Tangible Property
Regulations
Final Tangible Property Regulations
We have been talking about this subject for two years now, and we are pretty sure you are not looking
forward to a reprise. However, the time has arrived – taxpayers must actually report any accounting
method changes made in response to the regulations on their 2014 tax returns. Most taxpayers that
acquire and depreciate tangible property or that deduct repairs and maintenance are affected and
should report accounting method changes to the IRS.
The Final Tangible Property Regulations (TPR's) were issued by the Department of Treasury on
September 19, 2013 and August 14, 2014 for amounts paid to acquire or produce a unit of real or
personal property and for transactions involving dispositions of MACRS property, respectively. These
TPR's provide a framework for distinguishing currently deductible costs from capitalizable costs. The
TPR's are effective for tax years beginning on or after January 1, 2014, but many of the provisions can
and/or must be applied retroactively. Therefore, many repair and maintenance capitalization decisions
and expense deductions in previous years may need to be reviewed and addressed for tax year 2014.
These Regulations set forth various tests, safe harbors, elections, and accounting methods relating to
tangible property that are new and unfamiliar to most taxpayers.
The TPR's impact all taxpayers who acquire, produce, improve, repair, or dispose of tangible property
and provide a framework for distinguishing currently deductible costs from capitalizable costs. Prior to
2012, the Regulations in effect generally required taxpayers to capitalize expenditures when they added
value to property, substantially prolonged the useful life of property, and/or adapted the property to a
new or different use. However, these new Regulations are more specific, comprehensive, and rigorous
and will involve more analysis by taxpayers in determining how to treat tangible asset expenditures and
dispositions.
There are multiple areas that are impacted by these new Regulations, many of which are discussed
below, including:
 Materials and Supplies (Treas. Reg. 1.162-3)
 Repairs (Treas. Reg. 1.162-4)
 Rentals (Treas. Reg. 1.162-11)
 Special Rules for Leased Property (Treas. Reg. 1.167(a)-4)
 Property Dispositions (Treas. Regs. 1.168(i)-1, 1.168(i)-7, and 1.168(i)-8)
 Expenditures paid to acquire or produce tangible property (Treas. Regs. 1.263(a)-1 & 1.263(a)-2)
 Improvements to tangible property (the "R.A.B.I." rules) (Treas. Reg. 1.263(a)-3)
 Uniform Capitalization (UNICAP) Costs (Treas. Reg. 1.263A-1 & 1.263A-3)
Materials and Supplies (Treas. Reg. 1.162-3)
Definitions
Materials and Supplies: tangible property that is used or consumed in the taxpayer's operation that is
not inventory and that:
1. is a component acquired to maintain, repair, or improve a unit of tangible property owned,
leased or serviced by the taxpayer and that is not acquired as part of any single unit of tangible
property;
2. consists of fuel, lubricants, water, etc. reasonably expected to be consumed within 12 months
beginning when used in the taxpayer's operations;
3. is a unit of property, as determined under § 1.263(a)-3(e), with an economic useful life of 12
months or less; and
4. is a unit of property, as determined under § 1.263(a)-3(e), with production or acquisition cost of
$200 or less.
Non-incidental Materials and Supplies: amounts paid to acquire or produce materials and supplies for
which a record of consumption is kept OR for which physical inventories at the beginning and end of the
taxable year are taken.
Incidental Materials and Supplies: amounts paid to acquire or produce materials and supplies for which
NO record of consumption is kept OR for which physical inventories at the beginning and end of the
taxable year are NOT taken.
Rotable Spare Parts: materials and supplies that are acquired for installation on a unit of property,
removable from that unit of property, generally repaired or improved, and either reinstalled on the
same or other property or stored for later installation.
Temporary Spare Parts: materials and supplies that are used temporarily until a new or repaired part
can be installed and then are removed and stored for later installation.
