Should expenditures related to tangible property be expensed or capitalized?
This is the question that the IRS has addressed with its tangible property regulations, which has been the source of much confusion for many years.
On September 13, 2013, the IRS issued new and final tangible property regulations which will affect all taxpayers with tangible property—whether the property is owned or leased. These new regulations, which go into effect in 2014, modify and supersede the temporary regulations that were issued on December 23, 2011.
To view the previous guidance RubinBrown has provided on tangible property regulations, please click here.
The major changes for taxpayers are summarized below:
- Removes the “results in” standard from the material addition and the material increase in productivity betterment tests, which is intended to reduce controversy for expenditures that span more than one tax year or where the outcome of the expenditure is uncertain when the expenditure is made.
- Added a routine maintenance safe harbor for buildings
- Activities a taxpayer expects to perform as a result of using the property to keep the building structure or each building system in it ordinary efficient operating condition.
- Examples include inspection, cleaning, testing and replacement of damaged or worn parts.
- Routine only if the taxpayer reasonably expects to perform the activities more than once during the 10-year period beginning when placed in service.
Materials and Supplies
- Revises definition to include a unit of property with a cost of $200 or less (vs. $100).
- Adds "stand-by emergency parts" to the definition.
- If use optional method of capitalizing and depreciating spare parts, this method must be used for all spare parts in the same trade or business.
De Minimis Safe Harbor
Dispositions of Improved Property
- Ceiling calculation (greater of 0.1% of gross receipts or 2% of depreciation and amortization) has been eliminated and replaced with a new safe harbor determined at the invoice or item level and based on financial accounting policies.
- Taxpayer with an AFS may expense property of $5,000 or less per invoice, or per item as substantiated by the invoice; if the cost exceeds $5,000 per invoice (or item), the amounts paid for the property will not fall within the de minimis safe harbor.
- Taxpayers without an AFS may expense property of $500 or less per invoice, or per item as substantiated by the invoice.
- Must have written accounting policy/procedures in place (still).
- A taxpayer electing to apply the de minimis safe harbor isn’t required to include in the cost of the tangible property the additional costs of acquiring or producing such property if these costs aren’t included in the same invoice as the tangible property.
- A taxpayer must include in the cost of the property all additional costs (e.g., delivery fees, installation services) of acquiring or producing the property if these costs are included on the same invoice with the tangible property.
- Requires the de minimis safe harbor be applied to all eligible materials and supplies (spare parts exception) if the taxpayer elects the de minimis safe harbor.
- If examining agents and a taxpayer agree that certain amounts in excess of the de minimis safe harbor limitations are not material or otherwise should not be subject to review, that agreement should be respected. Taxpayer burden to show such treatment clearly reflects income.
- Allows taxpayers to forgo a loss upon the disposition of a structural component (same as taxpayers that make general asset account election).
Election To Capitalize
- Taxpayers may make an annual election to opt out of expensing repair and maintenance costs if the taxpayer treats the costs as capital expenditures on its books and records.
Relief for Small Business
- Qualifying small taxpayers may elect to not apply the improvement rules to eligible building property.
- The total amount paid for repairs, maintenance, improvements and similar activities performed on an eligible building cannot exceed the lesser of $10,000 or 2% of the unadjusted basis of the building.
- Eligible building property includes a building unit of property that is owned or leased by the qualifying taxpayer, provided the unadjusted basis of the building unit of property is $1,000,000 or less.
FOR YOUR ACTION
While generally these regulations are not effective until tax years beginning in 2014, there are actions taxpayers should consider taking now to be prepared.
- Establish or revise a written policy to expense certain “de minimis” expenditures. A taxpayer must have a written policy in place at the beginning of the tax year when the change in accounting method is to be adopted (tax years beginning 1/1/14 or later) that it follows for book purposes to expense these expenditures for tax purposes.
- Segregate each newly added building system (HVAC, plumbing, etc.) and the components of the building structure (especially those likely to be improved prior to their complete depreciation, such as a roof) into separate assets in your depreciation system prospectively to allow for ease in recognition of the net tax value of assets later “improved”. The new law allows for the net tax value of assets deemed improved to be written off at the time of the improvement. Segregating the assets when they are placed in service should promote ease in compliance with the tax law when the asset is later improved.
- Review your fixed asset records to identify any assets that have previously been “improved” and that have a remaining net tax value. The new law allows for the net tax value of assets to be written off when the asset has been improved. If there is a significant benefit a taxpayer may want to go through the effort to identify and write off the net tax value rather than continuing to depreciate the asset.
- Review your fixed asset records to identify any assets that have previously been capitalized that would not have been capitalized using the rules under the temporary regulations. The new law provides guidance on when to capitalize expenditures. If an expenditure was capitalized and under the new law capitalization would not be required, currently expense the item if the expenditure was incurred in the current tax year or consider a method change if for a prior year. This review should include not only fixed asset additions, but also repairs and maintenance expenditures and expenditures falling under the safe harbor for routine maintenance.
- Develop a method or process to capitalize / inventory “non-incidental materials and supplies. Such items are to be expensed when used or consumed rather than when purchased.
These new requirements are not simple to implement. The rules are complicated and, in many cases, not clear. The facts and circumstances of each business situation will need to be analyzed to determine the proper treatment of these expenditures.
Taxpayers should work closely with their tax advisor to assure proper compliance with the regulations.
Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.
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