Repair and Maintenance Costs under the Tangible Property Regulations (TPR)

Starting in 2014, business returns including businesses conducted by taxpayers on Schedules C, E or F of their form 1040s are required to follow new guidelines with regard to repair and maintenance costs on property as well as smaller additions of fixed assets.

For a sample Capitalization Policy, visit Best Practices under Resources on DBM website.

In general, the new rules are more formulaic compared to the way things used to be. In the past “facts and circumstances” were considered in determining whether or not costs incurred needed to be capitalized as an asset and depreciated over time, or whether they could be expensed immediately as repairs or maintenance.

Some of the logic from the old facts and circumstances protocols remains. Expenditures which enhance the asset, or which alter the asset to a new use are supposed to be capitalized whether or not the expenditure might otherwise be a current period expense under these new rules.

Care must be taken as well, because as part of the new protocols, if the IRS determines that expenditure should have been expensed and not capitalized in a prior period, they may disallow depreciation deductions on the cost that they determine was inappropriately capitalized.

To complicate matters there are elections which can be made to capitalize certain items, or everything in a certain year.

For expenditures which would generally be considered repairs, meaning that they pass the tests which would otherwise require the capitalization of the cost due to a change or enhancement, there is a subsequent test of magnitude. In general, if the expenditure for a repair is more than 30% of the remaining adjusted tax cost basis of that asset, it must be capitalized. (Example: major repair or new roof on a 25 year old residential rental property).

There is a silver lining to the new rules. For small or “de minimis” purchases of new assets, there is no need to capitalize the purchases at all, and this is on a line item basis. For taxpayers with an “applicable financial statement” meaning audited financial statement, the limit per asset for purchases of assets not requiring capitalization is $5000. For taxpayers who do not have their financial statements audited, the threshold is $2500. Again, this threshold is on a line item basis, so if an invoice comes in with a stove, a dishwasher, a refrigerator and a microwave oven for a rental, the $2500 threshold is applied on an item by item basis. It is likely that none of those items need to be capitalized. They can be expensed if their individual cost is under the threshold amount.

In order to qualify for this advantageous treatment, the taxpayer needs to follow the asset capitalization policy that it maintains on its books. The IRS also would prefer that the asset capitalization policy be written and exist prior to the beginning of the tax year that it applies to. Following is a draft asset capitalization policy which can be used to document your own capitalization policy. Please remember that if your asset capitalization policy exceeds the amount that the IRS allows, you will be limited to the IRS limitation on your tax return. This will create a book to tax difference which will need to be separately tracked to make sure that you do get your full depreciation deductions on into the future.