Stand-by Emergency Spare Parts: materials and supplies that are 1. acquired when particular machinery or equipment is acquired (or later acquired and set aside
for use in particular machinery or equipment);
2. set aside for use as replacements to avoid substantial operational time loss caused by
emergencies due to particular machinery or equipment failure;
3. located at or near the site of the installed related machinery or equipment failure;
4. directly related to the particular machinery or piece of equipment they serve;
5. normally expensive;
6. only available on special order and not readily available from a vendor or manufacturer;
7. not subject to normal period replacement;
8. not interchangeable in other machines or equipment;
9. not acquired in quantity (generally only one on hand for each piece of machinery or equipment);
AND
10. not repaired or reused.
New Methods of Accounting
Non-incidental Materials and Supplies are deductible in the taxable year in which the materials and
supplies are first used in the taxpayer's operations or are consumed in the taxpayer's operations.
Incidental Materials and Supplies are deductible in the taxable year in which these amounts are paid or
accrued, provided that taxable income is clearly reflected.
Rotable and Temporary Spare Parts, by default, are deductible in the year which the taxpayer disposes
of the parts. However, taxpayers can choose the Optional Method of Accounting for Rotable and
Temporary Spare Parts, which is administratively more burdensome or the election to capitalize these
parts (described below). Under the Optional Method of Accounting for Rotable and Temporary Spare
Parts, a taxpayer claims a deduction for the cost of a part when the part is installed on a unit of
property. Subsequently, when the part is removed from the unit of property, a taxpayer must recognize
income equal to the fair market value of the removed part and capitalize any costs incurred to maintain,
repair, and/or improve the part. A taxpayer will then deduct the adjusted basis of the part when
installed on a unit of property at a later time. This cycle would repeat until the taxpayer disposes of the
part and would be allowed to deduct the remaining basis. Also note that if the Optional Method of
Accounting for Rotable and Temporary Spare Parts is adopted, a taxpayer must use this method for all of
its pools of rotable and temporary spare parts used in the same trade or business.
New Annual Elections
The Election to Capitalize and Depreciate Rotable, Temporary, or Stand-by Emergency Spare Parts allows
taxpayers to elect annually to capitalize and depreciate any rotable, temporary, or stand-by emergency
parts acquired or produced during the taxable year over their applicable recovery period. Taxpayers may
NOT elect to capitalize these spare parts if:
1. the part is intended to be used in a unit of property that has a useful life of 12 months or less;
2. the part is intended to be used in a unit of property which costs less than $200; or
3. the taxpayer uses the Optional Method of Accounting for Rotable and Temporary Spare Parts
(discussed above)
Note that taxpayers can still use this election for emergency stand-by parts even if the Optional Method
of Accounting for Rotable and Temporary Spare Parts is adopted. A taxpayer can make this election for
each qualifying part, and it can only be revoked by filing a private letter ruling request with the IRS. A
taxpayer makes this election by capitalizing the amounts paid to acquire or produce the applicable
rotable, temporary, or stand-by emergency spare parts and by beginning to recover costs when the
asset is placed in service by the taxpayer for purposes of determining depreciation with a timely filed
(including extensions) original Federal tax return.
The De Minimis Safe Harbor Election on Accounting for Materials and Supplies is generally the same as
the De Minimis Safe Harbor (e.g. your capitalization policy) found under Treas. Reg. 1.263(a)-1(f) (see
section below), except for those materials and supplies that the taxpayer elects to capitalize and
depreciate under the Election to Capitalize and Depreciate Rotable, Temporary, or Stand-by Emergency
Spare Parts or for which the taxpayer properly uses the Optional Method of Accounting for Rotable and
Temporary Spare Parts (both discussed above).
Capital Expenditures Paid to Acquire or Produce Tangible Property (Treas. Reg. 1.263(a)-1 & -2)
Definitions
Amounts Paid: in the case of a taxpayer using an accrual method of accounting, the terms amount paid
and payment mean a liability incurred. A liability may not be taken into account under this section prior
to the taxable year during which the liability is incurred.
Produce: means construct, build, install, manufacture, develop, create, raise, or grow. This definition is
intended to have the same meaning as the definition used for purposes of IRC Section 263A(g)(1) and
Treas. Reg. 1.263A-2(a)(1)(i), except that improvements are excluded from the definition and are
separately defined and addressed in Treas. Reg. 1.263(a)-3.
