M&E Accounting: BRA Test, Safe Harbors, and Depreciation

Every dollar you spend on machinery and equipment forces a tax question: deduct it this year, or capitalize it and recover the cost through depreciation over several years. Machinery and equipment tax accounting turns on that single call. Routine repairs and maintenance are deductible under Internal Revenue Code Section 162 in the year you pay them.¹ Costs that go beyond upkeep must be capitalized. Several IRS safe harbors and first-year expensing provisions can collapse that multi-year recovery back into the current year when you qualify.

Deduct Now or Capitalize? The BRA Test

The IRS Tangible Property Regulations draw the line with a three-part test. You must capitalize a cost if it does any one of the following to the property: betters it, restores it, or adapts it to a new or different use.² Fail the test on all three fronts and the cost is a current-year deduction.

A betterment materially increases the capacity, strength, or quality of the property beyond what it could do before. Swapping a standard HVAC unit for a high-efficiency model that covers a larger area is a betterment. A restoration brings property back to working condition after it has deteriorated past normal wear or has been taken out of service. Rebuilding a production line that sat idle for years qualifies. Adaptation means converting property to a fundamentally different purpose, such as turning a warehouse into retail space.

Why the Unit of Property Changes the Answer

The test doesn’t measure the expenditure against the whole facility. It measures it against a specific unit of property, and the scope of that unit changes the result.

For buildings, the IRS treats the structure itself as one unit and breaks out eight separate building systems: HVAC, plumbing, electrical, elevators, escalators, fire protection and alarm, gas distribution, and security.² Fixing a leaky pipe is a repair to the plumbing system. Replacing all the plumbing throughout the building is a restoration of that system and gets capitalized, even if the building’s function never changes.

For machinery, the unit is typically the entire machine. Swapping a worn belt on a conveyor is a deductible repair. Overhauling the conveyor to add a decade of operational life is a restoration that must be capitalized. Scope relative to the full unit tends to decide it.

Safe Harbors That Let You Expense Smaller Costs

The IRS recognizes that running every small purchase through the BRA test would be impractical. Four safe harbors let you expense amounts that might otherwise look like improvements. Each is elected annually on your return; none requires advance approval.

De Minimis Safe Harbor

If your business has an applicable financial statement — audited financials, an SEC filing, or certain other statements — you can deduct individual items costing up to $5,000 each. Without an applicable financial statement, the per-item ceiling is $2,500.³ Cost is measured per invoice or per item as the invoice shows it, and you must treat the amount as an expense on your books to claim the deduction. This is the workhorse election for routine equipment and low-cost parts.

Small Taxpayer Safe Harbor

If your average annual gross receipts are $10 million or less and you own or lease a building with an unadjusted basis of $1 million or less, you can deduct repair, maintenance, and improvement costs on that building up to the lesser of $10,000 or 2% of the building’s unadjusted basis.² A $500,000 building caps the deduction at $10,000; a $400,000 building caps it at $8,000.

Routine Maintenance Safe Harbor

Recurring work that keeps property in ordinary operating condition can be deducted if you reasonably expect to perform it more than once during the relevant timeframe. For building structures and building systems, the window is ten years from the date the property is placed in service. For other property, it’s the asset’s class life.² Filter replacement, machinery lubrication, and floor resurfacing all fit. The catch: this safe harbor does not cover betterments. If the work improves the property beyond its original condition, you can’t use it.

Materials and Supplies

Items costing $200 or less per unit, or with a useful life of 12 months or less, qualify as deductible materials and supplies regardless of whether they might otherwise require capitalization.⁴ The deduction is taken when the item is first used or consumed, not when purchased. For most small replacement parts, this is the simplest path to a current-year deduction.

Writing Off Capitalized Costs in Year One

When a cost must be capitalized, you aren’t necessarily locked into years of depreciation. Two provisions let you pull the full deduction into the year the asset is placed in service, and for many businesses they eliminate ongoing depreciation tracking entirely.

Section 179 Expensing

Section 179 lets you deduct the full cost of qualifying equipment, machinery, and certain improvements in the year you buy and start using them. For tax years beginning in 2026, you can expense up to $2,560,000 of qualifying property. The deduction phases out dollar-for-dollar once total qualifying property placed in service exceeds $4,090,000, which effectively caps the benefit at small and mid-sized businesses.⁵ Qualifying property includes most tangible personal property used in your business, off-the-shelf computer software, and qualified improvement property for nonresidential buildings.

One constraint matters: the Section 179 deduction cannot exceed your business’s taxable income for the year. Any excess carries forward. You can’t use Section 179 to create or deepen a net operating loss.

Bonus Depreciation

The One, Big, Beautiful Bill restored a permanent 100% additional first-year depreciation deduction for qualified property acquired after January 19, 2025.⁶ Unlike Section 179, bonus depreciation has no dollar cap and can generate a net operating loss, which makes it the more flexible tool for larger capital investments. If you’d rather spread deductions, you can elect a reduced 40% first-year rate for property placed in service during the first tax year ending after January 19, 2025.

Qualified improvement property placed in service after 2017 is classified as 15-year property under MACRS and is eligible for both Section 179 and bonus depreciation.⁷ QIP covers interior improvements to nonresidential buildings, excluding enlargements, elevators, escalators, and changes to the building’s internal structural framework. This matters when you’re renovating leased commercial space or upgrading a production floor.

Which One to Pick

For most small businesses buying equipment well under $2,560,000, the practical difference is minimal and both produce a full first-year deduction. The choice matters when you’re in a loss position (bonus depreciation can deepen the loss; Section 179 cannot), when you’ve exceeded the phase-out threshold (bonus has no cap), or when state tax treatment diverges. A significant number of states decouple from federal bonus depreciation, which can leave you owing state tax on income you’ve already deducted federally. Check your state’s conformity rules before locking in a strategy.

