New Tangible Property Regulations

By Andy Hatfield

The IRS released the final tangible property regulations in September 2013, as well as, the final regulations relating specifically to property dispositions in August 2014. These new regulations are possibly the most dramatic change in tax law since the overhaul of the Internal Revenue Code in 1986. They relate specifically to the tax deductibility of materials and supplies, guidance on when an improvement cost and the cost to acquire property must be capitalized (and depreciated) and when it can be expensed as a repair or maintenance item, and provides guidance on when an already capitalized cost can be written off as a disposition.

Nearly every business, including sole proprietors, individuals owning rental real estate and those that have operating farms will feel some type of effect from these new rules. The new law must be implemented starting with tax years beginning on or after January 1, 2014. There are some potential opportunities that will be available, but also some very stringent and time consuming compliance measures that must be taken. Below are a few highlights of the new laws and also a list of some of the tax compliance measures that will potentially need to be addressed on your 2014 tax return.

Highlights of the Regulations

1. De minimis safe harbor election – This is an annual election that can be made with your tax return to expense up to $500 if you do not have an AFS (defined below) and up to $5,000 if you do. These amounts are safe harbors that the IRS has given to be able to write-off an expenditure for property under these amounts as an expense rather than having to capitalize and depreciate. The amount you elect to expense must match your financial accounting policy and you must have a written policy in place.
• AFS – Applicable financial statement is a statement that is audited by an accompanied opinion by a certified public accountant or a financial statement that is required to be provided to a federal or state government agency.
2. A safe harbor for “qualifying small taxpayers” (those businesses with gross receipts of $10 million or less) for improvements to “eligible building property.”
• A small taxpayer as defined above can generally expense items for repairs, maintenance and capital improvements during the year if the total of these items does not exceed the lesser of $10,000 or 2% of the original cost of the building.
• Eligible building property – A building or leased property that has an original cost of less than $1 million. There are special rules for calculating the $1M threshold for leased property.
• To take advantage of this new rule, an election must be filed with the tax return.
3. A safe harbor for routine maintenance to tangible personal property and buildings.
• An amount paid is generally deductible if it is for ongoing repair and maintenance activities that are expected to occur more than once during the property’s class life (as provided by the IRS) or in the case of building structures, expects to occur more than once in a 10 year period.
• To take advantage of this new safe harbor, Form 3115 (Application for Change in Accounting Method) must be completed and filed with the 2014 tax return.
4. The property disposition rules:
• Among other items, these new rules allow a taxpayer to dispose of a portion of a building when a replacement is added. For example, if a roof is replaced on a building, a calculated portion of the original cost of the building, specifically related to the roof, can be written off when a new roof is installed.

In addition to the items above, there are some new terms that are introduced in the regulations to help identify and illustrate when property must be expensed or capitalized. These terms include: incidental and non-incidental materials and supplies, unit of property (UOP), betterments, restorations and adaptions. As a part of adopting this terminology and methods of accounting, which is a requirement to comply with the Tax Code and Regulations, a Form 3115 might need to be filed with your tax return.

List of Required Filing and Compliance Issues

1. Some taxpayers will need to file Form 3115 (Application for Change in Accounting Method) with their 2014 tax return. In addition, there will be required statements attached explaining certain line items on the form.
2. Annual election statements (when needed or advantageous) will need to be attached to the tax return.
3. Internal policies and procedures will need to be maintained by you to comply with these new rules.
4. Tax depreciation schedules will need to be “scrubbed” to see if there are potential opportunities to treat previously capitalized items as repairs or maintenance as provided by the new rules. We will also need to review these schedules to ensure correct class lives and methods are being utilized.

In summary, these new tax laws will need to be complied with by almost every taxpayer that has a business activity, a piece of rental real estate or an operating farm that deals with issues related to material and supplies, repairs and maintenance and capitalization of costs and related future depreciation. We will be touching base with our clients in the next two months and during the upcoming 2015 filing season on how these rules apply to you and what we suggest you do from an internal policy standpoint and how we will address these issues on your 2014 tax return. These new laws are complex and will be burdensome to comply with and could require us to take additional measures when preparing and filing your 2014 tax return.