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IRS Updates Accounting Method Procedure for Adopting Favorable Capitalization Rules.

(Parker Tax Publishing January 30, 2014)

Last September, the IRS issued final regulations which address when amounts paid to acquire, produce, or improve tangible property must be capitalized. The final regulations are generally effective for tax years beginning on or after January 1, 2014, but may be adopted for earlier years under certain circumstances. The IRS also issued proposed regulations on dispositions of MACRS property and general asset accounts, which were expected to be finalized before 2014. Once those regulations are finalized, taxpayer will have the choice of applying them to years beginning on or after January 1, 2014, or for earlier years if certain conditions are met.

There are many favorable methods and safe harbors in the final capitalization regulations that taxpayers may want to adopt. To do so, however, taxpayers must file for an accounting method change.

While the IRS is granting automatic consent to change to many of these new methods, Form 3115, Application for Accounting Method Change, must still be filed and the appropriate procedures followed. Last week, the IRS issued Rev. Proc. 2014-16, which updates the procedures for making such accounting method changes. Rev. Proc. 2014-16 also includes new procedures for changing to a reasonable cost allocation method for allocating direct and indirect costs to certain property and for changing the method of accounting for costs associated with foreclosures or similar transactions. Finally, for certain small taxpayers, the amount of detail required when filing the Form 3115 is reduced.

Background

In December 2011, the IRS issued temporary regulations on the deduction and capitalization of expenditures related to tangible property, as well as temporary rules on the tax treatment of dispositions of MACRS property and assets in a general asset account. According to the IRS, the capitalization rules were necessary to reduce the constant controversies over whether an expense was currently deductible as a repair or had to be capitalized as an improvement. Initially, the temporary capitalization regulations were slated to apply to tax years beginning on or after January 1, 2012. Subsequently, the IRS reconsidered that effective date. On November 20, 2012, the IRS issued Notice 2012-73 which provided that, to assist taxpayers in their transitions to the temporary regulations and future final regulations, the IRS was changing the applicable date of the 2011 temporary regulations to tax years beginning on or after January 1, 2014, while permitting taxpayers to choose to apply the 2011 temporary regulations to tax years beginning on or after January 1, 2012, and before the applicable date of the final regulations.

In March 2013, the IRS issued LB&I Directive 04-0313-001. That directive ordered IRS auditors to discontinue audits relating to positions taken on original returns involving the following issues:

whether costs incurred to maintain, replace, or improve tangible property must be capitalized under Code Sec. 263(a); and

any correlative issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets (other than a building or its structural components).

The directive applies to tax years beginning on or after January 1, 2012, and before January 1, 2014. The directive does not apply to current audit activity relating to:

costs for which the IRS provides specific guidance, separate from the temporary regulations, for determining whether expenditures incurred to maintain, replace, or improve tangible property must be capitalized under Code Sec. 263(a); or

issues that do not pertain to whether costs incurred to maintain, replace, or improve tangible property must be capitalized under Code Sec. 263(a).

On September 19, the IRS finalized the capitalization rules. While the final regulations are generally effective for tax years beginning on or after January 1, 2014, taxpayers have the option of applying them to tax years beginning on or after January 1, 2012.

Also on September 19, the IRS issued proposed regulations that provide significant changes to the temporary rules for asset dispositions of MACRS property and for qualifying dispositions of an asset in a general asset account. The regulations are proposed to apply to tax years beginning on or after January 1, 2014, but allow taxpayers to rely on the proposed regulations for tax years beginning on or after January 1, 2012, and before the applicable date of the final regulations. The proposed regulations provide that taxpayers may apply the final regulations on dispositions, which are expected to be released shortly, to tax years beginning on or after January 1, 2012.

