“Repairs” or “capitalization” of expenditures under the new tangible property regulations

The recent tangible property regulations are a significant overhaul of rules impacting tax treatment of fixed assets, and thus are likely to affect almost all businesses in the country.

These regulations have chiseled out new criteria for taxpayers to employ to determine whether an expenditure should be deducted currently or capitalized. Past criteria that were employed to determine if an expenditure should have been capitalized, such as "we spent a lot of money" or "the life of the asset was extended" are no longer considerations or determinants. Taxpayer must now only employ the new capitalization criteria of restoration, adaption, betterment or improvement – the RABI rules – or risk losing deductions that were incorrectly capitalized.

Many new requirements

Additionally, these new rules will require most taxpayers to:

  • Determine and file annual new elections, such as the new "de minimis" safe harbor election that will allow a taxpayer to write off items of a certain dollar amount and under, such as all qualified items $5,000 and under
  • Defer, i.e. not write off currently, some material and supply purchases
  • Modify internal processes to comply with these new rules (such as a capitalization policy)
  • Modify current and future documents (such as landlord/tenant leases)
  • Change business practices (from landlord/tenant leasehold improvements negotiations to separating out removal costs on future invoices for improvement expenditures)
  • Scrub the tax depreciation schedule to match the items on that schedule with the new criteria to determine if past capitalized items must now be written off, and/or to verify asset class lives
  • File one or more additional IRS forms and supporting schedules, such as applications for accounting method changes, with the 2014 tax return

These new rules and requirements apply regardless of the form of business one is in, whether a "C" or an "S" corporation, a partnership, an LLC, a sole proprietorship, or a rental.

Demanding compliance ... with potentially large deductions

Complying with the laws will be demanding. Prior year fixed asset records or transactions now need to be revisited in light of the new rules. Not only will taxpayers be required to file one or more Forms 3115 for each accounting method change, it will need to be done for each separate entity, or trade or business. For example, an individual filing Form 1040 with three rental entities housed in LLCs will be required to file three (or more) separate sets of IRS forms with supporting information.

Note that these regulations also can provide large potential current and future tax deductions. Generally, taxpayers will be able to expense greater amounts for expenditures than they thought possible. Those include repairs and maintenance and the new "de minimis" amounts under a capitalization policy.

In addition, taxpayers may be able to write off the net remaining tax basis of certain previously capitalized assets. For example, roof expenditures that were previously capitalized may now have their remaining depreciation currently written off, if a roof improvement is (or was) subsequently made and/or if those expenditures did not arise to the level of being a RABI.

Caution and work are needed

Under these new regulations, if a taxpayer does not implement these new rules and properly file the necessary Forms 3115 under the correct new methods, they may lose or delay their current or future tax depreciation or potential current write-off of previously capitalized assets. This is a serious issue that MUST be addressed for tax year 2014.

Most of the internal processes that will have to be changed deal with the following "must do's:"

  • Accounting for "non-incidental" material and supplies; these should now be deferred at tax year end and not expensed until put in place or used.
  • Employment of a capitalization "write-off" policy dictating a certain write off amount (e.g., "our policy is that we are going to expense all purchases under $500"). If you do not, you may be limited to much lesser amounts.
  • Filing the required Forms 3115 and elections in future tax returns.
  • Reviewing the tax depreciation schedules to see what assets on that list qualify for write off in, and no later than, tax year 2014.

While these regulations provided taxpayers with the option of adopting these changes in either the 2012 or 2013 tax year, the IRS had not finalized many of the rules, and in fact did change many of the rules. If the new changes were employed in tax year 2012, for example, subsequent forms had/have to be filed to correct and modify what was filed. As such, we generally recommended that our clients wait to employ these new rules until tax year 2014. Again, please note that these changes must be employed by taxpayers by tax year 2014.

These new IRS rules, criteria and regulations are not going to be easy to implement. They are complicated and in many cases not clear. The facts and circumstances of each business situation will need to be analyzed to determine the proper treatment of past, current and future expenditures.

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To ensure that your company fully leverages – and adheres to – the new regulations, contact your Rehmann representative today.

Published in Tax

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