What taxpayers need to know to comply with the final tangible property regulations.

• Author: Abdoo, Kate

PREVIEW

* As discussed in this article, almost every business taxpayer will need to take some action this year to comply with the tangible property regulations,

* The regulations will require many businesses $$ file accounting method changes; making it necessary for practitioners serving business clients to know when a change will be necessary.

* A number of elections that call be made under the regulations are advantageous for businesses.

On Sept. 13, 2013, the IRS released final regulations providing rules regarding the treatment of materials and supplies and the capitalization of expenditures for acquiring, maintaining, or improving tangible property (the final repair regulations). Additionally, on Aug. 14, 2014, the IRS issued final regulations on dispositions of tangible property, including rules for general asset accounts (GAAs) (the final disposition regulations).The final repair regulations and the final disposition regulations (the final regulations) are generally effective for tax years beginning on or after Jan. 1, 2014. (1) Thus, taxpayers with short tax years beginning on or after Jan. 1, 2014, and taxpayers with 52/53-week tax years beginning at the end of December 2013 are subject to the final regulations for those tax years. (2)

In conjunction with the issuance of the final regulations, the IRS issued procedures for taxpayers to follow in making accounting method changes to comply with the final regulations. On Jan. 24, 2014, the government issued Rev. Proc. 2014-16, which provides the rules for taxpayers to change their accounting methods to comply with the repair regulations. On Sept. 18, 2014, the government issued Rev. Proc. 2014-54, which provides the rules for taxpayers to change their accounting methods to comply with the final disposition regulations. (3)

On Jan. 16, 2015, the IRS issued Rev. Proc. 2015-13 and Rev. Proc. 2015-14, which collectively provide the rules for making accounting method changes, including those to comply with the final regulations. Additionally, on Feb. 13, 2015, the IRS released Rev. Proc. 2015-20, which provides an exception to the general procedures for complying with the final regulations for certain small business taxpayers. This article begins with an overview of the final regulations before discussing the procedural guidance and what taxpayers will need to consider in complying with the final regulations, including what minimum compliance might entail for a taxpayer not eligible for the small business taxpayer exception that simply wants to continue to follow its book capitalization policies for tax purposes.

Overview of the Final Regulations

The final regulations provide rules to determine whether an amount paid (4) during the lifecycle of a unit of tangible property is currently deductible or must be capitalized. Additionally, the regulations provide guidance for dispositions, which take into account the interrelationship between the disposition rules and the capitalization rules. Specifically, the final regulations provide rules covering five general areas:

1. Materials and supplies (collectively "supplies");

2. Capitalized costs (including the de minimis safe-harbor election);

3. Costs to acquire or produce tangible property;

4. Costs to improve tangible property;

5. Dispositions of modified accelerated cost-recovery system (MACRS) property (including their components) and GAAs;

   Although the final regulations retain many of the provisions in the Dec. 27, 2011, temporary regulations, the final regulations also clarify, modify, and simplify a number of these rules. The final regulations also include provisions intended to reduce the administrative burden of complying with the regulations. For example, many of the provisions in the final regulations are elective and do not require a method change (see Exhibit 1 describing the various elective methods under the final regulations.)

   Supplies

   Consistent with earlier regulations, supplies that are not material and for which no record of consumption is maintained (i.e., incidental supplies) are deductible when purchased. Nonincidental supplies are deductible when used or consumed. The final regulations define supplies as tangible property that is not inventory that is used or consumed in the taxpayer's trade or business, and:

1. Is a component acquired to maintain, repair, or improve a unit of tangible property (5) the taxpayer owns, leases, or services, and that is not acquired as part of any single unit of property;

2. Consists of fuel, lubricants, water, and similar items that are reasonably expected to be consumed within 12 months or less after they begin to be used in the taxpayer's operations;

3. Is a unit of property that has an economic useful fife (6) of 12 months or less, beginning with the date the property is first used or consumed in the taxpayer's operations;

4. Is a unit of property costing $200 or less;

5. Is a ratable or temporary spare part (collectively, "ratable") (7) or a standby emergency spare part; (8) or

6. Is identified in published guidance as supplies. (9)

   Under the final regulations, a taxpayer may elect to capitalize only supplies that are ratable, temporary, or standby emergency spare parts. An elective optional method for ratable spare parts permits different treatment for a taxpayer with multiple pools of ratable spare parts where the taxpayer does not account for all pools on the optional method for book purposes.

