Repair or Improvement

Ten Forty + Quality Tax Preparation & Financial Services,Inc 281-397-7777 Fax 281-397-7443 Tax Tip When determining is a deduction is a current business expense or should be capitalized and depreciation care should be taken. Internal Revenue Code 162 generally allows a current deduction for the cost of repairs and maintenance incurred during the year. On the other had Internal Revenue Code 263 requires capitalization of amounts paid to acquire, produce, or improve tangible property. Since repairs and improvements have similar characteristics, it can be tricky to classify these expenditures. However, correct classification is important because the cost of repairs can generally be deducted in the year paid, while Improvements must be capitalized and the deduction taken over several years through depreciation. An improvement requiring capitalization occurs with an addition to or partial replacement of property that results in a betterment of the unit of property, restores the unit of property, or adapts the unit of property to a new use. The cost of an improvement must be capitalized and depreciated over a certain number of years as if the improvement were separate property. Repairs Improvements Costs that: • Keep the property in good operating condition. • Do not materially add value to the property. • Do not substantially prolong the property’s life. Costs that: • Improve or better the property. • Restore the property. • Adapt the property to new or different uses. Deductible as a current expense. Must be capitalized and depreciated.* Examples: • Repainting inside or out. • Fixing gutters. • Fixing damaged carpet. • Fixing leaks. • Plastering. • Replacing broken windows. • Servicing office equipment. • Cleaning and lubricating machinery. Examples: • Room additions. • Remodeling. • Landscaping. • New roof or flooring/carpeting. • Wiring upgrades. • New heating/cooling and plumbing systems. • Installing a security system. • Replacing gravel driveway with concrete. * The cost of an improvement is depreciated according to a prescribed class and recovery period of the underlying property. Most non-real estate assets such as computers or machinery are depreciated over five or seven years, with residential real estate depreciated over 27½ years, and nonresidential business property over 39 years. Business Use Requirement Repairs are deductible only on business-use or rental property. A homeowner with no business use of the home does not benefit when an expenditure is classified as a repair rather than an improvement. Repairs are nondeductible personal expenses, while an improvement increases the basis of the home and reduces any potential gain on the sale of the home. Recordkeeping Keep good records and ask contractors to provide an Itemized list showing repairs and separately stated improvements and costs. If repairs and improvements are All completed at the same time, the IRS may classify the Entire cost as improvement, even if some of the expenses were for repairs. Court Case: The taxpayer incurred expenses to add a lunch area, restrooms, and a loading and unloading ramp to his existing manufacturing plants. In addition, the interior of the plants were painted and ‘fixed-up.’ The taxpayer claimed a repairs and maintenance deduction for all of the expenses. The IRS disallowed the deduction, explaining that the additions/improvements were made under a proposal and were required to be capitalized. The court agreed with the IRS, noting that the additions of the lunch room, restrooms and ramps constitute nondeductible capital expenditures that were more than merely keeping the property in an ordinarily efficient operating condition. The additions and improvements not only increased the value of the plants, but also aided in adapting them to a different use. The painting of the facility would qualify as a deductible repair if those expenses were standing alone, however, when made as part of an entire capital investment in the improved property, as they were in this case, they must be treated as a capital expenditure. In addition, the court noted that it was not possible to determine from the evidence submitted what portion, if any, was attributable to deductible repairs. Without a segregation of expenses, the deduction cannot be allowed and all expenditures must be capitalized. (Rutter, T.C. Memo 1986-407, August 28, 1986) As always please call us if you have any questions. 1040 + Quality Tax Preparation & Financial Services Joseph C Becker Ten Forty plus Quality Tax Preparation & Financial Services www.tenfortyplus.com 281-397-7777, Fax 281-397-7443 joeb@tenfortyplus.com Contact Us There are many events that occur during the year that can affect your tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please contact us in advance if you have questions about the tax effects of a transaction or event, including the following: • Pension or IRA distributions. • Retirement. • Significant change in income or • Notice from IRS or other deductions. Revenue department. • Job change. • Divorce or separation. • Marriage. • Self-employment. • Attainment of age 59½ or 70½. • Charitable contributions • Sale or purchase of a business property in excess of $5,000. • Sale or purchase of a residence or other real estate.