Implementing the New Tangible Property RegulationsNovember 21, 2014 | Download PDF
Implementing the New Tangible Property Regulations The IRS released final regulations addressing the treatment of repairs and maintenance expenses for federal income tax purposes as well as regulations governing the treatment of dispositions of tangible assets and the treatment of assets included in general asset accounts (GAAs) that are deemed to be disposed of upon the completion of significant repairs. The changes, however, extend beyond just repairs and address the tax treatment of improvements, repairs and maintenance, materials and supplies, spare parts and acquisition costs as well as a broad range of capitalization and deduction issues associated with tangible property expenditures and potentially impacting businesses in all industries.
This article provides a brief description of the significant areas addressed by the final regulations.
As many of you may know, the Internal Revenue Service (IRS) released final regulations addressing the treatment of repairs and maintenance expenses for federal income tax purposes as well as regulations governing the treatment of dispositions of tangible assets and the treatment of assets included in general asset accounts (GAAs) that are deemed to be disposed of upon the completion of significant repairs. The changes, however, extend beyond just repairs and address the tax treatment of improvements, repairs and maintenance, materials and supplies, spare parts and acquisition costs. These changes address a broad range of capitalization and deduction issues associated with tangible property expenditures and potentially impact businesses in all industries. Compliance with the final regulations is generally mandatory for tax years beginning on or after January 1, 2014. As such, these rule changes need to be addressed for the 2014 tax year. Due to the information requirements and required timing associated with certain elections and policies, aspects of the new provisions should be taken into consideration prior to year-end. As noted, the regulations provide guidance with regard to the capitalization or current deduction for costs incurred to acquire or improve tangible property, repairs and maintenance of tangible property, the treatment of materials and supplies, as well as providing guidance for certain dispositions for federal income tax purposes. In addition to guidance, the regulations also provide safe harbor provisions and elections in an effort to reduce the administrative burden of applying the new rules. The following briefly describes the significant areas addressed by the final regulations: Materials and supplies The final regulations provide specific definitions to determine whether a cost is characterized as a material or supply and increases the dollar threshold for property included in the definition from $100 to $200. In addition, the regulations provide rules for determining the timing for deducting expenditures for materials and supplies, an optional method for rotable spare parts and an election to capitalize certain materials and supplies, but limit such election to rotable, temporary or standby emergency spare parts. Capital expenditures Amounts paid to improve property Taxpayers must generally capitalize amounts paid for the purchase of tangible property as well as expenditures incurred to improve tangible property. The final regulations provide that an expenditure is considered to improve a unit of real or personal tangible property if it results in a betterment of the unit of property, restoration of a unit of property or the adaptation of a unit of property for a new or different use. The final regulations provide definitions and examples of what may be considered betterment, restoration or adaptation of property as well as a definition of a unit of property for purposes of applying the capitalization provisions. The regulations also provide certain safe harbors and annual elections that allow for reduced administrative burdens in complying with the rules. We note that in applying the new provisions, there may be some opportunity to currently deduct certain expenditures where under prior rules such amounts or categories may have been required to be capitalized for tax purposes. The de minimis rule for expensing The final regulations provide an annual election that will allow taxpayers to apply a de minimis safe harbor to the capitalization provisions. Under the safe harbor, a taxpayer with an applicable financial statement (generally audited financials) can apply the de minimis rule to deduct all amounts properly expensed as long as the amount paid for property doesn’t exceed $5,000 per invoice or per item, and provided the taxpayer has a written accounting policy in place as of the beginning of the tax year and treats such items as an expense in its applicable financial statement. For taxpayers without an applicable financial statement, the safe harbor will apply for amounts paid for items costing up to $500, provided the other requirements of the safe harbor are met. Routine maintenance Expenditures are not considered improvements if the cost was incurred as a result of the taxpayer’s use of the property or to keep the property in operating condition. The regulations note that an expenditure is considered routine if, at the time the property was placed in service, the taxpayer reasonably expected to perform the maintenance and incur the related costs more than once during the property’s life. With regard to building maintenance, the taxpayer must reasonably expect to perform the building-related maintenance and incur the related costs more than once in a 10-year period. Small business safe harbor The regulations provide a safe harbor for qualified small businesses (generally, those with gross receipts of $10 million or less). For buildings that initially cost $1 million or less, taxpayers may elect to deduct the lesser of $10,000 or 2 percent of the adjusted basis of the property for repairs, maintenance, improvements and similar activity each year. Costs to acquire or produce tangible property Costs paid or incurred to facilitate the acquisition or production of tangible property generally must be capitalized under the final regulations. The regulations provide a list of certain costs that are inherently facilitative and, thus, must be capitalized under the new rules; they also detail certain exceptions to the capitalization provisions. Dispositions Finally, the disposition regulations issued in August of 2014 provide guidance regarding dispositions of tangible depreciable property and guidance regarding certain general asset account (GAA) elections. More specifically, the final disposition regulations provide rules for determining gain or loss upon the disposition of property, determining the asset disposed of and accounting for partial dispositions of property. The regulations also address similar provisions for taxpayers electing GAA treatment for certain assets including the rules and elections available when disposing of an asset included in a GAA and the ability to terminate prior elections. Going forward If you have expenditures related to tangible property, the final regulations will apply to you. As noted, generally, all taxpayers are required to comply with the final regulations for their first tax year beginning on or after January 1, 2014. In order to assess your compliance with the regulations, we recommend a review of each of the above areas as well as a review of your current accounting and capitalization policies. Compliance with the new rules may require changes to your current capitalization procedures, and consideration should also be given to making one or more of the annual safe harbor elections. In addition, we expect that most, if not all, taxpayers, will be required to file an “Application for Change in Accounting Method”, Form 3115, to reflect changes in methodology to comply with the new rules. Note that you will also be required to maintain documentation to support your specific treatment of items applicable to the final regulations to ensure compliance in 2014 and future years. As such, to aid in the compliance with the final regulations, it may be helpful to consider an adjustment to your chart of accounts to align with the new categories.
David R. Gette CPA, is a Partner in the Tax Practice at Marks Paneth LLP. He specializes in transactional matters with a focus on tax consulting and reporting. He has extensive experience with tax due diligence as well as planning and structuring for business acquisitions and dispositions and post-deal integration.
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