Repair
or Improvement? Know the Tax Rules
Critical difference for owners of business buildings
For tax purposes, the
difference between a “repair” and an “improvement” is more than just
semantics. Generally speaking, the cost of an improvement to business
property must be capitalized and written off over a period of years. In
contrast, if you simply repair a business asset, you may currently deduct
the entire cost.
Some expenses are clearly improvements. For example, if you pave over vacant
land and use it as a parking lot, you will have to capitalize the cost.
However, in many other cases, the line between repairs and improvements is
not as clear cut. Obviously, it may be in your best interest to have work
labeled a repair rather than an improvement.
How do you tell the difference between the two? Here’s a rule of thumb: An
improvement is work that prolongs the life of the property, enhances its
value or adapts it to a different use. On the other hand, a repair merely
keeps property in efficient operating condition. Let’s take a quick look at
a few examples.
Repairs: Generally, the term includes items such as painting and
wallpapering, repairing leaks in a roof, patching up cracks in a floor or
replacing a worn out or broken component of an air conditioning system.
Improvements: Replacing an old roof with an entirely new one clearly is an
improvement that must be capitalized and depreciated. So is the cost of
renovating an entire structure, remodeling a building to suit a different
purpose or reconditioning or rebuilding a piece of machinery.
Be aware that there are several tax pitfalls in this area. For instance, a
business owner who decides to renovate, remodel or expand a building will
often make necessary repairs at the same time. While this makes a good deal
of economic sense, it could be a bad idea from a tax viewpoint. Reason: The
IRS might argue that the repairs are part of the general betterment or
renovation plan. In that case, the entire cost—including the repairs
portion—must be capitalized.
One possible solution is to show that the two types of expenses are clearly
distinguishable. For example, if an owner puts a new exterior surface on a
building and makes interior repairs while the work is being performed, the
repairs should be currently deductible.
Probably the best way to ensure the current deduction is to keep the jobs
separate and apart. If possible, you might make all your repairs first.
Then, at some later point, you can have the improvements completed.
How are homeowners affected by these tax rules? In general, the cost of
repairs to your home won’t do you any tax good at all. On the other hand,
improvements increase your basis in the property. As a result, you can
reduce any gain that would be subject to tax if you sell the home.
Therefore, it generally is more advantageous to have a home expense labeled
as an improvement instead of a repair—just the opposite of the usual
situation for business owners. If you are planning to renovate or remodel
your home, you may want to defer any repairs that have to be made until that
time and do the entire job at once.
Contact us with any
questions.
Wherewithal
is provided by Somerset for our clients and other interested persons
upon request. Since technical information is presented in generalized
fashion, no final conclusion on these topics should be made without
further review. For additional information on the issues, please
contact
a member of the firm. Somerset provides total financial solutions,
including accounting, assurance, information solutions, litigation &
valuation, tax, wealth management and management consulting services to
entrepreneurs and their businesses. This document is not intended or
written to be used, and cannot be used, for the purpose of avoiding tax
penalties that may be imposed on the taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com
info@somersetcpas.com
.jpg)