IRS Grants Relief to Small Businesses Applying for Repair Regulations

As we announced last week, the IRS has issued relief to small businesses in applying the IRS Repair Regulations. The simplified procedures are available beginning with the 2014 return taxpayers are filing this tax season. Since the announcement, the Anders Repair Regulations Team has been hard at work analyzing and dissecting the IRS Revenue Procedure which spells out the small business relief.

We break it down into what changes are now in place, how the changes benefit taxpayers, why filing a Form 3115 may make sense for small businesses, and who should file a Form 3115. You can view our original announcement on these new rulings here.

What changes do the new rules bring?

  1.  Small taxpayers can make a prospective accounting method change to conform to the tangible property regulations WITHOUT filing a Form 3115 to do so.  Before this change, most taxpayers (small and large) were required to file a Form 3115 to adopt these new regulations.
  2.  Small taxpayers are defined as businesses with total assets of less than $10 million OR annual gross receipts of $10 million or less for the prior three taxable years.
  3.  This applies to taxpayers with one or more distinct trades or businesses.
  4. A small taxpayer that has already filed a Form 3115 to adopt the Repair Regulations may withdraw its Form 3115 by filing an amended federal tax return using the Revenue-Procedure as guidance.
  5. Small taxpayers will not be allowed to make any other method changes related to the repair regulations, such as the write off prior Partial Asset Dispositions, if they choose to apply the repair regulations on a prospective basis using the Revenue Procedure.
  6. Small taxpayers may still file a Form 3115, even if they fall below the criteria listed above, if they believe they will still receive benefit in doing so.

How do these changes benefit taxpayers?

  1. Many smaller businesses without extensive fixed asset holdings can adopt the new regulations without incurring the time or expense associated with filing Form 3115.
  2. Many individuals with sole-proprietor businesses (reported on Schedule C), small rental properties (reported on Schedule E), and small farms (reported on Schedule F or Form 4835) can adopt the new regulations without incurring the time and expense associated with filing Form 3115.

Why would filing a Form 3115 make sense for small taxpayers?

While many commentators are proclaiming that any taxpayer that falls within the criteria listed above should not file a Form 3115, we believe that these new rules are not an automatic “get out of jail for free card.”  Many small businesses would still benefit by filing a Form 3115.  A few of the reasons we believe filing a Form 3115 would be smart tax planning are:

  1. Taxpayers who do not file a Form 3115 do not get to take advantage of the opportunity to look back to prior years and make beneficial depreciation changes, such as reclassifying assets to repairs and taking a write-off in 2014. Many taxpayers have thousands of dollars in tax savings in making prior year depreciation changes on their 2014 tax return.
  2. Taxpayers who do not file a Form 3115 also do not get to apply the Partial Asset Disposition Election to prior years and take the write-off on their 2014 tax return. Click here for more on the benefits of the Partial Asset Disposition.
  3. forgoing the opportunity to define their Unit of Property.  This impacts many types of businesses, but particularly businesses with real estate holdings. Click here for more on the Unit of Property Rules.
  4. Taxpayers who do not file a Form 3115 are forgoing the opportunity to write off removal costs on future projects.  While identifying removal costs may require the assistance of the general contractor or architect, the immediate write-off of these items versus depreciating them can provide for significant tax savings.
  5. Taxpayers who do not file a Form 3115 are forgoing IRS audit protection related to the repair regulations.  While the IRS has not issued clear guidance as to what “audit protection” really means, we believe that they would not have specifically identified this caveat in the new rules if there was not a potential benefit for taxpayers in filing a Form 3115 for the purpose of receiving this audit protection.

Which small taxpayers should file a Form 3115?

While each taxpayer’s unique facts-and-circumstances would ultimately determine whether or not they should file a Form 3115 even if falling under the small taxpayer criteria, there are those that may make more sense than others. Businesses that warrant a second look before not filing a Form 3115 are:

  1. Businesses with large fixed asset schedules.  The more fixed assets a company has, the more opportunity for prior year depreciation changes and prior year write-offs.
  2. Business with real estate holdings.  When real estate is involved, taxpayers could potentially have large tax savings from the Partial Asset Disposition along with the ability to define their Unit of Property.  Buildings with multiple roofs, HVAC systems, plumbing systems, and other large additions on their depreciation schedules deserve further analysis.
  3. Even if a business believes they do not need to file a Form 3115, we recommend performing a thorough “depreciation schedule scrub” before filing their 2014 tax return.  Without performing the scrub, the business will not know for certain if they are leaving potential write-offs on the table.

As can be seen, it is not a slam-dunk decision to not file a Form 3115 even for qualifying small taxpayers.  There are many situations that may still warrant a Form 3115.  For more information on the small business rules, or to discuss how the repair regulations impact your business, contact your Anders advisor.  Also, visit our extensive repair regulations blog series to learn more about these new regulations:.