For six years the IRS has been working on new rules for repairs, supplies, and capitalization. Twice over this period they have issued proposed changes giving us some insight into what they were looking to do. Last week the IRS finally issued temporary regulations that take effect January 1st, 2012.
These regulations keep some of the rules that had been proposed, but have made some significant changes. I’m still digesting the 255 page regulations published in the federal register, and can share some highlights of the changes for now.
The IRS has established some new bright line tests as to whether expenses are to be capitalized or can be expensed. In the past one would look at the extent of improvement to the asset as a whole. Repairing any portion of the roof was considered a repair. Only if 100% of the roof was replaced did it require capitalization. Now the IRS requires businesses and investors to look at the components of an asset. If one were to do a 60% replacement of a roof it would be considered an improvement rather than repairs. Based on my initial read replacing a rotted bathroom floor might still be a repair, but replacing a hot water tank or shower quite likely would require capitalization.
Another important change has to do with component replacement. When an investor remodels a kitchen by replacing cabinets, flooring, countertops, etc, it used to be that the investor would continue to depreciate the old components and capitalize the improvement. Now, an investor can retire (dispose of) the replaced components while capitalizing the new. You might ask how that is going to be accomplished.
Good question — the answer is that any reasonable method is going to be allowed, but how the asset was set up is going play a big part in this.
When it takes 255 pages to clarify and simplify, you know that there are going to be many exceptions and gotchas. I promise to share more over the coming weeks as I better understand these new rules.
BawldGuy Here: Only the government must take over 250 pages to ‘clarify’ and ‘simplify’ an already fairly simple, universally understood concept.