1. Final Tangible Property Regulations
(TPR) Summary
(commonly referred to as the “Repair Regs”)

2. What Were the “Old” Rules?
• Capitalize amounts paid to acquire , produce or improve tangible
property.
– Generally required to capitalize amounts paid to either a.) increase the
fair market value of the property, b.) substantially prolong the useful life
of the property, or c.) adapt property to a new or different use.
• Expense all ordinary and necessary expenses including materials,
supplies, and repairs.
– Amounts paid to keep property in an “ordinarily efficient operating
condition” may be deducted as an expense.
• Taxpayers and the IRS have been at odds over these rules for
decades with taxpayers wanting to expense expenditures and the
IRS wanting to capitalize as improvements.
• The result has been a confusing mix of court rulings that utilize a
“facts and circumstances” method to determine how to treat an
expenditure.

3. Where Are We Now?
• Generally required to capitalize amounts paid that result in either a
betterment, adaptation or restoration (B.A.R. test) of a unit of
property (UOP).
– Specific rules define what comprises a UOP.
– Betterment, adaptation and restoration are defined in general terms
with numerous, specific examples provided in the regulations as
guidance.
– De minimis safe harbors were created to simplify the process for
smaller expenditures.
• New rules were created for the treatment of materials and supplies
that require the identification of incidental and non-incidental
materials and supplies.
• Most taxpayers will need to file one or more accounting method
changes and elections to become compliant with the new
regulations.

4. Critical Points
• Distinguish between unit of property (UOP) and building system
– Distinguish between structural component (Regs. §1.48-1(e)(2))and
major component or substantial structural part.
• Properly identify materials and supplies.
• Partial asset dispositions are now permitted. Guidance has been
provided to determine the basis of the partial asset disposed.
• Going forward, generally a good idea to determine and then track
cost of building and the 8 building systems identified in the final
regulations.
• Cost segregation studies will continue to be an important tool and
more focus should be placed on using them to accurately separate
and classify fixed assets.
• Annual elections will likely be required in the tax return.
• Automatic change in accounting methods (Form 3115) will likely be
required along with 2014 tax return.

5. What is the Property being Improved?
• Analysis must start with determining the unit of property (UOP).
Have to know the UOP to determine if the expenditure results in:
• Betterment
• Adaptation of the property to new or different use
• Restoration
• By relating expenditures to the repair of a larger UOP rather than a
smaller UOP, taxpayer is in a better position to argue there is not a
betterment, change in use or restoration.

6. UOP - Buildings
• Special rules apply to buildings
• Unit of property = building and its structural components
• Expenditures restore UOP if they restore the building structure or
one of nine defined “building systems.”
• A roof is considered part of the building structure (shell)
• Apply repairs standards separately to the building structure and the
nine defined “building systems”.
1. HVAC
2. Plumbing systems
3. Electrical Systems
4. Escalators
5. Elevators
6. Fire protection and alarm systems
7. Security systems for protection of building and occupants
8. Gas distribution system
9. Any other system defined in published guidance

7. UOP Continued
• If a UOP is not currently properly classified on a taxpayer’s
depreciation schedule, an automatic change in accounting method
(Form 3115) will be required with the 2014 tax return.
– Most likely this will not result in a §481(a) adjustment.
• A common example would be a multi-building apartment
development when the first three buildings were placed in service
together as one single asset.
– The cost of the three buildings will need to be broken out into individual
buildings and a Form 3115 will need to be filed with the 2014 return.
– Assuming depreciation was properly computed on the original asset,
there will likely be no §481(a) adjustment from this change.

8. UOP Examples
• Example 1: HVAC system incorporating 10 roof-mounted units is a
building system and treated as a UOP.
• Example 2: Two elevator banks consisting of 3 elevators each is a
building system and treated as a UOP.
• Example 3: Plumbing system in a office condominium is a building
system and treated as a UOP.
• Example 4: Extension to office building is compared to the building
structure and the buildings systems to determine if it is an
improvement.
• Example 5: Power plant’s boiler, turbine, generator and pulverizer
are each treated as separate UOPs. Turbine blades are not separate
UOPs.
• Example 6: Laundry plant’s sorter, boiler, washer, dryer, ironer,
folder and waste water treatment plant are separate UOPs.
• Example 7: Tortilla-making equipment is a UOP. Not plant property,
so not broken into components.

