The IRS has issued final regulations addressing whether a cost is a deductible repair or a capital expenditure.
* Small taxpayer Safe Harbor: The regulations add a new Safe Harbor for businesses with gross receipts of $10 million or less. The Safe Harbor is intended to simplify small taxpayers' compliance with the rules requiring capitalization of building improvements. Qualifying businesses can elect not to capitalize building improvements with an unadjusted cost basis of $1 million or less if the total amount paid during the year for repairs, maintenance, and improvements does not exceed the lesser of $10,000 or 2 percent of the unadjusted cost basis of the building. The Safe Harbor is elected annually on a building-by-building basis.
* Routine maintenance Safe Harbor: When it comes to expeditures for the routine maintenance performed by so many printing businesses, there’s another Safe Harbor. Routine maintenance includes the inspection, cleaning, and testing of the property, machinery, or equipment and replacement with comparable and commercially available and reasonable replacement parts. Unfortunately, in order for something to be considered “routine” maintenance, the shop has to expect to perform these services more than once during the class life (generally the same as for depreciation) of the property.
Electing to capitalize
The final regulations include an entirely new provision allowing a business to treat amounts paid for repairs and maintenance to tangible property as amounts paid to improve that property. Hence, if the print shop chooses, the amounts paid as property improvements become assets subject to depreciation – as long as the expenditures are business-related and the amounts are treated as capital expenditures on the shop’s books.
Another significant change in the new regulations allows a shop to take “retirement losses” on components. If, for example, a building’s roof is replaced and the old roof is disposed of, the company now has the option of taking a retirement loss for the old roof. Of course, the replacement roof must be capitalized; and the retirement loss can be claimed on the roof that’s been replaced.
Property units and accounting-method changes
Much of the new guidance provided by the IRS revolves around what constitutes a “unit of property” (UOP). In general, the smaller the UOP being placed in service, repaired, or improved, the more likely that the UOP’s cost will have to be capitalized. For example, work on an engine of a vehicle is more likely to be classified as an expense that must be capitalized if the engine is classified a separate UOP. By contrast, if the UOP is the vehicle, the engine work has a better chance of passing muster as a repair.
The new repair regulations have been described as the most comprehensive changes to the issues of capitalization and write-off in more than 20 years. Some of the new regulation’s Safe Harbors and elections can be implemented on a print operation’s annual tax return. Unfortunately, since the IRS considers many of the provisions to be accounting methods, many shops must file numerous Form 3115s, Application for Change in Accounting Method.
A shop seeking to change to a method of accounting permitted under the final regulations must get IRS consent before implementing that new method. Under the automatic-consent procedures, the IRS will consent when a Form 3115, Application for Change in Accounting Method, is attached to the company’s timely filed tax return for the year of change (with extensions). A signed copy must also be sent to the IRS’s national office.
Keep in mind that the tax strategies and methods you’ve used in the past may no longer be either feasible or advisable. Yes, the newly created “Safe Harbors” and other taxpayer-favorable features will provide tax-planning opportunities – and potential tax savings – for print service providers and businesses.
But while the new repair regulations bring some helpful clarity and order to the treatment of tangible property – and they go a long way to answering the question of what is a repair and what is an expenditure to be capitalized and depreciated – they also pose considerable compliance risks for every business. Many print shops will discover they need to take on new tax strategies requiring an accounting method change, and I suggest seeking out professional tax assistance rather than going it alone here.
Mark Battersby is a freelance writer who has specialized in taxes and finance for the last 25 years.