The Internal Revenue Service (IRS) has issued long-awaited final repair regulations on the treatment of costs to acquire, produce or improve tangible property. Taxpayers will need to apply these IRS regulations going forward to determine whether they can deduct costs as repairs and maintenance under Code Sec. 162 or must capitalize the costs and depreciation or amortization of them must occur over a period of years under Code Sec. 263.

The final repair regulations retain the basic requirements and the structure of the temporary and proposed IRS regulations issued in December 2011 (the 2011 regulations). At a length of more than 200 pages, the final regulations are complex. At the same time, they make significant changes that will benefit taxpayers, including new and revised safe harbors, as well as new relief provisions for small business.

As expected, the IRS regulations take effect Jan. 1, 2014. Some provisions apply only to amounts paid or incurred in tax years beginning on or after Jan. 1, 2014. The IRS is not expected to delay these effective dates, since taxpayers were informed of the impending changes in the rules almost two years ago. Complying with the final regulations will require significant time and effort, despite several taxpayer-friendly changes. Every business, especially those with significant fixed assets, must develop an understanding of the regulations and their requirements.

The regulations will provide simplification and reduce controversy to the extent they allow taxpayers to follow their financial accounting (“book”) policies. For example, the de minimis rules provide a $5,000 safe harbor per item, provided taxpayers have a policy on their books to deduct items within the safe harbor. The rules for repairs and maintenance also allow taxpayers to follow their book policies.

Retroactive Election of Final Repair Regulations

While the final repair regulations take effect Jan. 1, 2014, taxpayers can choose to apply them retroactively for their 2012 or 2013 tax years. Taxpayers can also choose to apply the 2011 regulations to 2012 or 2013. The IRS must provide additional guidance for taxpayers to change their methods of accounting to elect to apply either set of regulations retroactively and to comply with the 2014 effective date. Some accounting method changes will require taxpayers to make adjustments under Code Sec. 481(a), in effect, applying the regulations to past years and calculating the impact on income.

More to Come  

The IRS did not finalize every portion of the 2011 regulations. To address some problems with the temporary regulations on the disposition of property with depreciation capabilities, the IRS issued new proposed regulations. The new proposed regulations relieve many taxpayers of the requirement to set up general asset accounts and make retroactive elections so that they can deduct the cost of building components and other portions of property that they replace.

Significant Provisions to IRS Regulations

  • Materials and supplies – The threshold for deducting materials and supplies was increased from $100 to $200. Materials and supplies include many items that are expected to be consumed in 12 months or less, or that have an economically useful life of 12 months or less.
  • De minimis safe harbor – The final regulations eliminate a controversial ceiling on the use of this safe harbor. Taxpayers with financial statements can apply the safe harbor to an item that costs $5,000 or less. The regulations extend the safe harbor to taxpayers without a financial statement, but only for property that costs $500 or less. Taxpayers must have written book policies in place at the beginning of the year to use this safe harbor. This puts a premium on taxpayers developing a policy by the beginning of 2014.
  • Routine maintenance and improvements – The final regulations retain controversial unit of property rules that apply the rules for real property to eight separate building systems, as well as to the overall structure. However, the rules do provide some relief by extending the routine maintenance safe harbor to real property and by providing a new safe harbor for small taxpayers. While the routine maintenance safe harbor usually looks at whether taxpayers will have recurring maintenance over the class life of the property, the regulations limit the measuring period to 10 years, rather than the 40-year class life, for real property.
  • Capitalization election – The final regulations allow taxpayers to capitalize repair and maintenance costs if they are capitalized for financial accounting purposes. This is a significant simplification over the temporary regulations.

As you can see, the final repair regulations are extensive and complex. Determining whether particular costs should be deducted or capitalized will be challenging, especially with the Jan. 1, 2014, effective date looming.

Doeren Mayhew stands ready to help you digest and understand the IRS regulations, determine what accounting policies you may need and make appropriate elections to comply with the regulations. For more information, contact our tax advisors in Michigan, Houston or Ft. Lauderdale.

Source: CCH, a Wolters Kluwer company