars. You have to do it to keep it running — that is the type of expenditure that is repair and maintenance and that is deductible immediately,” he said.
Clark said businesses often will capitalize the expense, but under the new rules they are not required to do so.
“Let’s take it a step further and say it’s an overhaul or a rebuild that we do every three or five years,” he said. “These rules guide whether that has to be capitalized as an improvement to that asset or whether it is really just routine maintenance.
“The other example that is very common to these new regulations is that most businesses have a practice where they aren’t going to capitalize anything until it’s over a certain dollar amount — just for administration purposes because of the volume of things they are capitalizing. It requires a lot of data and tracking and it’s just immaterial at that lower level.
“A perfect example is, say, one of my office chairs broke and I have to go buy a new one. Well, if it meets certain criteria — meaning it’s a nominal dollar amount — you don’t have to necessarily capitalize it under these new rules because it’s a small-dollar item. It’s what they call de minimis.”
Clark said companies with a lot of assets will be most impacted by the final repair regulations. He said industries like manufacturing, retail and real estate are among those likely to see the greatest savings.
“It affects those the most that own and operate a lot of tangible property,” he said.
The IRS has been working on writing repair regulations for several years now — the final regulations are the organization’s fourth draft and replace the 2011 “temporary regulations” that were issued.
Clark said the IRS has done a good job of making the new regulations easy for taxpayers, but he said there is work involved in implementing them.
“The IRS requires you to make elections when you file your tax returns so there are some new statements that you will have to include to formally tell the IRS this is what we are doing,” he said. “You need to think about it in advance so you can make sure you are actually doing what you say you are going to be doing before it becomes time to file a tax return, which happens much later after the fiscal year has closed.”
There also are some book accounting and financial statement methodology implications, as well.
The IRS became motivated to write the final repair regulations following several court case losses.
“There is a very lengthy case law history where the IRS would audit taxpayers. They would make them capitalize things and depreciate what they had deducted, which is unfavorable to taxpayers because it means they don’t get their deductions this year, they just get (them) in the future,” Clark said. “There were a lot of court cases that taxpayers were fighting the IRS on this issue — what is deductible repair and maintenance?
“The IRS began to lose quite a few of those cases, so it led to the IRS writing more definitive rules for what is deductible repair and maintenance expense versus what is an improvement.”
Clark suggested companies take some time to look into how the new regulations might affect them, saying that when it comes to the IRS, “doing nothing is still doing something.”