Many business owners have questions concerning repair vs. capitalization problems. If Hamlet had owned a business, he might have pondered, 'To capitalize or to expense, that is the question.' A classic Tax Court decision (L & L Marine, TCM 1987-428) on the subject implies that the answer may be found in another Shakespearean paraphrase, 'A repair by any other name is expensed the same.'
Run-ins with the IRS frequently focus on issues of capital improvement vs. repairs. Repairs are currently deductible, but capital improvements must be depreciated over a period of years. The pivotal point is whether the expenditure is made to improve, alter, or renovate the property or equipment, or merely to repair it. The Tax Court decision just mentioned says that nomenclature is secondary to the real facts when making the determination.
Here's the story. L & L Marine spent money for work needed to continue to qualify six barges for sea duty, classifying the expenditures as 'repairs' on the books and taking a deduction for the expense on that year's tax return. But L & L's CPA thought the work was a capital expenditure and refused to issue audited financial statements unless the expenditure was capitalized.
The IRS was delighted. In its audit of the marine company's tax return, it adopted the CPA's treatment of the expenditure and disallowed the deduction for repairs.
But justice prevailed, and L & L was able to salvage the deduction for repairing the barges. L & L was persuasive in an argument that answered the real question in such cases: Did the repairs significantly increase the useful lives of the value of the barges? The IRS merely relied upon the CPA's classification, presenting no other argument for capitalization. 'Unconvincing!' said the Tax Court, a repair is still a repair, no matter how the CPA classifies it. The IRS was required to produce convincing evidence that the expenses were capital in nature, and they failed to do so.
Here's a little more help. In addition to the question posed in the L & L case, ask this: Can the property be used for the purpose for which it was originally intended unless the repair is made? If the answer is 'No,' then the cost of the repair is deductible. For example, the cost of a new roof (the old one leaks), or a new motor (the old one blew out), or the venting (no vent, can't use the machinery) is thus currently deductible as a repair because the building, boat, or tractor, respectively, cannot but used properly without them. The next time your CPA wants to capitalize such items, show him or her this article.