Applicable Financial Statement (AFS): means a:
1. a financial statement filed with the SEC;
2. a certified audited financial statement used for credit purposes, reporting to owners, or any
other substantial non-tax purpose; or
3. a financial statement (other than a tax return) required to be provided to the Federal
government, a state government, or any Federal or state agencies other than the SEC or IRS.
Inherently facilitative costs: an amount paid for:
1. transporting the property;
2. securing an appraisal or determining the price of the property;
3. negotiating terms or structure of the acquisition and obtaining tax advice on the acquisition;
4. application fees, bidding costs, or similar expenses;
5. preparing and reviewing the documents that effectuate the acquisition of the property (for
example preparing the bid, offer, sales contract, or purchase agreement);
6. examining and evaluating the title of property;
7. obtaining regulatory approval of the acquisition or securing permits related to the acquisition,
including application fees;
8. conveying properties between the parties, including sales and transfer taxes, and title
registration costs;
9. finders fees' or brokers' commissions, including contingency fees;
10. architectural, geological, survey, engineering, environmental, or inspection services pertaining
to particular properties; or
11. services provided by a qualified intermediary or other facilitator of a like-kind exchange under
IRC section 1031.
New Methods of Accounting
Generally, commissions and other transaction costs paid to facilitate the sale of property are no longer
deductible when paid or incurred. Instead, the amounts must be treated as capitalized costs that reduce
the amount realized in the taxable year in which the sale occurs or are taken into account in the taxable
year in which the sale is abandoned if a deduction is permissible. In the case of a dealer in property,
amounts paid to facilitate the sale of property are treated as ordinary and necessary business expenses
and deducted when paid or incurred.
Amounts Paid to Acquire or Produce Tangible Property that facilitate the acquisition or production of the
tangible property must be capitalized. Amounts paid to facilitate the acquisition of property include:
1. the invoice price;
2. transaction costs (including inherently facilitative costs); and
3. costs for worked performed prior to the date that the unit of property is actually placed in
service by the taxpayer.
However, taxpayers are not required to capitalize employee compensation and overhead costs
associated with the acquisition of real or personal property. (This exception does not apply to employee
compensation and overhead costs incurred with respect to personal property produced by a taxpayer,
which may be subject to capitalization under IRC Section 263A) (See below for an election to capitalize
these costs on an asset by asset basis). Moreover, except for inherently facilitative costs, amounts paid
by a taxpayer in the process of investigating or pursuing the acquisition of real property are not
considered facilitative if undertaken by the taxpayer in determining whether to acquire real property
and which real property to acquire (e.g. the "whether or which" test). If these investigatory costs are
incurred during the acquisition of both real and personal property in a single transaction a reasonable
allocation must be made to determine the costs allocable to the personal property acquired, which must
be capitalized.
Amounts Paid to Defend Title to Property must now be capitalized. These include amounts paid to
defend or perfect title to real or personal property.
New Annual Elections
The De Minimis Safe Harbor Election permits taxpayers to make an annual election to deduct amounts
paid for the acquisition or production of a unit of tangible property. Taxpayers will fall into one of two
baskets for this election each year:
1. Taxpayers with AFS - A taxpayer with an applicable financial statement may deduct up to $5,000
per invoice, or $5,000 per each item on the invoice, to the extent the item is deducted in the
taxpayer's applicable financial statement. A taxpayer with an applicable financial statement is
eligible to make the De Minimis Safe Harbor Election only if the taxpayer has at the beginning of
the taxable year written procedures treating as an expense for non-tax purposes amounts paid
for property costing less than a specified dollar amount or amounts paid for property with an
economic useful life of 12 months or less.
2. Taxpayers without AFS - If the taxpayer does not have an applicable financial statement, the
safe harbor deduction is limited to $500 per invoice or per item on the invoice. Taxpayers
without an applicable financial statement are NOT required to have a written procedure but
must treat amounts costing less than a specified dollar amount or amounts paid for property
with an economic useful life of 12 months or less in accordance with its policy.
