GAAP's Increasingly Influential Relationship with IRS Treatment

Man with US GAAP sign on green board behind him. Generally Accepted Accounting Principles and the IRS.


There have always been differences between what Generally Accepted Accounting Principles (GAAP) allows or requires and what the Internal Revenue Code may allow or require.  Most building owners are familiar with those differences and, for the most part, can deal with them as they have been around for a long time. For example accelerated depreciation versus straight line depreciation, salvage values and different asset lives have been traditions book to tax differences. It has been a reality that there were differences and it was perfectly acceptable to have those as the rules are different and somewhat independent of each other.  However, there have been some significant changes in the last few years that have made dealing with the differences much more complex and inter-related.  This has occurred as the IRS has finalized regulations governing repairs and capitalization (T.D. 9636) that make certain decisions and elections dependent on what owners do on their financial statements.  Not only are some of the regulations dependent on what owner’s do on their financial statements but they are dependent on what kind of financial statements owner’s prepare.  That is, are they internally prepared or are they audited by outside accountants.  Having your financial statements audited now gives you an advantage in making determinations of what expenditures you can expense for tax purposes or what you have to capitalize.  The expense allowance, those expenditures that can be expensed, amount for those with audited financials is $5,000 but only $2,500 for those that don’t.  When you realize that this determination is made on a per item or per invoice limit, it can be very significant.  

There is another area covered in T.D. 9636 that treatment is different depending on what you do on your financial statements which has to do with what is referred to as the BAR test.  If the expenditure results in a betterment, adaptation or restoration (BAR) it cannot be expensed.  GAAP requires that an expenditure must add to the useful life of an asset or enhance its function in order to be capitalized.  If an owner is inclined to want to capitalize an expenditure for financial statement purposes, it will almost certainly mean that it will meet the BAR test and will not be allowed as an expense for income tax purposes.  This conflict always existed but the new regulations make it much clearer that there needs to be conformity with tax and financial statement treatment.  

There is an area that hasn’t received a lot of attention regarding buildings and its structural components and how to employ the routine maintenance safe harbor.  Irrespective of the treatment for GAAP on financial statements, building owners who make expenditures under the restrictions of the safe harbor can expense them.   The restrictions are that if an owner reasonably expects to incur the expenditure more than once during the class life of the building (limited to ten years), then the expenditure can be expensed.  This may be difficult to prove in hindsight when the IRS is auditing it but good documentation of the expectation and the reasons for that expectation would protect owners from an adjustment at that later date should it not be done more than once in the ten year period. 

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