Question

Furnaces Pty Ltd was advised by a local building inspector that one of the chimneys on its premises was unsafe and, unless it was repaired, the factory would have to be closed. Furnaces decided that it was not feasible to stop operations to repair the chimney, so they gained permission to build an alternative chimney adjacent to the old chimney, thereby allowing production to continue. They found that although the new chimney was substantially the same size and make as the old one, it was cheaper to build than it would have been to repair the old one. Also, the new chimney can better ventilate the weather, which was not available in the previous one. After the new chimney was erected, the old chimney was demolished.

Is any amount allowable as a deduction for the cost of the new chimney?

Also elaborate on the following regarding this question:

1.General Deductibility Rules for Repairs

2.Identification of the case assisting in the decision making of this question.

3.Thorough yet succinct discussion of the considerations required for repairs

4.Thorough yet succinct discussion on cases where expenses are not considered as repairs and therefore, no deduction is available.

5.Apply the rules and cases above and provide a conclusion on the deductibility of expenses.

Answer 1

GENERAL DEDUCTIBLITY RULES FOR REPAIR 1 The IRS indicates what constitutes a real capital improvement as follows: Creating an addition, physical enlargement or expansion Creating an increase in capacity, productivity or efficiency Rebuilding Equipment after the end of its economic useful life Replacing a major component or structural part of the property • Adapting property to a new or different use . According to the IRS, routine maintenance keeps your equipments in good working condition without increasing its value or prolonging its useful life, and these expenses can be deducted in the year they occur. The IRS defines routine maintenance as something that "keeps your property in a normal efficient operating condition." 2 Also, the new chimney can ventilate the weather which was not available in the previous one

3 Capital Repair Improvements that "put" equipment in a better Improvements that "keep" equipment in operating condition efficient operating condition Restores the equipment to its previous Restores the equipment to a "like new" condition condition Addition of new or replacement components or Protects the underlying equipments material sub-components to equipment through routine maintenance Addition of upgrades or modifications to equipment Incidental Repair to equipments Enhances the value of the property in the nature of a betterment Extends the useful life of the equipment Improves the efficiency of the equipment Improves the quality of the equipment Increases the strength of the equipment Increases the capacity of the equipment Ameliorates a material condition or defec Adapts the property to a new use Plan of Rehabilitation Doctrine

The general rule is that expenses for repairs and maintenance must be capitalized and depreciated, but there are three exceptions that the IRS refers to as safe harbors. This basically means that you don't necessarily have to meet all the rules if extenuating circumstances exist. You can immediately deduct these expenses if you meet one of these rules.

You can't just write off an expense even with a safe harbor, however. The IRS requires that you make a specific election to do so by attaching a statement to your tax return.

# 1 A Safe Harbor for Small Invoices A person or business can immediately deduct repair and maintenance expenses if the cost is $2,500 or less per item or per invoice. This is up from $500, which was the threshold through December 31, 2015. A business with an "applicable financial statement," however, has a safe harbor amount of $5,000 # 2 A Safe Harbor for Small Projects Repairs can be deducted immediately if the total amount paid for repairs and maintenance on the property is $10,000 or under, or % of the unadjusted basis of the property, whichever amount is less. This safe harbor is only available for businesses with revenues under $10 million and when the property being repaired has unadjusted basis under $1 million. # 3 A Safe Harbor for Routine Maintenance Repair expenses can be deducted immediately if the repairs consist of routine maintenance and satisfy four criteria. The repairs are regularly recurring activities that you would expect to perform, and they result from the wear and tear of being used in your trade or business. They're necessary to keep the property operating efficiently in its normal condition. Finally, the repairs are expected to be necessary more than once during a 10-year period for buildings and structures related to buildings, or more than once during the property's class life for property other than buildings. The term "class life" refers to the number of years over which the IRS expects property to be depreciated

4 An expense is generally capitalized and depreciated over several years if it makes equipment better, restores the property to its normal condition, or adapts the property for a new or different use. Replacing a broken part on an engine is a repair expense, while upgrading the engine to increase a machine's capacity is a capital expenditure. If Engine will upgrade then it will increase the life of mashinery thus it should be capitilise. One way to remember this concept is the "BRA test," a mnemonic that refers to betterments, restorations, and adaptations. What Is a Betterment? As the name suggests, betterments are repairs that are intended to make something better than it was prior to the repairs being made. Repairs fall into this category if they: • Fix a defect that existed before you bought the property • Fix a defect that happened while the property was being made or built Enlarge or expand the property so that it has more capacity • Increase the property's quality, strength, efficiency, or productivity Costs That Are Restorations Restorations are repairs that restore or return an asset to its normal condition. Fixing a roof or replacing it entirely are examples. Repairs fall under the category of restorations if they: • Restore deteriorated property to its "ordinarily efficient operating condition" • Replace a major component or substantial structural part of a piece of property • Rebuild the property to like-new condition • Result in a deductible loss, sale or exchange, or casualty loss treatment for the property or a component of the property

Adaptation Expenses Adaptations are repairs that change how the property or equipment is being used. An example would be a building owner converting a factory into a showroom. How the building is being used changes from manufacturing to retail. Any repairs related to adapting the property are capitalized. Specifically, the IRS says that an adaptation expense is "paid to adapt a unit of property to a new or different use if the adaptation is not consistent with your ordinary use of the unit of property at the time you originally placed it in service. ת_| CONCLUSION-As this will improve the quality of chimney because the new chimney can ventilate the weather which was not available in the previous one. SO IT is a betterment expense and it should be capitilise and should be depreciated over its usefull life.

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