The IRS and Treasury have issued final regulations (T.D. 9636) regarding when costs incurred to acquire, produce or improve tangible property must be capitalized or may be deducted (commonly referred to as “repair regulations”). The IRS and Treasury have also separately reproposed regulations (REG-110732-13) regarding the disposition of depreciable property.
This Tax Flash highlights the long-awaited final regulations and the reproposed regulations.
What was issued
The final regulations replace temporary and proposed regulations issued in 2011 that provided guidance on amounts paid to improve, acquire, produce or dispose of tangible property. The final regulations must be applied for taxable years beginning on or after Jan. 1, 2014. For taxable years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014, a taxpayer may apply the final regulations, the temporary regulations or a combination of both.
The reproposed regulations replace previously issued proposed regulations regarding dispositions of depreciable property and general asset accounting rules. When finalized, the rules will apply to taxable years beginning on or after Jan. 1, 2014. A taxpayer may choose to apply the proposed regulations to taxable years beginning on or after Jan. 1, 2012.
The final regulations retain many of the provisions from the 2011 temporary and proposed regulations, adopting the same general format. However, the regulations also include significant changes that will affect all taxpayers that acquire, produce or improve tangible property.
Unit of property
The final regulations retain the unit-of-property rules included in the temporary regulations. Specifically for buildings, the regulations continue to apply the repair rules separately to both the building structure and defined building systems (for example, HVAC, plumbing and electrical systems).
The rules in the regulations for determining whether amounts result in a betterment of a unit of property — and therefore would result in capitalization of costs — are largely the same as the 2011 temporary regulations. The final regulations add examples applying the rules and also changing facts and analyses for certain pre-existing examples in the temporary regulations. For instance, the examples relating to building refreshes and remodels include significant changes.
The rules in the regulations for determining whether an amount is paid to restore a unit of property and therefore would result in capitalization of costs are again basically the same as the temporary regulations. However, the major component rule and the casualty loss rule both include significant revisions. The regulations add a new definition for major components and substantial structural parts of buildings but do not adopt a bright-line standard. The final regulations introduce a number of new examples and significantly change other examples, including those related to buildings.
Routine maintenance safe harbor
The safe harbor for routine maintenance has been expanded to apply to buildings. This rule allows taxpayers to deduct costs related to maintenance activities performed on buildings or building systems if the activities are reasonably expected to be performed more than once during the 10-year period beginning at the time the building or building system is placed in service.
The regulations include a number of new elections that need to be made with timely filed returns. For example, a “small taxpayer” (defined as a taxpayer with average annual gross receipts of $10 million or less) may elect not to apply the repair regulations to a building with an unadjusted basis of $1 million or less if the total amount paid during the taxable year for repairs, maintenance and other similar activities performed on the building does not exceed the lesser of (i) 2% of the unadjusted basis or (ii) $10,000. In addition, a taxpayer may elect to capitalize repair expenses for a taxable year if the taxpayer treats the amounts as capital expenditures for book purposes.
De minimis rule
The final regulations significantly change the complex and burdensome de minimis rule in the temporary regulations. The regulations create a new safe harbor allowing certain taxpayers to elect to deduct amounts paid for property if the amount does not exceed $5,000 per invoice or per item as substantiated by the invoice. To qualify for the safe harbor, a taxpayer must have an “applicable financial statement” and have in place written accounting procedures treating such amounts as expenses as of the beginning of the taxable year. A taxpayer without an applicable financial statement can elect to deduct amounts paid for property if the amount does not exceed $500 per invoice or per item as substantiated by the invoice.
Materials and supplies
The final regulations retain the general framework of the temporary regulations. The new rules do, however, expand the definition of materials and supplies to include property that has an acquisition or production cost of $200 or less (increased from $100 or less in the temporary regulations), clarify the application of the optional method of accounting for rotable and temporary spare parts, and simplify the application of the de minimis safe harbor to materials and supplies.
The reproposed regulations significantly change the rules for dispositions of depreciable property. The regulations allow a taxpayer to recover basis upon the disposition of a component of a unit of property, but eliminate the temporary regulations’ complicated rules related to building components that would have required many taxpayers to use the general asset account rules. Instead, the more- simplified new rules allow taxpayers to elect to recover basis upon the partial disposition of an asset.
Taxpayers will want to determine how the new rules may affect their methods of accounting to capitalize costs to tangible property and when to deduct such amounts. Taxpayers may also want to apply favorable aspects of the final regulations, the temporary regulations or a combination thereof for their 2012 or 2013 taxable years. Please contact Grant Thornton LLP for questions or to discuss how the regulations may affect a specific situation.
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