Capitalization Question

Technical topics regarding tax preparation.
#1
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I have a client who is renovating their office. I believe the owner's husband is doing most of the labor and they're hiring some of the labor out for things he can't handle. The owner is not paying her husband but they are incurring thousands of dollars in charges to Lowes & home depot. A majority, if not most of these charges are under $2,500. Even if they're over the DMSH the individual line items wouldn't be.

My question is should I be capitalizing these? I've never had this before so I'm conflicted. Obviously the contractors that are paid over $2,500 need to be capitalized, but I was sure if all these charges to Lowes and home depot should be. Maybe on a per project basis? Any thoughts are welcomed.
 

#2
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Under the regulations, you look at the invoice amount. That would be the amount on the receipt from Lowe's. If that receipt shows an amount that's $2,500 or less (or whatever capitalization threshold you're using for the books & records), then it's an expense and not capitalized.

Likewise for the labor: If the invoice from the contractor is for $2,500 or less, etc., then it's not capitalized. If there's a payment for more than $2,500 that's for two different invoices that are each $2,500 or less, then it's still not capitalized.
 

#3
MilesR  
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warnickcpa wrote: Obviously the contractors that are paid over $2,500 need to be capitalized, but I was sure if all these charges to Lowes and home depot should be. Maybe on a per project basis? Any thoughts are welcomed.


Just because a contractor is paid more than 2,500 doesn't mean it should be capitalized. It depends what it's for - a repair to bring the space back to operating order, or is it an improvement to the office?

Assuming the total costs are more than the safe harbor (10k/2%), the amount of the "structured" payments that make up one particular project shouldn't necessarily be looked at as all separate expenses just because certain costs of the project were paid at different times and in different transactions (wood bought at lowes, electrical systems from Home Depot, drywall from Ace, labor subbed out, etc.). If it's all part of the same project, then it's all the same project and should be added together as the cost of an improvement (or repair as the case might be).

Brush up on the difference between repairs and improvements. Skim through treas reg 1.263(a)-3 for some clarity or google it and you'll find plenty of articles summarizing the reg. https://www.law.cornell.edu/cfr/text/26/1.263(a)-3
 

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Correct. Split it up between the various building systems (flooring, roof, HVAC, exterior wall structure, electrical, plumbing, etc.), and then take a look at the invoices exceeding $2,500 for one particular system, and see whether those constitute a major improvement.
 

#5
TheGrog  
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Yes, if there is a large, systemic renovation then the whole work could be capitalized if it qualifies as a restoration or a betterment. Can't just say that no individual invoice or purchase was more than 2,500 so I can expense the whole thing. Quoting the IRS manual on this:

"The regulations under § 1.263(a)-3(g) require taxpayers to capitalize all direct and indirect
costs of an improvement, including those costs that would otherwise be deductible as re-
pair costs, if they directly benefit or are incurred by reason of an improvement."

However, the rules on what a restoration actually is are fuzzy although maybe case law since then has laid in some better dividing lines. And depending on what they are doing it might be a betterment instead. Or it might fall under the 'more than once in 10 years' exception for routine maintenance. I remember one of the original examples was basically 'replacing 10% of the windows? Repairs. Replacing 90% of the windows? Capitalize' without bothering to examine the space in between.

Is this a separate office, or an office in the home? For a office in the home you might be able to argue that the unit of property is the house and not the office.
 

#6
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TheGrog wrote:Is this a separate office, or an office in the home? For a office in the home you might be able to argue that the unit of property is the house and not the office.


My client has leased a new building and is renovating part of the office. Drywall, carpet, etc. I believe it all qualifies as QIP, just for accounting purposes wasn't sure what the best way to handle it in case I need to depreciate it.
 

#7
TheGrog  
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With a new lease & new location I would think there would be a fair amount of difficulty in arguing that any of the expenses weren't associated with the renovation, and just as much with arguing that the client isn't performing a betterment or just preparing for use.

I would capitalize basically everything involved with getting the work done until they get to 'ready for business use', down to the last gallon of paint & pack of screws. And then 179 it all due to QIP, which always made me feel like I wasted my time capitalizing everything.

Maybe worry about trying to do some cost segregation if they don't qualify for 179? We've never had to do cost seg so I'm not even sure what kind of benefit it might have.
 


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