9. UOP Examples
• Example 8: HVAC system of leased building is a building system and
is treated as a UOP.
• Example 9: Driveway constructed by lessee adjacent to leased
building is separate UOP.
• Example 10: Driveway constructed by lessee but owned by lessor
adjacent to leased building is separate UOP.
• Example 11: Two separate office spaces in same building subject to
separate leases treated as two separate UOPs.
• Example 12: Warehouse extension added to retail sales facility is not
a separate UOP.
• Example 13: Change in class of property as result of cost segregation
study results in separate UOP because portion of property reclassified
from nonresidential real property (with a 39 year life) to qualified
retail improvement property (with a 15 year life).

10. Betterment
• An amount paid results in a betterment only if it:
1. Ameliorates (fixes) a pre-existing material condition or defect at the
time you acquired the property (regardless of whether taxpayer was
aware of the defect),
2. Results in a material addition, or
3. Results in a material increase in capacity, productivity, efficiency,
strength, quality or output.
• Replacements due to technological improvements or product
enhancements do not necessarily require capitalization.
• Key is compare the condition of the property after the expenditure
to the condition of the property when initially placed in service.
• Taxpayer’s treatment of the expenditure on its financial statements
is not a factor to be considered.

11. Summary of conclusions from the 23
betterment examples
Not a Betterment
• Replacement of asbestos insulation with
similar non-asbestos insulation (Ex 2)
• Minor repairs and maintenance shortly
after purchase (Ex 3, 4)
• Retail refresh limited to cosmetic and
layout changes (Ex 6, 7)
• Relocate cash registers (Ex 9)
• Add concrete lining to meat plant (Ex
12)
• Roof membrane (Ex 13)
• Removal of drop ceiling (Ex 18)
• Replace 2 of 10 HVAC units that are
10% more efficient (Ex 20)
Betterment
• Remediation of soil by previous
owner (Ex 1)
• Bring assisted living building up to
higher standards (Ex 5)
• Retail refresh along with increased
storage, second loading dock (Ex 7)
• Major remodel of retail (Ex 8)
• Relocate machines to increase
capacity (Ex 10)
• Doubling depth of channel (Ex 15)
• 25% increase in depth of channel
(Ex 17)
• 50% reduction in energy or power
costs (Ex 21)
• Add restaurant drive through

12. Example 1: Building refresh is not a betterment
• Replace and reconfiguring display tables and racks to provide better
exposure of the merchandise
• Make corresponding lighting relocations and flooring repairs,
• Move one wall to accommodate the reconfiguration of tables and
racks
• Patch holes in walls
• Repaint the interior structure with a new color scheme to
coordinate with new signage
• Replace damaged ceiling tiles
• Clean and repair wood flooring throughout the store building, and
• Power washing building exteriors.

13. Adaptation to New or Different Use
• Improvement needs to be capitalized if paid to adapt a UOP to a new or
different use.
• Improvement needs to be capitalized if the adaptation is not consistent with
the taxpayer’s ordinary use of the unit of property at the time originally placed
in service by the taxpayer.

14. Summary of change in use examples
Not a Change in Use
• Combine 3 leased retail spaces
into 1 leased retail space (Ex 2)
• Minor refresh of building in
anticipation of sale (Ex 3)
• Clean up contamination after
closing manufacturing plant (Ex
4)
• Convert a portion of grocery
store space to a sushi bar (Ex 6)
• Convert a portion of hospital
emergency room to an
outpatient surgery center (Ex 7)
Change in Use
• Convert manufacturing
plant to showroom space
(Ex 1)
• Regrade land to
accommodate sale of land
for residential development
(Ex 4)
• Reconfigure part of a retail
pharmacy to a walk-in clinic
(Ex 5)

15. Restoration
• Amount is paid to restore UOP if it:
1. Is a replacement of a UOP and the taxpayer has properly deducted a loss
for that component;
2. Is for the replacement of a component of a UOP and taxpayer has
properly taken into account the adjusted basis of the component in
realizing gain or loss resulting from the sale or exchange of the
component.
3. Is for the repair of damage to a UOP for which the taxpayer has properly
taken a basis adjustment as a result of a casualty loss or casualty event
(but only to the extent of the claimed casualty loss).
4. 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;
5. Results in the rebuilding of the UOP to a like-new condition after the end
of its ADS class life; or
6. Is for the replacement of a part or a combination of parts that comprise a
major component or a substantial structural part of a unit of property.
– It is this provision the IRS uses to say roof replacements now must be
capitalized.

