Updated Tangible Property Rules Expand Safe Harbors, Disposition Rules (article)

Updated Tangible Property Rules Expand Safe Harbors, Disposition Rules (article)

The IRS has issued final rules on the capitalization and deduction of costs incurred to acquire, maintain, repair and replace tangible property. The IRS also issued new proposed rules pertaining to the disposition of tangible property. These updated rules expand, clarify and simplify several provisions of the 2011 temporary rules, including the de minimis safe harbor, routine maintenance safe harbor, and the treatment of partial dispositions of assets. These provisions generally are effective for tax years beginning on or after January 1, 2014, but may be applied to tax years beginning on or after January 1, 2012. Owners of tangible business property should begin preparations now to comply with and take advantage of these new rules.

Background

In December 2011, the IRS issued expansive temporary regulations providing guidance on the tax treatment of amounts paid to acquire, produce, or improve tangible property (see our March 2012 InTouch article, Treasury Takes Another Crack at Tangible Property Regulations). The temporary regulations also provided guidance concerning the dispositions of tangible property, most notably expanding the definition of a disposition to include the retirement of a structural component of a building (see our April 2012 InTouch article, New Tangible Property Regulations Impact Tax Accounting for Buildings). The temporary regulations were followed in March of 2012 by two revenue procedures detailing how taxpayers could apply for accounting method changes to adopt the new rules. Originally effective for tax years beginning on or after January 1, 2012, the IRS delayed the effective date of the regulations to tax years beginning on or after January 1, 2014 (though taxpayers could choose to apply the rules in tax years beginning in 2012).

On September 13th, the IRS issued final regulations on the capitalization and deduction of costs incurred to acquire, maintain, repair and replace tangible property, as well as new proposed rules pertaining to the disposition of tangible property. Generally, these new rules are applicable to tax years beginning on or after January 1, 2014, but may be applied to tax years beginning on or after January 1, 2012.

Many provisions in the new regulations are unchanged from the temporary regulations, but as expected, the IRS also made several important changes, as summarized below. Implementation guidance is expected for the final regulations in the near future and taxpayers likely will need to apply for accounting method changes in order to adopt and comply with these rules.

De Minimis Safe Harbor

The temporary regulations established a new de minimis rule stipulating that amounts paid to acquire tangible property did not have to be capitalized if all of the following applied:

  • The taxpayer had an applicable financial statement (AFS), such as a certified audited financial statement by an independent CPA;
  • The taxpayer had a written capitalization policy in place at the beginning of the year for expensing amounts paid for such property under certain dollar thresholds;
  • The taxpayer treated such amounts as expenses on its AFS in accordance with its written policy; and
  • The total amount deducted under the de minimis rule for the year was limited to less than or equal to the greater of (a) 0.1% of the taxpayer's gross receipts for federal income tax purposes, or (b) 2% of the taxpayer's total depreciation and amortization expense for the year for AFS purposes.

Application of the de minimis rule was not optional, although taxpayers had the option annually to elect out of the de minimis exception. Taxpayers also had the option to affirmatively elect to apply the same de minimis rule to materials and supplies, subject to the same limitations above.

The final regulations abandon the safe harbor ceiling discussed above in favor of a limitation based on an "invoice level test." Specifically, a taxpayer who otherwise meets the requirements above (AFS, written capitalization policy, etc.) may deduct amounts paid for property if the expenditure does not exceed $5,000 per invoice, or per item substantiated by the invoice. An eligible taxpayer may also deduct amounts expensed under a financial accounting policy that expenses all amounts paid for property having a useful life of 12 months or less, subject to the same $5,000 per invoice or item limitation.

The final regulations also expand the de minimis safe harbor to taxpayers who do not have an AFS. For those taxpayers, the safe harbor threshold is reduced from $5,000 to $500. Taxpayers without an AFS still must have and follow a capitalization policy, although there is no express requirement that the policy be written. Nevertheless, we recommend a written policy as evidence of the policy's existence.

Under the final regulations, the de minimis safe harbor is an annual election made by including a statement on the taxpayer's tax return for the year elected. The election applies to both expenditures for the acquisition of property and for materials and supplies. Taxpayers may no longer apply the de minimis rule to one type of expenditure and not another.

Materials and Supplies

The final regulations expand the definition of materials and supplies to include property with an acquisition cost of $200 or less (increased from $100 under the temporary regulations).

Routine Maintenance Safe Harbor

The temporary regulations introduced a routine maintenance safe harbor that allowed taxpayers to deduct the cost of recurring maintenance on tangible personal property to keep it in its ordinarily efficient operating condition. Examples of routine maintenance activities included inspection, cleaning, testing and the replacement of parts. Expenditures qualified for the safe harbor only if the taxpayer reasonably expected to perform those maintenance activities more than once during the depreciable class life of the property.

The final regulations expand the routine maintenance safe harbor to include routine maintenance for buildings. To qualify under the safe harbor, the taxpayer must reasonably expect to perform those maintenance activities more than once during a 10 year period.

