In 2013, the IRS released the final tangible property regulations, one of the largest changes to tax law in more than 20 years. The regulations apply to all entities that acquire, produce and/or improve tangible or real property. These regulations became effective for the 2014 tax year.

Taxpayers can obtain significant tax savings under the tangible property regulations. To take advantage of these opportunities, careful consideration should be given to determining the options available to deduct normally capitalized costs, the definitions of materials and supplies and the elections available for disposed assets and which expenses can be considered deductible repair costs.

More Room for Repairs

Costs that are classified as repairs or maintenance are deductible. Costs associated with improvements must be capitalized. The new tangible property regulations changed the rules for how to determine whether to capitalize an item or classify it as a repair. As a result, many expenses now qualify as repairs that did not under the previous guidance.

Entities must apply a facts and circumstances analysis to their expenditures to determine whether they qualify as routine repairs or improvement costs. Under the new guidance, costs must be capitalized when they relate to the betterment, restoration or conversion of a unit of property to a new use. Typically, these expenditures are for major projects, such as fixing a material defect in the unit of property, replacing a major component of the unit of property or repairing or replacing a combination of parts that make up a substantial part of a unit of property.

The option also exists to bypass the facts and circumstances analysis and elect to capitalize all repair and maintenance costs if:

• The amounts are paid as part of conducting your main business,
• The amounts are reported as capital expenditures and
• The election is made in the year the expenses were incurred.

Minimizing Your Capitalized Costs

The regulations create several safe harbor elections that allow taxpayers to deduct costs, such as improvement and materials expenses, that would otherwise be capitalized.

Small taxpayers can take advantage of a small taxpayer safe harbor provision that exempts them from capitalizing improvement costs if they meet all of the following requirements:

• Average annual gross receipts or total assets are less than $10 million;
• Owns or leases building property with an unadjusted basis of less than $1 million;
• The total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property doesn't exceed the lesser of:
  • Two percent of the unadjusted basis of the eligible building property; or
  • $10,000; and
• The election to use the safe harbor is made for each taxable year in which qualifying amounts are incurred.

Amounts related to recurring activities, use of property, keeping the unit of property in working condition and expenses expected to occur at least twice during a 10-year period (shorter if the unit of property has a shorter useful life) can qualify for the routine maintenance safe harbor. The safe harbor allows entities to deduct these expenses rather than classifying them as improvements and capitalizing them.

Under the de minimis safe harbor, entities can deduct individual items under a specified dollar threshold. Entities with applicable financial statements can deduct items up to $5,000. Those without applicable financial statements can deduct individual items that cost less than $500. The accounting policy to use the de minimis election must be in place at the start of the tax year in order for entities to elect the de minimis safe harbor.

Deductions Opportunities for Materials and Supplies

Most of the old rules for materials and supplies transferred over to the new tangible property regulations.  Acquired components used to maintain or improve the unit of property, consumable such as fuel, lubricants and water reasonably expected to be used during a 12-month period and tangible property costing less than $200 are generally classified as materials and supplies.

Entities can deduct the costs of incidental materials—pens, papers, trash cans, etc.—in the year they were incurred. They can also deduct materials and supplies in the taxable year in which the items were put into use, so long as the records of consumption and inventories are kept. Materials and supplies can also be deducted as part of the de minimis safe harbor.

Maximize Partial Disposition Election

The tangible property regulations allow entities to expense the undepreciated costs of assets that were removed from the property. This rule change marks a significant change from earlier guidance.

The partial disposition rule comes into play when an entity disposes of depreciable assets and replaces it with a new asset. The undepreciated basis of the removed asset may qualify for ordinary loss treatment depending on all the facts of each situation. Furthermore, any removal costs can also be expensed.

Entities preparing for a sale of their property should be sure to evaluate where undepreciated assets not in use can be expensed. Removing assets from the books, which are no longer in service, will yield an immediate tax savings and will lower the depreciation recapture a taxpayer would otherwise be subject to post-sale.

For More Information

The tangible property regulations are still relatively new and are complex to implement, however, they can provide significant tax benefits to taxpayers. For specific questions, comments or concerns about how to maximize your use of the regulations, please contact your local CBIZ MHM tax professional.