16. Summary of conclusions from 31 restoration
examples
Not a Restoration
• Replace power switch (Ex 13)
• Roof membrane (Ex 15)
• Replace 1 of 3 furnaces in HVAC system (Ex 16)
• Replace of 3 of 10 roof-mounted HVAC units
(Ex 18)
• Replace 30% of electrical (Ex 21)
• Replace 8 of 20 sinks (Ex 23)
• Replace 100 of 300 exterior windows
comprising 8.3% surface area (Ex 25)
• Replace lobby floors which comprise <
10% square footage (Ex 28)
• Replace 1 of 4 elevators (Ex 30)
Restoration
• Replace entire roof (Ex 14)
• Replace single chiller in HVAC (Ex 17)
• Replace sprinkler system (Ex 19)
• Replace entire electrical system (Ex 20)
• Replace all toilets and sinks with similar quality
and function (Ex 22)
• Replace 200 of 300 exterior windows comprising
16.67% surface (Ex 26)
• Replace 100 of 300 exterior windows comprising
30% of surface area (Ex 27)
• Replace floors in all public areas comprising 40%
of sq footage (Ex 29)
• Replace 1 of 4 elevators and claim partial
disposition loss (Ex 31)

17. Expenditures Over a Period of Time
• Amounts paid to improve a unit of property over a period of time
are required to be capitalized.
– Provision covers a plan of improvement taking place over a period of
time.
• Whether the amounts paid are related to the same improvement is
based upon facts and circumstances.
• How is “period of time” defined?
– Regulations do not define; based upon facts and circumstances.
– 1 to 3 year period most likely need to treat as related and capitalize.
– More than 5 year period most likely treat as unrelated.
– 3 to 5 year period will rely on facts and circumstances.
– But remember individual facts and circumstances are key!

18. Routine Maintenance Safe Harbor
• Routine maintenance consists of recurring activities that are
expected to be performed on a building or other unit of property
(UOP) as a result of its use to keep the asset in its ordinary efficient
operating condition.
• Taxpayer must reasonably expect to perform the activities more
than once during the useful life of the asset (or a 10 year period for
a building) beginning at the time the asset is placed in service.
• Routine maintenance includes inspections, cleanings, and
replacement of damaged or worn parts with comparable parts.
• The safe harbor does not apply to any expenditure that would be
considered betterment, restoration or adaptation.
• Must file an automatic change in accounting method (Form 3115) to
adopt the safe harbor method.

19. Acquisition Costs
Acquisition costs – the new rules
• Taxpayer must capitalize amounts paid to acquire or produce a UOP.
Generally the invoice price.
• Amounts paid to defend or perfect title must be capitalized into the
cost of the property.
• Must capitalize amounts paid to facilitate the acquisition of real or
personal property
• Must capitalize “inherently facilitative” costs (accounting, legal,
appraisals, environmental, etc.)
• Must capitalize costs for work performed prior to placed in service
dates

20. Removal Costs
• Removal costs are not capitalized if basis of the asset is taken into
account in realizing gain or loss.
• Costs of removing a component of a UOP are treated as any other
indirect cost incurred during the improvement of property.
• Removal costs are capitalized if they directly benefit or are incurred
by reason of an improvement.
• Removal costs unrelated to any improvement may be deducted.
• This provision provides an opportunity to claim prior year losses
when capitalizing replacement and did not previously take into
account remaining basis.

21. Removal Costs – Example Summaries
• Example 1 – Removal costs incurred to replace original columns and
girders supporting a second floor thereby permitting greater storage
of supplies must be capitalized as a betterment because the taxpayer
did not elect to treat the disposed items as a partial disposition.
• Example 2 – Same facts as Example 1, except the taxpayer elects to
treat the disposal of the structural components as a disposition. In
this case, the removal costs do not have to be capitalized, but the
other costs of the betterment still must be capitalized.
• Example 3 – Costs to remove old shingle and replace with new
shingles do not have to be capitalized as long as the replacement of
the shingles does not constitute an improvement to the building – in
this example they are assumed to not improve the building because
they were comparable to the original shingles.
• Example 4 – Same facts as Example 3, except taxpayer elects to treat
the replacement as a partial disposition. In this case the new shingles
must be capitalized. However, the cost of removing the old shingles
does not have to be capitalized regardless of their relation to the
improvement.