   If a taxpayer makes the de minimis safe-harbor election, any supplies that fit within the de minimis safe harbor are treated under the safe harbor and not as materials and supplies.

   Observation: This definition of materials and supplies includes amounts in excess of 1200 where a unit of property has a useful fife of 12 months or less, or is a component acquired to maintain, repair, or improve a unit of tangible property. Thus, an item may be a deductible supply even if its cost exceeds $200 or the limits under the de minimis safe-harbor election, discussed below.

   Observation: Although taxpayers that purchase a number of units of property costing $200 or less may capitalize and depreciate these amounts for book purposes, this cannot be done for tax purposes except for ratable and temporary spare parts. As a result, taxpayers may need to track this book/ tax difference.

   Capitalized Costs: De Minimis Safe-Harbor Election

   Consistent with prior rules, under the final regulations, a taxpayer generally must capitalize amounts paid to acquire, produce, or improve tangible property. (10) However, the regulations provide an elective exception to this general capitalization rule for a taxpayer that has a minimum capitalization policy under which it expenses small-dollar items (de minimis safe-harbor election).

   De Minimis Safe-Harbor Election

   The de minimis safe-harbor election is an annual, irrevocable election that is available for all taxpayers; however, separate rules apply depending on whether a taxpayer has an applicable financial statement. The final regulations define an applicable financial statement as a financial statement that meets one of the following requirements (fisted in descending priority):

   * A financial statement required to be filed with the SEC;

   * A certified audited financial statement that is accompanied by an independent CPA's report that is used for credit purposes; for reporting to shareholders, partners, or similar persons; or for any other substantial nontax purpose; or

   * A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or IRS).

   Regs. Sec. 1.263(a)-l(f)(4) clarifies that an entity that does not have a separate applicable financial statement, but that is included in a consolidated applicable financial statement (e.g., a partnership or controlled foreign corporation), is considered to have an applicable financial statement based on its inclusion in the consolidated applicable financial statement.

   Taxpayers With an Applicable Financial Statement

   A taxpayer that has an applicable financial statement may elect to treat amounts paid for the acquisition or production of a unit of tangible property as de minimis (and generally deductible in the year paid) if:

1. The taxpayer has, as of the beginning of its tax year, written accounting procedures that provide for the expensing of items costing below a certain dollar threshold and/or items that have an economic useful life of 12 months or less;

2. The taxpayer treats the amount paid for the property as an expense in its applicable financial statement in accordance with its written procedures; and

3. The amount paid for the property does not exceed $5,000 per invoice or per item. (11)

   Taxpayers Without an Applicable Financial Statement

   A taxpayer that does not have an applicable financial statement may elect to treat amounts paid to acquire or produce units of tangible property as de minimis if:

1. The taxpayer has, at the beginning of its tax year, accounting procedures that provide for the expensing of items costing below a certain dollar threshold and/or items with an economic useful life of 12 months or less;

2. The taxpayer treats the amount paid for the property as an expense for book purposes in accordance with those procedures; and

3. The amount paid for the property does not exceed $500 per invoice or per item. (12)

   Observation: For a taxpayer with an applicable financial statement, the written accounting procedures must be in place as of the beginning of the tax year. The IRS has indicated this means that changes to the policy after the beginning of the tax year are not the written policy in place as of the first day of the tax year. For taxpayers without an applicable financial statement, there is no requirement for written procedures. Those taxpayers may generally deduct tangible property with an acquisition or production cost of $500 or less.

   Observation: Importantly, for an item to...