Quite simply, a producer or contractor can claim tax deductions for certain expenses in the same year they are made by labeling them as “current expenses.” For other expenses – those so-called “capital expenses” – the portable plant operation must break up the deduction and take a portion of the total cost over a number of years.
A capital improvement is a permanent structural alteration or modification – even a repair – to equipment or property that substantially improves it, thereby increasing its overall value. This can involve updating the property or equipment to suit new needs or extending its useful life.
But, again, expenditures for basic maintenance and repairs are not considered to be capital improvements.
A repair is essentially maintenance that brings property or equipment back to working condition but doesn’t improve its condition beyond the quality or usefulness that existed before the work was done.
Just to confuse things, it should be noted that, according to the IRS, several expenses that otherwise might be considered as currently deductible, must be capitalized if part of a more extensive plan. For example, while painting is usually not considered a capital improvement, it must be capitalized if it is part of a large-scale improvement plan.
Fortunately, the tax rules contain a relatively new de minimis safe harbor for expenditures that would ordinarily have to be capitalized. Instead of capitalizing and depreciating many of those expenditures, taking advantage of bonus depreciation or the Section 179 election to expense, many other costs that ordinarily must be capitalized, can simply be expensed thanks to any one of the tax law’s so-called “safe harbors.”
Safe harbors
Safe harbors are “loopholes” built into tax regulations for the treatment of specific expenditures.
One such safe harbor, for example, allows purchases of either materials or supplies for use in the portable plant operation – ones that cost less than $200 – to be treated as expenses and currently tax deductible. The deduction for materials and supplies is available in the tax year when the item is used or consumed, so long as it has a useful economic life of less than 12 months.
Also in the tax rules is a safe harbor for amounts paid to acquire or produce tangible property. The so-called “de minimis safe harbor” is available to producers and contractors that do not have an applicable financial statement that allows them to immediately expense expenditures of less than $2,500 per invoice.
For those operations that do have an applicable financial statement (generally an audited financial statement), the threshold is increased to $5,000 per invoice – regardless of whether the expenditure meets the definition of a capitalizable expense or not. Best of all, the de minimis safe harbor is available without the necessity of changing the operation’s accounting methods.
Although not strictly a safe harbor, the tax rules, as mentioned, allow amounts paid for routine and recurring maintenance to keep property in working condition to be treated as repair costs.
In order to use the routine maintenance safe harbor, the portable plant operation should segregate amounts paid for real estate and other property.
If the expenditure is paid to maintain that real estate or other property, the amount can be expensed so long as it is expected the repair will occur more than once during a 10-year period. If the amount is paid to maintain other property, the amount can be expensed so long as it is expected to occur more than once during the property’s useful life.