When You Have to Depreciate: MACRS Basics

When a capitalized cost doesn’t get fully expensed in year one, the remaining basis is recovered through depreciation under the Modified Accelerated Cost Recovery System. MACRS applies to most tangible property placed in service after 1986.⁷ It assigns each asset a recovery period, often shorter than its actual economic life, which accelerates the deduction beyond what straight wear and tear would suggest.

Machinery, office equipment, computers, and vehicles typically get a 5-year recovery period. Office furniture, fixtures, and certain manufacturing equipment land in the 7-year category. Qualified improvement property gets 15 years; nonresidential building structure gets 39.⁷

Three methods are available under the General Depreciation System. The 200% declining balance method front-loads the deduction and is the default for 3-, 5-, 7-, and 10-year property. The 150% declining balance method is milder and defaults for 15- and 20-year property. Straight-line spreads the deduction evenly, and you can elect it for any class.⁷

Depreciable basis is the purchase price plus any costs required to put the asset in service: freight, installation, site preparation. If you claimed partial Section 179 or bonus depreciation, the remaining basis is what runs through the regular MACRS schedule.

Selling or Scrapping an Asset

When you sell, scrap, or retire a capitalized M&E asset, you recognize a gain or loss. Subtract the adjusted basis (original cost minus depreciation claimed to date) from what you received. The result goes on Form 4797.⁸

This is where many businesses get surprised. Section 1245 treats any gain on the sale of depreciable personal property as ordinary income to the extent of all depreciation previously claimed on that asset.⁹ Buy a machine for $100,000, claim $60,000 in depreciation, sell it for $70,000: the gain is $30,000 ($70,000 minus $40,000 adjusted basis), and all of it is ordinary income because it falls within the $60,000 of depreciation taken. Only gain beyond total depreciation claimed would reach capital gains rates, which rarely happens with equipment that’s been in service long enough to depreciate heavily. A loss on disposition is generally ordinary and can offset other business income.

Partial Disposition Election

You don’t always dispose of a whole asset. When you replace a building component such as a roof or a complete HVAC system, the Tangible Property Regulations let you elect a partial disposition. The election recognizes a loss on the retired component’s remaining undepreciated basis instead of letting you keep depreciating something that’s now in a dumpster.¹⁰ It must be made on a timely filed return for the year of disposition. Without it, the old component continues depreciating alongside the new capitalized replacement, inflating basis and costing you deductions you’re entitled to.

Fixing a Past Misclassification

If you discover you’ve been capitalizing costs that should have been expensed, or vice versa, you can’t simply switch going forward. The IRS treats the change as a change in accounting method, which requires Form 3115. For repair-versus-improvement corrections, the change falls under Designated Change Number 184 and qualifies for automatic approval, so you don’t need advance permission.¹¹

Attach the form to your timely filed return (including extensions) for the year of change and send a copy to the IRS National Office. Along with it, calculate a Section 481(a) adjustment that reflects the cumulative difference between what you deducted under the old method and what you should have deducted. A negative adjustment (you underclaimed) is taken entirely in the year of change. A positive adjustment (you overclaimed) is spread over four years.¹²

The filing is worth doing even if the error seems small. A pattern of misclassification that understates taxable income can trigger accuracy-related penalties of 20% on the resulting underpayment.¹³ Voluntary correction through Form 3115 is far cheaper than defending the same issue in an audit.

Records That Support Your Classification

The quality of your records decides whether your expense-versus-capital calls hold up. The foundation is the work order. Every maintenance activity should have a document identifying the asset worked on, describing what was done and why, listing the parts and labor involved, and recording who authorized the work. This is what an auditor uses to evaluate whether the BRA test was applied correctly.

Invoices, internal memos, and vendor quotes should cross-reference the work order. If you expensed a cost, the file should show why the work didn’t rise to a betterment, restoration, or adaptation. If you capitalized it, the file should reflect the depreciable basis, the recovery period, and the MACRS method applied. Businesses that keep this trail tend to come through audits intact. Businesses that don’t tend to lose classification arguments regardless of whether the original call was right.

Every capitalized asset should live in a fixed asset ledger that reconciles to the general ledger. For each one, the ledger needs the acquisition date, original cost, MACRS method, recovery period, convention, and a running balance of accumulated depreciation. This is where your Form 4562 data comes from each year and where adjusted basis calculations begin when an asset is sold or retired.¹⁴ Keeping it current is not optional. The IRS requires that information supporting your depreciation deductions remain in your permanent records, even though you don’t submit asset-level detail with your return.

1
Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
2
Internal Revenue Service. Tangible Property Final Regulations – Frequently Asked Questions
3
Internal Revenue Service. Increase in De Minimis Safe Harbor Limit for Taxpayers Without an Applicable Financial Statement – Notice 2015-82
4
eCFR. 26 CFR 1.162-3 – Materials and Supplies
5
Internal Revenue Service. Revenue Procedure 2025-32 – Section 4.24 Election to Expense Certain Depreciable Assets
6
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
7
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
8
Internal Revenue Service. About Form 4797, Sales of Business Property
9
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
10
eCFR. 26 CFR 1.168(i)-8 – Dispositions of MACRS Property
11
Internal Revenue Service. Instructions for Form 3115 – Application for Change in Accounting Method
12
Internal Revenue Service. 4.11.6 Changes in Accounting Methods – Internal Revenue Manual
13
eCFR. 26 CFR 1.6662-2 – Accuracy-Related Penalty
14
Internal Revenue Service. Instructions for Form 4562 (2025) – Depreciation and Amortization