In September 2013, the IRS released final regulations (“regs”) regarding repair/capitalization rules for tangible property, with an effective date of January 1, 2014. The IRS estimates that 4 million taxpayers will be affected by these regulations. The IRS also estimates that each taxpayer will be required to file 4 to 6 Forms 3115, Application for Change in Accounting Method, in order to comply - before they can file the necessary annual elections. Sound scary? Sound expensive? Maybe so, but taxpayers may find it well worth their efforts to review their records since there is potential for considerable tax savings. Retailers, manufacturers, utility companies, those in the hospitality industry, and those holding real estate will be especially impacted.
The five main areas affected by final repair vs. capitalization regs are materials and supplies, repairs and maintenance, capital expenditures, amounts paid for the acquisition of, and improvement of tangible property. Virtually all taxpayers with these costs are faced with complying with these regulations.
The intent of the regs is to reduce the subjective nature of the existing standards by creating more defined guidelines - to “simplify, clarify, and refine” prior law and the 2011 temporary regulations. Several new safe harbors have been created. For example, safe harbors have been created to allow a deduction for costs of routine maintenance to buildings (the temporary regs did not include buildings), as well as, allowing a more manageable, immediate deduction of up to $5,000 per item of tangible personal property acquired (the temporary regs used an aggregate ceiling and several factors in computing an allowable deduction amount).
New annual elections are also available. One election allows qualifying small taxpayers an immediate deduction equal to of the lesser of $10,000 or 2% of a building’s adjusted basis for maintenance costs on buildings having an adjusted basis of $1 million or less. Without these deductions, these costs would have to be depreciated over anywhere between 5 to 39 years.
The good news is that these final regulations are more taxpayer-favorable than the temporary regulations. In most cases, these regulations (and in certain cases, the temporary regulations) can be retroactively applied, at the taxpayer’s discretion, to tax years beginning January 1, 2012. Amended returns may be filed and can potentially produce significant tax savings.
The bad news is that the final regs must be followed by all affected taxpayers for tax years beginning January 1, 2014, not leaving much time for taxpayers to implement the written policies that are required in order to maximize benefits. (The IRS has promised to issue guidance to assist taxpayers with the transition of their accounting methods and recordkeeping in order to comply with these rules). The choice to do nothing will, at the very least, result in noncompliance, the risk of using accounting procedures which are not allowed, and missed opportunities for tax savings.
Because of the complexity and very specific timing requirements of these final regulations, it is strongly recommended that taxpayers contact their tax advisors immediately to implement a course of action to take before December 31, 2013, as well as, to comply with necessary tax filings beginning with the 2013 tax year.
Should you have any questions related to the new regulations and the need to capitalize costs, etc, contact your Marcum Tax Professional.