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Stephen Ehrenberg
Stephen J. Ehrenberg

IRS lets taxpayers choose when to implement new tangible property regs.

New effective date for the regulations provides a good opportunity to review the complex rules again.

December 13, 2012
by Stephen J. Ehrenberg, CPA

After much anticipation, in 2011 the IRS issued temporary regulations governing the treatment of tangible property. While the scope was far-reaching, the main intention of these temporary regulations was to provide taxpayers with standards for the capitalization and deduction of expenditures for tangible property.

When issued, the temporary regulations were made binding on taxpayers for tax years beginning on or after Jan. 1, 2012, and taxpayers immediately began to analyze the impact of the adoption of these rules. However, the Nov. 20, 2012, issuance of Notice 2012-73 has given taxpayers a choice as to the implementation date, delaying the mandatory effective date until tax years beginning on or after Jan. 1, 2014.

Background

On March 10, 2008, the IRS issued proposed regulations regarding the deduction vs. capitalization of tangible property expenditures. On Dec. 23, 2011, after receiving written comments and holding a public hearing, the IRS withdrew the 2008 proposed regulations and issued temporary regulations on this topic.

In response to taxpayer comments and in anticipation of finalizing the regulations in 2013, the IRS announced, in Notice 2012-73, that the temporary regulations will now apply to tax years beginning on or after Jan. 1, 2014, although taxpayers can choose to implement the regulations for tax years beginning on or after Jan. 1, 2012. The final regulations, when issued, will also apply to tax years beginning on or after Jan. 1, 2014, and taxpayers will have the option to apply them to tax years beginning on or after Jan. 1, 2012.

Furthermore, Notice 2012-73 stipulated that certain areas of the temporary regulations may be revised when issued in final form. These areas include the de minimis rule, dispositions of tangible property, and the safe harbor for routine maintenance.

Areas of emphasis

The broad scope of the tangible property regulations affected taxpayers in a number of areas. As currently issued in their temporary form, the main areas of emphasis surrounded the tax treatment of:

  • Amounts paid to acquire, produce, or improve tangible property under Secs. 162 and 263(a); and
  • Disposition of property subject to depreciation under Sec. 168

Although often referred to as the “repair regulations,” these standards are, in fact, much more comprehensive. Among the many areas affected, the regulations provide guidance on the definition of a unit of property, notably stipulating that the unit-of-property determination is based on a functional interdependence standard. This functional interdependence test must be applied when determining if an amount paid to improve tangible property can be expensed in the year incurred or must be capitalized and depreciated over a specified recovery period. In most situations, components of property that are functionally interdependent (i.e., the relationship between the components is such that they are dependent upon each other to function) will be deemed a single unit of property. Generally, the larger the unit of property, the more likely the expenditures will be deemed deductible current-year repairs under Sec. 162. While the regulations do provide standards for the unit-of-property definitions for certain types of property, including plant property, network assets, buildings, and leased property, taxpayers should note that the functional interdependence test will often be based on the facts and circumstances.

Additional areas covered by the temporary regulations include:

  • Materials and supplies. A definition of materials and supplies, including the year for deduction and the treatment of incidental vs. nonincidental materials and supplies, as well as rules for electing to capitalize or deduct materials and supplies.
  • De minimis rule. Through the application of a safe-harbor calculation, taxpayers with applicable financial statements may be able to claim a current-year deduction for low-cost tangible property, including certain materials and supplies. (For purposes of the regulations, an “applicable financial statement” generally means a certified audited financial statement.) Additionally, to be eligible to apply the de minimis rule, taxpayers must have a written capitalization policy in place as of the beginning of the year (i.e., Jan. 1, 2012, for taxpayers that choose early implementation of the temporary regulations) that treats amounts paid for property costing less than a specific dollar amount as an expense for nontax purposes.
  • Amounts paid to acquire or produce tangible property. Rules surrounding deductibility or capitalization for costs associated with the acquisition or production of real or personal property.
  • Amounts paid to improve tangible property. Guidance to distinguish repair costs, which would be deductible as current-period costs, from capital expenditures, which would be subject to depreciation as a means to recover the costs.

In addition to the guidance discussed above, the regulations also provide rules for depreciation and disposal of capitalized property. In particular, this portion of the regulations provides guidance pertaining to:

  • Treatment of modified accelerated cost recovery depreciation system (MACRS) property in general asset accounts. Taxpayers generally qualify to elect to recognize gain or loss on the disposal of an asset recorded within these accounts. Prior regulations required taxpayers to recognize ordinary income upon disposition; losses were disallowed.
  • Treatment of MACRS property in single- or multiple-asset accounts.The regulations generally allow taxpayers to use single-asset accounts or multiple-asset accounts. Single-asset accounts contain one depreciable asset, whereas multiple-assets accounts contain more than one depreciable asset. For assets to be pooled into multiple-asset accounts, they must have the same method of depreciation, be placed in service in the same year, and have the same recovery period and convention.

What to do now

While Notice 2012-73 does provide a choice as to when to implement the regulations, taxpayers that have not previously taken action should begin to do so. In many cases, accounting method changes, through the filing of Form 3115, Application for Change in Accounting Method, will be required in order to comply with these rules. Recognizing the administrative complexity that would result from the implementation of these regulations, the IRS issued the following revenue procedures to provide guidance to affected taxpayers:

  • Rev. Proc. 2012-19. Automatic changes in accounting methods for the deduction vs. capitalization of costs incurred to acquire, produce, or improve tangible property
  • Rev. Proc. 2012-20. Automatic changes in accounting methods for the depreciation, amortization, and disposition of fixed assets

The IRS has promised further accounting method change guidance when the final regulations are issued.

Conclusion

Notice 2012-73 gives taxpayers choices when to implement the tangible property regulations. While taxpayers can apply the temporary regulations to tax years beginning on or after Jan. 1, 2012, taxpayers may also await the issuance of the final regulations, thus implementing the rules for tax years beginning on or after Jan. 1, 2014. While significant changes to the temporary regulations are not anticipated, Notice 2012-73 does refer to certain areas that may be revised. Irrespective of the implementation date, taxpayers should make themselves aware of the broad impact of these regulations.

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Stephen J. Ehrenberg, CPA, is a tax principal in the Los Angeles office of Holthouse Carlin & Van Trigt LLP.