New Automatic Consent Provision for Changes to Reasonable Allocation Method

The final capitalization regulations added a favorable rule allowing taxpayers to adopt any reasonable method, within the meaning of Reg. Sec. 1.263A-1(f)(4), to properly allocate direct and indirect costs among units of property produced during the tax year. Because this was new, there was no automatic consent provision available to make this change. As a result, the IRS has added a new automatic consent provision to Rev. Proc. 2014-16 to accommodate taxpayers that want to change to this method.

New Automatic Consent Provision for Changes Relating to Costs Associated with Foreclosures or Similar Transactions

Under Code Sec. 263A(b)(2)(A), the uniform capitalization rules of Code Sec. 263A apply to real or tangible personal property acquired by the taxpayer for resale. According to the IRS, practitioners have asked whether these rules apply to real property acquired by certain taxpayers through a foreclosure proceeding, or a deed-in-lieu of foreclosure transaction. Prior to Rev. Proc. 2014-16, there was no automatic consent procedure for a change in method of accounting to stop capitalizing costs of acquiring and holding property obtained through foreclosure (or similar transaction). As a result, Rev. Proc. 2014-16 has added a section to provide automatic consent for a change in method of accounting to an otherwise permissible method of accounting that does not capitalize amounts for acquiring or holding real property obtained through a foreclosure proceeding, a deed-in-lieu of foreclosure transaction, or another similar transaction.

Applying for an Automatic Accounting Method Change under Rev. Proc. 2014-16

Periodically, the IRS issues a revenue procedure in which it provides the general and specific procedures taxpayers must follow in order to obtain the automatic consent of the IRS to make a particular change in method of accounting. The general rules for making the change are spelled out in the body of the procedure, and the Appendix describes the specific accounting method changes to which the revenue procedure applies. The current accounting method change procedure is Rev. Proc. 2011-14.

After issuing the temporary capitalization and disposition regulations in 2011, the IRS issued Rev. Proc. 2012-19 with respect to the capitalization rules, and Rev. Proc. 2012-20 with respect to the disposition rules. Both procedures modified the Appendix of Rev. Proc. 2011-14 to provide the procedures by which a taxpayer could obtain automatic IRS consent to change to the methods of accounting provided in those rules. Those procedures were favorable in that they waived the scope limitations under Rev. Proc. 2011-14 (i.e., the limitations that preclude certain taxpayers from being eligible to apply the automatic consent procedures) for accounting method changes filed for a taxpayer's first or second tax year beginning after December 31, 2011.

Rev. Proc. 2012-19 has now been superseded by Rev. Proc. 2014-16, which is effective January 24, 2014. To obtain automatic consent to change to a method of accounting in Rev. Proc. 2014-16, a taxpayer whose average annual gross receipts for the three preceding tax years is less than or equal to $10 million must complete only the following information on Form 3115:

(1) The identification section of page 1 (above Part I);

(2) The signature section at the bottom of page 1;

(3) Part I, line 1(a);

(4) Part II, all lines except lines 11, 13, 14, 15, and 17;

(5) Part II, line 13, if the change is to depreciating property;

(6) Part IV, lines 25 and 26; and

(7) Schedule E, if applicable.

All other taxpayers must complete Form 3115, and include:

(1) The citation to the paragraph of the final tangible property regulations or temporary tangible property regulations that provides for the proposed method, or methods, of accounting to which the taxpayer is changing;

(2) If the taxpayer is changing the method of determining any unit(s) of property or, in the case of a building, is changing the identification of any building structure(s) or building system(s) for purposes of determining whether amounts are deducted as repair and maintenance costs or capitalized as improvement costs, the taxpayer must include a detailed description of the unit(s) of property, building structure(s), or buildings system(s) used under its present method of accounting and a detailed description of the unit(s) of property, building structure(s), and building system(s) under its proposed method of accounting, together with a citation to the paragraph of the final regulation or temporary regulation under which the unit of property is permitted; and

(3) A taxpayer changing its method of accounting to capitalizing amounts paid or incurred and to depreciating such property must complete Schedule E of Form 3115.

