Learn About Deducting Repairs and Maintenance Expenses
An Overview of What to Pay Attention to in the IRS's New Repair Regs
Sole proprietors, businesses of all sizes and rental property owners can deduct expenses for repairs and maintenance of their property and equipment. The IRS issued new regulations that took effect in 2014. These new regulations tightened up the rules for how repairs and maintenance expenses are deducted.
If a particular repair makes equipment better, restores the property to its normal condition, or adapts property to a new or different use, then the expense is capitalized and depreciated over several years.
Repair and maintenance expenses that do not fall under the categories of betterments, restorations or adaptations can be deducted in full in the year the expense was paid.
"If you repair stuff, you can deduct it," says Steve Nelson, a certified public accountant who has written extensively about deducting repairs on the Evergreen Small Business blog and has written an up-to-date e-book Preparing Form 3115 for the New Tangible Property Regulations.
"If what you do is a betterment, restoration or adaptation," Nelson says, "the new rules say we're going to make you capitalize it and depreciate it unless it's such an amount that it's small potatoes."
Routine Repairs and Maintenance That Can Be Deducted Right Away
"Generally, you can deduct amounts paid for repairs and maintenance to tangible property if the amounts paid are not otherwise required to be capitalized." (IRS.gov, Publication 535, Business Expenses, chapter 7, section on Repair and Maintenance Costs.)
By defining what we can deduct in terms of what we are not required to capitalize, this forces us to ask the question: does this expense have to be capitalized? If not, then we can deduct it.
In another section of Publication 535, the IRS clarifies the distinction between maintenance and repairs:
"Repairs. The cost of repairing or improving property used in your trade or business is either a deductible or capital expense. Routine maintenance that keeps your property in a normal efficient operating condition, but that does not materially increase the value or substantially prolong the useful life of the property, is deductible in the year that it is incurred. Otherwise, the cost must be capitalized and depreciated." (IRS.gov, Publication 535, Business Expenses, chapter 11, section on Repairs.)
Notice that here the IRS defines what they mean by routine maintenance. Routine maintenance, the IRS says, "keeps your property in a normal efficient operating condition." An example would be changing the oil on a car. Changing the oil keeps the car operating normally and efficiently, but it doesn't substantially prolong the useful life of the car. Replacing the transmission or engine, however, would substantially prolong the useful life of the car, and so this would be more like a repair that needs to be capitalized.
Capitalizing Repairs and Maintenance: the "BRA" Test
Repairs and maintenance costs that make a property better, or restore it to working condition, or adapt the property to a new use need to be capitalized and depreciated over several years. This can be easily remembered if one uses the BRA test, a mnemonic coined by Tony Nitti.
Betterments are repairs that make something better than it was before. Specifically, repairs fall under the category of betterments if they:
- Fix a defect that existed before you bought the property
- Fix a defect that happened while the property was being made
- Enlarge or expand the property so that it has more capacity, or
- Are expected to increase the property's quality, strength, efficiency or productivity
For more details, see the What is a Betterment? section of the Tangible Property Final Regulations Q&A.
Restorations, as one might expect, are repairs that restore something to its normal condition. Fixing a roof or replacing the roof entirely are two examples of restorations. Specifically, repairs fall under the category of restorations if they are repairs that:
- Restore deteriorated property to its "ordinarily efficient operating condition"; or
- Replace a major component or substantial structural part of a piece of property; or
- Rebuild the property to like-new condition; or
- Result in a deductible loss, sale or exchange, or casualty loss treatment for the property or component of the property.
For more details, see the What are amounts to restore a unit of property? section of the Tangible Property Final Regulations Q&A.
Adaptations are repairs that change how the property or equipment is being used.
For example, suppose a building owner converts a factory into a showroom. How the building is being used changes from manufacturing to retail sales. Since the taxpayer has changed how he or she uses the property, any repairs related to adapting the property are capitalized.
Specifically, the IRS says an adaptation expense is "An amount is paid to adapt a unit of property to a new or different use if the adaptation is not consistent with your ordinary use of the unit of property at the time you originally placed it in service" (from the What adapts the unit of property to a new or different use? section of the Tangible Property Final Regulations Q&A).
Shortcuts: Three Safe Harbor Rules
The general rule is that expenses for repairs and maintenance need to be capitalized and depreciated. There are exceptions to this general rule. In fact, there are three exceptions, which the IRS calls safe harbors. But even with a safe harbor, one cannot just write off the expense. The IRS expects taxpayers to make a formal choice (called an "election") by attaching an election statement to their tax returns.
$2,500 Safe Harbor Election for Small Taxpayers.
A person or business can immediately deduct repair and maintenance expenses if the cost is $2,500 (or less) per item or per invoice. A business with an "applicable financial statement," however, has a safe harbor amount of $5,000. This $2,500 limit takes effect for the tax year 2016.
For tax years 2014 and 2015, the limit was $500. See Notice 2015-82, Increase in De Minimis Safe Harbor Limit for Taxpayers Without an Applicable Financial Statement (pdf), on the IRS Web site for details concerning this change. For more details on this provision, see the de minimis safe harbor election section of the Q&A on the IRS Web site.
