Tracking Capital Expenditures

By Vorkapich, Mark | The CPA Journal, February 2013 | Go to article overview

Tracking Capital Expenditures


Vorkapich, Mark, The CPA Journal


Exploring Cost Segregation Studies and Related Temporary Regulations

On December 23, 2011, the U.S. Department of the Treasury published temporary regulations (TD 9564, Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property) that affect all taxpayers who acquire, produce, or improve tangible property. The regulations, which expanded and clarified the rules surrounding capital expenditures under Internal Revenue Code (IRC) section 263(a), included many changes, such as the following:

* They refined the definition of "unit of property."

* They allowed dispositions of a building's structural components.

* They provided a facts-based approach for determining whether work performed on a building or leasehold improvements should be considered a deductible repair or a capital expense.

in addition, these regulations have changed the methods for tracking capital expenditures. The following discussion will explore the effects of the temporary regulations, which have an effective date of January 1, 2014. Taxpayers can elect to apply the temporary regulations for 2012 or 2013.

Unit of Property

An engineering-based cost segregation study has traditionally been used to identify and reclassify property that is included in the cost of the building but is not a building component and can be depreciated over shorter recovery periods. These breakdowns follow the modified accelerated cost recovery system (MACRS).

Under the new regulations, for all purposes other than repair, a building and its structural components are considered a single unit of property. The qualitative and quantitative information already contained in an engineering-based cost segregation study can be used to readily identify all of these assets.

A unit of property consists of a building's structure and a building's systems, including -

* heating, ventilation, and air conditioning (HVAC) systems;

* plumbing systems;

* electrical systems;

* all escalators;

* all elevators;

* fire protection and alarm systems;

* security systems;

* gas distribution systems; and

* other structural components identified in the temporary regulations.

The temporary regulations have established a qualitative framework to track expenditures. The replacement or improvement of these components is referred to as a "capital improvement."

Classifying Capital Expenditures

A capital expenditure, as defined by the regulations, refers to any betterment, restoration, or adaptation of a unit of property. A "betterment" corrects a material condition or defect that existed prior to the taxpayer's acquisition of the property. In addition, a betterment is an activity that results in a material addition or increase to the property's capacity, productivity, efficiency, strength, quality, or output. A "restoration" is the replacement of any major component or substantial structural part of a unit of property. If the property has deteriorated to a state of disrepair, such restoration should return the property to its ordinary efficient operating condition or should rebuild the property to a "like new" condition after the end of its class life. An "adaptation" modifies the property for a new or different use if the taxpayer's intended use of the property has changed from the time that it was originally placed in service. …

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