Waiver of Scope Limitations Extended to Years before 2015

Generally, automatic accounting method changes are not available under Rev. Proc. 2011-14 for taxpayers under audit, partnerships and S corporations with an accounting method change that is an issue under consideration in an audit of a partner or shareholder's tax return, entities engaged in a Code Sec. 381 transaction, a business in its final year of operation, and taxpayers who have changed their overall method of accounting within the past five years. As noted above, Rev. Proc. 2012-19 waived the scope limitation rules for changes made under that procedure. That waiver of the scope limitation rules continues under Rev. Proc. 2014-16 for accounting method changes made for tax years beginning before 2015.

The scope limitations also do not apply if a taxpayer makes accounting method changes under Rev. Proc. 2014-16 and also makes an accounting method change under uniform capitalization methods described in Section 11.01, 11.02, or 11.09 of the Appendix in Rev. Proc. 2011-14 for a tax year beginning before 2015.

Changes Under the Final Regulations to Which Rev. Proc. 2014-16 Apply

Rev. Proc. 2014-16 applies to the following accounting method changes made under the final capitalization regulations, which taxpayers can adopt for tax years beginning after 2011:

(1) A change to deducting amounts paid or incurred to acquire or produce non-incidental materials and supplies in the tax year in which they are first used in the taxpayer's operations or consumed in the taxpayer's operations in accordance with Reg. Sec. 1.162-3(a)(1) and Reg. Sec. 1.162-3(c)(1);

(2) A change to deducting amounts to acquire or produce incidental materials and supplies in the tax year in which paid or incurred (Reg. Secs. 1.162-3(a)(2), 1.162-3(c)(1));

(3) A change to deducting amounts paid or incurred to acquire or produce non-incidental rotable and temporary spare parts in the tax year which the taxpayer disposes of the parts (Reg. Secs. 1.162-3(a)(3), 1.162-3(c)(2));

(4) A change to the optional method of accounting for rotable and temporary spare parts (Reg. Sec. 1.162-3(e));

(5) A change to deducting amounts paid or incurred for repair and maintenance, including a change, if any, in identifying the unit of property or, in the case of a building, identifying the building structure or building systems for purposes of making the change to deducting the amounts (Reg. Secs. 1.162-4, 1.263(a)-3(e));

(6) A change to capitalizing amounts paid or incurred for improvements to tangible property and, if depreciable, to depreciating such property under Code Sec. 167 or Code Sec. 168, including a change, if any, in identifying the unit of property or, in the case of a building, identifying the building structure or building systems for purposes of making the change to capitalizing the amounts (Reg. Sec. 1.263(a)-3(e));

(7) A change by a dealer in property to deduct amounts paid or incurred for commissions and other transaction costs that facilitate the sale of property (Reg. Sec. 1.263(a)-1(e)(2));

(8) A change by a non-dealer in property to capitalizing amounts paid or incurred for commissions and other costs that facilitate the sale of property (Reg. Sec. 1.263(a)-1(e));

(9) A change to capitalizing amounts paid or incurred to acquire or produce property and, if depreciable, to depreciating such property (Reg. Sec. 1.263(a)-2);

(10) A change to deducting amounts paid or incurred in the process of investigating or otherwise pursuing the acquisition of real property if the amounts meet the applicable requirements (Reg. Sec. 1.263(a)-2(f)(2)(iii)); and

(11) A change to the optional regulatory accounting method to determine whether amounts paid or incurred to repair, maintain, or improve tangible property are treated as deductible expenses or capital expenditures (Reg. Sec. 1.263(a)-3(m)).

