Key aspects of the new tangible property regulations.

• Author: Anderson, Susan E.

On Dec. 23, 2011, the IRS released temporary regulations for Secs. 162(a), 168, and 263(a) regarding expenditures to acquire, improve, and maintain tangible property. (1) These temporary regulations, which were simultaneously issued in proposed form, are the third set of regulations issued on this topic in the past six years. Treasury issued proposed regulations in 2006, but comments indicated that the regulations were too burdensome and complex. In 2008, Treasury withdrew the 2006 proposed regulations and issued new proposed regulations.

The 2011 regulations incorporate feedback from commentators while retaining many of the provisions from the 2008 proposed regulations, which the IRS also withdrew. The temporary regulations when issued were generally effective for tax years beginning on or after Jan. 1, 2012. However, in response to numerous comments from taxpayers and practitioners, the IRS in November 2012 delayed their effective date to tax years beginning on or after Jan. 1, 2014. (2) Instead, taxpayers are permitted (but not required) to apply the temporary regulations for tax years beginning on or after Jan. 1, 2012, and before the applicability date of the final regulations. The IRS also announced that it intends to issue final regulations sometime in 2013, that the final regulations will also apply to tax years beginning on or after Jan. 1, 2014, and that taxpayers may choose to apply them to tax years beginning on or after Jan. 1, 2012. (3)

The temporary regulations make several significant changes affecting taxpayers that own and use tangible property. These changes include revised de minimis rules and safe harbors, new unit-of-property-rules, and new elections for property dispositions. The IRS notified taxpayers in Notice 2012-73 that it intends to simplify certain of the rules in the temporary regulations when they are finalized. These include the de minimis rule, the safe-harbor rule for routine maintenance, and the rules for dispositions, all of which are discussed below. However, the IRS did not specify how it would simplify these rules.

The regulations address:

1. Repairs and routine maintenance;

2. Material and supplies;

3. De minimis rules for acquisitions of tangible property;

4. Capital improvements to existing tangible property;

5. Disposals of modified accelerated cost recovery system (MACRS) property;

6. Transaction costs to acquire real property;

7. Costs to investigate and pursue the purchase of real property;

8. Acquisition of and expenditures for "network assets" and leasehold improvements;

9. Expenditures for property on which a casualty loss has been deducted;

10. Environmental cleanup costs;

11. Costs subject to capitalization under Sec. 263A;

12. Regulatory accounting methods;

13. Rotable and temporary spare parts; and

14. Costs to facilitate the sale of property by nondealers.

    This article describes the first five items and discusses tax planning ideas for businesses and tax advisers to use in responding to the temporary regulations.

    Unit of Property

    The temporary regulations use the concept of a "unit of property" as a basis for determining whether costs are capitalized or deducted. For real and personal property other than buildings, the new regulations retain the general rule that a single unit of property includes all components that are functionally interdependent. Components are functionally interdependent if "the placing in service of one component by the taxpayer is dependent on the placing in service of the other component." (4) The functional interdependence rules are based on decisions in FedEx Corp. (5) and Ingram Industries. (6)

    Example 1: A computer includes multiple components including a motherboard, random access memory, central processing unit, and hard drive, that work together or are functionally interdependent. Consequently, a computer is single unit of property. Example 2: A computer and printer are not functionally interdependent units of property since one is not required to place the other in service. (7) There are two exceptions to the functional interdependence rule:

1. Plant property (other than buildings) used in industrial practices such as manufacturing, electrical generation, distribution, and warehousing that is separated into components or a group of components that perform a discrete and major function or operation within the functionally interdependent machinery or equipment. (8)

2. A component that, at the time the taxpayer places it in service, is properly depreciated using a different MACRS class or method than that of the unit of property of which the component is a part. (9)

   Example 3: A taxpayer in the transportation business purchases a truck trailer. The trailer and its tires are functionally interdependent, but the taxpayer records the tires and trailer separately in its books and assigns them different depreciable lives. The trailer and the tires are considered separate units of property. (10) If the tires and trailer were depreciated using different methods but had the same useful life, they would still be separate units of property. The 2011 regulations remove the "book life consistency rule" of the 2008 proposed regulations that would have required a taxpayer to treat property as separate units if the taxpayer initially assigned a different life to the component for financial statement or regulatory purposes than the economic useful life of the property of which the component was a part. (11)

   Repairs and Routine Maintenance

   Amounts paid to repair and maintain property are deductible in the year incurred if not required to be capitalized under Temp. Regs. Sec. 1.263(a)-3T or any other provision of the Code or regulations. (12) Routine maintenance is provided a safe harbor in the regulations, where it is defined as the recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of the property to keep it in its ordinarily efficient operating condition. (13) Common examples of routine maintenance and exceptions are described in Exhibit 1. The routine maintenance safe harbor in Temp. Regs. 1.263(a)-3T(g) is one area the IRS says it intends to simplify when the final regulations are issued.

   Exhibit 1: Routine maintenance summary

   Examples:

   * Inspection

   * Cleaning

   * Testing

   * Replacement of parts with comparable parts

   Factors to be examined:

   * Recurring nature of activity

   * Industry practice

   * Manufacturer recommendations

   * Taxpayer's treatment on applicable financial statement

   Exclusions from safe harbor:

   * Expenditures made to a building or any of its structural components.

   * Amounts paid for replacement of a component of a unit of property if the taxpayer has deducted a loss (other than a casualty loss) on that component.

   * Amounts paid for replacement of a component of a unit of property if the taxpayer has used the adjusted basis of the component in calculating a gain or loss on the sale or exchange of the component.

   * Amounts paid for repairs to a unit of property for which the taxpayer has taken a basis adjustment due to a casualty loss.

   * Amounts paid to return a unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use.

   Source: Temp. Regs. Secs. 1.263(a)-3T(g)(1) and (3).

   The temporary regulations retain the same routine maintenance safe harbor that was in the 2008 proposed regulations. Under this rule, activities are routine if, at the time property is placed in service, the taxpayer expects to perform the activities more than once during the class life of the unit of property. (14) Taxpayers must use the alternative depreciation system class life of the asset under Secs. 168(g)(2) and (3) when making this assessment. (15)

   Example 4: A commercial airline removes its aircraft engines every four years so they can be disassembled, inspected, cleaned, repaired, and tested (an engine shop visit). If the unit of property is the aircraft and has a class life of 12 years, the engine shop visit costs are routine maintenance, since the visits are expected to be performed more than once during the aircraft's life. (16) There are exceptions to the safe-harbor provisions. The safe harbor does not apply to buildings or their structural components. (17) If the adjusted basis of a component of personal property has been included in the calculation of a loss on the sale, exchange, or casualty of the unit of property, the cost of its replacement cannot be...