NEW TEMPORARY REGULATIONS
On December 23, 2011, the IRS issued temporary regulations that provide guidance on the long-standing debate of capitalization or expense for certain costs incurred in connection with acquiring, maintaining, and improving property. The bulk of these new Temporary Regulations is focused on providing clarification in three main areas:
- Materials, Supplies and Repairs
- Amounts Paid to Acquire or Produce Tangible Property
- Amounts Paid to Improve Tangible Property
The regulations are generally effective for tax years beginning on or after January 1, 2012. The regulations carry the full effect of final regulations.
MATERIALS, SUPPLIES AND REPAIRS
The significant points to consider in the materials, supplies and repairs regulations are as follows.
Non-Inventory categories - There are five non-inventory categories of costs that are eligible for immediate expensing as Materials and Supplies:
- Certain component costs that are incurred separately from the acquisition of a unit of property
- Fuel, lubricants, water and similar items that are expected to be consumed in 12 months or less
- Unit of property with an economic life of 12 months or less
- Unit of property with an acquisition or production cost of $100 or less
- Certain "Federal Register" specified costs
Earlier revenue procedures - It is important to note that the new temporary regulations do not supersede, make obsolete, or replace earlier revenue procedures that qualify certain property as materials or supplies (e.g., small wares in the restaurant industry).
Optional method for rotable or temporary spare parts (RTSP) - An optional method is available which allows taxpayers to deduct rotable or temporary spare parts (RTSP) when first installed for use. This method requires fair market value determinations, and gain recognition, upon subsequent removal of the RTSP from service.
De minimis - Amounts paid to acquire or produce a unit of real or personal property must otherwise be capitalized unless an election is made to apply the "de minimis rule". The de minimis rule (see discussion below) can be applied to certain costs that would otherwise be subject to capitalization.
"Repair" type costs incurred prior to the placed in service date - Costs for work performed, prior to the date that the unit of property is placed in service, should be capitalized.
AMOUNTS PAID TO ACQUIRE OR PRODUCE TANGIBLE PROPERTY
The significant points to consider in the amounts paid to acquire or produce tangible property regulations are as follows.
Payments to acquire or produce property - Amounts paid to acquire or produce tangible property should be broken down into the following components in order to properly determine the capitalization requirement associated with the amount incurred.
- Facilitative Costs – An amount is paid to facilitate the acquisition of real or personal property if the amount is paid in the process of investigating or otherwise pursuing the acquisition of the property.
- Inherently Facilitative Costs - An amount is paid in the process of investigating the acquisition of real or personal property if it is inherently facilitative. Amounts paid for transporting the property, securing an appraisal or determining the value, negotiating the terms or structure and obtaining tax advice, application fees, preparation and review of documents that effectuate the acquisition, examining and evaluating title, obtaining regulatory approval, conveyance costs, finders’ fees, brokers commissions, architectural, geological, engineering, environmental inspections services, and qualified intermediary costs are all inherently facilitative costs.
- Employee compensation and overhead costs – Amounts paid for employee compensation and overhead are treated as amounts that do not facilitate the acquisition of real or personal property.
De minimis rule available – A taxpayer is not required to capitalize nor treat as a material or supply amounts paid for the acquisition or production of a unit of property if:
The taxpayer has an Applicable Financial Statement (AFS). AFS primarily applies to financial statements that receive an independent CPA’s "opinion" (commonly referred to as a "financial statement audit"). The written accounting procedures, for AFS purposes, in place at the beginning of the tax year, should treat the de minimis costs as expenses. The aggregate amounts paid and not capitalized, under the de minimis rule, should be less than or equal to the greater of (1) 0.1% of gross receipts, or (2) 2% of total depreciation and amortization expense for AFS purposes.
AMOUNTS PAID TO IMPROVE TANGIBLE PROPERTY
The significant points to consider in the amounts paid to improve tangible property regulations are as follows.
Unit of Property (UOP) - A taxpayer generally must capitalize all amounts paid to improve a unit of property owned by the taxpayer. The UOP definitions are as follows:
- Buildings – An amount is paid for an improvement to a building if the amount paid results in an improvement for betterment or repair of a pre-existing condition, restoration to original use, or adaptation to new or different use. Each building and its structural components is a single unit of property. A building structure consists of the building and its structural components, other than the structural components designated as "building systems".
- Building Systems – Heating, ventilation and air conditioning (HVAC), plumbing systems, electrical systems, escalators, elevators, fire protection and alarm systems, security systems, gas distribution systems, other structural components identified in Federal Register
- Non Buildings – All components that are functionally interdependent comprise a single unit of property. Functional interdependence exits if the placing in service of one component is dependent on the placing in service of the other component.
Safe harbor for routine maintenance - Amounts paid for routine maintenance on a UOP, other than a building or structural component of a building, are not deemed to improve the property and are therefore deductible. Routine maintenance activities include, for example, inspection, cleaning and testing of the UOP. The activities are routine only if at the time the UOP is placed in service, there is a reasonable expectation to perform the maintenance activities more than once during the UOP’s class life. Class life is determined under depreciation rules and is not necessarily the expected useful life.
OTHER SIGNIFICANT POINTS TO CONSIDER
Dispositions of MACRS property – A disposition occurs when ownership of the asset is transferred or when the asset is permanently withdrawn from use. A disposition includes retirement, physical abandonment, or destruction of the asset; retirement of a structural component of a building; and transfer to a supplies or scrap account.
Other key provisions - There are several unique areas of discussion, leased properties, condominium issues, general and mass asset account groupings, special capitalization elections, etc., that are discussed throughout these new regulations.
In summary, the new regulations apply to tax years beginning on or after January 1, 2012. The general rule with regard to amounts paid to acquire property requires capitalization of costs incurred prior to the "placed in service date" for the underlying asset. The general rule with regard to amounts paid to improve property requires capitalization of costs incurred for new buildings or for permanent improvements or betterments made to increase the value of the UOP or any amount paid in restoring a UOP or for modifying said UOP for a different use. The IRS spends significant time explaining the ins and outs of capitalization and provides numerous examples throughout the new regulations to help taxpayers understand the intent of the new regulations. Additional guidance should be issued soon to explain the correct methodology for conforming to the new regulations. There are several unique provisions that are specific to the regulations specific descriptions. The regulation descriptions are provided below for your reference.
WE CAN HELP
Contact your Decosimo professional for help in determining how these new regulations will affect your company. If you do not currently work with a Decosimo professional, please contact Vic Merkel or Kevin Begley.
Vic Merkel, CPA | Tax Director
Kevin Begley, CPA | Corporate Tax Principal