An overview of the tax treatment of expenditures related to tangible property in accordance with the new regulations, including capitalization of expenditures, unit of property, the deminimis rule and dispositions.
2. History & Effective Dates
Ten years in the making
– Advance Notice: 2004
– Proposed regulations issued: 2006 & 2008
– Temporary regulations issued: December 2011
• Effective beginning on or after January 1, 2012
– Public hearing in May 2012
– Final regulations repair & proposed disposition
regulations issued: September 2013
• Effective beginning on or after January 1, 2014
3. “The Repair Regulations”: A Misnomer
Applies to all costs incurred in connection with
tangible property
(1) acquiring
(2a) improving
(2b) repairing
(2c) maintaining
(3) disposing
4. Why is it Important?
• Explains how to classify costs: deduct vs. capitalize
– No longer based on facts & circumstances
– Provides new definitions
– Set new standards
• Introduces new “disposition” rules
– Allows taxpayers to claim a loss on disposition vs.
double depreciation
** Mixed Results – may be beneficial and/or unfavorable **
5. Acquiring Property
• Material & Supplies
– Tangible property that is used or consumed in the
operations that is not inventory
– Consumed in 12 months or less
– Has economic life of 12 months or less
– Costs of $200 or less
– Annual election to capitalize & depreciate spare
parts
6. Acquiring Property
• De minimis Safe Harbor
– Book conformity:
• Costs classified as expenses
• Capitalization policy
– Capitalization policy:
• In place at beginning of the year
• Cost per item less than threshold
• Item has an economic useful life of less than 12
months
7. Acquiring Property
• De minimis Safe Harbor
– Two thresholds:
• $5,000 per-item or per-invoice with
Applicable Financial Statements (AFS)
• $500 per-item or per-invoice without AFS
– Example: Bulk purchase of 10 computers for cost
$40,000. Computers invoiced in aggregate, not
individually. De minimis safe harbor applies.
8. Acquiring Property
• De minimis Safe Harbor
– Applicable Financial Statement is:
1. A financial statement required to be filed with the
Securities & Exchange Commission (SEC)
2. A certified audited financial statement
3. A financial statement (other than a tax return)
required to be provided to the federal or state
government (agency) other than SEC or IRS
9. Acquiring Property
• De minimis Safe Harbor
– What if book policy is less than threshold?
• Limited to amount expensed per book
– What if book policy is more than threshold?
• Limited to $5,000 to qualify for the safe harbor
• May deduct larger amount: upon audit must
demonstrate amount is immaterial or clearly reflects
income
10. Acquiring Property
• De minimis Safe Harbor
– Annual Election – made with tax return
• Election is irrevocable
• Not an accounting method
– Election applies to all qualifying expenses
• Cannot exclude certain expenses
• Applies to all repair & maintenance costs capitalized for
book
11. Unit of Property (UOP)
• Building, structural components & roof
– Single unit of property
• Building systems
– Each a separate unit of property
• Other property
– Generally a UOP consists of a group of functionally
interdependent components
12. Unit of Property (UOP)
• Building componentization
• Significant change
• Prior law: building & building systems were
likely one UOP
• Each component viewed as a separate asset
• Required on buildings
13. Unit of Property: Building
Each building system = a separate unit of property:
– HVAC
– Plumbing systems
– Electrical systems
– Escalators
– Elevators
– Fire protection & alarm systems
– Security systems
– Gas distribution systems
– Other systems identified in future published guidance
14. Unit of Property: Leased Building
• Lessee leases a portion of a building
– The portion of the building structure subject to
the lease is the unit of property
– The portion of any building system associated
with that portion of the leased property is a
unit of property
15. Improving Property: Capitalize
• A unit of property is improved if amounts are
paid for activities performed after the unit of
property is placed in service by the taxpayer
resulting in:
– Adaptation of the unit of property to a new or
different use
– Betterment to the unit of property
– Restoration of the unit of property
16. Adaptation: Capitalize
• Adapt a UOP to a new or different use
