On September 19, 2013, the IRS release regulations that clarify the rules related to the acquisition, production or improvement of tangible property. These were a long time coming as there was little or no guidance from the IRS on this topic in the past. They are generally applicable to tax years beginning on or after January 1, 2014, and are meant to help companies properly determine which expenditures should be deducted as repair and maintenance expenses, and which must be capitalized.
Who is impacted?
Every taxpayer that uses tangible property in its business is impacted by these new regulations. Considering most businesses use tangible property, these changes impact nearly all businesses.
What can we do for you?
One of the most important things we can do is get you ready for year-end tax filings, which will be more cumbersome than they have been in the past. With the numerous new elections and change of accounting methods, there will be a lot of requirements to file a complete and accurate tax return.
Additionally, we can review your fixed asset schedule to determine what corrections or adjustments need to be made going forward. There are many changes to the way fixed assets and repairs should be reported. It is a good idea to review before year end to ensure proper reporting and classification is being done.
Key Issues to Look out For:
Six new elections are available and include the following:
- De minimis Safe Harbor – As long as certain requirements are met, this election allows taxpayers a safe harbor for expenditures under $5,000 when the taxpayer has applicable financial statements (audited financial statements), and $2,500 when the taxpayer does not have applicable financial statements. One of these requirements is that the taxpayer has a capitalization policy in place at the beginning of the year.
- Safe Harbor for Small Taxpayers – Allows some small businesses to expense a certain amount of repairs without having to keep additional records. This relieves the administrative burden for the smallest of taxpayers. In order to qualify, the taxpayer must have average annual gross receipts of $10 million or less over the prior three tax years, and buildings with unadjusted basis of $1 million or less.
- Partial Asset Disposition – Allows a taxpayer to recognize a gain or loss upon the disposition of a structural component (or portion thereof) of a building or upon the disposition of a component (or portion thereof) of any other asset.
- Election to capitalize repair and maintenance costs
- Election to capitalize employee compensation costs or overhead
- Election to capitalize certain materials and supplies
Other key issues to address:
- Routine Maintenance – This change allows taxpayers to deduct the cost of recurring maintenance on personal and real property to keep it in its ordinarily efficient operating condition. Examples of routine maintenance activities include inspection, cleaning, testing and the replacement of parts. The taxpayer must reasonably expect to perform those maintenance activities more than once during the depreciable class life of the personal property, or more than once during a ten year period for buildings.
- Removal Costs – If the taxpayer realizes a gain or loss on disposition, these are not capitalized as an improvement. If no gain or loss is realized, the taxpayer must capitalize the costs if they are considered an improvement.
- Definition of materials and supplies – The regulations have changed the definition of what qualifies as a material and supplies, which impacts many industries.
- Understanding the definition of unit of property
What is considered a unit of property (UOP)?
A common dilemma for taxpayers has been how to determine when an asset has been improved versus when it has merely been maintained or repaired. In order to properly implement the repair regulations it is crucial to understand what makes up a unit of property and how functional interdependence is factored.
The following examples are considered separate building systems under the UOP rules:
- Fire Protection and Alarm
- Gas Distribution
- “Any other system identified in published Guidance”
An expenditure is considered an improvement to a UOP and is required to be capitalized if it results in one of the following three outcomes to any one functionally interdependent component:
- Results in a betterment or permanent improvement to the UOP
- Restores the UOP to its value or use
- Adapts the UOP to a new or different use
How to implement the repair regulations?
The various changes require different methods of implementations. Some of the changes can be implemented simply by following the new method, but most will need either an election statement or a change of accounting method to be attached to your tax return. Following the right procedure to implement the change will be extremely important going forward.
How We Can Help You?
There are a lot of changes with the regulations, but there are also many benefits. We can work with you throughout the year to make sure items are classified correctly, you aren’t leaving deductions on the table, and your tax return is correct. Visit our website to learn more from our blog series and contact an Anders advisor to see how we can help!
To learn more about our services or arrange a meeting with our team, click here to contact us.