IRS Final Capitalization Regs Contain Many Favorable Changes for Taxpayers
(Parker Tax Publishing: September 13, 2013)
Download T.D. 9636 pdf
The IRS has just released the final capitalization regulations that practitioners have been waiting for (T.D. 9636 (9/19/13). The regulations replace temporary regulations issued in December 2011. They are aimed at reducing controversy over the determination of whether an expense may be currently deducted as a repair or must be capitalized. While generally effective for tax years beginning on or after January 1, 2014, taxpayers have the option of applying the final regulations to tax years beginning on or after January 1, 2012.
There are many significant changes in the final regulations which are favorable to taxpayers. Some of the more important ones are the following:
(1) With respect to materials and supplies, the final regulations expand the definition of materials and supplies to include property that has an acquisition or production cost of $200 or less (increased from $100 or less), clarify application of the optional method of accounting for rotable and temporary spare parts, and simplify the application of the de minimis safe harbor to materials and supplies.
(2) The final regulations increase the dollar threshold for characterizing a unit of property as a material or supply from property costing $100 or less to property costing $200 or less.
(3) While the final regulations retain the rule permitting a taxpayer to elect to capitalize and depreciate amounts paid for certain materials and supplies, they also provide that this rule only applies to rotable, temporary, or standby emergency spare parts.
(4) The final regulations eliminate the de minimis safe harbor ceiling which required taxpayers to capitalize amounts paid to acquire or produce a unit of real or personal property that was over the ceiling amount. Practitioners said the rule was so complex that the administrative burden imposed would outweigh any potential tax benefit. Instead of that rule, the final regulations require taxpayers to use a reasonable, consistent methodology that clearly reflects income for tax purposes. The IRS replaced the ceiling rule with a new safe harbor determined at the invoice or item level and based on the policies that the taxpayer uses for its financial accounting books and records. A taxpayer with an applicable financial statement may rely on the de minimis safe harbor of the final regulations only if the amount paid for property does not exceed $5,000 per invoice, or per item as substantiated by the invoice. The final regulations give the IRS the authority to change the safe harbor amount through published guidance.
(5) The final regulations provide that the de minimis safe harbor also applies to a financial accounting procedure that expenses amounts paid for property with an economic useful life of 12 months or less as long as the amount per invoice (or item) does not exceed $5,000. Such amounts are deductible under the de minims rule whether this financial accounting procedure applies in isolation or in combination with a financial accounting procedure for expensing amounts paid for property that does not exceed a specified dollar amount.
(6) The final regulations expand the de minimis rule to not only amounts paid for property costing less than a certain dollar amount but also amounts paid for property having a useful life less than a certain period of time. Thus, the final regulations provide the de minimis safe harbor also applies to a financial accounting procedure that expenses amounts paid for property with an economic useful life of 12 months or less as long as the amount per invoice (or item) does not exceed $5,000. Such amounts are deductible under the de minims rule whether this financial accounting procedure applies in isolation or in combination with a financial accounting procedure for expensing amounts paid for property that does not exceed a specified dollar amount. Under either procedure, if the cost exceeds $5,000 per invoice (or item), then the amounts paid for the property will not fall within the de minimis safe harbor. In addition, an anti-abuse rule is provided to aggregate costs that are improperly split among multiple invoices.
(7) The final regulations add a de minimis rule for taxpayers without an applicable financial statement, if accounting procedures are in place to deduct amounts paid for property costing less than a specified dollar amount or amounts paid for property with an economic useful life of 12 months or less. The de minimis safe harbor for taxpayers without an applicable financial statement provides a reduced per invoice (or item) threshold because there is less assurance that the accounting procedures clearly reflect income. A taxpayer without an applicable financial statement may rely on the de minimis safe harbor only if the amount paid for property does not exceed $500 per invoice, or per item as substantiated by the invoice. If the cost exceeds $500 per invoice (or item), then no portion of the cost of the property will fall within the de minimis safe harbor.
(8) The final regulations provide that the de minimis rule is a safe harbor, elected annually by including a statement on the taxpayer’s timely filed original federal tax return for the year elected. The final regulations provide that, if elected, the de minimis safe harbor must be applied to all amounts paid in the tax year for tangible property that meet the requirements of the de minimis safe harbor, including amounts paid for materials and supplies that meet the requirements.
(9) To simplify application of the de minimis safe harbor, the final regulations require that the de minimis safe harbor be applied to all eligible materials and supplies (other than rotable, temporary, and standby emergency spare parts subject to the election to capitalize or rotable and temporary spare parts subject to the optional method of accounting for such parts) if the taxpayer elects the de minimis safe harbor.
(10) While the temporary regulations did not provide any special rules for small taxpayers to assist them in applying the general rules for improvements to buildings, the final regulations permit a qualifying small taxpayer to elect to not apply the improvement rules to an eligible building property if the total amount paid during the tax year for repairs, maintenance, improvements, and similar activities performed on the eligible building does not exceed the lesser of $10,000 or 2 percent of the unadjusted basis of the building. Eligible building property includes a building unit of property that is owned or leased by the qualifying taxpayer, provided the unadjusted basis of the building unit of property is $1,000,000 or less.
(11) Also not included in the temporary regulations, but added in the final regulations, is a safe harbor for routine maintenance for buildings. The inclusion of a routine maintenance safe harbor for buildings is aimed at alleviating some of the difficulties that could arise in applying the improvement standards for certain restorations to building structures and building systems. The final regulations use 10 years as the period of time in which a taxpayer must reasonably expect to perform the relevant activities more than once.
(12) The final regulations reorganize and clarify the types of activities that constitute betterments to property. Also, the final regulations no longer phrase the betterment test in terms of amounts that “result in” a betterment. Rather, the final regulations provide that a taxpayer must capitalize amounts that are reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of a unit of property or that are for a material addition to a unit of property. Eliminating the “results in” standard is aimed at reducing controversy for expenditures that span more than one tax year or when the outcome of the expenditure is uncertain when the expenditure is made.
Parker Tax Publishing Staff Writers
Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.