In an effort to make the tax code even more incomprehensible to people, this month the IRS issued over 200 pages of regulations to inform taxpayers when they can immediately deduct repair expenses or when they must depreciate the repairs over a number of years. The regulations address repairs to personal property and buildings. This post explains only building repairs.
Usually, building repairs must be depreciated over a number of years if the repair is for a permanent improvement or betterment that increases the value of the property, restores its use or value, substantially prolongs its useful life, or adapts the property to a new or different use. If a repair falls into one of these categories, the repair must be depreciated over 39 years for commercial property and 27.5 years for residential rental property. However, even if the repair must be depreciated, the expense may be deducted faster under two rules:
- Qualified leasehold improvement property may be depreciated over 15 years
- The special $250,000 Section 179 deduction for certain real property
Fortunately, there are two safe harbors for building repairs under the regulations. If either of these safe harbors is met, the repairs can be immediately deducted.
Per-Building Safe Harbor for Small Taxpayers
Taxpayers with $10 million or less in average annual gross receipts over the past three years are able to immediately deduct improvements made to an eligible building property. An eligible building property has a cost of $1 million or less.
This new safe harbor applies only if the total amount paid during the year for repairs, maintenance, improvements, and similar activities performed on the eligible building does not exceed the LESSER of $10,000 or 2% of the building’s cost. If these expenses exceed the lesser of these two amounts, the safe harbor is not available for any amounts spent on repairs or improvements.
Example: Classy Real Estate LLC owns a commercial rental property. The property’s cost was $460,000. Classy spends $9,000 to upgrade most of the electrical system. Under the new safe harbor, Classy can immediately deduct up to the lesser of $10,000 or $9,200 (2% of the $460,000 cost) in repairs or improvements. Therefore, Classy can immediately deduct the full $9,000 cost of the electrical improvements.
Without the safe harbor, Classy would have to argue that the $9,000 was an ordinary repair that should be immediately deducted. It is possible that the repair would be classified as an improvement that would have to be depreciated over 39 years.
The $10,000 or 2% limit applies per building, so if, in the above example, Classy paid the same amount for electrical improvements to multiple buildings of the same price, it would be able to immediately deduct $9,000 per building.
Routine Maintenance Safe Harbor for Buildings
Expenses that fall under the routine maintenance safe harbor are immediately deductible. Routine maintenance includes the recurring activities that a taxpayer expects to perform as a result of using the property to keep the building structure or each building system (e.g., electrical, plumbing, HVAC, etc.) in its ordinarily efficient working condition.
Routine maintenance includes inspecting, cleaning, and testing of the building structure or each building system, and the replacement of worn or damaged parts with comparable replacement parts.
The activities are routine only if the taxpayer reasonably expects to perform the activities more than once during the 10 year period beginning when the building or building system is placed in service. Factors to be considered in determining whether maintenance is routine and whether the taxpayer’s expectation is reasonable include:
- The recurring nature of the activity
- Industry practice
- Manufacturers’ recommendations
- The taxpayer’s experience with similar property
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.