1. Tax Flash
New federal tax developments
from Grant Thornton’s Washington National Tax Office
2011 14
Dec. 27, 2011
IRS releases long awaited ‘repair’ regulations Contact information
Scott Hamilton
Strategic Federal Tax Group
On Dec. 23, new regulations were issued Units of property
Southern California
on when costs are required to be The rules in the Regulations for Director
capitalized to tangible property or may be determining the proper unit of property for T 213.596.8436
E scott.hamilton@us.gt.com
deducted as repair and maintenance costs. the most part are the same as the Proposed
The new regulations replace proposed Regulations, including that a building and Rich Shevak
Strategic Federal Tax Group
regulations issued in March 2008. its structural components are a single unit Senior Manager
of property. One significant change, T 206.398.2489
however, is that the Regulations now E rich.shevak@us.gt.com
This Tax Flash provides a summary of
some of the highlights of the regulations. provide that the tests to determine if www.GrantThornton.com/tax
property has been improved must also be
What was issued applied to structural components of a
Treasury and the IRS issued temporary building (for example a roof) and building
regulations (“Regulations”) that provide systems. The Regulations define building
guidance on amounts paid to improve systems to include:
tangible property (commonly referred to as (1) heating, ventilation and air
the repair regulations). The Regulations conditioning (HVAC) systems;
also provide guidance on amounts paid to (2) plumbing systems;
acquire or produce tangible property, as (3) electrical systems;
well as guidance regarding the disposition (4) escalators;
of property. The Regulations are generally (5) elevators;
effective for taxable years beginning on or (6) fire8protection and alarm systems;
after January 1, 2012. It is anticipated that (7) security systems; and
sometime in January the IRS will issue (8) gas distribution systems.
revenue procedures containing transition
rules for changing to methods described in The Regulations also provide expanded
the Regulations. The text of the rules for determining the unit of property
Regulations was simultaneously issued as in situations where property is leased and
proposed regulations and the previous provide special rules for determining
proposed regulations (“Proposed improvement costs in lease situations.
Regulations”) were withdrawn.
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2. Betterments Restorations
The rules in the Regulations for The rules in the Regulations for
determining whether amounts result in a determining whether an amount is paid to
betterment of a unit of property—and restore a unit of property, and therefore
therefore would result in capitalization of would result in capitalization of costs, are
costs—are basically the same as the basically the same as the Proposed
Proposed Regulations. One change, Regulations with a few notable exceptions.
however, is that the Regulations specifically Consistent with the rules in other portions
provide that an amount results in a of the Regulations, the rules specifically
betterment to a building if it results in a provide that an amount is paid to restore a
betterment to a structural component or a building if it restores a structural
building system. The Regulations include component or a building system. Also, the
more examples than were contained in the regulations significantly change the rules in
Proposed Regulations to illustrate the the Proposed Regulations for determining
application of the betterment rules. whether the costs result in a replacement
Included in the examples are three fact of a major component or a substantial
situations involving costs incurred by retail structural part of a unit of property. The
stores that the Regulations label as: Proposed Regulations defined replacement
(1) “building refresh”; of a major component or substantial
(2) “building refresh” with “limited structural part to mean either:
improvement”; and (1) costs that comprise 50 percent or
(3) “substantial remodel.” more of the replacement costs of
the unit of property, or
The examples conclude that: (2) replacement of 50 percent or more
(1) none of the building costs are of the physical structure of the
required to be capitalized in the unit of property.
building refresh example;
(2) some of the building costs are The Regulations instead provide a facts and
required to be capitalized in the circumstances test for determining whether
building refresh with limited a major component or substantial
improvement example; and structural part is replaced. The Regulations
(3) all of the building costs are also provide that a major component or
required to be capitalized in the substantial structural part includes:
substantial remodel example. (1) “a large portion” of the physical
structure of the unit of property,
These three examples illustrate the general or
rule in the Regulations that a determination (2) a part or combination of parts
of whether costs result in a betterment that perform a discrete and critical
depends on the facts and circumstances function in the operation of the
related to the costs. unit of property that is more than
“a minor component.”
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3. The Regulations contain more examples does not apply to work performed on
than the Proposed Regulations to illustrate buildings.
the rules. Included are examples of costs
related to the structural components of a Dispositions
roof, roof membrane, HVAC system, fire The Regulations also provide rules for
protection system, electrical system, determining gain or loss on the disposition
plumbing system, windows and floors. The of depreciable property. Of significance is
examples illustrate that the determination that the Regulations expand the definition
of whether costs are required to be of disposition of property to include the
capitalized depends on the nature and retirement of a structural component of a
extent of the costs relative to the property. building.
Plan of rehabilitation Amount paid to acquire or produce
Consistent with the Proposed Regulations, property
the Regulations do not provide for a plan The Regulations also contain rules for
of rehabilitation doctrine as described in amounts paid to acquire or produce
case law. Instead, the Regulations property. These include rules related to
incorporate the Section 263A standard for material and supplies and rotable spare
the treatment of repair and maintenance parts. In addition, the Regulations contain
costs performed during an improvement, a de minimis rule that allows a taxpayer in
and require capitalization of all indirect certain situations to deduct amounts under
costs that directly benefit or are incurred a certain dollar amount if that is consistent
by reason of an improvement. The with the method used for financial
Preamble to the Regulations provides that accounting purposes, provided that
the plan of rehabilitation doctrine is amounts under this rule do not exceed
obsolete to the extent that the court4 certain annual thresholds. The total
created doctrine provided different amounts deducted under the de minimis
standards for determining whether an rule for a taxable year must be less than or
otherwise deductible indirect cost must be equal to the greater of:
capitalized as part of an improvement. (1) 0.1 percent of the taxpayer’s gross
receipts for the taxable year as
Routine maintenance safe harbor determined for Federal income tax
Also consistent with the Proposed purposes; or
Regulations, the Regulations provide a (2) 2.0 percent of the taxpayer’s total
routine maintenance safe harbor rule. If, at depreciation and amortization
the time the unit of property is placed in expense for the taxable year as
service, it is reasonably expected that the determined in its Applicable
maintenance activities will be performed Financial Statements.
more than once during the class life of the
unit of property, the maintenance is Next steps
deemed not to improve the unit of Taxpayers will want to determine how the
property. The Regulations, however, new rules may impact their methods of
specifically provide that the safe harbor accounting for when to capitalize costs to
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All rights reserved.
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4. tangible property and when to deduct the Tax professional standards
amounts as repair and maintenance costs. statement
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may impact a specific situation. LLP. It is not written tax advice directed at
the particular facts and circumstances of
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