We recently had this question posted on the forum: “Is it still possible to deduct the cost of a roof replacement the year it was installed?”
The responses varied because some were talking about the entire roof, while others were referring to only the membrane and the one that posted the question did not delineate.
However, the answer to the question lies in the Cap and Repair Regulations that come out several years ago and as I have expected for some time has faded from memory.
So, let’s start with this screen capture from the Big Book of Taxes page 3.27.14
So those thinking membrane were correct in saying it could be expensed, and those thinking the whole roof were also correct in saying it had to be capitalized.
There are two other cap and repair provision that come into play when it comes to roofs. The first is the:
Per-Building Safe Harbor for Qualifying Small Taxpayers
(Reg. Sec. 1.263(a)-3(h))
This safe harbor permits qualifying small taxpayers (those with $10 million or less average annual gross receipts in the three preceding tax years) to elect not to treat as capitalized expenses - in other words, to currently deduct - improvements made to an eligible building property (one with an unadjusted basis of $1 million or less, not including land value). This safe harbor election applies only if the total amount paid during the tax year for repairs, maintenance, improvements, and similar activities performed on the eligible building does not exceed the lesser of $10,000 or 2% of the building's unadjusted basis.
This safe-harbor rule applies to tax years beginning on or after January 1, 2014. However, a taxpayer may choose to apply the safe harbor to tax years beginning on or after January 1, 2012.
Under this safe harbor, qualifying small taxpayers include amounts expensed (not capitalized) under the de minimis safe harbor election and under the routine maintenance safe harbor for buildings to determine the annual amount paid for repairs, maintenance, improvements, and similar activities performed on the building. If the amount paid for repairs, maintenance, improvements, and similar activities performed on a building unit of property exceeds the per-eligible-building threshold (lesser of $10,000 or 2% of unadjusted basis) for a tax year, then the safe harbor doesn't apply to any amounts spent during the tax year. In such cases the taxpayer must apply the general rules for determining improvements, including the routine maintenance safe harbor for buildings.
Partial Disposition Election
Reg. Sec. 1.168(i)-8(d)
A taxpayer may make an election under this provision to report the gain or loss on the replacement, retirement, or other disposition of a partial asset. However, if the taxpayer makes this election the taxpayer must:
- Capitalize the replacement portion under the same asset class as the disposed portion, and
- The asset must be within the asset classes 00.11 through 00.4 of Rev. Proc. 87-56
- 00.3 Land improvements directly added to land whether such improvements are Sec 1245 or Sec 1250 property
This election does not apply to betterments or an adaptation of the asset to a new or different use.
What Does a Partial Disposition Election Accomplish? – It allows taxpayers to elect gain or loss on the replacement, retirement, or other disposition of a partial asset. A good example of that would be replacing the roof on a building that is not completely depreciated. Prior to the release of the new regulations the old roof would have to remain on the books as part of the whole asset and if not already depreciated to zero, continue to be depreciated.
Example – Rental Roof: Mel owns a residential rental property that needs a new roof. Mel determines the retiring roof has an unadjusted basis of $25,000 (27.5-year MACRS life, straight line) on which he has taken $16,817 in depreciation, leaving it with a remaining undepreciated basis of $8,183. If Mel elects a partial disposition for the roof, it will result in an ordinary loss of $8,183. However, he will have to capitalize the replacement roof and depreciate it over 27.5 years and forego any option to expense the roof under any other provision.