In interesting news, new regulations were finalized by the United States Department of Treasury regarding income taxation of property owners. Expect dramatic and significant ramifications. It took almost ten years of government efforts to reduce the confusion and subsequent litigation concerning what expenses may be deducted, as opposed to what expenses must be capitalized. These regulations are typically known as Tangible Property Regulations or the Repair Regulations.
As of now, any taxpayer may deduct all of their ordinary business expenses incurred in its respective trade, including repairs. It must be noted, though, that Code Section 263(a) of IRS Section 162 states that no deduction is permitted for expenses used for “new buildings..or improvements…made to increase the value of any property.”
According to these updated regulations, a taxpayer must divide his or her assets into “units of property.” A “unit of property” is typically a single building, while a “major component” is defined as a part or combination of said parts that perform an important task in the operation of the unit. The taxpayer must capitalize the expense if it does replace a significant portion.
To consider a brief example, say a taxpayer owns a significant office building with 300 windows. The office building itself is considered a “unit of property,” while the windows are considered a “major component” of the building. If the taxpayer fixes 200 windows, they are replacing a significant portion of the “major component,” and the taxpayer must capitalize the cost of those windows.
However, if only 100 windows are replaced, a significant portion of the major component would not be replaced, and the 100 windows may be deducted.
Under these updated regulations significant expenses may be deducted that may have previously had to be capitalized. As another example, what if a taxpayer owned a 10-story structure and decided to repair the lobby floors? The entirety of the building’s floors would be considered a major component. Therefore, the taxpayer has decided to improve a mere 10% of said major component. These renovations could be thus be deducted, since a large portion of the major component would remain untouched.
It must be noted that these regulations contain exceptions that still require capitalization. It is strongly recommended that these be studied in detail. As an example, a taxpayer is required to capitalize an expense if it is involved in restoring a property that had experienced a measure of deterioration to the extent that its intended use is compromised. An expense must also be capitalized if it is paid to adapt a property for an alternate use.
An expense must also be capitalized if it is used for the betterment of a unit of property, including the expansion of a building. If an improvement happens to substitute a substantial structural part of a property, the improvement must be capitalized.
These new rules are a minimal part of the property regulations. As of January, 2014, the regulations are generally in effect. If any taxpayers own pre-existing property they may be required to alter their methods of accounting.