The De Minimis Safe Harbor Election does not apply to amounts paid for:
1. inventory;
2. land;
3. rotable, temporary, stand-by emergency spare parts that the taxpayer elects to capitalize and
depreciate under Treas. Reg. 1.162-3(d); or
4. rotable or temporary spare parts that the taxpayer accounts for using the Optional Method of
Accounting for Rotable and Temporary Spare Parts under Treas. Reg. 1.162-3(e).
Taxpayers are only required to apply the De Minimis Safe Harbor Election to transaction and other
additional costs (such as delivery fees, installation services, or similar costs) if the costs are included in
the same invoice as the tangible property. While there is some latitude for taxpayers under this election,
there are also anti-abuse rules to limit taxpayer manipulation in this area.
As mentioned in the Materials and Supplies section above, if a taxpayer elects to make the De Minimis
Safe Harbor Election, then the taxpayer must also apply the De Minimis Safe Harbor threshold to
amounts paid for all materials and supplies that meet the requirements of the election, except as noted
above.
A taxpayer can make the De Minimis Safe Harbor Election by attaching a statement to the taxpayer's
originally filed tax return (including extensions) for the taxable year the amounts are paid. In the case of
a consolidated group, the election is made for each member of the consolidated group by the common
parent, and the statement must include the names and identification number of each member included
in the election. Generally, each annual election may not be made on an amended return or through the
filing of an application for change in accounting method (Form 3115), and once made, the election may
not be revoked.
The Election to Capitalize Employee Compensation and Overhead Costs allows taxpayers to treat
employee compensation and overhead costs as facilitative and capitalize the amounts on an annual
basis. The election is made separately for each asset acquired and applies to employee compensation,
or overhead, or both. For example a taxpayer may elect to treat overhead, but not compensation, as
amounts that facilitate the acquisition of property. A taxpayer can make this election by treating the
amounts to which this election applies as subject to capitalization; there is no additional statement
required to be filed with the timely filed original Federal return.
Repairs and Maintenance and Amounts Paid to Improve Tangible Property (the "R.A.B.I." Rules)
(Treas. Reg. 1.162-4 & Treas. Reg. 1.263(a)-3)
Definitions
Improvements: an addition to or partial replacement of property that adds to its value, appreciably
lengthens the time you can use it, or adapts it to a different use. This is the overarching theme of Treas.
Reg. 1.263(a)-3, which breaks improvements down into betterments, restorations, and adaptations.
Each improvement category has its own analysis criteria and examples.
Unit of Property (UOP): the general definition of a UOP is all the components of a property that are
functionally interdependent. Components of property are functionally interdependent if the placing in
service of one component by the taxpayer is dependent on the placing in service of the other
component by the taxpayer. The Regulations have also provided specific criteria on building UOP's;
specifically, the Regulations provide examples and insight into how the IRS will treat building systems
(see below) and building structures (see below). There are also specific rules that apply to plant
property, network assets, and leased property.
Building Systems: each of the following structural components, including the components thereof,
constitutes a building system that is separate from the building structure, and to which the
improvement rules must be applied:
1. Heating, ventilation, and air conditioning ("HVAC") systems (including: motors, compressors,
boilers, furnaces, chillers, pipes, ducts, and radiators);
2. Plumbing systems (including pipes, drains, valves, sinks, bathtubs, toilets, water and sanitary
sewer collection equipment, and site utility equipment used to distribute water and waste to
and from the property line and between buildings and other permanent structures);
3. Electrical Systems (including wiring, outlets, junction boxes, lighting fixtures and associated
connectors, and site utility equipment used to distribute electricity from the property line to and
between buildings and other permanent structures);
4. All escalators;
5. All elevators;
6. Fire-protection and alarm systems (including sensing devices, computer controls, sprinkler
heads, sprinkler mains, associated piping or plumbing, pumps, visual and audible alarms, alarm
control panels, heat and smoke detection devices, fire escapes, fire doors, emergency exit
lighting, and signage, and fire-fighting equipment, such as extinguishers, and hoses);
7. Security systems for the protection of the building and its occupants (including window and
door locks, security cameras, recorders, monitors, motion detectors, security lighting, alarm
systems, entry and access systems, related junction boxes, associated wiring, and conduit);
8. Gas distribution systems (including associated pipes and equipment used to distribute gas to
and from the property line between buildings or permanent structures); and
9. Other structural components identified in published guidance in the Federal Register or in the
Internal Revenue Bulletin that are specifically designated as building systems for purposes of
Treas. Reg. 1.263(a)-3.
