Repairs to tangible property, such as buildings, machinery, equipment or vehicles, can provide businesses a valuable tax deduction. Repairs can be expensed and deducted, but improvements to a business must be recovered through depreciation. So how do you tell the difference between a repair and an improvement?
Betterment, Restoration Or Adaptation
Generally, a cost must be depreciated if it results in an improvement to a building structure or any of its systems (for example, the plumbing or electrical system), or to other tangible property.
Under the “betterment test,” anything that is going to increase your production because of a material asset you have added to the business must be depreciated.
Under the “restoration test,” any change to the unit of property’s physical structure or any combination of its parts must be depreciated.
Under the “adaptation test,” if a part of the property is adapted to a function that it wasn’t used for originally, the amount paid to convert that part must be depreciated.
Safe Harbors
A couple of IRS safe harbors can help distinguish between repairs and improvements:
- Routine Maintenance Safe Harbor: Any maintenance activities you do on your business that keep the property in efficient operating condition and are performed more than once over the building’s class life (as defined by the IRS) can be expensed. Amounts incurred for activities outside the safe harbor don’t necessarily have to be depreciated, though. These amounts are subject to analysis under the general rules for improvements.
- Small Business Safe Harbor: If your business was bought for less than $1 million, and total receipts are less than $10 million, the lesser of $10,000 or 2 percent of the unadjusted base of the property can be expensed for repairs, maintenance, and improvements each year.
Have Questions Or In Doubt?
If you aren’t sure whether you improved your business or repaired it, or if you have questions about the process around deductions of this type, we are here to help. Our team at Froehling Anderson has financial experience and can help you classify and categorize your business's expenses. Contact us today to set up a meeting.
