Richard A. Lindsey, CPA

Lindsey & Waldo, LLC – Certified Public Accountants

  • Feb 20

    Whenever you fix or replace something in your business or rental property you have to determine, for tax purposes, whether you have made a repair or an improvement. What difference does it make? Because you can deduct the cost of a repair, but you must capitalize the cost of an improvement and recover that cost through depreciation. On your commercial building or rental property that could be as many as 39 years.

    For example, if you classify a $1,000 expenditure as a repair, you get to deduct the entire $1,000 in the year you spend it. If you classify the expenditure as an improvement, you’ll likely have to depreciate it over 39 years and the most you’ll get to deduct in depreciation this year is $25.

    HUGE Difference!

    The difference between a repair and an improvement has, historically, been difficult to determine. Often we relied on various subjective interpretations and court cases for guidance. In an effort to clarify matters, the IRS has issued over 200 pages of complex regulations explaining how to tell the difference.

    With the final regulations, the IRS has provided rules for classifying property as deductible materials and supplies and provided guidance for identifying (generally capitalized) costs of acquiring tangible real and personal property. A key area addresses what is a unit of property versus a component, with implications for determining depreciable class life.

    A capitalized improvement to property is also now more precisely defined, mainly as expenditures that result in a betterment, adapt the property to a new or different use, or restore it to working order or like-new condition after the end of its depreciation class life (the BAR tests).

    The IRS estimates the new regulations will affect about 4 million businesses. Every affected business will need to elect new treatment for 2014 that may require an application for an accounting method change.

    Significant provisions of the new regulations include:

    Materials and supplies. The threshold for deduction materials and supplies was increased from $100 to $200 and generally applies to items 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 new regulations allow a taxpayer with an “applicable financial statement” to deduct up to $5,000 of the cost of an item of property per invoice (or per item substantiated by an invoice). Taxpayers must have a written policy in place at the beginning of the tax year that specifies a per-item dollar amount (up to the ceiling) that will be expensed for financial accounting purposes. Taxpayers without an “applicable financial statement” may expense up to $500 per invoice/item.

    Example: David purchased an Orange Beach condo through his limited liability company (LLC) to add to his rental portfolio in November 2013. However, the condo came sans appliances, and in February 2014 David purchased a refrigerator for $499, a washer for $459 and a dryer for $479. They were all delivered the same day and the invoice totaled $1,437. If David elects to take advantage of the de minimis safe harbor, he must expense the appliances since they are each individually under the $500 threshold.

    Unit of property. The general rule for determining a unit of property other than a building provides that all of the components of a property that are “functionally interdependent” comprise a “single unit of property” (UOP). The regulations say: “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.”

    Example: John purchases a new automobile for his business. John cannot place the automobile into service without tires; therefore, the automobile and the tires may be a unit of property.

    Routine maintenance and improvements. The new regulations contain controversial “unit of property” rules that apply the rules for real property to eight separate building systems. However, the rules do extend the routine maintenance safe harbor to real property and provide a new safe harbor for small taxpayers. The real property safe harbor for small taxpayers allows expensing of amounts paid for repairs, maintenance and improvements when the total costs during the year do not exceed $10,000 or two percent of the unadjusted basis of the building.

    Example: Jack owns an office building with ten roof-mounted heating/air conditioning units. In June 2014, two of the units began malfunctioning and the tenants complained. Jack replaced the two malfunctioning units with new units that are 10% more energy efficient than the old units. No work is performed on the other roof-mounted heating/cooling units.  Jack can deduct the cost of the two new units as repairs because the “unit of property” is the HVAC system and replacing two of the ten units with similar units is not a betterment or improvement.

  • Feb 6

    Question

    My divorce isn’t final yet. How is this going to affect how I file? Would it be different if I wait until after the final hearing? And how is this going to affect the health insurance I got through the exchange? It’s really just the kids and I, but I’m still legally married and I think I included his income when applying for the advanced payment premium tax credit.

    Answer

    Your marital status is determined as of December 31 of each year. However, since your soon-to-be ex-spouse did not live in your household for the last six months you qualify for Head of Household status when filing your tax return. This will give you lower rates plus enable you to keep the advance premium credits. A taxpayer filing Married Filing Separate is not eligible for that credit, the child and dependent care credit and others.

    Do you have a question for the Taxpert that you’d like to see answered in a future Taxing Times? Or perhaps just an issue you’d like the Taxpert to address? Send the Taxpert a note to Taxing Times, 1050 Hillcrest Rd., Ste A, Mobile, AL 36695 or an  email to Taxpert@CPAMobileAL.com.