Change in Tangible Assets Regulations: What You Need To Know
After years of rework, the Internal Revenue Service (IRS) released final regulations governing taxpayers’ ability to capitalize or deduct costs associated with acquiring, producing, or improving tangible assets. The regulations are effective for tax years beginning on or after January 1, 2014. Because of the complexity and far reaching applicability of these regulations, it is crucial taxpayers compare the positions taken under the prior regulations to the positions available under the final regulations and determine if it is necessary to file a change in accounting method to comply with the final regulations.
Materials and Supplies
The definition of materials and supplies and the available methods and options are clarified and expanded. The definition of materials and supplies is extended to include items costing $200 or less, as well as standby emergency spare parts. In addition, the new regulations provide additional methods of accounting for temporary spare parts and standby emergency spare parts.
De Minimis Safe Harbors
Contrary to common belief, the regulations never allowed a taxpayer to utilize a capitalization policy for tax purposes. Under the new regulations, the IRS introduces a de minimis safe harbor. If the taxpayer has audited financial statements, the taxpayer may deduct items that cost $5,000 or less. If the taxpayer does not have audited financial statements, the taxpayer may deduct items that cost $500 or less. To apply the safe harbor, however, taxpayers must have written book policies in place at the beginning of the year and an annual election must be attached to the tax return.
Improvement of Tangible Property
The new regulations introduce a new definition of a unit of property. This changes how the taxpayer determines if an expenditure is an improvement or a repair. In the case of a building, while the unit of property for depreciation purposes remains the building and structural components, the new improvements standards must be applied to each separate building system, including:
- Heating, ventilation, and air conditioning
- Plumbing and electrical
- Escalators and elevators
- Gas distribution
- Any other system identified in IRS published guidance
The new regulations identify three different categories of cost generally considered to result in capitalized improvements to a unit of property. These categories include betterments, restorations, and adaptations. The regulations provide detailed subjective and objective tests and definitions to apply to costs incurred to determine if they result in a deductible expense or capitalized improvement.
In addition, the regulations provide two new safe harbors that may allow a taxpayer to expense certain costs. A safe harbor for routine maintenance is available if the activity is expected to be performed more than once during a specified period. There is also a small taxpayer safe harbor available to qualifying taxpayers. If specific requirements are met, the taxpayer may be able to elect to deduct costs incurred to improve a piece of property even if they would otherwise be considered improvement costs under the general rules.
Disposition of Property
The final regulations have expanded to include the disposition of structural components of a building. These regulations have also added an optional annual election to recognize a gain/loss on a partial disposition of an asset. This will provide taxpayers with an opportunity to write off old building components that have been replaced. It will also require the taxpayer to examine records to determine the cost of the original components that may have not been accounted for separately. In addition, the regulations clarify and modify the rules governing disposition of assets in general asset accounts.
Change of Accounting Method
Many provisions of the new regulations have changed or expanded the old provisions of the regulations. Generally, these new regulations require three different actions. Some of the changes can be made through simple elections on current and future tax returns. Other provisions may require the filing of multiple Form 3115, Application for Change in Accounting Method. Certain changes requiring Form 3115 may be implemented on a cut-off basis without a tax adjustment (Section 481(a) adjustment). Alternatively, certain changes require the taxpayer to review prior tax years and calculate a cumulative catch-up tax adjustment to adhere to the new regulations.
If your business has tangible property, it’s time to act. Each taxpayer will need to examine current practices surrounding fixed asset accounting for tax purposes. Companies should quickly act to formulate an implementation and compliance plan to adhere to the new regulations released by the IRS.