Building Structures: consists of the building and its structural components, other than the structural
components designated as buildings systems (see above) (e.g. roof, walls, windows and doors, etc.)
New Methods of Accounting
Going forward, the general rule is that taxpayers may deduct amounts paid for repairs and maintenance
to tangible property if the amounts paid are not otherwise required to be capitalized. Any amounts paid
to repair or maintain property are required to be capitalized if it improves a unit of tangible property.
Conversely, taxpayers must capitalize the related amounts paid to improve a unit of property owned or
leased by the taxpayer. A unit of property is improved if the amounts paid for activities performed after
the property is placed into service result in a betterment to the unit of property, restore the unit of
property, or adapt the unit of property to a new or different use.
Generally, the Costs Subject to Capitalization are all direct and indirect costs of an improvement,
including otherwise deductible repair costs incurred by reason of an improvement. For example, if a
taxpayer replaced minor sections of drywall in its building during an improvement to the building's
electrical system, the costs to replace the drywall are subject to capitalization even though they don't
improve the building structure because they were incurred by reason of the improvement of the
electrical system.
Taxpayer's are NOT required to capitalize Removal Costs if the taxpayer disposes of a depreciable asset,
including a partial disposition, and has taken into account the adjusted basis of the asset or component
of the asset in realizing a gain or loss. If a taxpayer disposes of a component of property, but the
disposal of the component is not a disposition for Federal tax purposes, then the taxpayer must deduct
or capitalize the costs of removing the component based on whether the removal costs directly benefit
or are incurred by reason of a repair to the unit of property or an improvement to the unit of property.
For example, if a taxpayer replaced certain electric wiring in its building and did not claim a partial
disposition for the replaced wiring, then the costs of removing the replaced wiring would be subject to
capitalization if the wiring replacement improves the buildings electrical system. If the wiring
replacement constitutes a deductible repair, then the costs of removing the replaced wiring would be
deductible.
The Routine Maintenance Safe Harbor allows taxpayers to deduct recurring maintenance activities,
including the recurring replacement of major components of units of property. An amount paid for
routine maintenance on a unit of tangible property, or in the case of a building, on the building's
structure or its designated systems, is deemed not to improve that unit of property. Routine
maintenance is recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of
the unit of property to keep the unit of property in ordinarily efficient operating condition. Routine
maintenance activities include, for example, the inspection, cleaning, and testing of the unit of property,
and the replacement of damaged or worn parts of the unit of property with comparable and
commercially available replacement parts. Routine maintenance may be performed at any time during
the useful life of the unit of property.
For buildings, maintenance is considered routine if the taxpayer reasonably expects to perform an
activity more than once over a 10-year period, beginning at the time the building structure or system is
placed in service. In regard to property other than buildings, maintenance is considered routine if the
taxpayer reasonably expects to perform the activities more than once during the class life of the unit of
property. For purposes of the routine maintenance safe harbor, the class life is considered the recovery
period of the unit of property for purposes of the Alternative Depreciation System under IRC Section
168(g) (See Rev. Proc. 87-56). Finally, routine maintenance does not include amounts paid which result
in the betterment, restoration (other than a replacement of a major component), or adaption of a unit
of property.
Factors to be considered in determining whether maintenance is routine and whether a taxpayer's
expectation is reasonable include:
1. the recurring nature of the activity;
2. industry practice;
3. manufacturer's recommendations; and
4. the taxpayer's experience with similar or identical property.
New Annual Elections
The Safe Harbor for Small Taxpayers allows taxpayers to make an annual election to immediately deduct
expenditures incurred with respect to eligible building property (building property owned or leased by
taxpayers that have an unadjusted basis of $1,000,000 or less) as repairs if the total amount paid or
incurred for repairs, maintenance, improvements, and similar activities performed on that specific
building UOP (including amounts deducted under the De Minimis Safe Harbor Election of Treas. Reg.
