Last month the IRS released final tangible property regulations which include significant taxpayer-friendly changes and will challenge virtually every business effective January 1, 2014. The basic requirements within the temporary regulations covering acquisition and improvements of tangible property issued in December 2011 remain intact. Changes to the temporary regulations were made to “clarify, simplify and refine” as well as to create several new safe harbors.
The IRS also released proposed regulations addressing property dispositions that modify and supersede the guidance provided in the temporary regulations. Final disposition regulations as well as additional guidance on implementation of the tangible property regulations are expected by the end of the year.
The following is a brief summary of the recent changes to the tangible property rules and the effect they may have upon your business:
Capital Expenditures and Improvements
The final regulations provide a general, simplified framework for distinguishing between costs that may be deducted, such as for repairs, maintenance or supplies, and costs to acquire or improve a unit of property (UOP) that must be capitalized and depreciated.
The temporary regulations classified improvements to a UOP that must be capitalized as betterments, restorations or adaptations. The new regulations include revised descriptions for betterments, restorations and adaptations. They also provide additional guidance for lessees and lessors on when to capitalize improvements to leased property.
A simplified de minimis safe harbor allows taxpayers to elect to deduct for tax purposes costs that were expensed in accordance with written financial procedures on an applicable financial statement (AFS). Eligible costs include amounts paid up to $5,000 per invoice, or per item if separately indicated on an invoice. The definition of an AFS was not changed. Taxpayers without an AFS may also elect to apply the de minimis safe harbor for costs up to $500 per invoice, or per item if separately indicated on an invoice, providing that the costs are expensed on its internal books and records following written financial procedures. The ceiling rule, which limited the amount of deductible de minimis expenditures, was eliminated.
Qualifying small taxpayers may elect to deduct annual costs incurred to repair, maintain or improve eligible building property as long as the total amount paid does not exceed the lesser of 2% of the unadjusted basis of the building or $10,000. A qualifying taxpayer’s 3-year average gross receipts must not exceed $10 million. Eligible building property has an unadjusted basis of $1 million or less, excluding land.
Materials and supplies
The definition of deductible materials and supplies was modified to include a UOP with a cost of $200 or less (formerly $100 or less).
The optional election to capitalize and depreciate materials and supplies was limited to rotable, temporary or standby emergency spare parts and the option is subject to certain exceptions.
The safe harbor for routine maintenance costs was extended to buildings. But the regulations require that the taxpayer reasonably expect the maintenance activities to be performed more than once in the 10-year period following the date the building was placed into service.
The regulations provide a new, optional election to capitalize and depreciate repair and maintenance costs if the business capitalizes the costs on its internal books and records.
Dispositions and General Asset Accounts (GAA)
The temporary regulations allowed taxpayers to record a loss on a retirement of a structural component of a building. However, if the building was included in a GAA, the taxpayer was not required to recognize a retirement loss. Under the new, proposed regulations the building is recognized as a single asset and taxpayers may waive loss recognition on disposition of a structural component, even if a GAA election was not made.
The proposed regulations retain the partial disposition election which allows taxpayers to recognize a loss upon disposition of a structural component of a building. Although generally elective, the partial disposition rule is required in certain situations. Additionally, for assets included in a GAA, a GAA termination election or qualifying disposition election may be necessary.
The proposed regulations also include changes to the basis and asset identification rules for partial dispositions.
These regulations will be effective for taxable years beginning on or after January 1, 2014. It’s expected that most businesses having tangible property will be affected, and implementation of many of the regulations will require businesses to apply for multiple changes in accounting methods. Whether these changes will have a favorable or unfavorable tax effect will depend upon each business’s specific set of circumstances.
If you’d like help in planning for the implementation of these new regulations, contact one of our tax professionals and we’d be happy to assist!
Author: Chalayane Woodke, CPA
This blog post is a summary and is not intended as tax or legal advice. You should consult with your tax advisor to obtain specific advice with respect to your fact pattern. Based on the most recent “best practice” standards for tax advisors issued by the Treasury Department, commonly referred to as Circular 230, we wish to advise you that this blog post has not been prepared to be used, and cannot be used, to provide assurance that penalties which may be assessed by the IRS or other taxing authority (including specifically section 6662 understatement penalties) will not be upheld.