Repair or improvement? The tangible property regulations for building owners

The basic question

Amounts paid to acquire, produce or improve tangible property must be capitalised. Amounts paid for repairs and maintenance may be deducted currently. The regulations define improvement through three tests: betterment, restoration and adaptation.

The building systems rule

The most consequential structural feature of the regulations. For a building, the improvement tests are applied not to the building as a whole but separately to the building structure and to each of nine defined building systems: HVAC, plumbing, electrical, escalators, elevators, fire protection and alarm, security, gas distribution, and any other structural components identified in published guidance.

This makes capitalisation more likely than it once was. Replacing three rooftop units out of twelve is measured against the HVAC system, not against the whole building — so what would once have looked like a minor repair may be a restoration of a major component.

The three tests

Betterment: fixes a pre-existing material defect, materially adds to capacity or productivity, or materially increases quality or strength.

Restoration: returns the property to operating condition after deterioration to a state of disrepair, rebuilds to like-new condition after the recovery period, replaces a major component or substantial structural part, or is a loss or basis-adjusted disposition.

Adaptation: adapts the property to a new or different use inconsistent with the ordinary use when placed in service.

The safe harbours

De minimis: elect annually to expense amounts up to $5,000 per item or invoice with an applicable financial statement, $2,500 without, provided a written accounting policy exists at the start of the year. The policy has to exist in advance — writing it in April does not work.

Routine maintenance: recurring activities expected to be performed more than once during a ten-year period for buildings.

Small taxpayer: for buildings with an unadjusted basis of $1 million or less, taxpayers with average gross receipts of $10 million or less may elect to expense amounts up to the lesser of $10,000 or 2% of unadjusted basis.

The connection to cost segregation

Both disciplines require a component-level view of the building. A study gives you the component basis that makes partial disposition elections possible and makes the building-systems analysis concrete rather than theoretical.

Owners who run a study and then apply the repair regulations properly to subsequent spending get compounding benefit. Owners who do neither capitalise everything to a 39-year building by default.