When to Expense or Capitalize a Fixed Asset
Guidelines on Distinguishing Between a Repair and a Capital Item
The cost of repairing property and equipment used in your business is a deductible business expense. In contrast, expenditures that materially add to the value of the property, prolong its life, or adapt the property to a new or different use must be capitalized (added to the basis of the property and recovered through depreciation). Repairs are expenses designed to keep property in good working condition. This includes the replacement of short-lived parts.
Typically, the cost of repairs is small compared with the cost of the property itself. Capital items, on the other hand, are akin to original construction. Costs are usually substantial.
To distinguish repairs from capital improvements, there are no bright line tests; the determination is based on facts and circumstances. Capital improvements include a betterment to or restoration of the unit of property, or an adaptation of the unit of property to a new or different use. A “unit of property” is functionally interdependent on components such as a machine or a building.
Examples of Repairs versus Capital Items
Repairs Capital Items
Painting the outside of office building Vinyl siding the outside of office building
Replacing missing shingles on roof Replacing entire roof
Replacing compressor for air conditioner Adding air-conditioning system
Cleaning canopy over restaurant Adding canopy over restaurant entrance
Resurfacing office floor Replacing office floor
Small Building Safe Harbor
Small business taxpayers can write-off certain costs under a safe harbor rule. This means having average annual gross receipts in the 3 prior years of no more than $10 million.
The safe harbor applies only if your repairs, maintenance, and improvements for the year do not exceed the lesser of $10,000 or 2% of the unadjusted basis of the building.
The safe harbor applies separately to each such building owned by a small taxpayer. Thus, if you are a small taxpayer, you may qualify to use the safe harbor on one building but not for another, depending on the extent of your costs for the year.