What Is a “Capital Improvement”?

THE TERM “CAPITAL IMPROVEMENT” is perhaps more controversial than it needs to be. There’s a widespread misconception that an “improvement” must be something new and different. Yet that’s not what the IRS says — which matters because Mishkon’s Policies cite the IRS’s regulations for business expenses as its model for determining what qualifies as a capital improvement.…

Executive Summary

1.  Under IRS regulations, an improve­ment is defined as an expenditure that is intended to accomplish one of the following:

• it results in a betterment to the facility;

• it restores a major facility component to its designed efficient operating condition when its pres­ent condition is such that ordinary maintenance cannot do so; or

• it adapts the facility to a new or different use;

2.  Under those regulations, the cost of a capital improve­ment includes both its direct and indirect costs. Indirect costs include all of the repairs and other expenses that directly benefit the improvement, or are incurred by reason of the improvement.

 

Why Does Mishkon Cite the IRS Regs for Businesses?

Mishkon has repurposed for its budgeting needs the IRS definition of an “improvement.” For the IRS, that definition determines whether a business can properly deduct the expenditure in question from taxable income for that year, or whether the expenditure must be amortized over (i.e., spread across) several years. In contrast, at Mishkon, our concern is instead whether we consider the expenditure subject to being funded from our normal operating account, versus paying for it from a special fund.

In the IRS’s Own Words

from IRS Publication 535, Business Expenses 

Improvements 

Generally, you must capitalize the costs of making improvements to a business asset if the improvements result in a betterment to the unit of property, restore the unit of property, or adapt the unit of property to a new or different use. Some examples of improvements include rewiring or replumbing of a building, replacing an entire roof, increasing the production output of your equipment, putting an addition on your building, strengthening the foundation of a building so you can use it for a new purpose, or replacing a major component or substantial structural part of a machine. 

However, you may currently deduct the costs of repairs or maintenance that do not improve a unit of property. This generally includes the costs of routine repairs and maintenance to your property that result from your use of the property and that keep your properly in an ordinary efficient operating condition. For example, deductible repairs [which are not improvements] include costs such as painting exteriors or interiors of business buildings, repairing broken window panes, replacing worn-out minor parts, sealing cracks and leaks, and changing oil or other fluids to maintain business equipment.

Costs incurred during an improvement. You must capitalize both the direct and indirect costs of an improvement. Indirect costs include repairs and other expenses that directly benefit or are incurred by reason of your improvement. For example, if you improve the electrical system in your building, you must also capitalize the costs of repairing the holes that you made in walls to install the new wiring. This rule applies even if this work, performed by itself, would otherwise be treated as currently deductible repair costs.