One of my favorite legal publishers, Thomson-Reuters, to whom I subscribe to their newsletter, “Checkpoint,” recently released an extensive report entitled, “NAVIGATING THE FINAL REGS ON DEDUCTION VS. CAPITALIZATION OF TANGIBLE PROPERTY COSTS.” In it, they say:
The IRS recently issued long-awaited final regs providing guidance on the application of Code Sec. 162(a) and Code Sec. 263(a) to amounts paid to acquire, produce, or improve tangible property. There is much for businesses to be pleased with in the final regs. For example, a substantially revised and expanded de minimis safe harbor election—effectively a book-tax conformity election—will allow many businesses to currently deduct their outlays for lower-cost assets, materials, and supplies. Building owners will be able to use a new safe harbor election allowing a current deduction for routine maintenance. This Special report provides an overview of the most widely applicable rules in the new regs and how they are to be applied in practice.
As I see it, the important points in this report for all business and property owners to now consider are these:
1. I feel the current scheme about what gets included in a capitalized asset hasn’t changed much. What it takes to put it in service is what gets capitalized. The new regs do let us write off compensation and overhead incurred to do so. Per the report, “unless the expense qualifies as a material or supply, or the de minimis safe harbor election applies, a taxpayer must capitalize amounts paid to acquire or produce a unit of property (UOP), whether real or personal property, including leasehold improvement property.”
2. Repairs made to get something into service are to remain capitalized.
3. Costs that are “inherently facilitative” in getting something into service are also capitalized. They may fall into 11 categories: shipping, moving or appraising property, application fees, sales and transfer taxes, finder’s fees, architectural, engineering, environmental or inspection services related to specific properties, brokers’ or appraisers’ fees, and services provided by a qualified intermediary in a Code § 1031 exchange.
4. These rules general apply to tax years beginning on and after January 1, 2014.
5. The de minimus safe harbor election rules allow taxpayers to write off certain lower cost business assets that they expense for book purposes under a written policy. This is called a “book tax conformity election.” To be elgible, the UOP can’t cost more than $5,000 if a business has an Applicable Financial Statement (AFS) and $500, if not. Acceptable financial statements for purposes of the de minimis safe harbor election are:
(1) A financial statement required to be filed with the Securities and Exchange Commission (SEC) (10-K or the Annual Statement to Shareholders).
(2) A certified audited financial statement accompanied by the report of an independent certified public accountant (or in the case of a foreign entity, by the report of a similarly qualified independent professional) that is used for:
(A) Credit purposes
(B) Reporting to shareholders, partners, or similar persons; or
(C) Any other substantial non-tax purpose
(3) 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). (Reg § 1.263(a)-1(f)(4))
Code Section 179 Rules still apply, though they are currently up in the air. Per the Thomson report:
Under Code Sec. 179, eligible taxpayers may deduct (in lieu of depreciation) the cost of most tangible personal property, and certain other property, used in the active conduct of a trade or business. For tax years beginning in 2013: (1) the dollar limitation on the expensing deduction is $500,000; and (2) the investment-based reduction in the dollar limitation starts to take effect when property placed in service in the tax year exceeds $2,000,000 (the investment ceiling). For tax years beginning after 2013, the maximum expensing limit is scheduled to drop to $25,000, and the investment ceiling is scheduled to drop to $200,000 (although Congress may not allow the expensing limit and investment ceiling limit to drop this drastically).
Making the election, while not complex, is daunting, considering all possible risks. Thomson continues:
The Reg § 1.263(a)-1(f) election, which is irrevocable, is made by attaching a statement to the taxpayer’s timely filed original Federal tax return (including extensions) for the tax year in which amounts eligible for the election are paid. The statement must be titled “Section 1.263(a)-1(f) de minimis safe harbor election” and include the taxpayer’s name, address, taxpayer identification number (TIN), and a statement that the taxpayer is making the de minimis safe harbor election under Reg § 1.263(a)-1(f).
Routine maintenance for building owners is also affected. Routine maintenance keeps the building in its “ordinarily efficient operating condition.” Activities are routine if they can, at the time the UOP is being placed into service, be expected to need to be done more than once in the 10 ensuing years. Routine maintenance for non-building UOP’s is designed to keep them in their “ordinarily efficient operating condition,” and examples include, inspection, cleaning, and testing; and the replacement of parts of the UOP with comparable and commercially available and reasonable replacement parts.
Expenses that are ineligible for the routine maintenance safe harbor include:
(1) For a betterment
(2) To replace a component
(3) To restore damage to a UOP for which the taxpayer has taken a basis adjustment
(4) To return a UOP to its former ordinarily efficient operating condition, if the property has deteriorated to a state of disrepair and is no longer functional for its intended use;
(5) To adapt a UOP to a new or different use
(6) For repairs, maintenance, or improvement of network assets; or
(7) For repairs, maintenance, or improvement of rotable and temporary spare parts to which the
taxpayer applies the optional method of accounting for rotable and temporary spare parts.
Finally, there is a per-building safe harbor election for qualifying small taxpayers, those with $10 Million or less average annual gross receipts in the past 3 years. Such taxpayers may elect not to treat as capitalized expenses, improvements made to an eligible building property, which is one with an unadjusted basis of $1 Million or less, if the total paid during the tax year for repairs, maintenance, improvements, and similar activities does not exceed the lesser of $10,000 or 2% of the building’s unadjusted basis.
I have highlighted just the main considerations of this new and promising set of regulations. See the Thomson Report for more details and be sure to get the advice of your qualified tax expert when attempting to deal with these new rules.