Repair vs. Capitalization Review
The IRS issued comprehensive Repair Regulations regarding the deduction and capitalization of expenditures related to tangible property also known as the “Repair Regulations.” The rules are applicable to businesses in all industries that acquire, produce, replace or improve tangible property. In most cases, these regulations present an opportunity for taxpayers to claim missed deductions, especialty if buildings, owned or leased, have been renovated or improved.
Even if a cost segregation study has already been performed, taxpayers should have those costs re-analyzed by an expert in this area. Application of the new Repair Regulations requires an in-depth understanding of various tax cases, regulations, and circumstances that must be met.
IRS procedures allow you to apply these rules retroactively and claim any missed deductions using IRS Form 3115. Correcting these errors is considered an Automatic Change of Accounting Method and does not require amending any returns.
Who Can Benefit?
Taxpayers that acquire, renovate or improve real estate. Generally, anyone that has incurred significant costs for renovations to their existing real property in the last 20 years is an ideal candidate.
These rules are particularly beneficial when the original improvements are placed in service for one year before renovations occur. National Cost recommends a detailed review if $350,000 or more is spent on renovations.
Whether building expenditures are capital improvements or repair expenses.
The IRS outlines numerous subjective factors that must be considered when deciding if the building expenditure is an improvement or arepair expense. National Cost engineers will help you determine when it’s appropriate to expense things such as windows, roofs, HVAC, plumbing and electrical based on your unique situation.
Write-off structural components of buildings when retired or demolished.
Structural components of a building include items with along tax life (generally 39, 27.5 or 15 years) such as lighting, roofs, HVAC systems, interior and exterior walls, etc. The new regulations allow you to assign a value to those items and write them off when replaced.
Example: ABC Corp acquires an office building for $5M. Five years later they spend $1 M to remodel the second floor. An Asset Retirement Study identifies $450,000 of 39 year life items that were removed during the remodel. This might include lighting, drywall, doors, floor coverings, acoustic ceilings, etc.
Results: $400,477 of additional deductions on current year return.
“Plan of Rehabilitation Doctrine” is now obsolete!
Under the old rules, you had to capitalize any routine repair work that was performed at the same time as other major improvements. If you did not expense repair work done in the past under the old rules, you are now able to claim those missed deductions without amending tax returns.
Example: Client capitalized $4M of ‘Yenovation” costs to their building four years ago. National Cost engineers find that $300,000 was incurred to replace certain windows, asphalt patchwork, painting, roof tiles, some plumbing fixtures and one HVAC unit. National Cost determines all these costs are repair expenses.
Results: Filing Form 3115 and claiming an additional $266, 985 of deductions on current year return.
What we can do?
For clients that have owned property for more than a year, and then renovate or replace parts of the building. This can include things such as HVAC, roofing, ceilings, drywall, ceramic floor tile, building lighting, and more. National Cost performs a detailed review of building expenditures to appropriately classify them as a repair expense or as a capitalized asset. If expenditures do not qualify as a repair expense, the old building components being replaced or removed can be “retired” and written off for tax purposes.
Questions We Ask
- Have you undertaken a major renovation or repairs on your property?
- How much did you spend on renovations or repairs?What year were they done?
- How much depreciable tax basis is in the original property being renovated?
- How long did you own or lease the property prior to undertaking the renovation or repair work?
- Do you have a schedule of costs including descriptions of the items repaired or replaced?
- What type of work did you perform?
- Replace rooftop air conditioning units? What kind of HVAC system is it?
- Replace roof or part of roof?
- Was the purpose of the construction to give the building a “face lift”
Was it a complete gut and renovate project?
- Replace any plumbing fixtures or electrical? Please describe
- Replace any windows? How many replaced?
- Were any repairs done to the property?
- Was the building expanded?
- Commercial property owners
- Multifamily property owners
- Retail, hotels, banks, restaurants
- Repair or renovation spend of less than $250,000
- Repairs or renovations on properties held for less than one year
Benefit to the Client
- Claim immediate expense deductions that would normally depreciate over 39 years
- Accurate classification of assets for tax depreciation purposes
- Benefits are in addition to any benefit received under a cost segregation study
- Must have repair or renovation expense of at least $250,000 (can be cumulative over several prior years)
- As a rule of thumb, repairs or renovations should have been performed within the last 15 years
- Assets must have been in service for at least one year prior to repair or renovation work
Getting More Information
National Cost can quickly review your situation to determine if there is an opportunity. To see if you qualify, call us today or contact us for more information.