A Taxing Question

Black Hardware Co. v. Commissioner
Black was located in Galveston, Texas. The city periodically experienced severe flooding, and in 1919 a committee recommended that the level of the entire city be raised about 12.5 feet above sea level. (The plan was never put into effect.)  In order to prevent any potential flood damage Black raised its flooring by 4.5 feet.

The court ruled that these costs should be capitalized and depreciated over their useful life.

In both cases, the costs were incurred to prevent damage. Both taxpayers deducted the costs as repairs on their tax returns.

However, the courts disallowed the deduction on Black’s tax return. Why would the courts allow Midland to deduct their cost as repairs, but rule that Black must capitalize its cost?

In the Midland case, there was no previous knowledge of the oil seepage. In order to continue business as usual, Midland believed it had to seal the basement to prevent any contamination. The court ruled that the expenditure was necessary because the basement would no longer be considered operational if it was not sealed.

In the Black case, the business had been operational for several years, even during periods of major flooding. The court concluded that the costs to raise the floor level provided protection from future flood damage and therefore did more than keep the property in normal operating condition.

The expenditures rendered the building better suited to the purpose for which it was being used.

When deciding if an expenditure is a capital improvement or a repair, the taxpayer must consider the purpose of the expenditure.  If the answer isn’t clear-cut, consider contacting a tax professional for advice in order to avoid any potential issues with the IRS.

This article is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the subject, please contact Chris Steedly or an independent tax advisor to discuss your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this article may be considered to contain written tax advice, any written advice contained in, forwarded with, or attached to this article is not intended to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

Chris Steedly
Chris Steedly
Chris Steedly CPA is a tax specialist at Williams Benator & Libby in Atlanta, GA. Chris specializes in Federal and Multi-State income tax issues.

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