AICPA Begs the IRS for Better Capitalization Rules
Late this Summer, the American Institute of CPAs told the Internal Revenue Service that its proposed regulations for capitalization and deduction of tangible property expenditures were unnecessarily complex and burdensome, and especially discriminatory towards small businesses.
As we reported earlier this year, the IRS proposed regulations on the capitalization of costs incurred for tangible property will impact how virtually any business writes off costs that repair, maintain, improve or replace any tangible property. This could affect anything from office furniture and roof repairs, to copy machine maintenance and everything else in between after January 1, 2012.
Key Point: These “repair regulations” apply not only to repairs, but to the capitalization of amounts paid to acquire, produce or improve tangible property. An ambitious effort by the IRS to address capitalization of specific expenses associated with tangible property, the regulations will affect manufacturers, wholesalers, distributors, and retailers—everyone who uses tangible property, whether the property is owned or leased.
Most taxpayers will have to make changes to their method of accounting to comply with the temporary regulations and will need to file Form 3115. Taxpayers who filed for a change of accounting method following the issuance of the 2008 proposed regulations will probably have to change their accounting method again. The regulations require taxpayers to make a Code Sec. 481(a) adjustment; this means that taxpayers will have to apply the regulations to costs incurred both prior to and after the effective date of the regulations.
The new regulations provide a more defined framework for determining capital expenditures, and provide rules for materials and supplies that can be deducted, rather than capitalized. The rules provide several methods of accounting for rotable and temporary spare parts, and allow taxpayers to apply a de minimis rule so that they can deduct materials and supplies when they are purchased, not when they are consumed.
The regulations address moving and reinstallation costs, work performed prior to placing property into service, and transaction costs. Generally, costs of simply removing property can be deducted, but costs of moving and then reinstalling property may have to be capitalized.
To determine whether a cost incurred for property is an improvement, it is necessary to determine the unit of property. Generally, the larger the unit of property, the easier it is to deduct expenses, rather than have to capitalize them. The regulations provide detailed rules for determining the unit of property for buildings and for non-building tangible property. For buildings, the IRS identified eight component systems as separate units of property, requiring more costs to be capitalized. However, the new rules also provide for deducting the costs of property taken out of service, by treating the retirement as a disposition.
The AICPA has recommended:
An increase in the number of bright-line tests and safe harbors
The general asset account election be made the default rule for buildings so taxpayers would only have to make an election if they did not want that treatment
The regulations not require taxpayers to determine the economic useful life of any property but instead incorporate a class-life standard throughout the regulations
Allowing labor and overhead costs to be included in costs of materials and supplies under the de minimis rule
Treatment of all materials and supplies with a useful life of not more than 12 months the same, rather than the currently different treatment for incidental and non-incidental items
When identifying non-incidental materials and supplies used, allowing taxpayers to use a reasonable cost-flow assumption to identify these items
The regulations allow taxpayers to elect to capitalize the costs of materials and supplies, the AICPA wants clarification on how that rule works in the year in which the taxpayer consumes the item
The current rules require the capitalization of broker’s fees even when they are incurred to identify a property to purchase, and the AICPA argues, it is not “inherently facilitative” of the process of ultimately acquiring a specific piece of property
Taxpayers should be permitted to use the same capitalization threshold that they use for financial reporting purposes. And that smaller taxpayers without applicable financial statements (AFSs) should be permitted to use the de minimis rule
Expansion of the routine-maintenance safe harbor to include building systems such as an HVAC system
Clarification whether certain store refreshes must be capitalized
Taxpayers be allowed to elect to capitalize repair expenditures as improvements
A change in an AFS capitalization policy should not be treated as a change in method of accounting.
Clarification on how many Forms 3115 must be filed in various situations involving late general asset account elections and disposition method changes
The new regulations require virtually every business to review how repairs, maintenance, improvements and replacements are handled for tax purposes, and may necessitate mandatory and/or optional adjustments made to past treatment as appropriate. Daszkal Bolton can assist you. Since these rules mostly affect real property, there may be significant benefits to our clients even if cost segregation studies have already been performed. Further, the rules allow taxpayers to go back to previous years and take advantage of these changes. We can advise you regarding a Form 3115 (Automatic Change of Accounting). If you have renovated a building in the last 15 years you may be able to take advantage of these rules.
Michael Daszkal, CPA, Managing Partner and Co-Founder of Daszkal Bolton, has expertise in this area and after a brief consultation can suggest the proper course of action for your business. Please contact him at [email protected]