After nearly a decade of review, the Internal Revenue Service finally released new repair and capitalization regulations last fall, and they could have a significant impact on a company’s bottom line for 2014. What do they affect? As of January 1, businesses must use new guidelines to determine the tax treatment of buildings, equipment, vehicles, property improvements and other business assets.
Since nearly all businesses have some kind of fixed assets, virtually every business is affected by the new regulations. They determine when a company must capitalize an expenditure and when it can deduct an expense for acquiring, maintaining, repairing or replacing tangible property.
Companies that own real estate, for example, will find that these rules apply to everything from plumbing repairs to the purchase of a new furnace. But the regulations also apply to a range of other purchases, including computers, phone systems, delivery trucks, furniture, manufacturing equipment, carpeting and even spare parts.
The rule changes means businesses should take a fresh look at their policies to ensure they are booking purchases appropriately. In some cases, they may even want to look into the possibility of filing amended returns for previous years to take advantage of some key elections in the regulations.
The new rules are intended to eliminate confusion over which expenditures can be used for immediate tax deductions and which must be capitalized with deductions spread over 10, 20 or even 40 years. In recent years, absence of clear guidelines had left businesses free to come up with their own interpretation of the appropriate tax treatment.
For some, this was a windfall, allowing them to expense a wide range of items for which there was no clear guidance. Others ended up capitalizing purchases that the new regulations now say can be expensed. For example, demolition costs incurred as part of a development project in the past were generally capitalized and deducted over many years but under the new regulations they can be deducted immediately as an expense when a partial asset disposition takes place and the election for partial asset dispositions is made.
Given the potential financial impact, businesses would be wise to their homework. Not only may they need to make some changes in the way they account for these expenditures, but they also may find the new regulations create some important planning opportunities.
Establishing a formal capitalization policy, for example, will allow companies to take advantage of some de minimis rules that eliminate the need for capitalization. One such rule allows taxpayers with certified audited financial statements to deduct purchases that don’t exceed $5,000 per invoice. Thus, a company could buy 10 computers for $4,900 each on separate invoices and expense the entire purchase, even though the total cost was $49,000. Companies without certified audited financial statements, however, are limited to expensing items costing less than $500 per invoice item.
Small-business owners should also be aware of the safe-harbor election that allows taxpayers to expense building improvements that may have previously been capitalized. Under certain conditions, businesses with annual gross receipts for the three preceding years of $10 million or less may elect to not capitalize improvements to their buildings. The total amount, however, can’t exceed the lesser of $10,000 or 2 percent of the unadjusted basis (the original cost without regard to salvage value) of the building. The unadjusted basis of the building is required to be $1 million or less.
What needs to be included in a capitalization policy? It can simply be a written statement outlining how the company plans to treat its fixed assets. That might include a dollar limit above which items will be capitalized as well as a statement making clear the difference between improvements and maintenance.
Such a policy might also explain how capitalized items will be depreciated, along with some examples of the estimated useful life of various types of assets. Finally, the policy should specify the documentation of capitalized assets so that their depreciation can be properly tracked and the item eventually removed from the company’s books.
Companies probably won’t actually feel the impact of these new IRS regulations until they file their quarterly taxes. But the sooner they start planning, the better equipped they will be to manage the change.
Scott B. Kaplowitch, CPA, a partner with Edelstein & Company LLP in Boston, has a broad range of experience working with retailers, wholesalers, real estate and construction companies, venture capital- funded start-ups, service companies and nonprofit organizations.