On September 19, 2013 the Internal Revenue Service issued new final Regulations which go in to effect for tax years beginning on or after January 1, 2014. These incredibly complex Regulations require you to keep better records for repairs, maintenance and supplies. In addition, require specifically analyzing each of these items costing over $500. We are writing you this letter to help you understand that if you do not analyze these individual items and classify them appropriately we will be required to spend additional professional time, with fees to analyze all items. Here is a summary of the new rules and what you will need to do to comply with the new IRS requirements.
Materials and Supplies
You are now allowed to write off any individual supply costing $200 or less, lasting less than 12 months, or fuel, lubricants or similar items that will be used in 12 months or less. Please add a new expense account to your accounting system titled “Materials and Supplies” and enter any expense meeting the above category in this account. Anything costing more will need to be individually analyzed under the rules below to determine if they are qualified expenses or treated as equipment that must be depreciated over several years. Special rules apply for extra parts (rotable parts).
Equipment, Repairs and Maintenance
You are now allowed to write off any individual equipment item or equipment repair or maintenance item costing $500 or less. For buildings a different rule applies as discussed below. We also suggest entering individual items costing this amount or less into your repairs account, but refraining from adding any items above that cost to this account. Items costing more than this will generally be required to be individually analyzed under the rules below to determine if they are qualified expenses or treated as equipment that must be depreciated over several years.
In order to be able to use the (maximum) $500 threshold to expense an item versus study its application, a business is required to adopt a capitalization policy each year. An example of such a policy is at the end of this letter. The threshold without the capitalization policy is $100.
Building Repairs & Maintenance
If your building has a cost basis of $1,000,000 or less a special rule applies. Any repairs that are expected to be made more than once in ten years, and costing less than $10,000 individually may be written off as repairs. Items that are not expected to be replaced more once in ten years must also be examined individually under the rules below to determine if they may be treated as expenses or depreciable assets.
Expenses Above the Limits
The IRS now requires you to examine each individual item outside of the above limits to determine if it has been a betterment, restoration or adaptation of the main unit of property. A unit of property is now defined as the inter-related parts composing one larger unit. For example a unit of property is a car composed of inter-related parts, so any repairs to the car must be examined as to whether they are a betterment, restoration or adaptation of the car as a whole rather than its individual components. For buildings the test must first be applied to the building as a whole and then applied to its components of HVAC, plumbing, electrical, structure, elevators, security, fire protection or gas distribution. Anything considered a betterment cost, restoration or adaptation under these rules must be depreciated and listed as equipment, otherwise it may be expensed as repairs.
A betterment is defined as fixing a condition that existed at purchase, or an increase in the physical size or capacity of an asset. Betterments must be capitalized and depreciated so they should be added to your fixed asset account rather than to an expense account.
A restoration is generally defined as a cost to return a non-functional asset to use, the cost of rebuilding an asset after the end of its depreciable life or replacing a major component of the unit of property. For example a transmission replacement would be the replacement of a major component of a unit of property of a truck and must be capitalized and depreciated. These costs should be added to your fixed asset account rather than to an expense account.
Finally an adaptation cost is one incurred to change the function of a piece of equipment or property to a different use and must also be capitalized and depreciated. These costs also should be added to your fixed asset account rather than to an expense account.
If, after reviewing each individual item to determine if it fits the betterment, restoration or adaptation criteria, and it does not, it may be a currently deductible repair cost.
Many additional nuances and applications apply to these new Regulations and we would be happy to discuss them in an appointment with you or your bookkeeper to help you keep the costs of IRS compliance down.
These new rules could have a significant impact on your personal property tax report as well.
Example Repair and Capitalization Policy
Note this policy is an annual irrevocable election and must be included with the timely filed Federal Tax Return upon adoption.
“XYZ Company hereby adopts for book and Federal income tax purposes the following policy regarding capitalization expenses for the year beginning January 1, 2014. In accordance with Internal Revenue Code Sections 167 and 168 and related Regulations XYZ Company has determined that amounts whose individual cost (including tax, installation and delivery costs) does not exceed $500 will be deducted as incurred as an operating expense. Amounts exceeding this dollar limit will be examined individually to determine if their use or purpose requires capitalization under the betterment, adaptation or restoration rules used by the Internal Revenue Service and will be capitalized or expensed as incurred as a result of the application of those rules.” (Companies with audited financial statements should replace $500 with $5,000).