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Repair vs. Capitalization: Seizing the Opportunity Before the Rules Change
Your Client just brought you this tax issue - “I just spent $40K on my building’s roof, $5K to replace an HVAC unit, and $5K to repave my parking lot – do I need to capitalize these, or can I write them off as repairs?” Not an easy question to answer – but the result will have a big effect on the Client’s current taxes – $20,000 in this situation!!
Background: The history behind this issue and why it is currently “hot” is very similar to the history behind Cost Segregation Studies. Cost Seg Studies have been performed since the 1960s. However, it took the landmark Hospital Corporation of America Tax Court Case in 1997, and the IRS agreeing in 1999 to follow the court case’s findings, to make Cost Seg Studies meaningfully beneficial to taxpayers.
You and your Clients have a similar tax saving opportunities with a Repairs vs. Capitalization Review. Over the years there have been many IRS regulations, notices and tax court rulings on this subject – and not always resulting in the taxpayer’s favor. However, in 2004, the landmark FedEx Tax Court Case was settled in the taxpayer’s favor (starting to sound familiar?).
Result: This past year the Service agreed to follow this Court Case and issued Proposed Regulations on the subject. Items that in the past had been considered “gray” and were capitalized are now considered “black and white” and can be expensed. In fact, the IRS will allow you to write off items on this year’s tax return that may have been incorrectly capitalized in the past! Items that real estate owners incur on a cyclical basis, such as outdoor painting and parking lot sealing, and noncyclical basis, like HVAC and roof repairs. The potential tax savings resulting from this write off can be huge!
Bad News: The clock is ticking on the opportunity to expense these previously capitalized items. Once the Service’s Proposed Regulations officially become law, the IRS may limit the opportunity to recover prior year items by stating that taxpayers can only change their accounting method on a “going forward” basis.
Good News: At no cost to you, we will review your tax depreciation records to see if there is an opportunity for your organization to benefit from meaningful tax savings. We will then present our analysis for your potential savings, and your investment for us to perform the work, including preparation of the Change in Accounting Method.
Manufacturing Facility
· Reviewing their records, we noted that they had capitalized as equipment over $300,000 of replacement parts and service calls for their large presses.
· Result - by filing a Change In Accounting Method and deducting the remaining equipment basis, we were able to save the owner $73,000 of taxes on their current year tax return.
Fast Food Franchise Owner
· The owner with multiple locations thought he was in very good shape tax wise, since he had Cost Segged every one of his restaurants.
· However, in reviewing the owner's records, we noted that over the years he had capitalized as 39 year building over $278,000 worth of repairs and replacements.
· Result - by filing a Change in Accounting Method and reclassifying these items as either 5 year equipment or repairs, we were able to save the owner over $88,000 on their current year tax returns.