Dealer Insights - May June 2014 - Applying the latest regs on repairs and maintenance
Keeping your showroom modern and appealing is one of the most important aspects of drawing customers into your dealership — and making a good first impression when they arrive. That’s why many dealerships invest heavily in tangible property upgrades, repairs and improvements to their showrooms.
There has long been confusion among dealerships about the tax treatment of tangible property improvements on things such as buildings, machinery, equipment and vehicles. Specifically, should these costs be capitalized and depreciated, or can they be deducted immediately? The IRS recently issued final regulations (IRS T.D. 9636) addressing repairs and maintenance (R&M) and providing guidance to help dealerships make this determination.
Can you deduct your costs?
If costs are incurred to acquire, produce or improve tangible property, they likely must be capitalized and depreciated over a period of up to 39 years. This includes costs incurred to replace major components or substantial structural parts of a unit of property (UOP), as well as expenditures that result in a betterment, restoration or change in use of a UOP.
But if the costs aren’t required to be capitalized under the aforementioned rules, they’re deducted as R&M in the year incurred. The regulations also offer some new safe harbor elections that will allow for the deduction of de minimis items (smaller cost items) or routine maintenance (for example, sealing a parking lot).
Additionally, because the R&M regulations are retroactive, your dealership needs to adopt them by adjusting for prior R&M that was capitalized incorrectly. This may be good news, as this adjustment will likely result in a deduction equal to the undepreciated cost of those previously capitalized R&M expenditures.
A typical dealership today does some sort of renovation or refresh to its facilities every five to seven years. Possible examples of these types of expenditures that you may have capitalized but are more properly classified as R&M include:
- Interior and exterior painting,
- Replacing and repairing damaged windows,
- Cosmetic updates to flooring and ceiling tiles,
- Replacing and repairing plumbing and restroom fixtures,
- Parking lot repaving, resealing and restriping (parking lots have a 20-year class life), and
- Other costs incurred to keep facilities looking “fresh.”
Of course, dealerships have to stay open while doing deductible R&M work. This is only one of the elements the IRS looks for in determining whether dealerships have properly expensed these kinds of costs: Did structural improvements necessitate closing the dealership? If so, it’s more likely you’ll have to capitalize and depreciate those expenditures.
Are there exceptions to the rules?
There are a few special circumstances faced by many dealerships that can make interpreting and applying the regs challenging. One of these is roof replacement. If a dealership replaces its entire roof, including its structural components, this generally wouldn’t qualify as an R&M deduction and would have to be capitalized and depreciated.
The regulations also specifically address nine of the most prominent “building systems” — including HVAC, plumbing and electrical systems. When a major component or a significant portion of a major component of the building structure or any of its building systems is improved (betterment, restoration, etc.), capitalization may be required.
Although the replacement of a furnace may not appear to be significant enough when considering the size of the building, such an improvement still might require capitalization if it’s a significant enough upgrade to the HVAC system itself. Therefore, any improvements to these building systems have to be reviewed carefully.
The final regulations apply to tax years beginning on or after Jan. 1, 2014, but can be adopted earlier. Compliance might require you to change how you account for R&M costs, so be sure to talk to your tax advisor for guidance on your specific situation.
Dealer Insights - May/June 2014