Expensed vs. Capitalized

Repair vs. Capitalized

The question is what items can be expensed vs. capitalized?

The provisions are as follows.

1. De Minimis safe harbor. $2,500 per invoice or item (as substantiated by the invoice). If you have an audit done, then $5,000.

If the taxpayer arranges with the contractor to take the cost of a $10,000 new bathroom and have the contractor break it up into 4 invoices, does that qualify?

The IRS thought about that one.

26 CFR 1.263(a)-1(f)(6)Anti-abuse rule. If a taxpayer acts to manipulate transactions with the intent to achieve a tax benefit or to avoid the application of the limitations provided under paragraphs (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, appropriate adjustments will be made to carry out the purposes of this section. For example, a taxpayer is deemed to act to manipulate transactions with an intent to avoid the purposes and requirements of this section if –

(i) The taxpayer applies the de minimis safe harbor to amounts substantiated with invoices created to componentize property that is generally acquired or produced by the taxpayer (or other taxpayers in the same or similar trade or business) as a single unit of tangible property; and

(ii) This property, if treated as a single unit, would exceed any of the limitations provided under paragraphs (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, as applicable.

The Regulation at 26 CFR 1.263(a)-1(f)(7) gives various examples.

Let’s take an example. You buy a computer worth 2,600 and with that you buy a printer that costs $400, 2 items on one invoice. The printer qualifies, but not the computer.

A. A written accounting procedures that the firm is going to write off as an expense items of $5,000, but written procedures not required for the $2,500 limit.

B. The election must be made each year.

C. Even if you do not qualify for the election, that does not automatically mean you have to capitalize.

Let take a look at that example above where the computer costs $2,600. And change the facts so that the computer is sent to the local shop for work. Is the $2,600 of work a repair or an improvement.

It could be that the $2,600 was spent to replace a computer board that was defective and qualifies as a repair. So regardless of the the de minimis safe harbor rules the $2,600 would be deductible.

Before you address the various safe harbors you have the question is this item a Unit of Property “UOP”? Is the printer in our example above a unit of property? Is the printer dependent on another piece of property (for example the computer)? If the printer is dependent on the computer, then it does not qualify for the De Minimus safe harbor even though it cost under $2,500.

(e)Determining the unit of property – UOP

(1)In general. The unit of property rules in this paragraph (e) apply only for purposes of section 263(a) and §§ 1.263(a)-1, 1.263(a)-2, 1.263(a)-3, and 1.162-3. Unless otherwise specified, the unit of property determination is based upon the functional interdependence standard provided in paragraph (e)(3)(i) of this section.

(3)Property other than building –

(i)In general. Except as otherwise provided in paragraphs (e)(3), (e)(4), (e)(5), and (f)(1) of this section, in the case of real or personal property other than property described in paragraph (e)(2) of this section, all the components that are functionally interdependent comprise a single unit of property. Components of property are functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayer.

Special rules. However, special rules are provided for buildings (see paragraph (e)(2) of this section), plant property (see paragraph (e)(3)(ii) of this section), network assets (see paragraph (e)(3)(iii) of this section), leased property (see paragraph (e)(2)(v) of this section for leased buildings and paragraph (e)(3)(iv) of this section for leased property other than buildings), and improvements to property (see paragraph (e)(4) of this section). Additional rules are provided if a taxpayer has assigned different MACRS classes or depreciation methods to components of property or subsequently changes the class or depreciation method of a component or other item of property (see paragraph (e)(5) of this section). Property that is aggregated or subject to a general asset account election or accounted for in a multiple asset account (that is, pooled) may not be treated as a single unit of property.

Lets take a look at Buildings:

The building is in 2 parts: the Building System and the Building Structure.

A. Building Structure
B. Structural components/Building system: plumbing, electrical, HVAC, elevators, security systems, natural gas, and other components.
So once you have defined the UOP; Was the expenditure a repair or cap expenditure.


What is a capital expenditure?

1. Betterment – amount paid to fix a material condition or material defect, material addition or materially increase productivity.
Of course what does “material” mean.

2. Restoration – replace a major component or a substantial structural part. Then of course you have to write of the cost of the component replaced. So for example a new roof. If I capitalize a new roof, then I should write off the adjusted basis of the old roof.

So now the question is what is the cost of the old roof. You will need either a cost segregation study or a IRS accepted method to determine the adjusted basis.

3. Adaption to a new or different use.

2. Small taxpayer safe harbor for OWNED or LEASED building

So lets say the cost meets the definition of a building improvement. How does this safe harbor work?

1. Taxpayer must have gross receipts less than 10,000,000.

2. Cost of building (excluded land) is less than 1,000,000.

3. Total cost of repairs and improvements do not exceed:

The LESSER of 10,000 or 2% of the original basis of the building. So even if it is an improvement, you can expense the lessor of 2% or 10,000.

3. Safe Harbor for Routine Maintenance

Even if the item is an improvement, you do not need to capitalize if:

Recurring activity

To keep property in the ordinary operating condition

You expect to preform this activity

A. Every 10 years for a Building. A new roof would last longer than 10 years so this would not be routine maintenance.

B. For non building more than once during its tax life.

For example, if you had a copier and had the repair man come out and clean, and he had to replace a part that cost $3,000. Even though the De Minimis safe harbor, and the small tax payer do not apply, the Routine Maintenance safe harbor would.

Safe Harbor for Routine Maintenance does not apply to improvements that are Betterments.
4. Facts and Circumstances – If the improvement does not qualify under the 2,500 exclusion De Minimus, nor the Small Taxpayer exclusion nor the Routine Maintenance, then look at the Facts And Circumstances.

Repair vs. Capitalized

What is a capital expenditure?

1. Betterment – amount paid to fix a material condition or material defect, material addition or materially increase productivity.

2. Restoration – replace a major component or a substantial structural part.
3. Adaption to a new or different use.

Even if you elect one of these simplfying provision it is possible that the safe harbor does not protect the entire cost.

You can elect to capitalize repair and maintenance as improvements.

Why you would want to do this, I am not sure. Possibly if you are not able to currently take the benefit of deducting the repairs and maintenance.

And the election has to be done each year.

5. Rehabilitation Plan.

Even if the cost is a repair, it may still end up being capitalized because it was part of an overall plan.

Say for example you buy a house and are going to rent it out. You decide to paint the home, patch the roof, clean the front walkway. Each of these item is a repair, but because it is part of a plan to Rehabilitate the house, then you have to capitalize. Does it matter that each of the items is separately invoiced? It certainly helps to make the case that the repairs were not part of an over Plan, but not if the overall Plan was decided before the start of the first repairs and the taxpayer is being billed as the work is completed.

How this is a better place than before the new IRS regs is hard to accept. This is a general discussion.

See you tax preparer for your particular situation  about whether a payment is a repair vs. capitalized item.