Richard A. Lindsey, CPA Lindsey & Waldo, LLC – Certified Public Accountants
  • The Capitalization vs. Repair Issue

    Filed under Taxes
    Nov 18

    The IRS has made changes in the capitalization vs. repairs accounting method, which means closer scrutiny.

    Cost will be considered repairs if they are incidental in nature and don’t add to the value of property or prolong the life of the property. Costs that permanently improve the value of the property, restore its value or restore it to adapt it to a new or different use must be capitalized.

    Example:  If an automobile engine is capitalized as an asset, then repairs on this engine would be likely capitalized.  However if the automobile is the asset, then repairs on the engine wouldn’t be capitalized but be classified as repair costs. 

            The IRS has issued a new Audit Technique Guide to assist in the audit of a change of an accounting-method involving capitalization vs. repairs. It will also be helpful in correctly classifying expenses as repair costs or capital improvements.

    IRS auditors are instructed to investigate the following for any costs that are reclassified as repairs:

    1. Determine through management reports, engineering assessments and invoices the reason the work was done.
    2. Decide if the costs were a unit of property (UOP) separate for the primary UOP.
    3. Determine the age of the asset, acquisition date and any prior work completed to that asset.
    4. What was the purpose of the repair, why was it done, the dates the repairs began and ended, when will the repairs have to be done again?
    5. Consider long term repairs and determine if the expenditures:
      • Result in new assets
      • Improve the property, making it operate better
      • Add new components
      • Add upgrades or modification, to improve the value of the property
      • Extend the useful life of the property
      • Improve the efficiency, quality, strength or capacity of the property
      • Give the property a new use.

    These factors tend to indicate that the expense must be capitalized and not be deducted as a repair.

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