Thursday, September 4, 2014

Unit of Property Defined

Central to the Repair Regulations, effective January 1, 2014, is the definition of a unit of property.  In order to determine whether you have improved your business or rental property, you must determine what the property consists of.  The IRS refers to this as the "unit of property" (UoP).  Identification of the UoP determines whether work done on a component will be a deductible repair or a capitalizable expense.

In general, a UoP includes all components that are functionally interdependent (i.e. the placing in service of one component depends upon the placing in service of another component).  For example, consider the components required to make a vehicle operable.  The vehicle could not be places into service without an engine, or without tires; therefore, the vehicle, engine, and tires may be one unit of property.

Special definitions for a unit of property apply for buildings, leased property, and plant property.  Plant property means functionally interdependent machinery and equipment used to perform an industrial process.  Under this definition, a manufacturing line could be one unit of property.

Under the Regulations, buildings are required to be dividend up into as many as nine different UoP's:  the entire structure and up to eight separate building systems.  An improvement to any of these UoP's must be capitalized.

The entire building and its structural components as a whole are a single UoP.  This includes components such as walls, roofs, partitions, floors and ceilings, as well as any permanent coverings (paneling and tiling), windows, and doors.  In addition, the following eight building systems are separate UoP's where an improvement to any of these must also be depreciated:  heating and air conditioning systems, plumbing, electrical, escalators, elevators, fire protection and alarm systems, security systems, and gas distribution systems.

Unfortunately, it isn't as straightforward as it seems.  There are variations to the UoP depending on the use of the building.  For example, if the building is a condominium complex, the unit of property is the individual unit owned by the taxpayer and the structural components that are part of each condo unit.  There is a similar rule for leased buildings which defines the unit of property as each building and its structural components or the portion of each building subject to the lease and the structural components associated with the leased portion.

Transitioning to these new rules might prove challenging, especially for rental properties.  Please contact a KOS advisor today if you would like to discuss how these regulations apply to you or the next steps needed to obtain available tax benefits.

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