Today, the cost of roof repairs on an average building can be six figures–and the Service will always scrutinize such a deduction. The issue of whether to capitalize or expense a roof repair has been the subject of much tax litigation over the years; unfortunately, it has not resulted in any full-proof test to determine whether to deduct or capitalize. Instead, taxpayers must determine this on a case-by-case basis. Thus, to deduct the costs of repairing a roof, taxpayers have to understand thoroughly the various standards for current deductibility and to document properly their facts.
The initial standard for deductibility is found in Sec. 162(a), which provides, “[t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Regs. Sec. 1.162-4 expands on this for repairs, providing that taxpayers can deduct the cost of incidental repairs that neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition. This deduction is allowed provided that the taxpayer does not otherwise capitalize repair costs.
If repairs are in the nature of replacements, arrest deterioration and appreciably prolong a property’s life, taxpayers can either capitalize and depreciate them under Sec. 167, or charge them against depreciation reserve (if they keep such an account). In addition, Sec. 263(a)(1) provides that taxpayers cannot deduct amounts paid for new buildings or for permanent improvements or betterments made to increase a property’s value; see Regs. Sec. 1.263(a)-1(a).
Regs. Sec. 1.263(a)-l(b) further states, “[i]n general, the amounts referred to in paragraph (a) of this section include amounts paid or incurred (1) to add to the value, or substantially prolong the useful life, of property owned by the taxpayer, such as a plant or equipment, or (2) to adapt property to a new or different use. Amounts paid or incurred for incidental repairs and maintenance of property are not capital expenditures.”
Perhaps the leading case in this area is Oberman Mfg. Co., 47 TC 471 (1967). In Oberman, the taxpayer leased the facilities used by its manufacturing operations. Under the lease, the tenant was required to take good care of the premises, including the buildings, and to make improvements. The tenant was also required to make promptly all necessary repairs (e.g., interior and exterior, structural and nonstructural). All such repairs were to be equal in quality and class to the original work.
The taxpayer occupied the building in 1956; the roof was in working order. No defect was apparent until 1958 or 1959, when the roof began to leak. After a roofing contractor repaired the roof approximately five or six times a year until 1961 without charging the tenant, both he and the building’s general contractor refused to make any further repairs. The taxpayer then accepted a proposal to correct the leaks, which involved inserting a roof expansion joint to run the length of the building and covering it with a layer of one-half inch fiberboard insulation and a 20-year four-ply asphalt and gravel top.
The IRS argued that the work was a capital expenditure to be amortized over the remaining lease term; the taxpayer contended the repair costs were deductible under Sec. 162.
The court held for the taxpayer; the costs were deductible under Sec. 162 because the taxpayer’s only purpose was to fix the leak and, thus, keep the leased property in an operating condition over its probable useful life and for the uses for which it acquired the property, and not to prolong the property’s life or increase its value.
From Oberman, the following standards for deductibility can be deduced:
* The taxpayer’s intention should be to repair, not improve, the property;
* Any increase in value must be determined by comparing the repaired property’s value before the incident requiring the repair and after the repair;
* Any increase in useful life must be determined by comparing the over all property before the incident requiring the repair and then after the repair, and must be material for the item being repaired;
* Repairs must be the taxpayer’s responsibility;
* Repairs must not have been contemplated when the taxpayer acquired the property;
* Repairs must only restore the property to its previous working condition; and
* Repairs should alter the property only if such repair is the most cost-effective method.
Ordinary and Necessary
As noted above, a repair must be an ordinary and necessary business expense to be deductible under Sec. 162. It is easy to establish that an expense incurred to fix a roof is necessary, but how is the “ordinary” provision met? In Welch v. Helvering, 290 US 111 (1933), the Court concluded that ordinary does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. The situation may be unique in the individual’s life, but not in the life of the group or the community of which he or she is a part.
Thus, an expense does not have to be incurred on a regular basis to be ordinary and necessary. However, it does have to be one that a taxpayer would expect to incur, such as a roof repair.
Oberman indicated that a taxpayer’s intent is an important factor when considering whether a roof repair or replacement is deductible or capitalizable. In Gerald W. Pontel Family Estate, TC Memo 1981-303, the court held that when the purpose for replacing roof shingles on a barn used in a dairy operation was to maintain the property and not to improve or prolong the barn’s life, the expenditure was currently deductible. (A wind storm had damaged approximately one half of one side of the roof of a barn used in the dairy farm operation.)
There are cases in which deductibility has been denied based on the taxpayer’s intent. In LaPoint, 94 TC 733 (1990), the taxpayer renovated properties in anticipation of selling them, which she did in 1983. The court held that the taxpayer made the expenditures with the intention of selling the properties; thus, they were capital expenditures. As in Pontel, LaPoint seemed to hinge on intent–the taxpayer made the repairs in anticipation of selling the properties.
In Auerbach, 2 BTA 67 (1925), the court held that expenditures for a new roof and for repairing boilers, made immediately on the purchase of a building, were capital items to be added to the cost of the taxpayer’s original investment. Presumably, the taxpayer was aware of the need for the repairs and, thus, incurred these costs as part of the building’s intended use after acquiring it.
Increase in Value
In Cerda, DC IL, 4/30/84, the taxpayers maintained that various plumbing, carpentry and electrical expenses incurred on their 10-apartment building were ordinary and necessary expenses. These repairs did not prolong the building’s life nor increase its value or the taxpayers’ rental income. Instead, the taxpayers made the repairs to keep the building in a safe condition to comply with the city’s building code. In so doing, the repairs merely restored the building to its previous condition and were not major improvements.
The Service argued that the repairs were capital expenditures, as they were performed to comply with the building code and would increase the property’s value. The court agreed with the IRS, holding that any repairs done to a building for this purpose would be capital expenditures, because compliance would materially increase the property’s value.
Prolong Useful Life
In determining if repaired property’s useful life has been prolonged, it is necessary to determine the property that has been repaired. For a roof, the question is whether the building is the property being repaired, or whether the roof is separate and apart from the structure it covers. Often, the Service will argue that the roof is the property and the repair extends the property’s useful life. In Okla. Transportation Co., WD OK, 12/29/66, the court held that the taxpayer could claim a deduction for a roof repair expense, because the roof was an integral part of the building, and the repairs did not extend the property’s useful life.
Finally, in Tsakopoulos, TC Memo 2002-8, the court found that the cost of replacing built-up portions of roofs on shopping centers in which the taxpayer had an interest was not currently deductible; the cost was capital because the work was not of a recurrent nature to repair storm damage, but to completely replace certain sections. Also, the replacements carried 10-year warranties, thus prolonging the roofs’ useful lives. The court deemed the actual roof to be the property repaired; the work appreciably extended its life. Thus, for repairs to a roof, there is no definitive answer as to what is “property” when determining whether useful life has been prolonged.
The cases demonstrate that leaky roofs are by no means cut and dried. Taxpayers have to evaluate each situation on its merits. However, the following guidelines may be helpful:
* The roof repair must not materially increase the property’s life as a whole. Note: The IRS may argue that the definition of “property” is the roof, not the building. Obviously, in most cases, the roof’s useful life has been extended.
* The roof repair cost must be only a fraction of the building’s total cost and, thus, does not substantially increase the building’s value.
* The repair must restore the roof to its original working state in the most cost-efficient manner.
* The repair must not put the building to a new use.
* The repair must not be part of an ongoing building-renovation program.
* The repair must not be undertaken to sell the building or to comply with city building codes.
FROM ROBERT E. WHITTALL, CPA, ACA, COHEN & COMPANY, LTD., MENTOR, OH