Changes Under the Temporary Regulations to Which Rev. Proc. 2014-16 Apply

Because taxpayers have the option of applying the 2011 temporary regulations to their tax years beginning before 2014, Rev. Proc. 2014-16 applies to the following accounting method changes made under those temporary regulations:

(1) A change to deducting amounts paid or incurred to acquire or produce non-incidental materials and supplies in the tax year in which they are used or consumed in the taxpayer's operations (Reg. Secs. 1.162-3T(a)(1), 1.162-3T(c)(1));

(2) A change to deducting amounts to acquire or produce incidental materials and supplies in the tax year in which they are paid or incurred (Reg. Secs. 1.162-3T(a)(2), 1.162-3T(c)(1));

(3) A change to deducting the amounts paid or incurred to acquire or produce non-incidental rotable and temporary spare parts in the tax year which the taxpayer disposes of the parts (Reg. Secs. 1.162-3T(a)(3), 1.162-3T(c)(2));

(4) A change to the optional method of accounting for rotable and temporary spare parts (Reg. Sec. 1.162-3T(e));

(5) A change to deducting amounts paid or incurred for repair and maintenance, including a change, if any, in identifying the unit of property or, in the case of a building, identifying the building structure or building systems for purposes of making the change to deducting the amounts (Reg. Secs. 1.162-4T, 1.263(a)-3T);

(6) A change to capitalizing amounts paid or incurred for improvements to tangible property and, if depreciable, to depreciating such property, including a change, if any, in identifying the unit of property or, in the case of a building, identifying the building structure or building systems for purposes of making the change to capitalizing the amounts (Reg. Sec. 1.263(a)-3);

(7) A change by a dealer in property to deduct amounts paid or incurred for commissions and other transaction costs that facilitate the sale of property (Reg. Sec. 1.263(a)-1T(d));

(8) A change by a non-dealer in property to capitalizing amounts paid or incurred for commissions and other costs that facilitate the sale of property (Reg. Sec. 1.263(a)-1T(e));

(9) A change to capitalizing amounts paid or incurred to acquire or produce property, and if depreciable, to depreciating such property (Reg. Sec. 1.263(a)-2T);

(10) A change to deducting amounts paid or incurred in the process of investigating or otherwise pursuing the acquisition of real property if the amounts meet the applicable requirements (Reg. Sec. 1.263(a)-2T(f)(2)(iii));

(11) A change to apply the de minimis rule to amounts paid or incurred to acquire or produce a unit of property (Reg. Sec. 1.263(a)-2T(g)); and

(12) A change to the optional regulatory accounting method to determine whether amounts paid or incurred to repair, maintain, or improve tangible property are treated as deductible expenses or capital expenditures (Reg. Sec. 1.263(a)-3T(k)).

Effective Date and Transition Rules

Rev. Proc. 2014-16 is generally effective January 24, 2014. However, certain transition rules apply if, before January 24, 2014, a taxpayer filed an accounting method change application under either Rev. Proc. 97-27 or Rev. Proc. 2012-19.

If a change under Rev. Proc. 97-27 is pending with the IRS on January 24, 2014, the taxpayer may choose to make the change under Rev. Proc. 2014-16 if the taxpayer is otherwise eligible. The taxpayer must notify the IRS National Office of its intent to make the change under Rev. Proc. 2014-16 before the issuance of a letter ruling granting or denying consent for the change. If the taxpayer timely notifies the National Office that it will make the change under Rev. Proc. 2014-16, the National Office will return the Form 3115 to the taxpayer to make the necessary modifications to comply with the applicable provisions of Rev. Proc. 2014-16 and will refund the user fee submitted with the Form 3115.

If a taxpayer filed for an accounting method change under Rev. Proc. 2012-19 and the application was either post-marked or received by the IRS on or before January 24, 2014, the taxpayer makes the change under Rev. Proc. 2012-19. Otherwise, if on or before January 24, 2014, a taxpayer filed an application under Rev. Proc. 2012-19, the taxpayer may choose to file an amended application for that year of change under Rev. Proc. 2014-16 if, by the due date of the federal income tax return for the year of change (excluding extensions), the taxpayer follows the procedures outlined in Rev. Proc. 2014-16. (Staff Editor Parker Tax Publishing)

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.

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