The question of whether a physical rental structural adjustment should be taxed as an improvement or a repair has been the subject of huge debates within the tax community over decades. In an effort to resolve the various issues, Congress instituted recent changes to the tax code that supposedly settled the various issues in the Updated LBI Directive. These changes were made after intense deliberation and study.
The difference for landlords boils down to whether the money spent to adjust the physical structure can be written off in total as an expense for one year’s tax advantage, or whether it must be “capitalized,” that is, must the cost of the adjustment be spread out over a number of years. This capitalization is one way of thinking about depreciation, that is, depreciation in one sense is the recovery of the cost of a business asset over a period of years instead of taking the cost all
in one year.
The one-year write-off as an expense is usually the favored method and the most sought-after in terms of tax advantage, but that is not necessarily so. Generally, the guidelines of whether or not the adjustment activity qualifies as a repair (expense in one year) or an improvement (depreciate over time) involve:
- Whether or not the activity increased the useful life of the asset, or
- Whether or not it merely maintained its current functionality.
The new regulations offer options in some cases where the landlord may wish to capitalize items that may qualify to be counted as repairs, for instance:
- If income is too high to qualify for the special allowance for active participation by an individual taxpayer.
- Sometimes the decision involves how it has been handled in the past, and whether or not a policy has been established affirming the actions.
- Sometimes the issue is decided by the nature of the involved assets; for instance, replacing the carpet in a rental can be considered a repair, but the installation of a hardwood floor would be considered an improvement.
- The replacement of a portion of a roof could be considered a repair, but replacing a considerable amount of a roof would be considered an improvement to the building, and must depreciate over a period of time equal to the “life” of the building.
- A commercial building is separated into components that could dictate aspects of how the activity is taxed.
If you have questions regarding how your facilities are being taxed, and whether or not adjustments in your expense/depreciation policies are needed, then do not hesitate to contact us regarding an analysis of the policies in place for your rental activity.