New Repair Deduction Rules for 2014 Trigger Need for Expert Tax Guidance
If you run an asset-based business, the tax guidelines for deducting the costs of repairs are changing for 2014 because of new rules recently issued by the IRS. These dramatic changes must be understood by business owners.
In 2011, the IRS proposed game-changing rules regarding when amounts spent to acquire, produce or improve tangible property were currently deductible as repairs and when the costs had to be capitalized, or rolled into the basis of the property. The goal was to move from a "facts-and-circumstances" test of what was a deductible business expense versus a capital expense to a rules-based system.
Not surprisingly, the rules were complex and difficult to apply. The effective date was delayed while tax professionals and the IRS squared off to try and hammer out compromises that were more palatable for taxpayers. Last month, the regulations were finalized—with some (but not all) criticisms addressed and resolved in a pro-taxpayer manner. The finalized regulations are set to take effect on January 1, 2014.
These regulations are sweeping and affected virtually every business—large or small. The IRS estimates the number of taxpayers affected at 4 million and the combined amount of time required to comply at 1.1 million hours! The more capital intensive your business, the more they are likely to affect you. Manufacturers, restaurants, and retailers may feel the strongest impact, but even service businesses that own real property or equipment need to be aware of the changes.
The final regulations, which are hundreds of pages in length, provide highly complex rules in a number of key areas, including:
- the treatment of expenses for materials and supplies, including a safe harbor for expenses up to $200
- the characterization of expenses incurred for routine maintenance, including the election to capitalize repair and maintenance costs
- tests to determine the appropriate unit of property for purposes of analyzing the costs
- safe harbors for de minimus expenses and routine maintenance of buildings
- tests to determine when an expense is incurred for improvements, betterments, and restorations--each classification having a significant tax impact
- the impact of property dispositions
- the requirement that taxpayers can change their methods of accounting to reflect previous decisions
The difference between deducting and capitalizing can have a significant effect on one's tax liability. For example, a $20,000 repair cost can be fully deducted in the year in was incurred. But if the same $20,000 is an improvement, it must be capitalized, with the deduction spread out over class life of the property, which can be 5, 10, 15 20, or even more years.
Given the complexity of these provisions and the impact the characterization will have on present and future tax years--including the need for accounting method changes and amended returns--it is imperative that you consult your tax professional before incurring costs related to your assets.