LEGISLATIVE ADVOCACY -Page 2
Boning up on the New Repair Regs, by Gallina, LLP, Certified Accountants
IRS guidance can help you and your clients reduce taxes
In December 2011, the IRS issued temporary regulations entitled Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property. Commonly referred to as the "repair regs," the new guidelines address the tax treatment of expenditures made to acquire, produce or improve tangible property. This includes buildings and building components, land, machinery, and equipment, as well as furniture and fixtures.
Contractors should familiarize themselves with the regs because: 1) they affect the tax treatment of investments in their own buildings, and 2) they may provide opportunities to help clients reduce their tax bills.
Capitalize or deduct
Generally, the regs require taxpayers to capitalize (rather than deduct) amounts paid to:
Acquire a new building,
Create permanent improvements or betterments to property,
or Adapt property to a new or different use.
Betterment involves eliminating a pre-existing material condition or defect, as well as material additions or improvements that increase a property's capacity, productivity, efficiency, strength or quality. Restoration includes work that restores property to like-new condition at the end of its useful life, returns property to efficient operating condition from a state of disrepair, or replaces a major component or substantial structural part.
Property owners are permitted to deduct expenses for maintenance or repairs that keep property in efficient operating condition.
Determining whether an expense should be capitalized or deducted can be a challenge. There's no bright-line test for doing so.
In fact, the final regs omitted a proposal that would have defined "major component" or "substantial structural part" based on a 50% cost or size threshold in relation to the relevant unit of property. Thus, the determination is made on a case-by-case basis according to a taxpayer's particular facts and circumstances.
One of the most significant provisions of the repair regs changes the way the rules apply to buildings. The regs continue to treat a building and its structural components as a single unit of property, but they also require owners to capitalize expenses for betterments or restoration of the building structure or of any of these specified building systems: 1) HVAC, 2) plumbing, 3) electrical, 4) escalators, 5) elevators, 6) fire protection and alarm, 7) security, and 8) gas distribution. This change shrinks the unit of property, increasing the chances that expenses must be capitalized.
Suppose that an owner has substantial repair work done on a building's HVAC systems. Under the old rules, the expense would have been deductible if it didn't result in a betterment or restoration of the building as a whole. But the same expense would have to be capitalized under the new rules if it results in a betterment or restoration of the HVAC system.
The regs contain several special rules, including a safe harbor for "routine maintenance." Maintenance is considered routine if, at the time the unit of property is placed in service, the owner reasonably expects to perform it more than once during the unit of property's useful life.
The safe harbor doesn't apply to buildings, though. Otherwise, owners could deduct the expense of major maintenance projects, such as roof replacements, simply because they expect to perform them more than once over the building's life. The safe harbor might apply, however, to maintenance performed more than once during the life of the roof.
Assist your clients
Familiarity with the repair regs provides an opportunity to help clients lower their tax bills. For example, providing clients with itemized bills makes it easier for them to separate deductible expenses (such as routine maintenance) from capitalized expenses. In some cases, the choices you and your clients make (such as the types of materials used) can have significant tax implications. (See the sidebar "Repair or improvement?")
The repair regs are heavily fact-driven, so it's critical to review the many examples included in the regs and to consult a tax professional.
Sidebar: Repair or improvement?
Often, there are several solutions to a construction problem, and the solution you choose can make a big difference on your client's tax bill. Consider this example from the repair regs:
A storm damages the roof of a small retail shop, displacing many wooden shingles. The owner hires a contractor to replace all of the shingles on the roof with new wooden shingles. The expense is deductible. The work doesn't result in a betterment, because it doesn't result in a material addition or increase the building structure's capacity, productivity, efficiency, strength or quality. The result would be the same if it were impractical to use new wooden shingles, causing the contractor to replace all of the wooden shingles with comparable (albeit stronger) asphalt shingles.
The result is different, however, if the contractor replaces the wooden shingles with shingles made of lightweight composite materials that are maintenance-free, don't absorb moisture, and have a 50-year warranty and a Class A fire rating. In that case, the work would resultin a betterment, because the new shingles materially increase the quality of the building structure. Therefore, the expense must be capitalized.
Article provided by: GALLINA LLP, Certified Public Accountants
(Nov 30, 2012)
Back to the TOP
RECAPPING THE CAPITOL
This is ASAC’s preliminary list of bills that affect Subcontractors. Your Government Relations Committee is analyzing them and will recommend positions of “Support”, “Oppose” or “Seek to Amend” those that are most important. AB 1354 is our bill. This is only a partial list which is divided by general categories. Hearings start in a month and may last until September. Most bills will, if signed by the Governor, become effective January 1, 2012 unless they are “urgency bills”.
