2014 was the first year under the new Tangible Property Regulations (“TPR”) that the Internal Revenue Service has finally published. It turns out that the new TPR are surprisingly taxpayer friendly. Because we do so many tax returns that involve investment real estate, including owner occupied multifamily homes, we have needed to get familiar with TPR quickly. The new “routine maintenance safe harbor” in TPR has opened up opportunities for taking immediate write-offs of significant repairs and restorations that in the past had to be depreciated. There are also new safe harbors for “small taxpayers” and “de minimis” transactions, that also aid in the immediate expensing of items we used to depreciate. It has taken some time to get comfortable with these new regulations, but fortunately we do such a volume of these kinds of tax returns that our office has gotten rather fluent with this.
One of the nice things about TPR in general is that it defines “small business” as having less than ten million dollars of revenue OR having less than ten million dollars of assets. As such, every residential property that has come into my office has constituted a “small business”. In fact, very few properties, residential or commercial, in and around the City of Lowell are going to exceed the small business restrictions. Even if the property is worth more than ten million dollars ($10,000,000.00) and has more than ten million dollars ($10,000,000.00) of revenue, this safe harbor can still be utilized. However, it requires a bit more paperwork.
“Routine maintenance” is, of course, a recurring expense. We always knew that changing air filters in an HVAC unit was a recurring expense. While some recurring repairs are obvious, others are less clear. Generally, the Internal Revenue Service would use words like “substantial”, “material” or “structural” to indicate that certain repairs were actually capital expenses and had to be depreciated. The new TPR clarifies this issue, and it does so in a taxpayer friendly way. When talking about “building structures and building systems” something is considered to be “routine maintenance” if the owner anticipates having to do it “more than once during the ten year period beginning when placed in service”. For personal property, it is considered routine maintenance if it has to be done “more than once during the class life of the unit or property”.
For personal property, this is not such a big deal, although it is nice to know that putting a new drum in my copy machine is now considered routine maintenance, and is not a capital expenditure. However, for real estate, it is now possible that in at least some cases projects as significant as re-shingling a roof or resurfacing a parking lot could be considered routine maintenance. Section 8 landlords and others who rent to destructive tenants should have little difficulty expensing bathroom and kitchen remodeling (although not upgrades) as routine maintenance.
There are a couple other safe harbors that have been added to TPR, although I do not think they are as interesting as the routine maintenance safe harbor. One is the de minimis safe harbor. It allows the immediate write off of any expense of less than five hundred dollars ($500.00). With careful accounting, a lot of expenses can be less than five hundred dollars ($500.00). The bathroom remodel that I referred to above could become a toilet, a sink, a banister, a medicine cabinet, floor tiles and the like. With proper expensing, this five hundred dollar ($500.00) limit can be expanded to be quite large. However, the five hundred dollar ($500.00) limit has some limitations. It mostly applies to costs of consumables, such as fuel, lubricants and the like that are expected to be consumed within twelve months or property that has a useful life of twelve months or less. Fortunately, it can also apply to components acquired to maintain, repair or improve property that is not part of a larger item. There is some ambiguity in that last one, but it would certainly include tools and certain fixtures. However, if something does not fit into one of those two pigeon holes, then the per item limit drops to two hundred dollars ($200.00).
There is also a general safe harbor for “small taxpayers”. The problem there is that the safe harbor is capped at the lesser of ten thousand dollars ($10,000.00) or two percent (2%) of the unadjusted basis of the property. The problem here is that for an owner-occupied two family home, the unadjusted basis is commonly a hundred thousand dollars ($100,000.00) or less. That would place the cap at two thousand dollars ($2,000.00) or less. To reach the ten thousand dollar ($10,000.00) cap, the unadjusted basis for the property would have to be at least five hundred thousand dollars ($500,000.00). Such properties commonly have well more than ten thousand dollars ($10,000.00) of repair and maintenance expenses associated with them.
One important caveat, while using these safe harbors does not require a change of accounting declaration for current tax returns, some may require an election statement. This can be a bit of a mine field.