Find out what has changed—and how to maximize the related tax advantages.
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.
Taxpayers who frequently renovate their property to keep it "fresh" will have the largest opportunity, and they will need to understand how the new rules affect them or risk missing valuable tax benefits.
Key changes included in the regulations
New building systems
One of the most significant changes made by the regulations is the new approach for applying the capitalization standards to a building.
The temporary regulations retain the general rule that a building and its structural components are a single "unit of property." Similarly, the tests used to determine which costs should be deducted as repair and maintenance costs or remain capitalized are essentially the same.
For buildings, the capitalization standards must now be applied separately to the building structure and eight specific building systems listed in the regulations: plumbing, HVAC, electrical, escalator, elevator, fire protection, security, and gas distribution.
In addition to offering numerous examples of how to apply the capitalization standards to buildings and structural components, the new guidance and regulations also provide examples related to refreshing and remodeling retail buildings, including: 1) a basic refresh, 2) a refresh that includes an improvement to a building system, and 3) a large-scale refresh and remodel that includes an improvement to the building. While the examples are somewhat useful, they contain assumptions and stipulated facts. Taxpayers must consider their own specific facts and circumstances when applying the capitalization standards and reaching conclusions about the treatment of repair and maintenance costs.
Taxpayers can now treat the retirement of a building structural component as a disposition of property
The temporary regulations make numerous changes to the depreciation rules. Under the new regulations, a "disposition" now includes the retirement of a structural component of a building, giving taxpayers the ability to immediately recover the remaining basis of building components that are retired or replaced. The new rule mitigates the potentially unfair result that could occur when an original building component and its subsequent replacement are required to be capitalized and depreciated at the same time.
How to take advantage of the new regulations
The temporary regulations have the same binding effect as final regulations and are effective for tax years beginning on or after Jan. 1, 2012. Since it is likely most companies will need to file accounting method changes with their 2012 tax returns, consider the following:
- Review capitalization policies and current accounting methods.
- Review any recent automatic changes you have filed for repair and maintenance costs.
- Consult with a tax advisor.
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