Improvements and B.A.R.

Betterment: Improves a material condition or defect if the defect existed prior to acquisition or during production of the UOP, even if the taxpayer was aware of the defect. Or is a material addition such as an enlargement, expansion or extension of the UOP. Or is reasonably expected to materially increase the productivity, efficiency, strength, quality or output of the UOP.

Adaptation: Amounts paid to adapt or change the use of the UOP from its original use when placed in service.

Restorations: Amounts paid to bring the UOP back to regular efficient operating condition after a casualty, disrepair, or after the end of the class life.

This does not include any amounts used to make the UOP better then it was before the restoration. For example, a tree falls on part of the roof and you decide to replace the entire old shingle roof with a new energy efficient metal roof. The amount above the cost to restore the roof to is original condition is a Betterment.

This does not include any amounts paid for fixing disrepair if the taxpayers actions resulted in the disrepair. For example, if the taxpayer allows the roof to fall into disrepair due to lack of reasonable maintenance and a storm causes the house to flood through the defective roof, the costs to repair the flood damage must be capitalized and may not be expensed.

You will notice the words materially and reasonably are repeated several times. These terms are critical and are the terms the IRS and the Tax Court like to hang their hats on. Like most things in the Tax Code, the IRS has drawn no “line in the sand” for determining these actions. Each case must be determined on its individual merits, facts and circumstances.

Repairs

As we defined earlier, repairs are usually maintenance type items that keep a UOP in serviceable condition or bring a damaged or worn UOP back to the condition it must be in to be considered serviceable. These are things that keep the major components in working condition such as, switches, paint, spark plugs, etc. They are part of the major component but do not have an individual or critical function in and of themselves.

Example: A spark plug would go in any engine it is designed for, not just a specific engine, however, without the engine the spark plug itself has no functionality. However, if the entire engine needs to be replaced, that is a major component which performs a critical function and must be capitalized.

Why is it important to understand the difference between a major component and non-major components? Because the type and amount of safe harbor you can claim is determined by the type of expense.

For example, the routine maintenance safe harbor is excluded under restorations if the restoration is beyond the repair of the UOP, however, if the UOP is in (non-negligent) disrepair and beyond its class life it may qualify for this safe harbor.

Example: Back to our roof in disrepair above, if the house is in a storm plagued area and it is normal to have to replace the roof on a home every three or four years, even though a total roof would normally be considered a major component, this would qualify under the repairs and maintenance safe harbor.

Our last part will put everything together for us.

In accordance with Circular 230 Disclosure