The new tangible property regulations will provide the most dramatic change in tax law in the area of expenditure capitalization to affect for-profit businesses since the overhaul of the Internal Revenue Code in 1986.
It does not matter what form of business one is in, whether a “C” corporation, an “S” corporation, a partnership, an LLC, a sole proprietorship (Schedule C on individual return), or a rental (Schedule E on individual return); these new rules and requirements will apply.
Taxpayers will be required to file one or more Form(s) 3115 for each accounting method change for each separate entity, or trade or business. For example, an individual filing Form 1040 with three rental entities housed in LLCs will be required to file three (or more) separate Form(s) 3115.
Please note that these regulations also provide potential opportunities. Taxpayers may be able to expense greater amounts for certain repairs, materials and supplies, and “de minimis” amounts. In addition, taxpayers may be able to write off the net tax value of certain previously capitalized assets (e.g., roof costs that were previously capitalized may now have their net tax value written off when a roof improvement is or was subsequently made).
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 that it follows for book purposes to expense these expenditures for tax purposes. While this de minimis expensing rule is currently only available under the temporary regulations for taxpayers with an “Applicable Financial Statement” (one filed with the SEC, audited or required to be provided to a governmental agency), we suggest all taxpayers consider establishing a written expensing policy.
- Establish a method or process to quantify the amount of expenditures that are expensed under the de minimis rule. The amount that may be expensed under the de minimis rule is limited to the greater of 0.1% of total gross receipts or 2% of book depreciation and amortization. In order to perform the required “ceiling” test, taxpayers must be able to quantify the amount expensed for book purposes under the de minimis rule. While there are no rules prescribing how this is to be done, an example would be the establishment and use of a new general ledger account to track such expenditures (similar to how many taxpayers track meals and entertainment expenses so that the 50% disallowance for tax purposes may be easily computed).
- 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 to allow for ease in recognition of the net tax value of assets later “improved.” The new law allows for (requires) 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 elect to adopt this component of the temporary regulations in 2012 or 2013 to allow for write off prior to 2014.
- 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 previously capitalized and under the new law capitalization would not be required, currently expense the item if a 2012 addition 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 going to be easy 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. We encourage you to contact your RubinBrown engagement representative with any questions that you have.
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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