Accounting Method Changes Under the New Tangible Property Regulations (article)

Accounting Method Changes Under the New Tangible Property Regulations (article)

As discussed in previous InTouch articles, in late 2011 the IRS issued Temporary Regulations modifying the treatment of amounts paid to acquire, produce, or improve tangible property. In March 2012, the IRS issued two Revenue Procedures to assist taxpayers in making any required accounting method changes to comply with these new rules. Rev. Proc. 2012-19 deals with the improvement standards, capitalization rules, materials and supplies, and the de minimis rule. Rev. Proc. 2012-20 deals with dispositions of property and the general asset account rules. In these Revenue Procedures the IRS makes clear to taxpayers that formal accounting method changes may be required to comply with the new tangible property rules.

When originally issued last December, the Temporary Regulations were effective for tax years beginning on or after January 1, 2012. In November 2012, the IRS delayed the effective date of these regulations until 2014 in anticipation that final regulations would be issued in 2013. However, taxpayers may still apply the Temporary Regulations (and the related Revenue Procedures) to 2012 and 2013 tax years and may find doing so advantageous in certain circumstances.

Before examining any of the specific accounting method changes in the Revenue Procedures, it is important to understand the general rules of what constitutes an accounting method and when a formal request to change an accounting method is required. A method of accounting is a practice that involves the timing of when an item is deducted or when it is reported as income. A method of accounting is established when it is used in the filing of one tax return if the method of accounting clearly reflects income. In addition, a method of accounting is established when it is used in the filing of two or more consecutive tax returns if the method of accounting does not clearly reflect income.

Once a method of accounting is established, any change to that method requires the consent of the IRS. The IRS has stated in regulations that a change in the method of accounting includes a change in the treatment of any material item. A material item is defined as any item that involves the proper time for the inclusion of the item in income or the taking of a deduction.

In the March 2012 edition of InTouch, we discussed briefly the new tangible property rules. Taxpayers will need to look at whether any of the new rules will apply to them. If so, taxpayers wishing to apply for any accounting method changes outlined in Rev. Proc. 2012-19 and Rev. Proc. 2012-20 for the 2012 or 2013 tax years should follow those procedures until new guidance is issued. The IRS has stated that a change from capitalizing to deducting an item (or vice-versa) is a change in accounting method. This change from capitalizing (and depreciating) to deducting an item will be a common change with theses new rules.

Although a change in method of accounting requires the consent of the IRS, in many cases this consent is automatic (as is the case with those changes stipulated in Rev. Proc. 2012-19 and Rev. Proc. 2012-20). Any adjustment from an accounting method change that reduces taxable income (a negative adjustment) can be taken in the current tax year. Any adjustment from an accounting method change that increases taxable income (a positive adjustment) can be taken into income ratably over four years. Failure to obtain consent from the IRS to change a method of accounting can cause the IRS to reverse the change or minimize the taxpayer's ability to reduce any tax penalties related to the unapproved change.

To request a change in accounting method under Rev. Proc. 2012-19 and Rev. Proc. 2012-20, a taxpayer needs to file Form 3115, Application for Change in Accounting Method. The original Form 3115 is attached to the timely-filed tax return and a copy is sent to a separate IRS office. All the changes contained in Rev. Proc. 2012-19 and Rev. Proc. 2012-20 are automatic changes and there is no user fee required (unlike non-automatic changes). Also, Rev. Proc. 2012-19 and Rev. Proc. 2012-20 waive almost all of the scope limitations that can sometimes limit a taxpayer's ability to make an automatic change.

The policies adopted under Rev. Proc. 2012-19 and Rev. Proc. 2012-20 are so taxpayer-friendly that a conservative "better safe than sorry" approach should be considered whenever there is any doubt. The safer position would be to file the request for a change in accounting method. It is important to understand that many of the taxpayer-friendly policies in Rev. Proc. 2012-19 and Rev. Proc. 2012-20 are limited to two years. Specifically, they apply to the first and second taxable year beginning after December 31, 2011. Therefore, for many taxpayers, these rules need to be considered in their 2012 and 2013 tax filings.

