This Tax Alert includes a comprehensive overview of the changes included within the regulations and key issues.
On Sept. 13, 2013, the IRS and Treasury Department released final regulations providing guidance regarding the deduction and capitalization of expenditures related to tangible property (commonly known as the repair and maintenance regulations). The final regulations will affect all taxpayers that acquire, produce, or improve tangible property.
Additionally, proposed regulations were released providing guidance regarding dispositions of tangible depreciable property under section 168. They also amend the general asset account regulations and the accounting for MACRS property regulations. The proposed regulations will affect all taxpayers that dispose of MACRS property (most property acquired after 1986 is MACRS property).
The final regulations refine and simplify some of the rules contained in the 2011 temporary regulations and create a number of new safe harbors, as follows:
Materials and supplies
The regulations expand the definition of materials and supplies to include property that has an acquisition or production cost of $200 or less (previously $100 or less) and has an economic useful life of 12 months or less.
The regulations retain the rule permitting a taxpayer to elect to capitalize and depreciate amounts paid for certain materials and supplies but provide that this rule is only applicable to rotable, temporary, or standby emergency spare parts. This election must be made on a timely filed (including extensions) tax return.
Lastly, the regulations provide that a taxpayer that uses the optional method for rotable and temporary spare parts for federal tax purpose must use the optional method for all of the pools of rotable and temporary spare parts used in the same trade or business regardless of book treatment.
De minimis safe harbor election
The regulations remove the ceiling limitation provided in the 2011 temporary regulations. Under the new safe harbor, a taxpayer may follow its book minimum capitalization policy if there is a written accounting procedure in place at the beginning of the taxable year and the policy includes a specified dollar amount that does not exceed a per invoice or per item cost as substantiated by the invoice.
- For taxpayers with an applicable financial statement, the dollar amount is not to exceed $5,000.
- For taxpayers without an applicable financial statement, the dollar amount is not to exceed $500.
An applicable financial statement includes:
- a financial statement required to be filed with the SEC;
- a certified audited financial statement that is accompanied by the report of an independent certified public accountant; or
- a financial statement (other than a tax return) required to be provided to the federal or state government or any federal or state agency (other than the IRS).
The annual election is not revocable and must be included on a timely filed original federal tax return. The safe harbor must be applied to all amounts expensed under the book policy including materials and supplies.
Election to follow book capital improvement costs
The final regulations add a new provision allowing taxpayers to elect to follow its book capitalization policy for improvement costs that were capitalized for book purposes. The election does not apply to repair and maintenance costs that are expensed for book purposes. The annual irrevocable election must be included on a timely filed original federal tax return for the tax year in which the improvement is placed in service. The election will preclude a taxpayer from including those items in an accounting method change from capitalization to deductible repairs in a later year.
Routine maintenance safe harbor for building property
The final regulations extend the concept of the routine maintenance safe harbor introduced by the 2011 temporary regulations to building property. This includes the recurring activities that a taxpayer expects to perform as a result of their use of the building to keep the building structure or system in its ordinarily efficient operating condition. The taxpayer must reasonably expect to perform the activities more than once during a 10-year period beginning at the time the building structure or building system is placed in service.
Routine maintenance for property other than buildings has the same general definition but with maintenance activities occurring more than once during the useful life of the unit of property. Routine maintenance may be performed at any time during the useful life of the unit of property. A taxpayer’s expectation will not be deemed unreasonable merely because it may not actually perform the maintenance a second time in the 10-year period as long as they can demonstrate that they reasonably expected to do so.
Exceptions to this rule include amounts paid for betterments, restorations, adaptations to a new or different use, property that a loss has already been deducted or gain realized, or network assets.
