Deconstructing the General Plan of Rehabilitation Doctrine

The general plan of rehabilitation doctrine provides that expenses incurred as part of a plan of general rehabilitation must be capitalized even though the same expenses incurred separately would be deductible as ordinary and necessary repairs. The emerging general standard after INDOPCO for current deduction of an expenditure with future benefits, the case with most repair/improvement expenditures, is a balancing test: Whether the taxpayer's administrative and record keeping costs associated with capitalization outweigh the potential distortion of income from a current deduction of the future benefit expenditures. "Rough justice" rules for current deduction of future benefits expenditures, reflecting that balancing standard, include whether (1) the expenditure is relatively small or the future benefit is "incidental" to the current benefit, (2) the expenditures are regularly recurring, (3) future benefits are short-term or variable, and (4) the burdens of capitalization outweigh in general the revenue benefits to the Treasury from capitalization of the expenditure; for example, where the cost once capitalized may not be depreciated or depreciated only over a period longer than the expected future benefit (slow or no depreciation). The Service and courts often have incorrectly relied on the general plan of rehabilitation to capitalize post-INDOPCO repair or improvement costs, where one of these rough justice exceptions to capitalization should have been used. This article maintains that the only sound basis for the general plan of rehabilitation doctrine is the rule of tax parity or horizontal equity, viz., equivalent treatment between a taxpayer who purchases a business asset and one who constructs it herself. Thus, a taxpayer who rehabilitates a run-down building should be treated the same as a taxpayer who purchases a renovated similar building. Applying this analysis this article discusses (1) the inapplicability of the general plan of rehabilitation doctrine to assets other than the particular asset being improved; (2) unavailability of depreciation or too slow depreciation as a basis for currently deducting remediation costs to avoid the distortion of income that would arise from no or too slow depreciation, so that a current deduction should be allowed, notwithstanding a concurrent general plan of rehabilitation under the "reverse" rule of tax parity; (3) such distortion of income reasoning does not apply where remediation is anticipated at time of purchase since the acquisition cost doctrine would then apply (under a rule of tax parity reasoning although not so articulated in the case law), even in the absence of a general plan of rehabilitation; (4) a minimum distortion of income analysis of repair versus improvement expenditures; (5) where cyclical repairs occur more frequently than the recovery period of the repaired asset, the cost of the repairs should be treated as a freestanding intangible and depreciated over the recurrence period or currently deductible if sufficiently insubstantial or short or variable term, or no or only slow depreciation would be available if capitalized; and (6) where those repairs occur in a cycle substantially identical to the recovery period of the repaired asset, their cost should be capitalized and depreciated over that recovery period to avoid distortion of income.