1) Should I expense (deduct) or capitalize this repair?
2) Is there a threshold under which my repairs would not be subject to capitalization?
3) Are certain repairs or maintenance contracts inherently deductible by nature, and therefore specifically excluded from capitalization?
The IRS has recognized that the answers to these questions are not always simple or straight forward in nature. As highlighted in the recent William Vaughan Company blog “New Regulations Now in Effect for Capitalization of Tangible Property,” the IRS has attempted to clarify guidance on deductions related to repairs and maintenance with their recent regulations.
Part of this clarification involves an updated definition of “materials and supplies.” Materials and supplies are innately deductible expenses falling outside the auspices of capitalization. Accordingly, the IRS developed tests to determine if an item of tangible property is a material and supply item. These tests, generally speaking, allow deductions for materials and supplies:
1) Acquired to maintain and/or repair a unit of property
2) Acquired with an economic useful life of 12 months or less
3) Acquired at a cost of $100 or less
Depending on your prior business policies, many of your repair and maintenance costs could be a deductible material or supply. It is imperative that these types of accounts be reviewed for an accurate and current determination.
Repairs and maintenance costs are deductible if they do not materially add to the value of the unit of property, add to its useful life, or are otherwise required to be capitalized. This simply means that repairs and maintenance classifications rely greatly upon the definition of a unit of property. A unit of property in reference to a building is the building structure or 1 of 9 building systems. In other words, testing a repair (in regards to its eligibility for deduction) depends upon whether the repair was made to the building structure (walls) or to a building system (elevator). A unit of property in reference to tangible property other than a building is considered a single unit when the components are “functionally interdependent.” If one component cannot be placed in service without placing the other component in service, then they are by definition functionally interdependent. For example, a shoe and its laces are functionally interdependent, unless of course, you are wearing Velcro or slip-on styles.
In addition, the IRS offers de minimis rules allowing tangible property to be exempt from capitalization (deductible as repairs, maintenance, materials, and/or supplies) if they meet specified requirements. To meet these requirements in their current form, you are obligated to have audited financial statements and written accounting procedures that are followed in regards to your business’s capitalization policy. Moreover, amounts that are paid for tangible property that are not capitalized (and would normally be subject to capitalization) must fall under a threshold directly dependent the gross receipts and depreciation/amortization expense of your business.
By: Nate Bernath, CPA