Should Your Improvements be Capitalized or Expensed?

Temporary IRS regulations for expensing and capitalizing repairs and improvements require taxpayers to consider the effect of the expenditure on certain and specific components of the building, rather than the building and its components as a whole.

These temporary regulations were issued late last year to provide some clarity and expand on current regulations, yet retain the basic framework of the 2008 proposed regulations.

Under the current temporary regulations, an amount paid for an improvement must be capitalized if it results in betterment, adapts the property to a new or different use, or results in restoration of the property, also known as the B-A-R test. Classifying improvements that fit within the adaptation and restoration categories of improvements is more often than not straightforward. Therefore, the temporary regulations focus more on pinpointing what betterments should be capitalized.

Betterment is defined as:

  • A fix to a material condition or defect that existed prior to the acquisition of the property or production.
  • A material addition to the unit of property.
  • A material increase in the capacity, productivity, efficiency, strength, or quality of the unit of property or its output.

For example, retail outlets that pay for changes to the layout, flooring, wall coverings, and overall design of the store when the seasons change are not required to capitalize these cost since they do not result any of the material changes as defined above.

However, if the same retail outlet, in addition to the changes above, decides to revamp the store’s restrooms by replacing toilets, sinks, and plumbing fixtures, they would be required to capitalize each plumbing system as an improvement to the retail building.

Please note that while the first example did not require the improvements to be capitalized, you must still capitalize and depreciate any tangible personal property purchased such as shelving.

If you are uncertain whether you should capitalize or expense your improvements, please contact your Anders advisor as every case is unique.