Treasury Takes Another Crack at Tangible Property Regulations (article)
In late 2011 the IRS issued temporary regulations under IRC §§ 162 and 263 that provide guidance on the tax treatment of amounts paid to acquire, produce, or improve tangible property. IRC § 162 allows an expenditure on tangible property to be a current deduction if it is incidental in nature, and neither materially adds to the value of the property nor significantly prolongs its useful life. This Code section also states that expenditures are currently deductible if they are for materials and supplies consumed during the year. IRC § 263 requires an expenditure on tangible property to be capitalized if the expenditure substantially prolongs its useful life, is for permanent improvements or betterments that increase the value of the property, restores its value or use, or adapts the property to a new or different use.
The new regulations were issued as temporary regulations, and as such, they are required to be followed by both taxpayers and the IRS. The regulations are effective for tax years beginning on or after January 1, 2012, and are the Treasury Department's third attempt to provide guidance in this area, replacing the 2006 and 2008 proposed regulations. Ultimately, the 2008 proposed regulations are closely followed, but there are some significant modifications.
Some highlights of the new regulations:
- Repairs: the temporary regulations closely follow the 2008 proposed regulations in that a taxpayer is permitted to deduct amounts paid to repair and maintain tangible property as long as such amounts are not required to be capitalized under IRC § 263(a) or any other provision of the Code or Regulations.
- Materials and supplies: the temporary regulations provide a new election to deduct certain materials and supplies under a de minimis rule, and provide an alternative method of accounting for rotable spare parts. The IRS has stated that the temporary regulations do not supersede, obsolete, or replace earlier revenue procedures to the extent they deem certain property to constitute materials and supplies under Reg. § 1.162-3. For example, Rev. Proc. 2002-12 allows a taxpayer to treat smallwares (a restaurant's glassware, flatware, etc.) as materials and supplies that are not incidental under Reg. § 1.162-3. The IRS position is that such property continues to qualify as materials and supplies under the temporary regulations because it is identified in published guidance as materials and supplies. A taxpayer may elect to apply the de minimis rule as allowed in Reg. § 1.263(a)-2T(g) to any material or supply as long as the taxpayer has an applicable financial statement (as defined in this regulation).
- Capitalization of acquisition costs: the temporary regulations follow the 2008 proposed regulations regarding the capitalization of expenditures to acquire or produce tangible property. The temporary regulations do make some clarifications to the application of the rules for moving and reinstallation costs and transaction costs. The temporary regulations require the capitalization of costs that are facilitative to the acquisition of property and similarly require capitalization of most costs that are inherently facilitative in nature. Several examples are provided in Reg. § 1.263(a)-2T(f)(4).
- Unit of Property: much of the guidance provided in the temporary regulations revolves around what constitutes the "unit of property" ("UOP") that is being placed in service, repaired, or improved. As a general rule, the smaller the unit of property the more likely it is that costs incurred in connection with that unit of property will have to be capitalized. For example, costs incurred on an engine of a vehicle are more likely to be classified as an expenditure that must be capitalized if the engine is classified as a separate unit of property. By contrast, if the unit of property is the vehicle itself, then the engine work has a better chance of generating a current deduction as a repair.
- Costs of improvements to property: the temporary regulations follow many parts of the 2008 proposed regulations including the "routine maintenance" safe harbor and the "optional regulatory accounting method." The temporary regulations retain the rule that the unit of property for a building consists of the building and its structural components, but modifies the manner in which the improvement standards must be applied to the building and its structural components (see the building structure section below). Unlike the 2008 proposed regulations, the temporary regulations do not include the 50% threshold and recovery period limitation for determining whether a replacement rises to the level of a major component or substantial structural part of a unit of property. The temporary regulations provide detailed rules for determining the units of property for the leasehold improvements and for additional costs incurred during an improvement such as related repair and maintenance costs.
- Building structure and building system: under the temporary regulations each building and its structural components are one UOP ("the building"). Expenditures are treated as an improvement to a building if they improve either the "building structure" or any designated "building system." The building structure consists of the building and its structural components as currently defined in Reg. § 1.48-1(e). The new regulations list nine structural components that are to be treated separately as "building systems" and are detailed in Reg. § 1.263(a)-3T(e)(2)(ii)(B). Examples of building systems are such items as HVAC, plumbing, and electrical systems. The new regulations also include new provisions under IRC § 168 that expand the definition of "dispositions" to include the retirement of a structural component of a building. Our April issue of InTouch will discuss this portion of the new regulations in further detail as it will permit taxpayers to write off the costs of an old structural component when it is replaced with a new structural component (e.g., write off the costs of an existing roof if it is replaced).
Taxpayers cannot request a change in accounting method to these new regulations for their 2011 returns since the regulations are effective for returns with tax years beginning on or after January 1, 2012. The temporary regulations now state that any accounting method changes must be made with the consent of the Commissioner (i.e., a non-automatic change). However, the IRS has stated its intent to publish guidance on obtaining automatic approval for any required accounting method changes provided in these new regulations. These automatic accounting method changes will likely be available for inclusion with 2012 tax returns. Therefore, we recommend that taxpayers wait to see if the automatic change guidance comes out before preparing the non-automatic change request.
Through mid-March, the IRS has issued two Revenue Procedures related to these Regulations. Rev. Proc. 2012-19 deals with the materials and supplies rules, rotable spare parts, de minimis property acquisition costs, and changing the tax treatment of costs to meet the new UOP rules. Rev. Proc. 2012-20 provides rules for changing from impermissible depreciation periods for leasehold improvements, several changes related to the impact of these new Regulations to general asset account groups, and changes to the disposition of a building or structural component.
On March 15, 2012, the IRS issued a Large Business & Industry (LB&I) Directive on the repair vs. capitalization issue for field examinations that are currently in progress. LB&I-4-0312-004 generally suspends the current examination on this issue in order to allow the taxpayer to file any required changes under Rev. Proc. 2012-19 and Rev. Proc. 2012-20. The IRS agents are instructed to stop the current exam activity and not begin any new activity on this issue.
As new developments arise related to these regulations, CBIZ MHM will issue additional guidance as necessary. In the meantime, if you have further questions please contact your local CBIZ MHM tax professional.
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