Question

Matt hired Apex Services to repair his business equipment. On November 1 of year 0, Matt paid $2,000 for the repairs that he expects to begin in early March of year 1. (Leave no answers blank. Enter zero if applicable.)

a. What amount of the cost of the repairs can Matt deduct in year 0 if he uses the cash method of accounting for his business?

b. What amount of the cost of the repairs can Matt deduct in year 0 if he uses the accrual method of accounting for his business?

Answer 1

As per IRS one is not required to capitalize amounts for creating an intangible asset if the right or benefit created does not extend beyond the earlier of 12 months after the date that one first receive the right or benefit or the end of the tax year following the year in which you made the advance payment. If you are a cash method taxpayer and your advance payment qualifies for this exception, then you can generally deduct the amount when paid. If you are an accrual method taxpayer, you cannot deduct the amount until the all-events test has been met and economic performance has occurred.

In simple words a cash basis taxpayer deducts expenses in the year they are paid off, which is not necessarily the year they were incurred. However, expenses paid in advance may not be deducted; instead, the IRS allows the taxpayer to capitalize certain costs. Expenses paid in advance are deductible only in the year to which they apply, unless the expenses qualify for the 12-month rule, under which a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer.

In Year 0 Matt can deduct $ 2000 towards cost of repair if he uses cash method of accounting for business

In Year 0 Matt cannot deduct any amount paid towards cost of repairs, he can deduct only in year 1, if he uses accrual methid of accounting for his business