Safe Harbor for Small Taxpayers
Repairs can be deducted immediately if the total amount paid for repairs and maintenance on the property is less than or equal to $10,000 or 2 percent of the unadjusted basis of the property, whichever amount is lower. And the safe harbor is only available for businesses with revenues under $10 million and the property being repaired has an unadjusted basis under $1 million. For more details on this provision, see the safe harbor election for small taxpayers section of the Q&A on the IRS Web site.
Safe Harbor for Routine Maintenance
If the repairs consist of routine maintenance, then the repair expenses can be deducted immediately. These are the type of repairs that happen on a regular basis.
The IRS has spelled this out in some detail. For routine maintenance to be immediately deductible, the IRS wants the expense to satisfy all four of the following criteria:
- Repairs are regularly recurring activities of the type you would expect to perform;
- The repairs result from the wear and tear of being used in a trade or business;
- The repairs are needed to keep the property operating efficiently in its normal condition;
- And it's fully expected that the repairs would need to be performed either:
- More than once during a 10-year period (for buildings and structures related to buildings), or
- More than once during the property's class life (for property other than buildings).
(Class life refers to the number of years over which the IRS expects us to depreciate property. This is outlined in Publication 946, How to Depreciate Property, especially the property class section of chapter 4 and Appendix B.)—from the Safe Harbor for Routine Maintenance section of the Q&A on the IRS Web site. A word of caution: the routine maintenance safe harbor does not apply for expenses that fall under the category of betterments.
Suppose a landlord replaces a roof on a rental property. Let's think about this situation. When the property was placed in service as a rental, the cost of the property was split into two: land and building. The land is a non-depreciating asset. The cost of the building was capitalized and depreciated over a period of years (27.5 years for residential real estate or 39 years for commercial real estate). Thus the cost of the old roof is included in the cost of the building and is being depreciated over time.
Now the landlord replaced the roof. This type of restoration needs to be capitalized and depreciated (over 27.5 years or 39 years, as applicable). So now the landlord has two assets being depreciated: the original building and the new roof. But the old roof is included in the building. So in a way, the landlord is depreciating an asset (the old roof) that no longer exists. In this scenario, the IRS allows the landlord to make a partial disposition. In essence, the landlord can write off the cost of the old roof (thus removing that part of the cost from the building's depreciation schedule).
What's the benefit? This gets an immediate deduction for the old roof, which offsets the downside of having to depreciate the new roof over several years. And, this removes the old roof (its historical cost and its accumulated depreciation) of the taxpayer's balance sheet. An added bonus: "There is no depreciation recapture because there was no sale or exchange," says Phil Zaman, a director in the CBIZ National Tax Office. Thus partial dispositions result in less accumulated depreciation to recapture if the property is ever sold in the future.
What You Need to Look At
In order to properly determine what can be deducted and what has to be capitalized, we review what the expense is, how much it cost, and how the expense relates to the property being repaired or maintained. "We got to be careful not just to write stuff off," Nelson says, "These tangible property regulations have said, we need to really look at these expenses." So how do we really look at these expenses?
For each repair or maintenance expense:
- Review the invoice for the expense
- What is the expense for? Apply the BRA test: is the expense a betterment, a restoration or an adaptation?
- How much is the expense?
- Is each item on the invoice equal to or less than $2,500? Is the total invoice equal to or less than $2,500? If so, consider using the de minimis safe harbor.
- Is the amount equal to or less than $10,000? Equal to or less than 2 percent of the unadjusted basis of the property being repaired? If so, consider using the safe harbor election for small taxpayers.
- What is the nature of the repair? Is the repair an expected and necessary part of keeping the property in ordinarily efficient operating condition? If so, consider using the safe harbor for routine maintenance.
- Consider whether one can write off a "partial disposition."
- Capitalize any expenses as needed and set up a depreciation schedule for writing off the repair expense.
Resources for digger deeper into Repairs and Maintenance Deductions:
- An In-Depth Look: IRS Finalizes Regs on Dispositions of Tangible Depreciable Property (Parker Tax Publishing, September 8, 2014).
- Notice 2015-82 (IRS.gov, pdf), which changed the de minimis safe harbor from $500 to $2,500; summarized in IR-2015-133: For Small Businesses: IRS Raises Tangible Property Expensing Threshold to $2,500; Simplifies Filing and Recordkeeping (IRS.gov, November 24, 2015).
- Tangible Property Regulations - Frequently Asked Questions (IRS.gov, March 13, 2015).
- Treasury Decision 9636: Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property (IRS.gov, effective date September 19, 2013).
- Revenue Procedure 2015-20 (IRS.gov, pdf); summarized in IR-2015-29: IRS Makes it Easier for Small Businesses to Apply Repair Regulations to 2014 and Future Years (IRS.gov, February 13, 2015).
- Tangible Property Regulations - Repair Regs Guidance and Resources (AICPA.org)
- Implementing the New Tangible Property Regulations (Journal of Accountancy, January 31, 2014).
- Routine Maintenance Safe Harbor Under New IRS Repair Regulations (Nolo.com)
- Small Taxpayer Safe Harbor for Repairs and Maintenance (Nolo.com)
- Landlords' Requirements Under the IRS Repair Regulations (Nolo.com)