Accounting for income tax implications of the tangible property regs.

• Author: Malik, Mariam

The IRS issued final regulations under Secs. 162 and 263 (T.D. 9636) that provide guidance on amounts paid to acquire, produce, or improve tangible property. The final regulations further clarify the capitalization and expensing of amounts paid to acquire, maintain, improve, or replace tangible property, which will affect both taxable income and accounting for income taxes. Differences in tax treatment with respect to an entity's accounting policies versus the final regulations can change the balance of an entity's deferred taxes and potentially the recognition of a liability under Accounting Standards Codification (ASC) Subtopic 740-10.

Pursuant to Sec. 162(a), a deduction is allowed for all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. These include costs of repairs and maintenance incurred in carrying on a trade or business. Under Sec. 263(a), amounts paid for permanent improvements or betterments, adaptation, or restorations made to any property must be capitalized. Determining whether to capitalize or deduct is based on the taxpayer's facts and circumstances and is subjective. The final regulations clarify and provide guidance on the criteria for deducting or capitalizing expenditures related to tangible property.

The final regulations, although effective Jan. 1, 2014, can be applied retroactively to tax years beginning on or after Jan. 1, 2012 (Rev. Proc. 2014-16). Any change implemented by taxpayers to comply with the final tangible property regulations may result in a change in method of accounting, thus generally requiring fifing Form 3115, Application for Change in Accounting Method, with a Sec. 481(a) adjustment unless the taxpayer qualifies for the small business taxpayer exception found in Rev. Proc. 2015-20. Rev. Proc. 2015-20 allows small business taxpayers to make certain accounting method changes under the tangible property regulations without fifing Form 3115 in their first tax year beginning on or after Jan. 1, 2014, the effective date of the repair regulations.

Under the revenue procedure, small businesses can also make certain accounting method changes on a cutoff basis, that is, with a Sec. 481(a) adjustment that only takes into account only amounts paid or incurred, and dispositions, in tax years after Jan. 1,2014. For these purposes, the revenue procedure defines a small business as one with total assets of less than $10 million on the first day of the tax...