• Adaptation is inconsistent with intended use
• Analyze facts & circumstances
• Examples:
– Capital: Expansion in retail drug store for a walk-in
medical clinic
– Deductible: expansion in grocery store for a sushi
bar that already includes counters for prepared food
& deli meats
17. Betterment: Capitalize
• Alleviates a material condition or defect that
existed prior to the acquisition of property
• Results in a material addition or expansion
• Is expected to materially increase in
productivity, efficiency, strength, output or
quality of the unit of property
18. Betterment: Example
• ABC Corp. purchases a parcel of land. The soil was
contaminated by leaking underground storage tanks
left by a previous owner
• ABC Corp.’s remediation costs to remove the
contaminants result in a capitalized betterment to
the land because ABC Corp. incurs the costs to
ameliorate a material condition or defect that existed
prior to its acquisition of the land
19. Restoration: Capitalize
• Replaces a component, and adjusted basis has
been taken into account in realizing gain/loss
• Returns a UOP to its ordinary efficient operating
condition if the property is no longer functional
• Rebuilds a UOP to a like-new condition after end of
its useful class life
• Replaces a part that comprises a major component
or a substantial structural part of a UOP
20. Restoration: Example
• ABC Corp. replaces the waterproof membrane
of the roof
• Not a major component or substantial
structural part of the building structure
• Improvement or repair? Depends if ABC Corp.
will recognize a loss on the replaced
membrane
21. Restoration: Example (Cont.)
• Will ABC Corp. recognize a loss on the
replaced membrane?
– Yes: Improvement = Capitalize
– No: Repair = Expense
22. Restoration: Example (Cont.)
• ABC Corp. rebuilds a manufacturing machine
with a seven-year class life:
– After eight years: Restoration = Capitalize
– After five years: No Restoration = Repair = Expense
23. Safe Harbor: Routine Maintenance
• Current deduction for certain on-going, routine
maintenance expenditures
• Applies only if:
– Activity is performed more than once over the property’s life
– The maintenance keeps the property in an efficient
operating condition
– The need for the maintenance results from the taxpayer’s
use of the property
24. Safe Harbor: Routine Maintenance
• Also applies to buildings & structural
components
• For buildings:
– Maintenance is expected to be completed more
than once in a 10-year period
25. Safe Harbor: Small Taxpayers
• Applies to buildings
• Average gross receipts: less than $10,000,000
• Average unadjusted basis (cost) of building:
less than $1,000,000
• Deduct costs of improvements:
– that do not exceed the lesser of $10,000 or
– 2% of the unadjusted basis of the property
26. Proposed Disposition Regulations
• Temporary regulations were issued
• 2011 regulations too complex
• New proposed regulations issued in 2013
• Final regulations to be issued in 2014
– Effective for tax years beginning on or after
January 1, 2014
27. Proposed Disposition Regulations
• Prior to 2011 temporary regulations
– Retirement of a structural component of a
building could not be treated as a disposition
– Continue depreciating retired component and
begin depreciating replacement component
– Example: Replacing a roof – if capitalize new roof
cannot write off old roof
28. Proposed Disposition Regulations
Revised Rule:
• May recognize a loss on the retirement of a
portion of an asset
• Created a “partial disposition” election
• If election is made: recognize a loss on retirement
• If no election is made: continue to depreciate the
basis of the retired asset
29. Proposed Disposition Regulations
Revised Rule:
– Special rules for General Asset Accounts (GAA)
– Partial disposition rule is elective except for
certain cases including
• Casualty event
• Like-kind exchange
• Involuntary conversion
30. Proposed Disposition Regulations
Tax basis of asset retired
– May use any reasonable method to determine
value of retired asset including:
• Cost segregation studies
• Replacement cost percentage extrapolation
• Original construction costs
31. Proposed Disposition Regulations
• Rev Proc 2014-17
• Change in accounting method
• Recognize a loss on assets that were physically
retired in prior years
• “Ghost” or “phantom” assets
• No later than due date of 2013 return
• Consider GAAP treatment