Tangible Property Capitalization Regulations
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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.
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Tangible Property Capitalization Regulations
- 1. Tangible Property Capitalization Regulations Angelina Milo, CPA, MT Parnter, Cohen & Company
- 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
Editor's Notes
- Temp. Reg. §1.263(a)-3T(e)
- Temp. Reg. §1.263(a)-3T
- Temp. Reg. §1.263(a)-3T
- Temp. Reg. Reg. §1.168(i)-8T.
- Temp. Reg. Reg. §1.168(i)-8T.
- Temp. Reg. Reg. §1.168(i)-8T.
- Temp. Reg. Reg. §1.168(i)-8T.
- Temp. Reg. §1.263(a)-2T(g)