Tax Regulations on Tangible Property Repairs

[Julio Gonzalez]

There are new ways to treat improvements to properties based on recent tax court decisions. This can be a significant tax benefit for real estate owners. The changes are related to what types of repairs should be expensed versus capitalized. One example is that the court allowed for a $500,000 roof repair to be expensed when it was previously a cost that was capitalized. Rather than have a dollar threshold for capitalization and expensing, the new regulations take into account the reason behind the repair. As with many tax regulations, they are complex, but taking advantage of them will help you save on taxes, increasing your cash flow.

One way to take advantage of the new regulations is through an Engineered Tax Deduction vs. Capitalization Study. The first step in the study is to review the repair costs and reclassify them utilizing the Internal Revenue Code, sections 162 and 263. “Incidental Repairs” should be expensed. These are repairs that are more maintenance in nature and don’t necessarily add material value, prolong the life of the asset or adapt the asset for a new or different use. If you perform maintenance often, reclassifying these costs as expenses could help you recapture thousands of dollars by accelerating the depreciation.

Here’s an example of a case study assuming a 35% tax rate:

The company had repair and maintenance expenditures that were miscapitalized totaling $3,134,215.

The company had $696,267 of tangible property regs for year 1.

The company had $28,180 in dispositions.

The total savings resulting from the Engineered Tax Deduction vs. Capitalization Study was $3,858,662.

How do you currently determine which costs to expense and capitalize in your real estate portfolio?