22. Materials and Supplies
• Defined as tangible property that is used or consumed in the taxpayer’s
operations that is not inventory and that are:
1. Components acquired to maintain, repair, or improve a UOP;
2. Consists of fuel, lubricants, water, and similar items that are reasonably
expected to be consumed in 12 months of less;
3. A UOP with an economic useful life of 12 months or less;
4. A UOP costing $200 or less; OR
5. Identified as such in guidance
• General rule for when deducted:
– Incidental (not inventoried) – deduct when paid (provided clearly reflects
income)
– Non-incidental (tracking consumption) – deduct when first used or
consumed in taxpayer’s operations
– Rotable, temporary, emergency spare parts – deduct when part is disposed;
deduct when used (and include in income when removed from service); treat
as depreciable property.
• Required method change (Form 3115) to adopt new rules

23. Materials and Supplies – Examples
• Taxpayer purchases 3 microwaves for a total cost of $500. Each
microwave is considered a UOP and costs less than $200 and
therefore would be considered materials and supplies. Deductible
when first placed in service (unless the taxpayer has a de minimis
safe harbor election in place).
• Items purchased for rental costing less than $200 each are materials
and supplies and deductible when first used in the rental business.
So if purchased in year 1, but not used until year 2, then deductible
in year 2.
• Appliances – separate UOP; may qualify as materials and supplies.
• Carpeting – not a separate UOP; part of a building component; may
be deductible.
• Windows – not a separate UOP; part of a building component; may
be deductible.

24. De Minimis Safe Harbor (DMSH) Election
• Annual election made in tax return.
• Allows taxpayer to deduct expenditures below a set threshold.
• Threshold is $500 per invoice or per item unless the taxpayer has an
applicable financial statement (AFS). If AFS, threshold is $5,000.
– AFS = audited or government-required financial statement.
• Taxpayer must maintain a written accounting policy.
• Book treatment must match tax treatment.
• Applies to property with a useful life of 12 months or less if the
amount per invoice (or item) does not exceed the $500/$5,000
threshold.
• The $500/$5,000 threshold are safe harbor amounts – taxpayers
may elect a higher capitalization threshold if they can justify the
amount.
• Threshold is $200 if the taxpayer does not have an accounting policy
or if the annual election is not made.

25. Safe Harbor for Small Taxpayers
• Taxpayers with average annual gross receipt for the 3 preceding tax
year of $10 million or less may elect to not capitalize improvement
to property if the total amount paid during the tax year for repairs,
maintenance, improvements, and similar activities performed on
eligible building property does not exceed the LESSER of: (1) 2% of
the unadjusted basis of the eligible building or (2) $10,000.
• Eligible building property – building, condominium, cooperative, or
leased building or portion of building that has an unadjusted basis of
$1 million or less.
– In case of lease, the unadjusted basis is deemed to be the total amount
payable over the expected lease term without any discounting.
• Must make annual election in the tax return.

26. Small Taxpayer–Example Summaries
• Example 1 –Taxpayer who incurs $5,500 of repairs can expense under small
taxpayer safe harbor because the expenses do not exceed the lesser of 2 %
of the building’s unadjusted basis of $750,000 or $10,000.
• Example 2 – Taxpayer who incurs $10,500 of repairs cannot expense under
the small taxpayer safe harbor because while the expenses do not exceed
2% of the building’s unadjusted basis of $750,000 (which is $15,000), they
do exceed $10,000. The limitations is the lesser of 2% of the unadjusted
basis or $10,000.
• Example 3 – Taxpayer with two rental properties, both of which have an
unadjusted basis of $1 million or less, may test each building separately to
determine if the expenses applicable to each can be deducted under the
small taxpayer safe harbor. In the case of building 1, the taxpayer can
expense under the safe harbor because the lesser of limitation is met;
however, in the case of building 2, the taxpayer cannot deduct under the
safe harbor because while the expense is less than $10,000, it also is not less
than 2% of the unadjusted basis of the building which was $300,000 in the
example. Point here is that it is a building by building analysis.

