A long awaited clarification of the Modified Accelerated Cost Recovery System will impact the accounting on a wide range of routine expenses. For-profit healthcare entities that haven’t incorporated the changes into their planning may want to schedule a meeting with their tax advisor soon since there is still time to take advantage of the rule in 2014.
“For years, the Internal Revenue Service has been at odds with taxpayers over how to account for repairs to property with no clear regulations in this area,” said Dean Sonderegger, executive director of product management at Bloomberg BNA. “In September of last year, the IRS released regulations telling taxpayers clearly what can be deducted or has to be capitalized.”
Among the regulation’s “safe harbors” are those distinguishing routine maintenance from betterment. They also established a “de minimis threshold” which allows companies to deduct any expenditure below a certain amount without fear of audit.
Because the IRS was not clear in the past, many companies took an ultra-conservative route, capitalizing all repairs. For the most part, if expenses can be classified as a repair it is better to take the current deduction. Should you need to call them capital expenditures, the costs will be capitalized and depreciated over many years.
Prior to the changes, major repairs such as replacing a building’s roof often was capitalized and depreciated over a long life. The part being replaced could not be expensed but was depreciated as if part of the original building. The replacement roof was capitalized as a building addition, meaning that, for tax purposes, the building had two roofs.
“You can still have expense policies that are different, but if you are audited you have to defend their reasonableness,” said Thomas Zoebelein, an accountant with Pearce, Bevill, Leesburg, Moore, P.C. in Birmingham, Ala. “As long as the safe harbors are properly constituted, the IRS accepts them at face value.”
Under the new rules the IRS is allowing companies to elect a “partial disposition.” This means the un-depreciated value of the old roof can be expensed as a repair and only the new roof is capitalized.
“The IRS now breaks the building into components called systems,” Zoebelein said. “The systems include the outer shell, electrical, heating and cooling, etc. Before, these parts were viewed as part of the old building on its depreciation schedule and couldn’t be expensed when replaced; now you can. Partial disposition is available to each individual system.”
There are also downsides.
“Less friendly aspects of the regulation includes an expectation by the IRS that taxpayers will track changes in property and be able to defend decisions on whether that is a repair or improvement,” said Sonderegger. “Companies that have been routinely recognizing expenses as repairs but not capital improvements may have to start seeing them as improvements. You are probably talking about a 5 percent to 10 percent swing in taxes.”
Both stressed these considerations are very sensitive to the policies and measures of the individual entity. These changes need to be discussed with your tax advisors. There is still time to incorporate them in the 2014 calendar year.