Regulations

IRS finally provides guidance on building repairs vs. improvements

Real Estate Tax Talk

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On the eerily appropriate day of Friday the 13th, the IRS released the final version of its Tangible Property Repair Regulations.

The IRS has been working on these regs since 2004. The final regulations are the fourth version released by the IRS. They supersede temporary regulations that were issued at the end of 2011, and resulted in many complaints from the business community and tax practitioners due to their extraordinary length, complexity, and often hard-line approach.

The somewhat business-friendlier and simplified final regulations go into effect for tax years beginning Jan. 1, 2014.

To call these regulations important is an understatement. For owners of tangible business property, including commercial buildings and residential rental properties, they represent the most significant change in the tax laws since 1986.

So what’s the big deal? Well, literally for generations, a small war has been going on between owners of business property and the IRS over two IRC Sections: 263(a) and 162(a).

IRC Section 263(a) says that amounts paid to acquire, produce or improve tangible property must be capitalized over its useful life and not deducted in a single year.

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On the other hand, IRC Section 162(a) says that a taxpayer may deduct all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business, including the costs of supplies, repairs and maintenance.

The upshot is that if an expense is classified as an improvement, it must be capitalized a little at a time over many years — 39 years in the case of commercial buildings. If it’s a repair or maintenance, it can be currently deducted in a single year.

Obviously, business property owners prefer expenses to be classified as repairs (or maintenance) so they can deduct the whole amount in a year. The IRS often prefers the opposite.

Until Sept. 13, the IRS had produced no useful regulations describing how to determine whether something was a repair or an improvement. Instead, business property owners and the IRS itself had to rely on a hodgepodge of court decisions and IRS rulings that sometimes conflicted with each other.

Now, for the first time ever, we have very highly detailed guidance on this issue that the IRS is bound to follow. So now, if you want to know whether you can deduct in a single year the money you spend to replace all the windows in your rental property or repave the driveway, you can look to these regulations for your answer.

Unfortunately, the regulations remain complex and very lengthy. They are 222 pages long — more than 80,000 words. It’s impossible to even begin to summarize them in a single article. Next week we’ll go over the most significant changes the IRS made to the 2011 temporary regulations, several of which are very helpful for owners of smaller residential rental properties.

Stephen Fishman is a tax expert, attorney and author who has published 18 books, including “Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants,” “Deduct It,” “Working as an Independent Contractor” and “Working with Independent Contractors.