CPA & Business Advisory Blog

Changes to Repairs and Maintenance Rules – General Asset Account Rules

We have recently written blogs discussing the changes in the Repairs and Maintenance rules and regulations.  We have reviewed the changes to the basic rules reviewing what type of expenditures have to be capitalized and looked at the changes to the definition of a Unit of Property (UOP), as it relates specifically to real estate.  In this blog, we will expand the discussion on these changes to cover the General Asset Account (GAA) rules, related election, and the importance of understanding and implementation of these rules.

It’s crucial to understand these rules due to their relation to the new repairs and maintenance regulations and how they can affect the related treatment.  The GAA rules and election are particularly important to real estate.  In order to understand the role of the GAA rules, you need to understand how it relates to the changes in the rules defining a UOP of a building and disposition of components.

As we have previously discussed, a building is now viewed as nine separate components (UOPs) rather than the building being one UOP.  With this, each individual component is reviewed to see what is repaired or replaced to determine what should be capitalized and what should be written off.  For example, with windows being a component of the building, replacing one window can be seen as a restoration of a component.  In this example, the cost of the new window would have to be capitalized and the adjusted basis of the old window would have to be written off.  Think of how difficult this could be if the building has a large number of components (i.e. fixtures, windows, etc.) – the basis of each would have to be calculated if one is replaced. 

The GAA rules state that a taxpayer is not required to recognize a loss on disposition of a component.   The taxpayer can choose to write-off the adjusted basis of the old component or continue to depreciate it.  The treatment of the new component is based on the type of component – major vs. minor:

  • A major component is all or substantially all of the grouped components within a building, for example if 200 of 300 windows are replaced that would be considered a major component. 
  • A minor component is a lesser amount of the grouped components within a building, for example if 30 of 300 windows are replaced that would be considered a minor component. 

The following table lays out the treatment of components depending on the type (major vs. minor) and if a GAA election has been made.

Replacement of a Minor Component

  • Without a GAA election – Taxpayer MUST write-off the adjusted basis of replaced component.  The replacement component cost MUST be capitalized.
  • With a GAA election – Taxpayer MAY write-off the adjusted basis of a replaced component or continue to depreciate it over the useful life.  The replacement component cost MAY be capitalized (if the old component is written off) or be expensed as repairs and maintenance (if the old component is not written off).

Replacement of a Major Component

  • Without a GAA election – Taxpayer MUST write-off the adjusted basis of replaced component.  The replacement component cost MUST be capitalized.
  • With a GAA election – Taxpayer MAY write-off the adjusted basis of a replaced component or continue to depreciate it over the useful life.  The replacement component cost MUST be capitalized.

Simply stated, taxpayers that depreciate real estate, whether they own the building or are a lessee depreciating leasehold improvements, should look to make this election when the new regulations are implemented.

The extension of these rules and regulations means more time for review, interpretation, and planning by taxpayers and their advisors.  Even though the IRS has granted an extension these rules and regulations should be reviewed now as some taxpayers may benefit from early implementation which is allowed.  There will be more to come over the next few months but one does not want to procrastinate due to the amount of work that will be involved.

Have a question on how the General Asset Account rules impact your business?  Contact our Tax Planning and Preparation Group at 440-449-6800.

 

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