New rules from the Internal Revenue Service for the tax treatment of repairs or improvements to property apply to nearly every company, starting with tax years beginning on or after January 1, 2012.
But most tax executives are still unsure about how these so-called repair regs will affect their businesses, according to a January survey of 1,900 tax executives by KPMG. Sixty-two percent reported they were unsure whether to view the new regulations as favorable or unfavorable, while 23% saw them as favorable and 15% as unfavorable.
The repair regulations dictate how companies must treat their costs of acquiring, maintaining, improving, and replacing tangible property. One point of confusion pertains to whether an upgrade to a commercial building should be treated as a repair or an improvement, says Eric Lucas, a principal in KPMG’s national tax practice. The cost of a repair can be treated as a deduction in the tax year the repair is made, while the cost of an improvement must be capitalized and depreciated over the life of the asset — 39 years for a commercial building.
Lucas says the new repair regs clarify that each major system within a building must be considered separately — heating and air conditioning, plumbing, and electrical systems, for example — when determining whether a project is a deductible repair or a capitalizable improvement. Generally speaking, upgrading a significant portion of one of those systems is considered an improvement, a minor upgrade a repair.
Companies that have been overly aggressive on the repair-versus-improvement issue will have to adjust their cost calculations from previous years to align with the new rules, which will have a negative impact on their tax positions. But, the repair regs will also allow some companies to file adjustments for past projects that will improve their tax positions, says Lucas.
Because the new rules are so comprehensive and can be applied retroactively, companies should review asset repairs and relevant capital-improvement projects.