Construction’s impact on your property’s functionality is the key
If you own a commercial property that has been productive for some years, you will need maintenance construction from time to time. The work could be considered a repair or a capital improvement.
But what is the difference between the two? It has to do with functionality, tax categories, and planning. Let’s start with some definitions.
What are the definitions?
According to Investopedia Capital Improvement is:
“the addition of a permanent structural improvement or the restoration of some aspect of a property that will either enhance the property’s overall value or increases its useful life. Although the scale of the capital improvement can vary, capital improvements can be made by both individual homeowners and large-scale property owners.”
To repair is to fix or mend something suffering from damage or a fault.
According to Wikipedia A Capital Improvement Plan (Program), or CIP is
“a short-range plan, usually four to ten years. It identifies capital projects and equipment purchases, provides a planning schedule and identifies options for financing the plan.”
They are often used for government projects but work well for commercial ones as well.
What’s the difference in the IRS’s eyes?
There is a difference between repairs and capital improvements as regards your tax filing. Consult your tax accountant for how this impacts you. This post is not advice, just a synopsis.
According to Dermody, Burke & Brown, CPAs:
“There has been much debate and controversy not to mention a number of court cases regarding whether, or to what extent, the amounts paid to restore or improve property are capital expenditures or deductible ordinary and necessary repair and maintenance expenses.”
The IRS has now defined what is capital as opposed to what would be considered a repair and routine maintenance.
Property capital improvements include:
- Fixing a defect or design flaw
- Creating an addition, physical enlargement or expansion
- Creating an increase in capacity, productivity or efficiency
- Rebuilding property after the end of its useful economic life
- Replacing a major component or structural part of the property
- Adapting property to a new or different use
Under the IRS regulations, capital improvements can be applied to buildings themselves and individually to structural components. These include “heating and ventilation, plumbing, electrical, fire protection and security systems and escalators and elevators.” 1
IRS regulation indicates that “recurring activities (inspection, cleaning, testing, replacing parts, and so on) that are expected to be performed as a result of the use of property to keep the property in its ordinarily operating condition aren’t capital improvements. The activity is considered routine if, at the time the property was placed in service, the taxpayer reasonably expected to perform the activity more than once during the property’s life.” 1
Dermody, Burke & Brown, CPAs have provided this helpful chart.
|Improvements that “put” property into a better-operating condition||Improvements that “keep” property in efficient operating condition|
|Restores the property to a “like new” condition||Restores the property to its previous condition|
|Addition of new or replacement components or material sub-components to property||Protects the underlying property through routine maintenance|
|Addition of upgrades or modifications to property||Incidental Repair to property|
|Enhances the value of the property in the nature of a betterment|
|Extends the useful life of the property|
|Improves the efficiency of the property|
|Improves the quality of the property|
|Increases the strength of the property|
|Increases the capacity of the property|
|Ameliorates a material condition or defect|
|Adapts the property to a new use|
|Plan of Rehabilitation Doctrine|
What goes into a Capital Improvement Plan?
As mentioned above a CIP identifies capital projects and equipment purchases, provides a planning schedule, and identifies options for financing the plan.
Benefits of a CIP
A CIP provides many benefits including:
- Allows for a systematic evaluation of all potential projects at the same time.
- The ability to stabilize debts and consolidate projects to reduce borrowing costs.
- Serve as a public relations and economic development tool.
Features of a CIP
The CIP typically includes the following information:
- A listing of the capital projects or equipment to be purchased.
- The projects ranked in order of preference.
- The plan for financing the projects.
- A timetable for the construction or completion of the project.
- The justification for the project.
- Explanation of expenses for the project.
Capital improvement examples
Let’s look at when some maintenance construction may or may not be a capital improvement. For example, windows. If you replaced a broken pane in a window, that would be a repair. But, if you replaced all the old windows in your building with new, energy-efficient ones that would be a capital improvement.
Adding a part to replace a broken one in an HVAC unit would be a repair. Putting a new unit in for a second floor or newly enclosed garage would be a capital improvement.
Adding a screen door might not be a capital improvement but adding a ramp and ADA compliant entrance door would be.
Repainting interior walls most likely would not be a capital improvement. The painting done as part of a freestanding office addition to your backyard would be.
Replacing your old roof shingles with tiles = yes. Replacing a few shingles that blew off during the last tropical storm = no.
You get the idea.
A capital improvement plans example
CAM Contracting’s work on Old Town Theme Park is an excellent example of a capital improvement project. A wide variety of upgrades, additions, and improvements make up the scope of the project.
The innovative canopy roof system upgrades are a perfect example of an individual capital improvement.
How can we help?
If your existing facility could use some tender loving care, we can assist you with either long-term capital improvements or immediate repairs. Just contact us today. We can’t wait to help!