Implementation of New IRS Tangible Property Regulations

(EXPENSING VS. CAPITALIZING AND DEPRECIATING)

SUMMARY

The IRS has released final regulations providing guidance on the deduction and capitalization of expenditures related to tangible property. The rules associated with these regulations apply to all business activity related to the acquisition, production, or improvement of tangible property, and are generally effective for tax years beginning on or after January 1, 2014.

These regulations may provide certain advantages with regard to timing of deductions and minimizing the risk of IRS assessments. However, in order to conform to the new regulations and reduce the risk of IRS scrutiny and future audit adjustments, HBE advises all taxpayers with business activity that may be affected by the new regulations to consider changing their accounting method for repairs and maintenance expenditures as well as their capitalization procedures for tangible property improvements. To do so may require the filing for Form 3115, Application for Change in Accounting Method. 

BACKGROUND

Generally, all ordinary and necessary expenses paid or incurred during the tax year related to trade of business operations may be deducted. Conversely, amounts paid to acquire, produce, or improve tangible property must be capitalized as fixed assets and depreciated. Current IRS standards for determining whether an expense may be deducted as a repair or must be capitalized require a facts and circumstances test. Various versions of temporary and proposed tangible property regulations attempted to simplify these rules.

With the release of the final IRS tangible property regulations, the general rule states that amounts paid to improve a unit of property must be capitalized. An improvement is defined as an expenditure that betters a unit of property, restores it, or adapts it to a new and different use.

ADDITIONAL PROVISIONS AND HIGHLIGHTS OF THE FINAL REGULATIONS

A few new provisions in the regulations include:

  • An annual election to capitalize certain rotables or temporary supplies.
  • Separate annual de minimis elections for repairs and maintenance of up to $5,000 for taxpayers with an applicable financial statement (AFS) and up to $500 for those without an AFS.
    • An “AFS” is generally a set of financials audited by an independent CPA or financial statements provided to any Federal or state agency other than the IRS.
  • A new rule that addresses the accelerated deduction related to a partial disposition.
  • A safe harbor elected annually for routine maintenance for buildings—lesser of $10,000 or 2% of building’s unadjusted basis.
    • Allowed for “qualifying small taxpayers” (those businesses with gross receipts of $10 million or less) for improvements to “eligible building property” (building with unadjusted basis less than $1 million).
  • Routine maintenance safe harbor for buildings and non-buildings.
    • This differs from the “small taxpayer” safe harbor.
    • The rules are different for a building vs non-building, but could allow for expensing instead of capitalizing.

Other highlights of the regulations include:

  • The increased dollar amount threshold under the de minimis safe harbor for materials and supplies (from $100 to $200)—no election required.
  • The refinement of the rules for improvements made by a lessee.
  • The clarification of the types of repairs that now constitute betterments/restoration/adaptation to property and the new rules on how to segregate real property assets into “units of property” to apply the new standards.
  • The revision of the major component rule and the casualty loss rule under the restoration standards.

DE MINIMUS ELECTION

To utilize the $500/$5,000 de minimis election, businesses must revise their written accounting procedures to comply with the new regulations as of January 1, 2014. A capitalization policy stating the chosen de minimis threshold regarding capitalizing or charging to expense must be kept in your business or personal records. This threshold will be followed for both book and tax purposes. If you’d like a copy of an appropriate accounting procedure template, please contact our office at (402) 423-4343.

FORM 3115

It has been determined that since some of the guidelines for the safe harbors and betterment/restoration rules did not previously exist, it is not possible for taxpayers to comply with these new regulations without obtaining IRS consent via Form 3115, Application for Change in Accounting Method. Even though there may not be a current change to the timing of deductions, an accounting method change is still required if it affects the future timing of deductions for related tangible property expenditures. It is important to note that filing Form 3115 is a one-time method change; once the form is filed, it will cover the taxpayer for all future years. This is different than the previous annual election mentioned above.

In order to conform to the new regulations and reduce the risk of IRS scrutiny and future audit adjustments, HBE advises all taxpayers to whom the new regulations may apply to file Form 3115.

In summary, these regulations are lengthy and complex. It is important to understand how expenditures should be recorded on your books and what elections need to be made as a taxpayer. We would be happy to answer any questions you have about the tangible property provisions and help you to implement these rules for your business.

Should you have any questions or concerns, please contact our office at (402) 423-4343 at your earliest convenience. As always, our team of trusted advisors is here to help.

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