February 28, 2018 9:39 pm

No Deduction for Capital Improvements to Commercial Properties

A couple owned commercial rental properties and claimed deductions for repairs on their 2013 federal income tax return. The IRS recharacterized the expenditures as capital improvements that must be depreciated, rather than currently deducted. The expenditures were for carpeting, remodeling, new ceilings and tiles, and wiring.

The Tax Court sided with the IRS (Brandon Brown, TC Summary Opinion 2018-6). Their argument that they merely replaced existing items that were damaged or worn did not sway the court. They didn’t provide any information about when the old items were placed in use or the values of the properties before and after the renovations (information that would indicate whether the expenditures added value as would occur with a capital improvement).

Note: Under so-called “repair regulations,” the cost of certain capital improvements can be currently deductible. For example, there’s a safe harbor election for “small taxpayers,” meaning those with average annual gross receipts of $10 million or less that own or lease buildings with an unadjusted basis of $1 million or less. If this safe harbor applies, then the total annual expenditures for repairs, maintenance, and improvements on a building can be immediately deductible as long as the expenses don’t exceed the lesser of 2% of the unadjusted basis of the building, or $10,000.

Tax Glossary

Section 1231 property

Depreciable property used in a trade or business and held for more than a year. All Section 1231 gains and losses are netted; a net gain is treated as capital gain, a net loss as an ordinary loss.

More terms