In late December 2011, the Treasury Department issued temporary and proposed regulations—commonly referred to as the "repair regulations"—providing guidance on the tax treatment of costs incurred to acquire, repair, or improve tangible property.
The new repair regulations are a framework for analyzing whether and when costs incurred in acquiring, maintaining, or improving tangible property must be capitalized. Taxpayers must apply the standards in the regulations to determine if expenditures are currently deductible as ordinary and necessary business expenses or must be treated as capital improvements and depreciated over a longer recovery period.
The regulations adopt a new framework for determining the treatment of building improvement costs. The improvement tests (betterment, restoration/replacement, adaptation) are applied separately to specific building systems and components, rather than the building as a whole. If an expenditure results in an improvement to a specific building system or component, it is deemed to improve the building/unit of property as a whole and, therefore, must be capitalized. The specific building systems listed in the regulations are HVAC, plumbing, electrical, escalators, elevators, fire protection and alarm, security, gas distribution, and any other system identified in published guidance.
The regulations also revise the definition of a disposition, so a taxpayer may treat the replacement or retirement of a structural component of a building as a disposition of property. This new rule will mitigate the result that occurs when an original building component and any subsequent replacement are required to be capitalized and depreciated simultaneously.
Timing of the final regulations
Final regulations are expected to be released late spring to early summer 2013. The final regulations will be effective for tax years beginning on or after Jan. 1, 2014, but can be adopted early for tax years beginning on or after Jan. 1, 2012, or Jan. 1, 2013.
Steps to take now
Companies should determine the extent to which they will be required to change their current accounting methods to conform to the new regulations. Even if an accounting method change is not necessary, companies should analyze whether adopting the new standards will be more advantageous than their current methods for future deductions.