Small Taxpayer Safe Harbor

The final regulations add a new safe harbor for taxpayers with gross receipts of $10,000,000 or less. The safe harbor is intended to simplify small taxpayers' compliance with the rules pertaining to capitalization of building improvements. Qualifying small taxpayers can elect not to capitalize improvements to a building with an unadjusted cost basis of $1 million or less if the total amount paid during the year for repairs, maintenance and improvements does not exceed the lesser of $10,000 or 2% of the unadjusted cost basis of the building. The safe harbor is elected annually on a building-by-building basis.

Election to Capitalize Repair and Maintenance Costs

The final regulations add a new election that allows taxpayers to treat amounts paid during the year for repairs and maintenance to tangible property as amounts paid to improve that property, thus enabling the taxpayer to capitalize the expenditure and claim depreciation deductions. The availability of this election reduces uncertainty of the proper treatment of a particular expenditure.

In order to elect this treatment, the taxpayer must also capitalize those expenditures on its books and records. In addition, the taxpayer must apply the election to all expenditures for repairs and maintenance to tangible property that it treats as capital expenditures on its books and records.

Partial Dispositions of Tangible Property

The temporary regulations permitted a taxpayer to treat the retirement of a structural component of a building (e.g., a roof) as a disposition, thus enabling the taxpayer to claim a loss on the remaining cost basis of that component. The proposed regulations replace that provision with a new one that achieves a similar result, while also expanding its applicability.

Under the proposed regulations, a structural component of a building is no longer a separate asset for disposition purposes; instead, the entire building is the asset. Taxpayers can make a partial disposition election, however, to claim a loss on the remaining cost basis of a retired component. This achieves the same result as the one afforded by the temporary regulations without forcing the taxpayer to account for retired components separately (without making a general asset account election).

The proposed regulations also expand the partial disposition rules to apply to significant components of tangible personal property (e.g., an airplane engine) as well as to structural components of buildings.

In order to claim a partial disposition on an asset, the expenditure to replace the component must be capitalized. A partial disposition may not be claimed if the replacement expenditure was deducted as a repair. In instances where the IRS disallows a repair deduction for the amount paid to replace a portion of an asset and capitalizes that amount, the taxpayer may make a partial disposition election for the disposition of the related component by applying for an accounting method change.

For owners of pass-through entities, a partial disposition of real estate not only accelerates a deduction, but it could also generate permanent tax savings due to the tax rate differential between the loss on partial disposition and the gain from the sale of the rest of the building.

The proposed regulations provide that a taxpayer may use any reasonable method, consistently applied, to calculate the unadjusted depreciable basis of the component of an asset and provide some examples of reasonable methods, such as:

  • Discounting the cost of the replacement asset to its placed-in-service year cost using the Consumer Price Index,
  • A pro rata allocation of the unadjusted depreciable basis of the general asset account or multiple asset account, as applicable, based on the replacement cost of the disposed asset and the replacement cost of all of the assets in the general asset account or multiple asset account, as applicable, or
  • A study allocating the cost of the asset to its individual components.

The partial disposition election applies to tax years beginning on or after January 1, 2014, though taxpayers may apply these provisions to tax years beginning on or after January 1, 2012. The IRS has yet to issue guidance on how to claim a partial disposition on components disposed of in tax years beginning prior to January 1, 2012.

Summary

Despite the IRS's efforts to make the tangible property rules more "taxpayer friendly," the new regulations are still exceedingly complex and require careful and thorough consideration to ensure that your business is in compliance with the rules and can benefit from the various safe harbors. As the majority of the rules are now in final form, taxpayers should not expect any additional delays from the January 1, 2014 effective date and, in some cases, must act before the end of the year to take advantage of safe harbors. For more information on the tangible property rules and how they apply to your business, contact your local CBIZ MHM tax advisor.

CBIZ MHM Webinar – Are You Ready for the New Tangible Property Rules?

Be sure to join us on Tuesday, September 24, 2013 at 3 pm EDT as our experts navigate you through the new tangible property rules – how to take advantage of them to accelerate deductions, what new accounting policies need to be established, how the rules impact financial statement presentations and how to adapt accounting systems and procedures. 


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Updated Tangible Property Rules Expand Safe Harbors, Disposition Rules (article)The IRS has issued final rules on the capitalization and deduction of costs incurred to acquire, maintain, repair and replace tangible property. The IRS also issued new proposed rules pertaining to the disposition of tangible property. These updated rules expand, clarify and simplify several provisions of the 2011 temporary rules, including the de minimis safe harbor, routine maintenance safe harbor, and the treatment of partial dispositions of assets. ...2013-09-17T14:31:00-05:00The IRS has issued final rules on the capitalization and deduction of costs incurred to acquire, maintain, repair and replace tangible property. The IRS also issued new proposed rules pertaining to the disposition of tangible property. These updated rules expand, clarify and simplify several provisions of the 2011 temporary rules, including the de minimis safe harbor, routine maintenance safe harbor, and the treatment of partial dispositions of assets.