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New tax rules coming for tangible property, repairs

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Harry Harless Harry Harless
Kevin Highlander Kevin Highlander

This summary is intended to provide a high-level overview only and should not be relied on for application to specific fact patterns and situations. Taxpayers should consult their tax advisors to determine how the final regulations will apply to their specific facts and situations. For information, visit http://www.aftcpas.com/final-regulations-governing-tars.

About the authors: Harry "Skip" Harless is a member with Arnett Foster Toothman PLLC. He has more than 23 years of public accounting experience,18 of which have been concentrated in taxation. Harless was formerly the member-in-charge of the Arnett & Foster office in Martinsburg and as such worked with many closely held businesses, providing tax and business advice. His email address is Skip.Harless@aftcpas.com.

Kevin Highlander is a senior manager with Arnett Foster Toothman PLLC and has more than 12 years of experience solving complex tax matters for corporations and partnerships. With a background in tax compliance, Highlander regularly provides planning and consulting services for business clients. Highlander specializes in fixed assets and accounting method optimization for capital intensive business clients. His email address is Kevin.Highlander@aftcpas.com.

On Sept. 19, 2013, the IRS published final and proposed regulations governing the tax treatment of (1) materials and supplies, (2) costs incurred to acquire or produce tangible property, (3) repairs versus improvements to tangible property and (4) dispositions of Modified Accelerated Cost Recovery System, or MACRS, property. The regulations are effective for taxable years beginning on or after Jan. 1, 2014 (or costs paid or incurred in such taxable years where applicable).

While the final regulations are generally effective for taxable years beginning on or after Jan. 1, 2014, many taxpayers see advantages to "early adoption" of select provisions, which is a favorable implementation approach encouraged by the IRS. Additionally, in order to use a special de minimis safe harbor for certain costs, taxpayers will need to ensure a written capitalization policy is in effect prior to Jan. 1, 2014. The final and proposed regulations contain several significant concepts.

Materials and supplies

The definition of materials, supplies and available methods and elections has been clarified and expanded. Materials and supplies now include items costing $200 or less, as well as standby emergency spare parts. Additionally, different options for accounting for rotable and temporary spare parts and/or standby emergency spare parts are available.

De minimis safe harbors

The final regulations provide general rules regarding capital expenditures. Under the final regulations, taxpayers have the ability to annually elect to apply a de minimis safe harbor, provided certain conditions are met. Under the safe harbor, a taxpayer may deduct amounts paid for property costing up to $5,000 (on a per invoice or item basis), provided the taxpayer has an applicable financial statement, has written accounting procedures as of the beginning of the tax year and treats such items as an expense in its applicable financial statement in accordance with its written procedures. For taxpayers without an applicable financial statement, such taxpayers may elect the safe harbor for amounts paid for items costing up to $500, provided the other requirements of the safe harbor are met (i.e., taxpayer has accounting procedures in place as of the beginning of the year and expenses such items for books and records in accordance with its procedures).

Improvement of tangible property

The improvement versus repair determination hinges on the specific unit of property, or UOP, being worked on. In the case of a building, while the UOP is defined as the building and its structural components, the improvement standards must be applied separately to each of the following building systems: heating, ventilation and air conditioning; plumbing and electrical; all escalators and elevators; fire protection and alarms; security; gas distribution; and any other systems that may be identified in published guidance.

The final regulations identify betterments, restorations and adaptations as the categories of costs generally considered to result in capitalizable improvements to a UOP. The regulations also provide a safe harbor for routine maintenance activities that are expected to be performed more than once during a specified period. The final regulations further provide for a small taxpayer safe harbor that allows qualifying taxpayers to elect not to apply the improvement rules to costs paid or incurred as part of trade or business activity with respect to eligible small buildings. If elected, costs that fall under the safe harbor may be treated as deductible in the taxable year paid or incurred, even if they would otherwise be considered improvement costs under the general rules.

Dispositions of property

The newly proposed regulations define the asset for disposition purposes to include the building (including all structural components). Additionally, there is an optional annual election in the year of disposition to recognize gain or loss on a partial disposition of an asset. While this provides the opportunity to write off old building components (or components of nonbuilding assets) that have been replaced, it will require examining old records to determine or estimate the cost of the original components that were not previously accounted for separately. The proposed regulations provide guidance on this and also modify the rules governing dispositions of assets in general asset accounts.

Change in accounting method

Many provisions of the final and proposed regulations that a taxpayer chooses to early adopt for a taxable year beginning on or after Jan. 1, 2012, must be implemented by making an annual election on the taxpayer's timely filed tax return. Additionally, the final regulations provide for a special transition rule for taxpayers that wish to make an election but have already filed their 2012 tax returns. Other provisions may require the filing of an Application for Change in Accounting Method (Form 3115). These significant method changes involve many nuances and options that require careful analysis. In order to comply with the final regulations by the 2014 tax year, impacted companies should act quickly to formulate an implementation and compliance plan and determine the optimal timing for making elections and filing required method change requests.