By Andy Smith, Tax Principal Do you or your business deduct depreciation expenses for the cost of fixed assets?  Do you purchase materials and supplies?  Do you deduct repairs and maintenance costs? If you answered “yes” to any of these questions, the final Tangible Property Regulations that were issued by the IRS on September 13, 2013 will apply to you and/or your business.  We have shared the ongoing development of these rules with our readers in previous BNN Briefing articles, most recently summarized in a September 2013 Tax Advisory.  However, the rules are very complex and voluminous, requiring additional guidance addressing solely how to implement the new rules.  For this purpose, the IRS recently issued Revenue Procedure 2014-16 in late January 2014, and more guidance is due in Revenue Procedure 2014-17, which is expected very shortly.  Based on the most recent guidance, following is a brief overview of the changes. Much like the Regulations themselves, the implementation policies are lengthy and complex. 

Unfortunately, although adopting the rules is mandatory, the IRS will require most taxpayers to go through the formality of requesting a change in accounting method for the 2014 tax year simply to comply.  Other taxpayers may be able to utilize a variety of elections. A change in accounting method is accomplished by completing IRS Form 3115.  Although the process can be a bit complicated and time consuming, many taxpayers have the potential to reap substantial tax savings on both current and past expenditures.  Many of the changes created by the final regulations address whether or not certain costs should be capitalized and depreciated rather than expensed in the year incurred.  Several “safe harbor” rules were created that may be adopted by making one or both of the following annual elections: These elections allow certain taxpayers to automatically expense the cost of a certain qualifying items rather than consider the in-depth “RABI” (Restoration, Adaptation, Betterment and Improvement) rules outlined in the final Regulations. 

Costs that do not qualify for safe harbor treatment must be evaluated to determine whether they restore, adapt, provide betterments, or improve a unit of property.  If so, the costs must be capitalized and depreciated over the asset’s useful life.  ruud ac units for saleAll other costs may be claimed as current expenses.  jeep cherokee ac compressor bracketStarting in 2014, taxpayers must apply these standards to current year costs and evaluate all outlays made in prior years to determine if the costs have been properly treated.  cost of hvac per m2Prior costs that are rendered “improperly capitalized” as part of the rule change can be removed from depreciable cost basis as part of an accounting method change, thereby creating additional deductions when the change is filed. 

For taxpayers with a considerable number of fixed assets, this evaluation process can be time consuming but also quite beneficial. The final Regulations also allow taxpayers to record partial dispositions of tangible personal and real property, which also accelerates deductions.  This disposition will allow a taxpayer to deduct a portion of a previously capitalized asset when it is replaced by a new, capitalized item.  An example of this is as follows: There are considerable planning opportunities available with the implementation of these new Regulations and the recently and soon-to-be issued Revenue Procedures.  Although many taxpayers will properly address these changes beginning with their 2014 tax returns, it is imperative you review and align your internal capitalization policies as well as discuss them with your BNN Tax Advisor. 1Small Taxpayers are defined as entities with $10 million or less in Average Annual Receipts. Disclaimer of Liability: This publication is intended to provide general information to our clients and friends.

It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter. IRS CIRCULAR 230 DISCLOSURE Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact us if you wish to have formal written advice on this matter.Whenever you fix or replace something in a rental unit or building you need to decide whether the expense is a repair or improvement for tax purposes. Why is this important? Because you can deduct the cost of a repair in a single year, while you have to depreciate improvements over as many as 27.5 years. For example, if you classify a $1,000 expense as a repair, you get to deduct $1,000 this year.

If you classify it as an improvement, you'll likely have to depreciate it over 27.5 years and you'll get only a $35 deduction this year. Unfortunately, telling the difference between a repair and an improvement can be difficult. In attempt to clarify matters, the IRS has issued lengthy regulations explaining how to tell the difference between repairs and improvements. Implementation of these rules was delayed but they became effective on January 1, 2014. For more details on current vs. capital expenses refer to the article Current vs Capital Expenses. If You are a Landlord Maximize your tax deductions, including how to deduct repairs and losses, depreciate improvements. Check out Every Landlord's Tax Deduction Guide » Under the new IRS regulations, property is improved whenever it undergoes a: Think of the acronym B A R = Improvement = Depreciate. If the need for the expense was caused by a particular event--for example, a storm--you must compare the property's condition just before the event and just after the work was done to make your determination.

On the other hand, if you’re correcting normal wear and tear to property, you must compare its condition after the last time you corrected normal wear and tear (whether maintenance or an improvement) with its condition after the latest work was done. If you’ve never had any work done on the property, use its condition when placed in service as your point of comparison. An expenditure is for a betterment if it: An expenditure is for a restoration if it: You must also depreciate 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. To determine whether you’ve improved your business or rental property, you must determine what the property consists of. The IRS calls this the “unit of property” (UOP). How the UOP is defined is crucial. The larger the UOP, the more likely will work done on a component be a deductible repair rather than an improvement that must be depreciated.

For example, if the UOP for an apartment building is defined as the entire building structure as a whole, you could plausibly claim that replacing the fire escapes is a repair since it doesn’t seem that significant when compared with the whole building. On the other hand, if the UOP consists of the fire protection system alone, replacing fire escapes would likely be an improvement. New IRS regulations require that buildings be divided up into as many as nine different UOPs: the entire structure and up to eight separate building systems. An improvement to any of these UOPs must be depreciated. As a result, more costs will have to be classified as improvements, rather than repairs. The entire building and its structural components as a whole are a single UOP. A building’s structural components include: For example, replacement of a building’s roof is an improvement to the building UOP. In addition, the following eight building systems are separate UOPs. An improvement to any one of these systems and must be depreciated: