The tax write offs for what is or isn’t considered a repair in a portable plant operation have long been an issue with the IRS.
Although the tax rules are pretty cut and dried when it comes to expenditures for repairs, replacements, improvements or routine maintenance, it is the actual definition of each activity that all too often causes the problem.
Tax rules allow a construction material producer or contractor to deduct all of the “ordinary and necessary” expenses incurred during the tax year, including the cost of repairs, maintenance, supplies and the like. Another tax rule requires the costs of acquiring, producing and improving equipment or other property – regardless of the amount of the cost – be capitalized and written off over a period of years.
Defining the difference
The IRS usually defines a repair as an expenditure that keeps the property in normal operating condition. A capital improvement, on the other hand, is defined as an expense that either extends the useful life of the property or allows it to perform a new function.
When attempting to determine the difference between immediately deductible repairs and those improvements that should be capitalized and written off over a number of years, the general rule of thumb is: an improvement is any work that prolongs the life of the equipment or property, enhances its use or adapts it to a different use. A repair merely keeps that property or equipment in efficient operating condition.
Clouding the issue is routine maintenance. Expenditures for regularly scheduled, routine maintenance on property or equipment – including inspection, cleaning, testing, replacement of parts and other recurring activities performed to keep property or equipment in ordinary efficient operating condition – don’t, at least according to the rules, need to be capitalized.
While routine maintenance can be performed any time during the property or equipment’s useful life, there must be a reasonable expectation when the property is first placed in service that maintenance activities will be performed one or more times during its useful life. Failure to actually perform the maintenance more than once is not fatal – provided the portable plant operation can substantiate that its expectation was reasonable when the property or equipment was first placed in service.
Factors to consider when determining that the portable plant operation’s expectation was reasonable include the recurring nature of the activity, practices within the industry, the manufacturer’s recommendations and the contractor or material producer’s own experience with similar or identical property or equipment.
Related: Preventing downtime with proactive maintenance