Can We Fix It? The IRS Says Yes

Are maintenance costs a repair that should be expensed, or a property investment that should be capitalized? The IRS proposes a way to solve this r...
Helen ShawAugust 25, 2006

The Internal Revenue Service has proposed regulations that could simplify taxpayers’ decisions regarding whether to deduct maintenance costs against current taxes or capitalize and depreciate them over time. The regulations would affect any company with property to repair and maintain, and thus would have a wide impact on American industry.

“This is a breakthrough in tax policy,” comments Carol Conjura, a partner in the Washington national tax office of KPMG. Currently there is a vague distinction in the law that requires capitalizing anything that improves a property’s value or life, but allows deductions for repair costs, notes Conjura. The ambiguity of the law, coupled with limited guidance, has sparked arguments between companies and the IRS over such minutiae as whether a new roof extends a building’s life and whether it is a deductible repair.

The proposed new rules offer a significant remedy for such battles — an optional “repair allowance.” If companies choose this option, they can add up their maintenance costs and multiply the total by a prescribed percentage, which varies depending upon how much the company spends on maintenance. The result is the amount taxpayers can deduct immediately against taxes.

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“This is one welcome change the taxpayers will like,” comments George Manousos, a partner in PricewaterhouseCoopers’s Washington national tax office and a former Treasury official. “It’s good in that it gives [companies] a budget and they can expense immediately instead of going through all the rules,” he says. “Rules are subject to interpretation, and there could be a difference between your interpretation and the IRS interpretation.”

Conjura also believes the new regulations will be well received by firms: “Simplification is always welcome in tax law, especially when it is optional.” Because the allowance is optional, Conjura says companies will need to check the regulations against their own maintenance schedules to determine which method works best for them.

One important consideration: cash flow. Choosing the repair allowance formula could reduce cash flow if it results in a smaller deduction than the company believes it would get by characterizing some percentage of its maintenance as deductible repairs. “Sometimes taxpayers are willing to forgo the maximum cash-flow benefit in order to have certainty with regards to how the IRS will treat [an issue],” says Manousos.

Among the proposed regulations is another that taxpayers should welcome — the 12-month rule. Under this rule, any tangible asset with a useful life of 12 months or less can be taken as an immediate expense, and does not need to be capitalized and depreciated, explains Manousos. In sum, it allows firms to recover an expense in the year it is paid. “It’s all about cash flow, and you want more deductions earlier,” says Manousos.

The IRS is currently accepting comments on the proposed regulations.