Temporary
Regulations, effective January 1, 2012, provide guidance on IRC Sections 162
and 263(a),
address when amounts paid to acquire, produce, or improve tangible property are
deductible or capitalizable. The Regulations modify the "general plan of
rehabilitation" doctrine, define a safe harbor for routine maintenance on
property other than buildings, and explain how landlords and tenants must
capitalize expenses related to leased buildings. In this Analysis, Patricia
Mills J.D. LL.M. discusses and clarifies the guidance provided by the Temporary
Regs. She writes:
Repairs and maintenance are expenditures that are intended to maintain
the operating efficiency of an asset over its useful life. Capital additions,
however, are intended to add to the asset's value, extend its useful life, or
adapt it to a different use. The difference between maintenance and repairs (a
difference that is of academic interest only) is that maintenance generally is
continuing and designed to prevent disruption in service, whereas repairs
usually occur in connection with a disruption in service. For example, the cost
of lubricating the circulator pump in a hot water heating system is
maintenance; the cost of fixing the unlubricated pump that has failed is
repairs.
The distinction between repairs/maintenance, on the one hand, and
capital expenditures, on the other hand, is much more significant. The Tax
Court has described the test for distinguishing between deductible repair
expenses and improvements that must be capitalized as the difference between
"keeping" and "putting" a capital asset in good condition. The
Tax Court has also used a test (the Plainfield-Union test) for determining
whether an expenditure is capital by comparing the value, use, life expectancy,
strength or capacity of the property after the expenditure with the status of
the property before the condition necessitating the expenditure. A merely
incidental expense is currently deductible, but if the repair is an improvement
or replacement, or if it increases the property's value or substantially
prolongs its useful life, it is capital in nature and is not deductible. A
repair in the nature of a replacement, to the extent that it arrests
deterioration and appreciably prolongs the life of the property, must either be
capitalized and depreciated or charged against a depreciation reserve. Under
this rationale, the cost of replacements of tile, tubs, sinks, faucets,
showers, toilets, baseboards, cabinets, countertops, and flooring have been
held to be capital expenditures and not deductible repairs. Even the
installation of new cabinet doors and countertops in a kitchen has been held to
be a capital improvement and not just an incidental repair.
....
The
Temporary Regulations also attempt to reflect the large body of case law on the
repair versus improvement question. The Temporary Regulations somewhat modify
the judicially developed "general plan of rehabilitation" doctrine,
providing that indirect costs made at the same time as an improvement, but that
do not directly benefit or are not incurred by reason of the improvement, do
not have to be capitalized under IRC Section 263(a). Under a safe
harbor,routine maintenance on property other than buildings is deemed not to improve
that unit of property. Routine maintenance is defined as the recurring
activities that a taxpayer expects to perform as a result of the taxpayer's use
of the unit of property to keep the unit of property in its ordinarily
efficient operating condition.
(footnotes omitted)
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