ASAC recently convened the annual “Construction Industry Round Table” among a dozen associations that lobby these bills. 2011 will be a busy year for us; please stand ready to help by communicating with certain legislators when asked!
BONDING, LIENS, & INSURANCE CLAIMS
Summary: Would require that a person forfeit his or her lien if the person willfully includes labor or materials in a lien claim that were not furnished to the property in the claim.
Small claims court: jurisdiction.
Summary: Would increase the jurisdiction of the small claims court to $10,000 from $7,500.
Payment bonds: laborers.
Summary: A preliminary notice to enforce a claim against a payment does not apply to a laborer. The bill might be amended to effect late bond claims for all subcontractors.
SB 424(Rubio) Mechanics liens: design professionals.
Summary: Would authorize a design professional to convert a recorded design professional lien to a mechanics lien.
AB 1342(Dickinson) Public contracts: roof projects.
Summary: Requires specifications for a roof project to contain certain information regarding manufacturers, and would prohibit specifications requiring proprietary products or a proprietary warranty.
SB 474(Evans) Insurance: construction.
Summary: Would express the intent of the Legislature to enact legislation to govern the use of indemnification and additional-insured provisions in construction contracts in order to provide for the equitable resolution of claims fraud, willful injury, or any other violation of law. Expect significant amendments.
AB 249(Berryhill, Bill) Contractors.
Summary: Would authorize a person who utilizes the services of an unlicensed contractor for the construction or improvement of residential property, as specified, to bring an action in any court of competent jurisdiction in this state to recover all compensation paid to the contractor for performance of any act or contract during the time the contractor was not properly licensed.
SB 341(Lowenthal) Vehicles: dump trucks: backup alarms.
Summary: Requires a dump truck to be equipped with an automatic backup audible alarm.
SB 541(Price) Contractors' State License Board.
Summary: Would extend the operation of the CSLB until January 1, 2016.
SUBCONTRACTOR BIDDING... RIGHTS & PROTECTIONS
AB 356(Hill) Public works projects: local hiring policies.
Summary: Would exempt any public works project that is funded, in whole or in part, with state funds from a policy imposed by a local agency that mandates that any portion or percentage of project work hours be performed by local residents.
AB 457(Wagner) Public works contracts: relief for bidders.
Summary: Would entitle a bidder who successfully challenges the award of a contract determined to be invalid due to errors or omissions of the public entity to recover costs and attorney's fees incurred in pursuing the challenge.
AB 720(Hall) Public contracts: uniform construction cost accounting provisions: alternative procedures.
Summary: Would repeal the law that specifies that a board of supervisors or a county road commissioner is not prohibited from using alternative procedures governing county highway contracts.
AB 780(Calderon, Charles) Sales and use taxes: exemption: fixed price contract.
Summary: Would, for any increase or extension of counties and cities, also impose a sales and use tax at a combined rate of 1% the sales and use tax rate on and after July 1, 2011, exclude from that increased rate of tax, the gross receipts from certain sales and uses of tangible personal property that are subject to a fixed price pursuant to a contract entered into prior to the operative date of the sales and use tax rate increase.
AB 948(Furutani) Public contracts: competitive bidding: best value.
Summary: Would provide that bid evaluation and selection for these contracts may include competitive means for obtaining best value.
AB 1354(Huber) Public works: payments: retention. (ASAC’s bill)
Summary: Would delete the prohibition against payments being made in excess of 95% of the work completed and the requirement that the department withhold not less than 5% of the contract price until final completion and acceptance of the project, and would instead prohibit the retention of any amount with respect to all contracts entered into on or after January 1, 2012, between a public entity and an original contractor, between an original contractor and a subcontractor, and between all subcontractors thereunder, relating to the construction of any public work of improvement.
SB 497(Rubio) Public contracts: bid preferences.
Summary: Would require a state agency that accepts bids or proposals for a contract for supplies, materials, or equipment to provide a preference of 5 percent to a California business.
SB 555(Hancock) Public contracts: state: bid preferences.
Summary: Would require a state agency that accepts bids or proposals for specified contracts for goods or services exceeding $1,000,000, or for the distribution of funds pursuant to the federal American Recovery and Reinvestment Act of 2009, on or before July 1, 2017, to provide a 5% preference, as provided, to a business that directly provides the goods or services when 90% of the employees of the business performing work on the contract reside in the state. This bill would state that these bidding preferences are not applicable to contracts that are subject to the State Contract Act or to contracts for specified professional services.
SB 693(Dutton) Public contracts: local agencies.
Summary: Would allow private-public partnership agreements for transportation projects.
ASAC Legislative Advocate