Navigating the IRS Tangible Property Regulations

Staying on top of IRS regulations can feel like a full-time job for small business owners and self-employed professionals. One complex set of rules you need to understand is the IRS tangible property regulations. These regulations play a major role in determining what property owners can deduct as an expense (and receive tax benefits immediately) versus costs that they must capitalize (and receive tax benefits over time, sometimes as long as 39 years).

The tangible property regulations apply to anyone who pays or incurs amounts to acquire, produce or improve tangible real or personal property. These regulations apply to corporations, S corporations, partnerships, LLCs and individuals filing a Form 1040 or 1040-SR with Schedule C, E or F.

Misunderstanding how to apply these regulations could lead to penalties, interest charges and unwanted increases in your tax liability. On the other hand, developing a working knowledge of these specifications presents opportunities to maximize legitimate expenses and streamline your tax burden.

With the support of an experienced CPA like James Moore, real estate operators can feel confident they are compliant and are harnessing the power of these regulations – which are known for being friendly to taxpayers.

Understanding the Tangible Property Regulations

The IRS Tangible Property Regulations contain specifications around deducting or capitalizing expenses related to tangible business property. This includes the buildings, equipment, furniture and fittings used in your business activities.

Generally speaking, if costs extend the useful life of a property, restore its use or adapt it to a new use, they must be capitalized. This means that the costs should be depreciated over time rather than deducted as a one-time expense. Upgrades and new installations also generally fall under capitalization rules. Basic ongoing repairs and maintenance costs tend to be fully deductible in the year they occur.

These regulations evolved from previous IRS codes and court decisions around capital and ordinary expenses. Over decades, many ambiguities developed around proper classification. The tangible property regulations came into effect in 2013, creating clarity and uniformity about what could be deducted vs. capitalized.

The tangible property regulations are favorable to taxpayers, allowing for a lot more expensing and also providing improved classifications that allow taxpayers to accelerate deductions. However, they can be complex. So it’s important for real estate operators to build up a robust working knowledge of the regulations.

Key Provisions of the Tangible Property Regulations

The tangible property regulations are based on improvement standards that determine whether a restoration, adaptation or betterment has occurred. These are sometimes referred to as RABI standards (Restoration, Adaptation, Betterment, Improvement). If a restoration, adaptation or betterment has occurred, the property is considered to have been improved and the associated expenses should be capitalized.

Restorations occur when a unit of property is returned to a like-new condition that extends its useful life. An example would be replacing a leaky roof with an entirely new roof.

Adaptations occur when a property is converted to a new use. For example, converting a manufacturing facility into a showroom incurs costs that must be capitalized, as the property is now used for a different purpose.

Betterments occur when an amount is paid to fix a material condition or defect, make a material addition to the property or increase the quality of the property. This might include expanding a floor plan or replacing low-grade insulation with higher-grade material.

The James Moore real estate team has a RABI flowchart that we apply to determine whether expenses meet the RABI criteria. Reach out today to learn more.

Simplifying the Maze: Safe Harbors to the Rescue

The IRS offers several safe harbors that simplify the process of determining whether costs should be expensed or capitalized. Three main safe harbors provide significant relief:

De Minimis Safe Harbor

If the cost of a tangible property item is under $2,500 (or $5,000 with applicable financial statements), it may be deducted as an expense. However, it must be treated as a unit of property. For instance, a roof replacement is a single unit and must be evaluated as a whole.

Taxpayers must have a formal capitalization policy in place at the start of the year and maintain clear documentation to support these deductions.

Small Taxpayer Safe Harbor

Taxpayers with average annual gross receipts under $10 million and buildings with an unadjusted basis under $1 million can deduct up to the lesser of $10,000 or 2% of the property’s unadjusted basis each year for repairs and improvements.

Routine Maintenance Safe Harbor

Routine maintenance costs, like repainting or carpet replacement, can often be expensed if expected to occur at least once every ten years. However, this safe harbor generally excludes major systems like roofing or electrical, which are more likely considered improvements.

Safe harbors can simplify compliance but aren’t always the best choice for complex or high-cost improvements. Consulting with a tax advisor ensures the optimal strategy is used.

Partial Asset Disposition

Even when improvements must be capitalized, partial asset disposition rules may allow taxpayers to expense a portion of the related costs. For example, replacing a roof may qualify as a restoration (thus capitalized), but the taxpayer may deduct the cost of removing the old roof and the remaining undepreciated value of it.

This rule reduces depreciation recapture when the property is sold, offering a long-term tax benefit.

James Moore: Experienced Real Estate Tax Professionals

For real estate professionals, applying tangible property regulations correctly requires clear protocols and experienced guidance. Tracking costs, categorizing expenses and following capitalization rules can be challenging without structured systems.

The James Moore real estate accounting team can help. Our professionals offer deep experience in navigating these regulations while identifying opportunities to optimize tax savings. With thoughtful planning, we help you reduce tax exposure and enhance compliance.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.