Collateral issues to consider in repair regs. accounting method changes.

• Author: Lucas, Eric

The tangible asset regulations (the repair regulations) provide rules for distinguishing deductible repair costs from capital improvements that must be capitalized and recovered through depreciation (T.D. 9564). Although the IRS delayed the effective date of the repair regulations to tax years beginning after Dec. 31, 2013, taxpayers may opt to apply the repair regulations for tax years that began after Dec. 31,2011 (Notice 2012-73 and Rev. Procs. 2012-19 and 2012-20).

Accounting method changes adopted under the repair regulations will, in certain cases, affect the computation of other deductions or credits allowed under the Internal Revenue Code. Taxpayers should carefully consider these collateral consequences when quantifying the effect of changes made under the repair regulations. This item discusses in detail some of those collateral consequences:

* Sec. 199: A taxpayer's permanent Sec. 199 domestic production activities deduction could change.

* Sec. 263A: A taxpayer's Sec. 263A uniform capitalization (UNICAP) computation could be significantly affected, whether the Sec. 263A method relates to inventory or self-constructed assets.

* LIFO: A taxpayer that uses the LIFO method of accounting for inventories must reduce the Sec. 481 adjustment for repairs by allocating a portion of the adjustment to prior-year LIFO layers.

* Ordering rule: A taxpayer must consider the ordering rule in the Sec. 263A regulations for computing Sec. 481 adjustments for multiple changes filed in the same year.

Sec. 199: Domestic Production Activities Deduction

A taxpayer's permanent Sec. 199 deduction could be reduced, and the projected effective tax rate increased, if the change made to comply with the repair regulations yields a significant Sec. 481(a) adjustment in the taxpayer's favor. Conversely, if the adjustment is unfavorable to the taxpayer, the Sec. 199 benefit may be increased. A closer look at the Sec. 199 deduction and Sec. 481(a) adjustment shows the correlation.

The American Jobs Creation Act of 2004, P.L. 108-357, added Sec. 199 to the Code to provide a permanent tax deduction for certain domestic production activities. In 2012, the deduction is equal to 9% of the lesser of (1) the taxpayer's taxable income (determined without regard to the Sec. 199 deduction) for the tax year, or (2) the taxpayer's qualified production activities income (QPAI) for the tax year. The deduction is limited to 50% of the W-2 wages allocable to production gross...