New rules on whether to classify a purchase as an Expense (Repair) or when there is a need to Capitalize the purchase?

In economically slow times the governemnt allows faster depreciation (or expensing) to encourage (stimulate) large asset purchases.  However, quickened expensing opportunities are intended as temporary measures designed to stimulate business activity. When the business climate moderates, normal depreciation rules return.  This is when companies will focus on what constitutes a repair or expense deduction and what expenditures create a new asset that must be capitalized and the cost recovered through depreciation deductions.
In the Small Business Jobs Act of 2010 (SBJA), Congress raised the Section 179 deduction amount to $500,000 for tax years beginning in 2010 and 2011. And they also extended 50-percent bonus depreciation to qualified assets placed in service during 2010.  Also, in an effort to relieve businesses in the Job Creation Act of 2010, Congress increased the bonus-depreciation percentage to 100 percent for qualifying property acquired and placed in service after September 8, 2010 and before January 1, 2012.

Recent IRS Audit Guide
Amid all the potential stimulus surrounding the announcement of higher tax write-offs for asset purchases, the IRS issued a new Audit Technique Guide and instructed its auditors to focus on the issue of whether expenditures should be capitalized or deducted.
Under current rules, repair expenses are currently deductible if they are incidental in nature and neither materially add to the value of the property nor appreciably prolong its useful life. Costs for materials and supplies consumed during the year are also currently deductible.
However, expenditures must be capitalized if they are for permanent improvements or betterments that increase the value of the property, restore its value or use, substantially prolong its useful life or adapt the property to a new or different use.

Unit of Property
A key component in determining whether an expenditure should be capitalized or expensed is the unit of property (UOP). The smaller the UOP, the more likely it is that costs incurred in connection with that UOP will have to be capitalized.
A significant amount of the guidance in the temporary regulations centers on what constitutes the “unit of property” that is being placed in service, repaired, or improved. The definition for a unit of property is different for personal and real property as compared to a building.
In general, for real or personal property that is not a building, all the components that are functionally interdependent comprise a single unit of property. Components of property are functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayer.
A building is defined as its structure and structure components. Structure components include walls, partitions, floors and ceilings, paneling, tiling, windows, and doors. Also, within the structure are building systems.

For example, In Ingram Industries, Inc. v. Commissioner, the Court addressed whether the costs of cleaning, inspecting and repairing towboat engines were capital expenditures. The IRS focused on the engines and argued that the work performed increased the value and prolonged the useful life of the engines. Ingram argued that the appropriate focus was on the towboat. The Court agreed with Ingram, stating that the record did not support a practice (industry or otherwise) to purchase or treat towboat engines separately from the towboats.
The Court reasoned that the towboats and engines, if properly maintained, were both expected to last 40 years, that the towboats were purchased with the engines and that the engines were designed to be maintained without removing them from the boat. The Court also noted that there was no evidence indicating that towboat owners regularly and periodically replaced the towboat engines. The Court held that the expenditures did not increase the value or useful life of the towboat or the engine and could be deducted.

Capitalization Policies
Many companies make capitalization/expense decisions based on the dollar amount of the expenditure. For example, a business may regularly deduct amounts less than $1,000, while higher expenditures are reviewed to determine the proper accounting and tax treatment.  The IRS will examine these under the threshold expenses in much greater detail going forward.