Two previous InTouch articles dealt with specific accounting method changes under Rev. Proc. 2012-20:

  • The April 2012 edition of InTouch described a situation where a loss could be taken on the prior year disposition of a component of a building. Rev. Proc. 2012-20 describes in accounting method change #177 the procedures for taking this loss on the disposition of a building structural component. In Rev. Proc. 2012-20 there is a similar accounting method change, #178, that applies to dispositions of property other than a building structural component.
  • The July 2012 edition of InTouch described the potential benefits of making a late general asset account election for buildings. Rev. Proc. 2012-20 describes in accounting method change #180 the procedures for making a late general asset account election.

The determination of the need for a formal request for an accounting method change in the above two situations is clearly described in Rev. Proc. 2012-20. There are several accounting method changes described in Rev. Proc. 2012-19 that may also be relevant to many taxpayers:

  • Change #162: Rev. Proc. 2012-19 describes an accounting method change to deduct repair expenditures. This change will likely result in a favorable adjustment as the taxpayer is now deducting the costs of items previously capitalized. The taxpayer will need to analyze prior capitalized expenditures and the benefits of changing its accounting method from capitalization to deduction. If a type of expenditure has been treated consistently as a capitalized cost and under these new rules can now be deducted, it should be included in the request for change in accounting method.
  • Change #174: Rev. Proc. 2012-19 describes an accounting method change that is to the reverse of change #162. In accounting method change #174, the taxpayer is changing to capitalize amounts deducted in prior years in order to comply with the new improvement standards and unit-of-property definitions. If a type of expenditure has been treated consistently as a deducible cost, then it should be included in the request for change in accounting method. This change will likely result in an increase to income as it is reversing prior year deductions. However, the adjustment can be spread ratably over four years. If the IRS subsequently determines that a previously deducted cost should have been capitalized, it is likely to deny the four-year spread and include all of the income in the earliest open year. Therefore, this change should be considered as a way of cleaning up prior years and benefitting from the four-year spread.
  • Change #171: Rev. Proc. 2012-19 describes how a taxpayer can apply the "routine maintenance safe harbor" that is outlined in the Temporary Regulations. Expenditures that were previously capitalized that now would qualify as a deduction under the routine maintenance safe harbor will be eligible for a deduction in the current year. As with change #162, this accounting method change will likely result in a favorable adjustment since it is reversing previously capitalized costs.
  • Change #169: Rev. Proc. 2012-19 describes how to apply the new de minimis rules for fixed assets and supplies. This accounting method change only applies to amounts incurred on or after January 1, 2012.

One overriding rule for these method changes is that IRC § 263A (UNICAP) must be considered, if applicable. The adjustment resulting from any of these changes must also take into consideration the impact on the taxpayer's UNICAP calculation. For example, if the taxpayer determines under change #162 that it now has $100,000 of deductible repairs, the actual tax benefit needs to be reduced by the depreciation that may have been taken in prior years on these items and whether the repairs would then need to be capitalized as part of the annual UNICAP calculation. Depending on how long ago the expenditure was made, the actual current tax savings may be diluted.

While the effective date of the Temporary Regulations has been delayed until 2014, many of the accounting method changes available in Rev. Proc. 2012-19 and Rev. Proc. 2012-20 can result in current tax savings. Taxpayers should consider these changes now while the friendly automatic change procedures are definitely available. Taxpayers should balance this benefit against the possibility that the final regulations will make subsequent changes to the rules that may necessitate yet another accounting method change. If you have further questions on the accounting method changes required as part of the new tangible property rules or would like to discuss the potential tax savings available please contact your local CBIZ MHM tax professional.


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Accounting Method Changes Under the New Tangible Property Regulations (article)As discussed in previous InTouch articles, in late 2011 the IRS issued Temporary Regulations modifying the treatment of amounts paid to acquire, produce, or improve tangible property....2012-11-27T21:08:00-05:00As discussed in previous InTouch articles, in late 2011 the IRS issued Temporary Regulations modifying the treatment of amounts paid to acquire, produce, or improve tangible property.