Real Estate, Construction, & Development Industry Insight

	1st Quarter, 2010

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about the Author

Mira has over 30 years of professional experience and serves as the National Director of HEIN & ASSOCIATES LLP real estate practice area. She provides tax planning and compliance services for both individuals and businesses, regularly assisting with corporate reorganizations, partnerships, estates and trusts, and succession planning. Mira assists real estate organizations with entity planning, capital structure, capital formation, mergers and acquisitions, and compensation issues. She consults with clients in highly specialized areas such as like-kind exchanges, condemnations, and tax issues related to land development. In addition to her experience in real estate, Mira has developed a focus in the construction, manufacturing and distribution, technology, and service industries.

Mira’s technical knowledge, experience, and passion for her profession are evidenced by the high quality service that she provides to clients. In 2003, Mira was honored by the Colorado Society of CPAs as a "CPA Making a Difference" for her significant volunteer contributions.

Mira served as Chair for the Colorado Society of Certified Public Accountants (CSCPA), and is currently serving on the American Institute of Certified Public Accountants (AICPA) Council. She is also a member of the Downtown Denver Partnership. Prior to joining HEIN & ASSOCIATES LLP in 1985, she was a Senior Tax Manager with Laventhol & Horwath. Mira received a bachelor’s degree in accounting and a master’s degree in taxation from the University of Denver.

Mira can be reached at 303.298.9600 or mfine@heincpa.com.

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Cost Capitalization Rules – To Deduct or Capitalize

By Mira Finé, CPA, Tax Partner

An age-old and difficult tax issue for those in the real estate business is whether to expense or capitalize expenditures for a real estate project. Stated another way, when you spend cash on business property you own, are you making a capital improvement to the property, or are you merely repairing or maintaining it?

This issue was contested between taxpayers and the Internal Revenue Service (IRS) for many years. Finally, in 1992, the Supreme Court confirmed that the creation of a separate and distinct asset is one, but not the only, basis for capitalization. The court stated that creation of a separate and distinct asset is a sufficient, but not necessary predicate to capitalization. Capitalization also may be required where the costs give rise to a significant future benefit. Specifically, the Supreme Court unanimously held that investment banking, legal fees and related expenses incurred by a taxpayer to evaluate a friendly takeover by another corporation were not deductible as current business expenses, but rather had to be capitalized. The court dismissed the argument that a separate and distinct asset must be created for an amount to be classified as a capital expenditure.

The distinction between the notion of making a capital improvement or undertaking a repair or maintenance has important tax consequences. Expenditures for repairs and maintenance are recovered immediately; they are deductible as business expenses in the year they are incurred. On the other hand, outlays for improvements must be capitalized. Capitalization means that cost recovery is delayed until the expenditure is written off through depreciation or until the property is sold.

The IRS has issued regulations that set up detailed rules specifying when capitalization is required for expenditures in connection with tangible property, such as a building or other similar asset. For example, the regulations require capitalization for expenditures that:

Fixes a defect to property that existed prior to the time it was acquired;
Are for work performed prior to the date the property is placed in service;
Adapts the property to a new or different use;
Extends the useful life of the property by more than one tax year.

The IRS’ regulations also create a new optional repair allowance that a property owner can choose to minimize disputes with the IRS. With the repair allowance, such expenditures in connection with a property would be automatically deductible up to a specified limit while expenditures over the limit would have to be capitalized. The precise limit would depend on the type of property and the owner’s cost of the property.

These issues arise with all remodeling projects, repairs, maintenance activities and the segregation of costs for a particular project. Cost segregation issues represent a separate but increasingly important challenge in the real property area. The regulations purport to provide a path through the maze. However, this area involves so many individual factual patterns that it is difficult to apply any set of finite rules. We welcome the opportunity to assist you in dealing with these expense versus capitalization issues as they relate to your real estate assets.