Do you need to make repairs to your business premises or equipment? It can make a big tax difference if the work is characterized as a “repair” or an “improvement.” In brief, a repair is currently deductible by your business, while the cost of an improvement must be written off over time.
The IRS and taxpayers often disagree over the exact tax treatment. At least recently-issued final regulations provide a measure of clarity.
As a rule of thumb, the IRS has traditionally said that a repair merely keeps property in efficient operating condition, while an improvement prolongs the useful life of the property, enhances its value or adapts it for a different use. For example, fixing a leaky faucet is likely to be a currently deductible repair. But the addition of a new wing to a business building is considered to be an improvement.
The final regulations sought to provide more definitive guidelines for distinguishing repairs from improvements. The main takeaway from the regs for many small business owners is that they can rely on these three safe-harbor rules.
- Small-cost items: A business can currently deduct repair and maintenance costs that don’t exceed $2,500 per item. What’s more, this threshold is increased to $5,000 for a business with an “applicable financial statement” (AFS) approved by a CPA.
- Small projects: A small businesses with $10 million or less in average gross receipts can currently deduct improvements to a building with an unadjusted basis of $1 million or less. However, the total amount paid for repairs, maintenance and improvement to the building can’t exceed the lesser of (a) $10,000 or (b) 2% of the unadjusted basis of the property.
- Routine repairs and maintenance: If amounts are paid only for routine repairs and maintenance, those expenses are currently deductible. But the IRS imposes the following requirements:
- The repairs must be regularly recurring activities that are expected to be performed.
- The repairs must result from the wear and tear of being used in a trade or business.
- The repairs are required to keep the property operating efficiently in its normal condition.
- The repairs are expected to be necessary more than once during the first ten-year period for buildings, and structures related to buildings, or more than once during the property’s class life for other property. The “class life” is the number of years over which the IRS expects property to be depreciated.
The IRS requires business owners to make a tax return election to take advantage of any one of these three safe harbors. Note that other special rules—for example, when there is a partial disposition—may come into play. Consult with your professional tax advisor concerning partial dispositions or any borderline calls.
Finally, be aware of a potential tax trap. If you make repairs and improvements at the same time, the entire cost may be lumped together as a “general betterment plan” that must be depreciated over time. Depending on your situation, it may be preferable to arrange to have repairs performed separately. Take all of the tax factors into account.