The RABI rules are essential because they determine whether an expenditure on a building after it’s placed in service needs to be expensed or capitalized.
These are the four rules that have to be passed for an expenditure to be expensed. There are other nuances to the regulations, like the safe harbor and Partial Asset Dispositions, but this is the meat and potatoes in a single article.
- Taxpayers must capitalize all the direct costs and indirect costs (including expenditures that would typically be expensed) that are categorized as an improvement.
- Indirect costs that are NOT PART of a betterment, major improvement, adaptation, or betterment are not required to be capitalized under the Tangible Property Regulations, even if the costs were incurred at the same time.
- If a Taxpayer disposes of a depreciable asset, including a partial asset disposition, and has realized gain or loss, then the costs of removing the component can be expensed.
- If a Taxpayer or building owner disposes of a component of a building but does not realize gain or loss (partial asset disposition), then the removal costs must be capitalized.
- Expenditures that fall into the category of an improvement also include amounts paid over multiple years if the project or effort spans more than one year.
- A federal, state, or local requirement that a building must undergo modifications that fall into the category of a betterment or major improvement must still be capitalized.
- If a component of a building needs to be replaced, but technology or product improvements have advanced so much that the comparable component improves the building, the replacement of the component does not by itself result in a betterment and can be expensed.
- In situations when a replacement component is required because of normal wear and tear that occurred during the current owner’s use of the building, the decision of whether an expenditure qualifies as a betterment is made by comparing the condition of the property immediately after the expenditure with the condition of the property immediately before the expenditure.
- If the expenditure returns the component (s) to its ordinarily efficient operating condition after it had deteriorated to a state of complete disrepair and is no longer used for its original intended purpose, it must be capitalized.
- If the expenditure rebuilds the building component to like-new condition after the end of its depreciable ADS class life, it also must be capitalized.
- If the replacement parts comprise a major building component or substantial structural part of the building structure, the expenditure must be capitalized IF the replacement part or parts affect more than 33% of all the like parts.
- For example, if more than 33% of the building’s wiring is replaced, the cost must be capitalized.
- Another example is if eight out of 20 sinks are replaced, the cost can be expensed.
- If the expenditure changes the building’s original intended use, the cost must be capitalized.
- An example is the cost of changing the building from a strip mall to a residential rental. The entire cost must be capitalized.