In 2013, the IRS issued final regulations (“Repair Regs”) establishing a framework for distinguishing between deductible repairs and capital improvements. It is important to carefully consider each expenditure in light of the Repair Regs to determine whether each expenditure should be:
- Expensed immediately.
- Capitalized and depreciated using accelerated depreciation methods.
- Capitalized and depreciated over a longer period, up to 39 years.
2023 Changes in Accelerated Depreciation Options: The Tax Cuts and Jobs Act decreased bonus depreciation by 20% per year beginning in 2023 through 2027, meaning bonus depreciation expense on eligible capital assets will only be 80% in 2023 and 60% in 2024. While 100% Section 179 expensing may still be available for eligible assets purchased by eligible taxpayers, some types of capital improvements might not be eligible for either accelerated depreciation method. You want to avoid being stuck with a 39-year depreciation deduction if immediate expensing is available.
Differentiating Repairs from Capital Improvements: This is the heart of the Repair Regs and where all the complicated rules come into play. A business should generally capitalize amounts paid to acquire, produce, or improve a unit of property, while routine repairs and maintenance can be expensed as incurred. The IRS-approved criteria for deductible repairs & maintenance items might surprise you.
- Routine Maintenance: Regular and recurring activities essential to keep property in normal and efficient operating condition can be immediately deducted as repairs. This includes tasks like repainting walls, cleaning carpets, and numerous other kinds of routine repairs and maintenance.
- Small-Scale Improvements: Costs related to improvements that don’t significantly extend the property’s useful life or add substantial value can also be expensed.
- Capital Improvements: There are three categories of capital improvements: (1) betterments, (2) adaptations, and (3) restorations. There are materiality concepts included in these considerations. For example, replacing one HVAC unit in a building with ten HVAC units might not be considered a capital improvement, no matter how much it costs. In addition, replacing the roof membrane over the entire building might not be considered a capital improvement, no matter how much it costs, if the overall productivity or efficiency of the building is unchanged.
Safe Harbor Provisions: These provisions were established to simplify the decision-making process for taxpayers:
- De-Minimis Safe Harbor: This may be the most common provision applicable to nearly every business. Private businesses with audited financial statements can elect to expense any single item or invoice less than (or up to) $5,000. If a business purchases several laptops under $5,000 each, it can immediately deduct these as routine expenses instead of depreciating them. For those without audited statements, the de-minimis safe harbor election is up to $2,500 per invoice or item. Each business needs to decide which safe-harbor amount applies, document its accounting policy, and apply that dollar threshold across the board for all eligible purchases. Assets purchased in excess of the safe-harbor amount may still be eligible for accelerated bonus or Section 179 depreciation.
- Routine Maintenance Safe Harbor: Amounts paid for routine maintenance are not capital improvements. Routine maintenance includes the recurring activities a business expects to perform to keep the property in its ordinarily efficient operating condition. Routine maintenance may be performed at any time during the useful life of the property. Still, the maintenance is routine only if the taxpayer reasonably expects to perform the maintenance more than once during the class life of the property or for a building more than once every ten years.
- Small Taxpayer Safe Harbor: Small businesses with average annual gross receipts of $10 million or less who own or rent a building with an unadjusted basis of $1 million or less have a special safe harbor. During any taxable year, the total amount of repairs or improvements not exceeding the lesser of 2% of the unadjusted basis of the property or $10,000 may be expensed, even if the expenditure otherwise meets the criteria of a capital improvement.
If you are going to tackle a large project, it is best to be certain of the tax deductibility before you start. If you are unsure of the treatment for a specific repair or potential asset purchase, please consult your Dent Moses advisor.