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To Capitalize or Expense? That Is Now the "Repairs and Maintenance Cost" Question

In August of 2009 the Internal Revenue Service added the repairs method to its list of automatic accounting changes originally outlined in Revenue Procedure 2008-52 and reinforced in Revenue Procedure 2009-39. The IRS Large and Mid-Size Business Division issued two directives relating to positions that taxpayers were taking when it came to accounting method changes. Taxpayers were recharacterizing costs that were previously capitalized under I.R.C. Section 263(a) and deducting them as deductible repairs and maintenance expenses under I.R.C. Section 162.

The first of the two directives advances the repairs method changes to a Tier 1 issue for IRS examinations. Due to this designation examiners who come across this issue are now required to address the issue with additional importance. The directive reminds the field agents that the granting of the automatic consent under Revenue Procedure 2008-52 does not preclude the examiners from auditing the issue of whether certain expenses are deductible repair costs or costs that should have been capitalized.

The second directive repeats the first directive on the automatic consent in that the change is not a terms and condition that governs the accounting method change. This issue explicitly states that no determination is made as to whether the correct assessment is being made on expensing or should it have been capitalized.

Some key points to keep in mind:

• Currently No De Minimis Rule. Some may, as a matter of administrative convenience, have a de minimis policy that automatically treats all amounts below a certain dollar level as currently deductible expenses. At present, there is no de minimis rule exempting small expenditures from the capitalization requirements. 
• Unit of Property. In determining whether an expense connected with property must be capitalized, a key issue is what is the appropriate unit of property. For example, if replacing an engine in an airplane materially increases the value of the property, the new regulations require that it be capitalized. But is the “property” the airplane or the engine? If the engine is the “property,” the replacement clearly is required to be capitalized. That may not be true if the entire airplane is considered the “property.” The regulations contain specific rules beyond the scope of this article for determining the appropriate unit for four categories of property: 
  • Property owned by taxpayers in a regulated industry 
  • Buildings and structural components 
  • Other personal property 
  • Other real property 

It should be noted, it is important that the taxpayer has the proper documentation and disclosures attached to the change-of-accounting request. A report by engineers detailing the reasons that an item should be an expense over capitalization is an important piece of information that should be a part of the taxpayer's records, if the need arises to defend the position of expense over capitalization.

For further information please contact Michael Calahan at mcalahan@BlackmanKallick.com or 312-980-2996, or your Blackman Kallick representative. Our thanks to Greg Mudd for his contribution to this article.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.