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Expensing or Capitalization? New IRS Tangible Property Regulations

(posted: May 15th, 2015)

The regulations are generally effective for tax years beginning after January 1, 2014, or for amounts paid in or incurred in tax years beginning after January 1, 2014.

In this post we will talk about some of the more significant aspects of the regulations.

De Minimis Safe Harbor

Applicable Financial Statements (AFS)

Defined as:

  • Financials filed with the SEC
  • Audited by independent CPA
  • Required to be provided to a federal or state government or agency

Does not include financial statements that are reviewed or compiled.

You need to follow book capitalization policies, and must have the policies in place at the beginning of the tax year.

If AFS applies, you can expense the item or invoice cost if the cost is $5,000 or less or has a useful life of 12 months or less. If no AFS, you can expense the item or invoice cost if the cost is $500 or less or has a useful life of 12 months or less.

Example: Taxpayer does not have an audited F/S and has a written policy to expense anything costing $500 or less. If the taxpayer purchases 20 printers costing $300 each, 14 desks costing $250 each, and 30 chairs costing $200 each for a total cost of $15,500, the entire cost can be expensed. If the taxpayer also purchased 20 laptop computers costing $1,000 each, the taxpayer must capitalize the computers because they are more than $500 each, but ONLY if the taxpayer makes the De Minimis election. Sec. 179 can be used for the laptops. The Sec. 179 limits are not affected by the $15,500, which was expensed. You must attach an election statement to the tax return each year.

Repairs Vs. Improvements

Under IRS regulations, a property is improved whenever it undergoes a BAR:

  • Betterment - Results in a material addition to the property, for example, physically enlarges, expands, or extends it, or results in a material increase in the property's capacity, productivity, strength, or quality.
  • Adaptation - Results from amounts you spend to adapt property to a new or different use. A use is new or different if it is not consistent with your intended ordinary use of the property when you originally placed it into service.
  • Restoration - returns a property that has fallen into disrepair to its ordinary operating condition, rebuilds the property to a like-new condition after the end of its economic useful life, replaces a major component or substantial structural part of the property, replaces a component of a property for which the owner has taken a loss, repairs damage to a property for which the owner has taken a basis adjustment for a casualty loss.

Unit Of Property (UOP)

When it comes to buildings, the regs generally treat each building and its structural components as one UOP. The regs also list nine specific building systems that are treated as an improvement to the single UOP consisting of the building. The nine units of property are:

  1. Building shell
  2. HVAC systems
  3. Plumbing
  4. Electrical
  5. Escalators
  6. Elevators
  7. Fire protection and alarm systems
  8. Security systems
  9. Gas distribution systems

If you restore a building structure, such as by replacing the entire roof, the expense is treated as an improvement to the single UOP of the building.
However the regs also expand the ability to recognize disposition of partial assets at your option. For example, you can now elect to recognize a loss on a replaced roof on a building even though the old roof is not separately stated. The partial disposition election is made by reporting the disposition and recognizing the loss. You can use any reasonable means to determine the remaining adjusted basis of the old roof, which was not separately stated.

You have the option, on a transaction-by-transaction basis, to treat as a repair rather than a capitalized asset any improvement that is not "substantial" to the unit of property. Some examples:

  • An office building has 300 exterior windows that represent 25% of the surface area of the building. 100 of the windows are damaged and there are no plans to replace any more. The 300 windows are a major component of the building structure. However, the 100 windows do not comprise a significant portion of this major component of the building structure. Therefore, the replacement of the 100 windows does not constitute the placement of a major component or substantial structural part of the building and the windows do not need to be capitalized.
  • Assume the facts as above except that the windows cover 90% of the building surface. The amounts spent replacing the 100 windows would be considered a restoration and must be capitalized and depreciated.
  • You own and lease out space in a building consisting of 20 retail spaces. You convert three of the spaces into one larger space to accommodate a new tenant. The costs are not treated as a new or different use because it is consistent with the owner's intended use of the property and therefore, the costs can be deducted.
  • 30% of the building's wiring is replaced, and therefore the cost of the replacement is a deductible repair.

Materials and Supplies

Are defined as tangible property that is used or consumed in the taxpayer's business, and that are:

  • A component acquired to maintain, repair or improve a unit of tangible property.
  • A unit of property that has an economic useful life of 12 months or less.
  • A unit of property having an acquisition cost of $200 or less.

Routine Maintenance Safe Harbor

"Routine maintenance" means recurring activities that keep business property in ordinary efficient operating condition, such as inspection, cleaning, testing, and replacement of damaged or worn parts.

For a building unit of property having an acquisition cost of more than $200, the taxpayer must reasonably expect to perform the maintenance more than once during the 10-year period that begins when the structure or system is placed in service. For property other than buildings, you must reasonably expect to perform the activities more than once during the property's class life for depreciation purposes.

Per-Building Safe Harbor for Qualifying Small Taxpayers

Defined as those taxpayers with average annual gross receipts of $10.0 million or less in the three preceding tax years and have an unadjusted building basis of $1.0 million or less. Those taxpayers can expense repairs, maintenance, and improvements to the building that do not exceed the lesser of $10,000 or 2% of the building's unadjusted basis.

The safe harbor may be elected annually on a building-by-building basis, and is elected by including a statement with the tax return for the year the costs are incurred.

Key Takeaways

  • The De Minimis requirements give you greater ability to expense, without the use of the section 179 election, especially residential property owners where no section 179 election is available.
  • Elections need to be filed in 2014 and subsequent years.
  • Tenant "roll over" move out/move in costs (paint, replacement of rugs, appliances, toilets, etc.) are now deductible under the De Minimis election or the more than once in ten (10) year rule.
  • You have the option to write off the adjusted basis of the old unit of property, where the new unit of property is required to be capitalized. Therefore, you will not have to continue to depreciate the old unit of property along with the new unit of property.


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