This guest post was written by Alan Clark, CPA, a construction industry accountant at Smith, Adcock and Company.
The IRS issued Temporary Regulations in its current round of attempts to clarify when to deduct and when to capitalize tangible property costs.
Cost of tangible property – materials, supplies, parts, improvements, repairs which are purchased or produced – property that will last more than a year is generally required to be capitalized and it can be expensed if less than a year. Also, if it will extend the useful life, capitalization is the general rule.
Materials and supplies can be expensed when they are used, not necessarily in the year that they are purchased. Materials and supplies are not inventory or depreciable property. A new category in the Regs is for items such as fuel, lubricants and water products. Materials and supplies of less than $100 can generally be expensed, but for contractors, that is such a small number that the Regs may not have any real-life benefit. Amounts on hand at the end of the year will not be deductible in that year.
Under a de minimis rule, taxpayers can deduct up to .01 percent of the gross receipts for the taxable year or 2 percent of the taxpayers depreciation and amortization on their financial statements for the year. Again, for many contractors this is a very small allowance. With costs exceeding these small allowances, other rules may support the deduction for materials, supplies, and repairs. An election is required to use these rules and for most contractors, a request to the IRS Commissioner for a change in accounting method will be required. Conformity of the tax write-offs and the expenses on the contractor’s financial statements is required and a written policy should be in place to protect deductions in an IRS audit.
The “unit of property” (UOP) is a very important concept and definition that every contractor should consider. For example, a small truck mounted crane could be the UOP for one contractor yet for another the crane and the truck could be separate units. The larger the unit, in relation to the repair cost, the better the chance of sustaining a major repair cost compared to the smaller unit definition. While the rules sound very tight, the IRS staff who wrote the Regs stated (at the AGC Tax Committee meeting June 14, 2012) that they had no intent to disallow regular repair costs such as a $30,000 tire on a large piece of construction equipment although the published rules would indicate that the tire, because of its high cost, should be capitalized.
The 100+ pages of the IRS Regulations contain many more concepts and limitations, but another item of particular interest to contractors is the opportunity to determine possible write-offs of the demolished property for their customers for whom they are performing building upgrades, changes, build-outs, and other tasks.