27. Election to Capitalize Repairs
• Taxpayer may elect to capitalize repair and maintenance costs on an
annual basis.
– Costs must be incurred in the taxpayer’s trade or business.
– Book and tax treatment must be the same.
• Taxpayer is not required to capitalize ALL repairs and maintenance.
– Election only applies to those repairs and maintenance costs treated as
capital expenditures by the taxpayer for books.
• Annual election attached to tax return.
• Election may be beneficial if the taxpayer capitalizes certain
expenditures which potentially could be classified as repairs and
maintenance – provides a backup plan in the event of an IRS auditor
attempts to disallow depreciation claiming the asset should have
been expense as a repair.

28. Partial Asset Dispositions
• New regulations provide that the disposition rules apply to a partial disposition of an asset.
• This rule allows taxpayers to elect to claim a loss upon the disposition of a structural component of a
building or upon the disposition of a component of any other asset (properly included in one of the asset
classes 00.11 through 00.4 of Rev. Proc. 87-56) without identifying the component as an asset before the
disposition event
• For 2014, ability exists to review depreciation schedules and record partial asset dispositions that occurred
in prior years.
– Most commonly this will apply when roofs and other major building components were replaced in a
prior year.
• Will require an automatic change in accounting method (Form 3115) be filed with the 2014 return.
• The undepreciated basis of the PAD will result in a negative §481(a) adjustment which will be deductible in
2014.
• Additional benefit of eliminating depreciation recapture upon sale of the building.

29. Dispositions – Example Summaries
• Example 1: Taxpayer replaces 1 of 4 elevators in office building and
does not make the special partial disposition election to claim a loss
on the remaining basis of the disposed elevator. Replacement of the
elevator must be capitalized as a betterment or restoration
(example doesn’t say which) and the remaining cost of the disposed
elevator continues to be depreciated as part of the building.
• Example 2: Same facts as Example 1, but the taxpayer has
componentized the building in its fixed asset systems. If no election
is made to claim a loss on partial disposition, no loss is claimed and
the results are the same as Example 1.
• Example 3: Same facts as Example 1, but in this case the taxpayer
makes the special partial disposition election. In this case, the
taxpayer can claim a loss on the remaining basis of the elevator and
must capitalize the cost of the new elevator.

30. Prior Year Classifications
• Regulations provide a method for taxpayers to correct prior year
classifications in the treatment of expenditures.
• Review depreciation schedules and identify any expenditures for
repairs and maintenance that were capitalized under prior rules.
– The ability to write these off eliminates potential future depreciation
recapture.
• Review repair and maintenance account for any expenditures
treated as repairs that should have been capitalized..
• Need to file an automatic change in accounting method (Form 3115)
with the 2014 tax return to take advantage of this provision.
– A net negative adjustment will be deductible in 2014.
– A net positive adjustment will be taken into income over 4 years
starting in 2014.

31. Action Steps
• Determine if the de minimis safe harbor (DMSH) election will be
adopted and the appropriate threshold to be used.
– Should the capitalization policy use an amount higher than $500 or
$5,000?
• Ensure the appropriate written accounting policy is in place.
• Modify internal processes to comply with the Regulations regarding
capitalization, repairs and materials and supplies.
• Review depreciation schedules to identify potential prior year
partial asset dispositions, depreciation methods and lives needing
correction, and repairs that should be expensed.
• Consider reviewing prior repair and maintenance expenses for
expenditures that should have been capitalized.
– This will probably depend upon how aggressive the company was in
expensing repair and maintenance in prior years.
• Consider the financial statement impact of current, past and future
changes to treatment of expenditures.
– Keep in mind any loan covenants.

32. Action Steps continued
• Prepare appropriate Form 3115s for automatic changes in accounting
methods. Some will be required; others will be optional based upon the
taxpayer’s circumstances. Changes most commonly needed will be:
– Treatment of materials and supplies
– Capitalization versus repairs and maintenance
– Identify the unit of property
– Change depreciation methods and bonus
– Prior year partial asset dispositions
– Proper treatment of removal costs
– Adopting the routine maintenance safe harbor