The Internal Revenue Service and businesses have long contested the line that divides spending on repairs, which companies can deduct on that year’s tax return, and spending on improvements, which must be capitalized and depreciated over time. The IRS has come out with a new set of “repair regulations” that make significant changes in how companies should treat such expenditures for tax purposes.
The changes pose a compliance challenge, with a KPMG survey of 1,900 corporate tax executives showing 42% expect the revised regulations will be harder to administer. In the long run, though, companies could benefit because the rules may make it easier for them to take losses on building components they have replaced.
One change involves how companies judge whether spending should be deducted or capitalized. In the past, the cost of the work was measured against the value of the entire building, but the new rules say to compare the cost against the building system involved. That means more expenditures are likely to be capitalized, rather than deducted, says Eric Lucas, a principal in KPMG’s national tax practice in Washington.
The new rules also allow companies to take a loss on building systems or components that they discard. That’s a change from previous regulations, says Lucas, under which a company that got a new roof still had to continue to depreciate the cost of the old roof for the remainder of its 39-year statutory life. “Under the old rule, say you replaced the roof twice, you could be depreciating the original roof and both sets of replacement roofs,” he says.
The repair regs also include a new de minimis rule regarding smaller purchases. Many companies have policies that say purchases under a certain amount are treated as expenses for financial accounting purposes, explains David Auclair, national managing principal in Grant Thornton’s national tax office. The new regulations say if a company has a written policy on that policy, it can use the same limit for tax purposes. But the rule imposes a ceiling on the total amount that can be deducted, of either 0.1% of gross receipts or 2% of book depreciation.
“I think most companies are not keeping track of the entire amount they’re deducting,” Auclair says. “There is probably additional record keeping that is going to be required to meet this new rule.”
Companies must comply with the new repair regulations in 2012, though as of mid-February, the IRS had yet to provide revenue procedures on implementing the regs. Depending on that guidance, companies could end up going back to reconsider how they treated costs of this type for a number of years.