Over the last two years, the IRS has finalized two new sets of regulations specifically addressing the proper tax recording of tangible property; and how to address the disposal of tangible and other capitalized property. These new regulations apply if you own buildings, fixed assets, and/or use and consume materials and supplies in your business. Both these regulations are effective for tax years beginning on or after January 1, 2014, which is now. To comply with these regulations, you may need to file one or more IRS Form 3115, Application for Change in Accounting Method with your 2014 tax returns.
These change in accounting methods or elections include:
Materials and Supplies, and Tangible – Personal Property Assets: Materials and supplies are defined to include tangible property used in business operations, but are not considered inventory. They also must be used, consumed, or have an economic useful life of 12 months or less. In addition, each unit of property must be under $200. Under these thresholds, you have the option to expense these items. The IRS also added the concept of standby emergency parts, which you can elect to capitalize and depreciate, instead of expensing. Various facts and circumstances would dictate this election.
De minimis safe harbor Personal Property Assets: You can choose to expense individual items under a prescribed amount, which is capped at $500 per item It is recommended that you have a written policy in place, which explains your procedures for expensing items under a specified dollar amount for financial statement purposes, or at the very least, consistently applying this process of expensing items under $500 This should be in place effective the first day of each taxable year. If you have an audited financial statement, this amount can be increased to $5,000, and a written policy has to be in place effective the first day of the taxable year, stating the same process as above.
As we have stated in previous correspondence, we can assist you in developing these written procedures and language.
Acquisitions and Facilitative Costs: Rules were updated to explain the types of acquisition and production costs on tangible property that must be capitalized. These include invoice costs; transaction costs; work performed prior to the date the unit of property was placed in service (repairs, installation costs; testing costs); defending or perfecting title; and inherently facilitative amounts. These facilitative costs apply to real and personal property; and were further defined to include appraisals, title costs, broker fees, and other professional fees such as architectural, engineering, etc. These costs would have to be factored in the overall value of purchased or constructed property.
A special rule was added on acquisitions of real property, that if costs were incurred on determining whether to acquire real property and which real property, some of these costs may be able to be expensed.
Partial Dispositions on Property: One of the new IRS Regulations specifically dealt with partial asset dispositions, both building assets, and non-building fixed assets. These would be property that was previously disposed of, i.e. tangible property replaced in a store remodel, but were not able to be written off under the old tax rules. It is extremely important that for disposals made prior to December
31, 2013, that we identify these and address for the 2014 tax return. Pre-2013 disposals cannot be written off after the 2014 tax returns are filed.
Units of Property and Repair vs. Capitalize: The definition of a unit of property (UOP), is noted as a building which is broken down into nine categories including HVAC, plumbing systems, electrical systems, escalators, elevators, fire protection and alarm systems, security systems, gas distributions
systems, and any other structural components deemed by the IRS in future guidance. For property other than buildings, there is a functional interdependence test, i.e. place one component into service is dependent on placing other components into service as well, example a computer and printer are not interdependent on one another – therefore can are separate, but the ramps associated with car lifts are interdependent and comprise one unit of property.
A betterment improves a material condition or defect that either existed prior to the acquisition of the property or arose during production of the UOP (regardless of whether the taxpayer was aware of the condition); results in a material addition of the UOP; or results in a material increase in capacity, productivity, strength, efficiency, or quality of the UOP or the output of the UOP.
A restoration results in the rebuilding of the UOP to a like-new condition after the end of its class life; is for the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of the UOP; or returns the UOP to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use.
There are very specific rules that were defined in the new regulations in this area, in discussing repairs and replacements vs. capitalization. Each of the expenditures has to be examined separately on its own facts and circumstances. These include replacements with improved but comparable parts; comparisons to property before and after expenditures are made; etc. We will assist in you determining these distinctions, for example, in the case of store remodels.
The new rules also expanded the definition of routine maintenance (expense) to include building properties, including building systems. Routine maintenance activities would include inspection, cleaning, and testing of building structures or systems which may have otherwise been required to be capitalized and depreciated. These procedures can be expensed. if you reasonably expect to perform them within 10 years of the placed in service date. Similar definitions apply for non-building properties.
- Annual election to capitalize repair and maintenance costs if treating as such on books for financial statement purposes, and are incurred while carrying on a trade or business. This is done on an annual basis.
- Small taxpayer safe harbors for building improvements and repairs; the building must be less than $1 million, and annual gross receipts must be under $10 million.
Overall: We realize that this is complicated, and will be time-consuming in terms of record keeping. The automatic changes which would require a change in accounting method to be filed were quantified under IRS Revenue Procedures 2015-13 & 2015-14.
It is possible that anyone whose businesses and entities involve personal and real property may require some of these method changes. We are available to assist during tax return preparation to identify all potential changes needed in order to be in compliance with the new tax laws.
If you have any questions regarding the changes in IRS Tax Law or need assistance for your tax needs, please contact one of the qualified CPAs at Rosenfield & Co by calling (407) 849-6400.