Safe harbor for small taxpayers
The final regulations adopt a new safe harbor allowing a qualifying taxpayer to elect to immediately deduct amounts paid for repairs, maintenance, and improvements made to an eligible building property if the total amount paid during the taxable year, including amounts not capitalized under the de minimis safe harbor election and under the routine maintenance safe harbor for buildings, does not exceed the lesser of:
- 2 percent of the unadjusted basis of the eligible building property; or
This applies to taxpayers that have average annual gross receipts for the three preceding taxable years of less than or equal to $10 million. An eligible building is one that has an unadjusted basis of $1 million or less.
A taxpayer may make this election annually on a building-by-building basis by attaching a statement to the timely filed original federal tax return.
If total amounts paid by a qualifying taxpayer during the taxable year for repairs, maintenance, improvements, and similar activities performed on an eligible building property exceed the safe harbor limitations, then the safe harbor election is not available for that eligible building property and the taxpayer must apply the general improvement rules.
The final regulations retain the general capitalization framework included in the 2011 temporary regulations, refine the rules applying capitalization versus expensing standards, and provide new and simplified examples.
Consistent with the 2011 temporary regulations, the unit of property for buildings is each building and its structural components. Amounts are treated as improvements to a building if the costs improve either the building structure and/or any of the building systems.
The final regulations add new definitions for major components and substantial structural parts of buildings and clarify the distinction between the two. A major component is defined as a part or combination of parts that performs a discrete and critical function in the operation of the unit of property. A substantial structural part is defined as a part or component of parts that comprises a large portion of the physical structure of the unit of property. The regulations also clarify that an incidental component of a unit of property, even though such component performs a discrete and critical function in the operation of the unit of property, generally will not, by itself, constitute a major component.
Retail store refresh or remodels. The IRS and Treasury received a substantial number of comments on the betterment examples in the 2011 temporary regulations related to retail store refresh or remodel projects. Many of the comments requested that the final regulations include quantitative bright lines for the capitalization of refresh/remodel projects and additional detail in the examples. The final regulations do not provide quantitative bright lines in applying the betterment rules. However, the final regulations include additional detail in a number of the examples, including the examples related to building refresh or remodels, illustrating distinctions between betterments and maintenance activities when a taxpayer undertakes multiple simultaneous activities on a building.
Dispositions of property
Due to the administrative burden imposed on taxpayers and the IRS by the proposed regulations released in 2011, the rules for dispositions of tangible property have been re-proposed.
The proposed regulations permit taxpayers to make a partial disposition election to recognize gain or loss on the disposition of building structural components without having to elect general asset account treatment.
In addition, because the regulations provide that the unit of property consists of an entire building (versus each of its structural components) taxpayers are no longer required to recognize a loss on the disposition of a structural component.
The partial disposition election is made by claiming the gain or loss on a timely filed original tax return for the year in which the portion of an asset is disposed.
The proposed regulations provide examples of reasonable methods that taxpayers may use to determine the adjusted basis of disposed assets, including discounting the cost of the replacement asset using the Consumer Price Index, allocating the original unadjusted basis of the building based on the replacement cost of the component versus the replacement cost of the building as a whole, or conducting a cost allocation study.
The final regulations generally apply to taxable years beginning on or after Jan. 1, 2014; however, certain provisions only apply to amounts paid or incurred in taxable years beginning on or after Jan. 1, 2014.
Alternatively, taxpayers may choose to apply the final regulations to taxable years beginning on or after Jan. 1, 2012. For taxpayers choosing this early application, certain provisions only apply to amounts paid or incurred in taxable years beginning on or after Jan. 1, 2012. The final regulations provide transition relief for taxpayers that did not make the certain elections (for example, the election to apply the de minimis safe harbor or the election to apply the safe harbor for small taxpayers) on their timely filed original federal tax return for their 2012 or 2013 taxable year (the applicable taxable year).
Finally, taxpayers may also choose to apply the 2011 temporary regulations to taxable years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014. For taxpayers choosing to apply the temporary regulations to these taxable years, certain provisions of the temporary regulations only apply to amounts paid or incurred in taxable years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014.
For more information or any questions you might have on this topic, please contact your Baker Tilly advisor or send an e-mail to firstname.lastname@example.org.