The recent release of the IRS regulations Tangible Property Regulations – 080713 v1 and IRS Revenue Section 263(a) define the tax differences between repairs or maintenance and replacement of long life building systems and components.
How do these regulatory changes apply to commercial building owners that are considering repair or replacement of long life systems or components?
If a commercial building owner is considering or has incurred building related costs in recent years, various tax strategies may apply to their particular situation. There are components of these regulations that may help a commercial building owner determine whether building related costs are considered routine repair or maintenance to an existing long life system or component or a capitalized improvement or betterment.
If the work performed is considered a repair or routine maintenance it may be expensed in the year the work is completed. If it is an improvement or betterment it must be capitalized over 27.5 years for commercial apartments or 39 years for commercial buildings.
The difficulty lies in determining whether the expenditure is considered routine maintenance or an improvement or betterment under the regulations.
For example if a commercial building has a leaky roof and a silicone coating is applied over the existing roof to stop the leaks it may be considered a routine repair as it does not improve the roof. In this case, the cost may be expensed during the year it was incurred.
On the other hand, if a local building code allows the building owner to place a new roof over an existing roof and an insulating material is placed between the old and new roofs it may be considered an improvement or betterment because the insulating material increases the “R” factor of the roofing system. In this case, the cost under the new rules would be capitalized. However, the original roof may be considered no longer in service and the remaining depreciation may be available.
Obviously, if the existing roof is removed or abandoned and replaced with a new roof the expenditure typically would be capitalized. However, if the roof being removed has not been fully depreciated the regulations may allow the building owner to deduct the remaining depreciation of the roof in the year that it was abandoned.
These regulations are complex and require engineering and accounting expertise. A commercial building owner should have a Tangible Property Study prepared to determine:
- If future expenditures should be expensed in the year they are incurred or capitalized over a longer term.
- If prior year building related costs can be expensed as a repair and/or as maintenance
- If there is remaining depreciable value in a long life system or component that is abandoned.
A properly prepared Tangible Property Study will establish the nature of the work performed, determine tax benefits, place a value on abandoned property and provide audit protection.
Note: There are some important decisions that should be considered before the 2014 return is filed as the IRS is granting an automatic consent for certain changes. After 2014 the process is a little bit more tedious.