Accounting reportSept. 10, 2012
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In a decision that could impact the tax planning and accounting practices of real property owners, developers and tenants, the Internal Revenue Service has issued a new set of regulations that seek to clarify the manner by which the cost of certain building improvements qualify for a federal tax deduction.
[caption id="attachment_61131" align="alignright" width="373"] Christopher Paris, Linda Clark Phillips, Jon Dal Poggetto[/caption]
At issue is the distinction between repairs -- eligible for a full-value deduction in that same tax year -- and capital improvements, which receive a tax deduction over several years along with the depreciable life of the asset.
While the guidance helps brings clarity to a long-contentious issue that has reached as far as the U.S. Supreme Court, accounting leaders in the North Bay and beyond stress that those involved in property improvements should familiarize themselves with the regulations and anticipate a potential change to the flow of tax deductions to their federal tax bill.
"This will have a big effect on people who are extremely active in the real estate industry and making a lot of improvements, but also the industries that own or lease their property," said Christopher Paris, partner in tax services at Moss Adams LLP in Santa Rosa. An increasing number of companies seek property ownership in a low-interest-rate environment, and many have improvement agreements with a landlord, he noted.
Nearly eight years in the making, the new rules clarify a sometimes litigious case in which property owners and the IRS were at odds over which expenses, including those related to property acquisition, improvement or maintenance, qualified for an immediate or long-term tax deduction. Released in April, the rules apply to 2012 and following tax years.
Property owners would typically see a greater benefit in a one-time income tax deduction, with an incentive to argue that capital improvements qualified as repairs, according to experts in the field. In its 250-page regulation, the IRS cited five cases since the early 1930s when a legal battle over the distinction between capital improvements and ordinary repairs has received judgment by the U.S. Supreme Court.
Yet despite that judicial guidance, disputes remained, and the IRS and the Treasury Department began taking public comment for a clarifying rule on the matter in 2004. Proposed amendments were revised in 2008. The current regulations, which provide guidance on the application of sections 162(a) and 263(a) of the Internal Revenue Code, are considered temporary and binding but are up for public comment and final adoption.
"These regulations are more reflective of what case law has been over the years," said Linda Clark Phillips, CPA, a director with Burr Pilger Mayer accountants and consultants in San Francisco.
"Many items that you used to be able to expense, you now have to capitalize," she added.
While former regulations allowed an entire building and its systems to be evaluated as a single "unit of property" when applying metrics to determine if work qualifies as a capital improvement or repair for tax purposes, the new standards establish a number of categories of building "systems" that must be evaluated individually, according to Ms. Clark Phillips. By narrowing that definition, the new regulations would generally lead to a decrease in the amount of work that would qualify as a repair and receive a more immediate tax benefit.