Spiffing Up Your Place with the Help of Uncle Sam
by BarbaraWeltman, Guest Blogger
- Created: March 28, 2013, 8:58 am
There is little doubt that customers respond positively to the attractiveness of your workplace. In addition, it’s been *found that being in a good environment helps to motivate employees and adds to productivity. Improvements to your workspace may be modest or substantial, depending on your needs and your pocketbook. Either way, Uncle Sam can help defray the costs with tax write-offs. Here’s what you need to know.
A new coat of paint is a low-cost upgrade for your facilities. Other repairs may be more costly. Fortunately, the cost of paint and other repairs, whatever amount it may be, is fully deductible.
However, the cost of capital improvements has a different tax treatment than the cost of repairs, as you’ll see in a moment. The challenge in some projects is distinguishing between repairs, which are fully deductible now, and capital improvements, which are subject to special write-off rules. As a general rule, repairs to restore or maintain property, in contrast to capital improvements that materially add to the value of property, substantially prolong its life, or adapt it to a new or different use. (Pending rules discussed later may impact the definition of capital improvements.)
A determination of whether a cost is an ordinary repair or a capital improvement is based on the facts and circumstances. The following chart can help you distinguish repairs from improvements:
Fix a leaky roof
Replace a roof
Fix a dripping faucet
Replace old lead pipe with new copper pipe
Apply a new coat of epoxy sealer to a concrete floor
Install a new concrete floor
Fill a pothole
As a practical matter, you must make a business decision on whether you need to make a capital improvement or can remedy a situation with a simple repair. Don’t let tax results dictate your business decision.
Writing off capital improvements
Usually, the cost of capital improvements to realty must be treated as if you’d acquired a piece of realty; it is a separate asset. Since buildings have a 39-year recovery period for depreciation, it can take many, many years to write-off the cost of capital improvements. The good news: The write-offs for capital improvements can be claimed whether you pay cash or finance the project.
Special rules for leasehold, restaurant, and retail improvements. If your property fits into any of these categories, you can deduct improvements more rapidly than for improvements to other commercial realty. Leasehold improvements are improvements to the interior of a commercial building that was placed in service at least three years prior to the improvements. The improvements can be made by the lessor or lessee, but they do not include elevators or escalators, the enlargement of the building, the internal framework of the building, or any structural component of a common area. For restaurant improvements, more than half of the square footage of the property must be devoted to the preparation of meals and seating for on-premises food and beverage consumption. Retail improvements mean improvements to the interior of retail space open to the public.
The special tax rules for leasehold, restaurant, and retail improvements are:
- First-year expensing (Sec. 179 deduction). You can write off up to $250,000 of the cost of improvements in the year the improvements are made. This deduction, however, only applies to improvements completed before January 1, 2014 (unless Congress extends the law).
- 50% bonus depreciation. You can deduct half the cost of the qualified improvements if you place them in service this year. Like the expensing deduction, bonus depreciation is set to end this year unless Congress extends it.
- 15-year recovery period. Instead of deducting the cost of improvements over 39 years, you can deduct them over 15 years. Again, the 15-year recovery period will end on December 31, 2013, unless Congress extends it.
These special rules can be combined to permit a write-off of all or most of your costs. For example, if improvements to the space you lease cost $400,000, you can expense $250,000, use 50% bonus depreciation for $75,000, and depreciate the remaining $75,000 of cost over 15 years.
Proposed and temporary regulations from the IRS use new terminology (such as “betterment”) for distinguishing repairs from capital improvements. Unfortunately, they do not contain any “bright-line” rules, so you – as well as the IRS – will have to continue relying on facts and circumstances.
In addition to new terminology, the proposed and temporary regulations also adopt a favorable rule that lets you fully deduct the unrecovered costs of certain building components, such as HVAC and roofing, when they are replaced. For example, you own an office building and installed a new air conditioning system eight years ago. You’re still depreciating the cost, but now have to replace the system with a new one. You can deduct the remaining cost of the old one (the portion of the cost you had not yet depreciated), along with depreciation for the new one.
These regulations had been set to be effective starting in 2012, but the effective date has been postponed until January 1, 2014. However, they can be used for 2012 and 2013 returns at a taxpayer’s election. Whether they alter the classification of costs you incur for your facilities is difficult to say; work with a knowledgeable tax advisor for this purpose.
Some IRS publications can help you assess whether your expenditures for changing the look or functions of your workplace are repairs or improvements:
- Audit Technique Guide on Repairs Versus Capital Improvements shows the government’s thinking on the question
- Publication 946, How to Depreciate Property
Before you begin any project to change your workplace, determine the tax impact of your actions. Upfront deductions can help defray the costs and allow you to expand the scope of your project without a net cost to you.
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About the Author
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser's Small Business Taxes, J.K. Lasser's Guide to Self-Employment, and Smooth Failing as well as a trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and host of Build Your Business Radio. She has been included in the List of 100 Small Business Influencers for three years in a row. Follow her on Twitter: @BarbaraWeltman.
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