The characterization of expenditures relating to fixed assets (tangible property) has been a challenge since the inception of the concept of capitalization and depreciation. The tax regulations that address repairs and capitalization have been vague enough to confuse lawmakers, taxpayers, and CPAs for many years. In 2004, the IRS initiated an effort to clarify these regulations. After two versions of proposed regulations in 2006 and 2008, the IRS released binding temporary regulations on December 23, 2011 that were to take effect on January 1, 2012. After a year of additional commentary and debate, the temporary regulations were not finalized. On December 17, 2012 the IRS revised the mandatory effective date to tax years beginning on or after January 1, 2014, with the option of compliance in either 2012 or 2013. This gives taxpayers choices.
By the 2014 tax year, all businesses with any tangible property will have to make sure they are following the new regulations. In most cases, the taxpayer will be required to make up to 19 or more accounting method changes, which includes filing one or multiple Forms 3115 - Change in Accounting Method in the years that the regulations are adopted. Each issue that relates to the new rules must be reviewed to determine whether a taxpayer is already in compliance or needs to report a change to comply.
Making the decision on when to comply with what changes will depend on several factors including:
- Is there anything on our current depreciation schedule that needs to be corrected before making capitalization rule changes?
- Are there any areas in the temporary regulations that are expected to change when finalized?
- Will the adjustment be more beneficial in a future year when increased individual tax rates apply?
- What kind of records do we need to dig up in order to accurately identify expenditures?
- Should we have a cost segregation study to assist us in identifying costs of building components before we make accounting method changes?
The significant issues in the regulations include:
- Determining what assets are considered a single unit of property for tax purposes, and whether expenditures on that asset are substantial enough to require capitalization or whether they may be expensed as repairs.
- Identification of newly defined building systems.
- Definitions of betterments, restorations, and adaptations.
- Definitions of materials and supplies.
- A routine maintenance safe harbor for units of property other than buildings or building systems.
- De minimis expensing rules.
- General asset account rule changes.
- Allowance of write-offs for partial disposals of building assets.
The effects of these regulations are far-reaching, and decisions should be well thought out before taking action.