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Tangible Property Regulations Executive Summary


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In 2014, the IRS and Treasury issued final tangible property capitalization regulations, which are commonly referred to as the “repair regulations.”  These final regulations attempt to bring clarity to a complicated area of tax law. Concurrently, proposed regulations dealing with dispositions of property, including partial dispositions were also issued.  

The line between an improvement that has to be capitalized and depreciated vs. a deductible expenditure for repairs or maintenance is not always clear. The prior tax regulations dealing with capitalization of costs for tangible assets (other than inventory) were very general (4 pages). This left much room for interpretation as to which expenditures were deducted vs. capitalized. Most of the old law was developed through many years of case law and IRS rulings. These new regulations replace the old law and are generally effective for tax years beginning on or after January 1, 2014.

Brief Summary Of The Tangible Property Regulations

The unveiling of these final tangible property capitalization regulations is the culmination of a multi-year effort involving intermediate guidance and taxpayer feedback. The new regulations are extensive and include over 200 pages of guidance and over 170 examples.  The regulations include guidance in the following areas:

  1. De minimis safe harbor – Taxpayers may make an annual election to claim a current deduction for the cost of acquiring items of tangible property and materials and supplies up to safe harbor limit if certain requirements are met.  The safe harbor amount is $5,000 for taxpayers with applicable financial statements and $500 for taxpayers without applicable financial statements.  Immediate attention needs to be given to this safe harbor election since it generally requires written accounting procedures in place to account for the safe harbor amounts as deductible expenses at the beginning of the taxable year (i.e. January 1, 2014 for calendar year taxpayers).
  2. Materials and supplies – Specific accounting methods and rules regarding the accounting treatment and the deductibility of materials and supplies (including rotable and temporary spare parts) are provided, along with a definition as to which items are considered materials and supplies.
  3. Amounts paid to acquire or produce tangible property – Specific guidance is provided as to which costs associated with the acquisition or production of real or personal property must be capitalized to the basis of the property and which costs may be claimed as a current deduction (including transaction costs, moving and reinstallation costs, and costs related to the defense or perfection of title to property).
  4. Amounts paid to improve tangible property – This is the "main course" of the regulations which provides rules for distinguishing repairs from capital expenditures.  Capital expenditures are divided into three categories of improvements: betterments, restorations, and adaptations.  The regulations provide specific guidance as to which expenditures are considered betterments, restorations, and adaptations.  Generally, whether an expenditure is a capital improvement is based on facts and circumstances.  In order to determine whether an expenditure has to be capitalized as an improvement or is deductible as a repair, it is necessary to determine the “unit of property” for which the expenditure relates.  An expenditure on a large unit of property is more likely to be considered a repair expense. The regulations contain detailed rules for determining the unit of property in the case of buildings and other types of property.

    The regulations provide exceptions to capitalization by providing:
            A.   A safe harbor for small taxpayers
            B.   A routine maintenance safe harbor

    The regulations also provide for an election to capitalize repair and maintenance costs consistent with books and records.
  5. Improvements to leased property – Guidance is provided for determining whether amounts paid by a taxpayer for an improvement to a leased property must be capitalized.
  6. Dispositions of property – Specific rules are provided for dispositions of assets and partial dispositions of assets, including dispositions of building components.   Previously, taxpayers were generally not allowed to write off dispositions of building components.  The new regulations provide for a partial disposition election; allowing for a taxpayer to recognize a loss on retirement of a building component.

Implementing The Required Changes To Comply With The Tangible Property Regulations

There will generally be two phases to fully implement the new regulations as follows:

Phase 1 - Implementing the new rules going forward for tax years beginning on or after January 1, 2014 - Taxpayers are required to change their accounting methods used for federal income tax reporting purposes to comply with the new regulations for tax years beginning on or after January 1, 2014.  Alternatives for dealing with the required tax accounting method changes going forward are as follows:

Alternative 1 – The taxpayer does not change accounting methods for book and financial statement purposes and only changes accounting methods for tax reporting purposes.   At the end of the tax year, additional procedures would be required to determine the book and tax differences for tax reporting purposes.  In some cases, these additional procedures each year could be substantial.  For example, one of the procedures would be to review various transactions during the tax year in expense accounts to determine if any items or repairs should be capitalized under the new rules and if so, they would be added as assets to the tax depreciation schedules.  This could create many book and tax differences in the cost basis of fixed assets going forward.

Alternative 2 – Many taxpayers have previously used accounting methods relating to capitalization for book and financial reporting purposes that were acceptable for tax reporting purposes.  Therefore, previously book and tax differences dealing with capitalization differences have been minimal.  In order to keep these book and tax differences relating to capitalization issues minimal going forward, taxpayers should consider changing their book and financial statement accounting methods to the methods required for tax reporting purposes at the beginning of the first tax year beginning on or after January 1, 2014. 

Phase 2 – Determining the impact of the required changes in accounting methods and related reporting –Even though the changes in accounting methods that are required to comply with the new rules are mandatory, such changes are still considered changes in accounting method that will have to be reported to the IRS on form 3115 for the year of the change. 

Most of the changes in accounting methods apply to tax years beginning on or after January 1, 2014. To give effect to a change in accounting method, an adjustment is generally required (481(a) adjustment) as of the first day of the taxable year of the year of change. This essentially means such changes are retroactive.

For example, if an expenditure was deducted by a taxpayer in a previous year but would have been capitalized under the new regulations and the taxpayer owns the property as of the first day of the year of the change; to effect the change, the taxpayer would be required to add the capital expenditure to its tax fixed assets (i.e. as of January 1, 2014 for calendar year taxpayers) and determine the accumulated tax depreciation that would have been taken through the year prior to the year of change.  If positive, this net adjustment is required to be included in taxable income over 4 tax years.  Any negative adjustments can generally be deducted entirely in the year of change.  However, some of the changes to comply with the new regulations apply to amounts paid or incurred in tax years beginning on or after January 1, 2014 and, therefore, are not retroactive and do not require the calculation of an adjustment to effect the change. 

For more information you can visit the Tangible Property Regulations - Frequently Asked Questions page on the IRS website or contact us for further discussion.

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Posted in: Financial Solutions, Tax
Tagged with: Business Tax