Construction Industry Alert: Changes to Tax Rules Relating to Repairs and Maintenance, and Costs Related to Acquisition, Production, or Enhancement to Property

In December, 2011 the IRS released temporary and proposed regulations revising rules relating to the determination of the timing of deductions for expenditures connected with repairs and maintenance of both real and personal property as well as costs incurred in connection with the acquisition, production or improvement of such property.  These new provisions are generally effective January 1, 2012.

The new regulations will have some impact upon all business taxpayers.  Business entities within the construction industry typically have material fixed assets on their balance sheets with significant annual expenditures devoted to keep operating equipment in good working order and, therefore, will likely be affected.

Conformity with the new rules will require a thorough review of historical practices, in many cases leading to lower current year tax deductions in favor of greater cost capitalization whereby tax benefits will be recovered via future deductions flowing from depreciation, amortization and/or recovery of tax basis at the time of disposition of property.

Compliance with the new rules will present some new administrative challenges for many companies even in cases where current capitalization policies may be viewed as fairly conservative.  New concepts, such as unit of property, are introduced that will have important implications in determining whether an expenditure should be deducted currently or capitalized.  The administrative task of tracking capitalized costs will also become more burdensome.

A de minimus exception is provided to exclude relatively modest expenditures from capitalization requirements.  However, qualification provisions require the existence of a written policy statement and consistency in treatment in audited financial statements (or equivalent financial reporting to governmental agencies).  In addition, a relatively low ceiling will apply in determining the overall annual costs qualifying for the de minimus rule.

Amidst mostly bad news, there are some interesting opportunities for acceleration of tax deductions relating to costs that may have been capitalized in the past.  Perhaps you have seen some reference to these provisions, typically referencing a replacement to a building component such as a roof carried out sometime in the past wherein costs of the original component have not previously been claimed as a loss.

This past spring, the IRS issued two revenue procedures outlining transition rules for taxpayers choosing to change their historical accounting practices to conform to the new regulations.  These pronouncements cover the filing of Form 3115 to make such changes.  Most business taxpayers will be required to file one or more Form(s) 3115 with some interesting planning options in choosing whether to do so for either 2012 or 2013.

We are prepared to assist you with understanding the impact of the new regulations for your particular company and to assist you in evaluating any accounting method changes that may be appropriate.

Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.