1.263(a)-3) during the taxable year do not exceed the lesser of:
1. 2 percent of the unadjusted basis of the eligible building property or
2. $10,000.
This election is available to taxpayers whose average annual gross receipts for the three preceding years
are less than $10,000,000. If applicable, a taxpayer can make this election by attaching a statement to its
timely filed original Federal return (including extensions). Note that this election is made annually on an
asset-by-asset basis. For example, if a qualifying taxpayer, which has two buildings (both of which have
an adjusted basis of less than $1,000,000), pays $9,000 for applicable repairs, maintenance,
improvements, and similar activities for each building in 2014, then they qualify to make this election on
each building and do not need to evaluate whether the repairs are required to be capitalized under the
R.A.B.I. rules. However, once made, this election may not be revoked for the applicable asset and
specific tax year.
The Election to Capitalize Repair and Maintenance Costs is commonly referred to as the “Book
Conformity Election.” Under this annual election, taxpayers may treat amounts paid for repair and
maintenance expenditures related to tangible property as amounts paid to improve that property and as
an asset subject to the allowance for depreciation. A taxpayer making this election must capitalize and
depreciate all repair and maintenance expenditures treated as capital expenditures in its books and
records in the election year. Note that this election applies to amounts that are NOT already required to
be capitalized as improvement by the Regulations or required to be expensed under the De Minimis Safe
Harbor Election of Treas. Reg. 1.263(a)-3. A taxpayer makes this election by attaching a statement to its
timely filed original Federal return (including extensions).
Dispositions of MACRS Property (Treas. Reg. 1.168(i)-8)
Definitions
Disposition: occurs when ownership of an asset is transferred or when the asset is permanently
withdrawn from use in either the taxpayer's trade or business or in the production of income. A
disposition includes the sale, exchange, retirement, physical abandonment, or destruction of an asset. A
disposition also occurs when an asset is transferred to a supplies, scrap or similar account, or when a
portion of an asset is disposed. A disposition also includes the disposition of a structural component (or
portion of a structural component) of a building.
Reasonable Allocation Method: taxpayers are permitted to use any reasonable method for allocating
unrecovered costs to disposed component(s). The Regulations provide examples of acceptable
allocation methods (e.g. using the Producer Price Index to index replacement costs, prorata allocation,
or a cost segregation or similar study) but allow for any reasonable method by taxpayers.
New Methods of Accounting
Going forward, the general rule regarding dispositions of MACRS assets is based on the facts and
circumstances of each disposition. However, the asset for disposition purposes may not consist of items
placed in service by the taxpayer on different dates. Moreover, the final disposition Regulations
illustrate that for purposes of determining what is the appropriate disposal asset, the unit of property
determination under Treas. Reg. 1.263(a)-3(e) does NOT apply, and as such, the disposition Regulations
provide some special rules for this disposition purposes, including:
1. each building (including its structural components) is "the asset" except as provided in Treas.
Reg. 1.1250-1(a)(2)(ii) or item numbers 2 or 4 below;
2. each condominium or cooperative unit (including its structural components) within a building is
"the asset" except as provided in Treas. Reg. 1.1250-1(a)(2)(ii) or item number 4 below;
3. each item of property included in asset classes 00.11 through 00.4 of Rev. Proc. 87-56 or in one
of the categories under IRC Section 168(e)(3), except for a category that includes buildings or
structural components (for example, retail motor fuels outlets, qualified leasehold
improvements, qualified restaurant property, and qualified retail improvement property) is
considered "the asset," provided that item 4 below does not apply; and
4. If the taxpayer places in service an improvement or addition to an asset after the taxpayer
placed the asset in service, the improvement or addition (including structural components) is a
separate asset.
The Regulations also allow for the Disposition of a Portion of an Asset, which allows taxpayers to claim a
loss upon the disposition of a component of any asset, including the structural component (or portion of
a structural component) of a building, without identifying the component as an asset before the
disposition event. The partial disposition rule minimizes the circumstances in which an original part and
any subsequent replacements of the same part are required to be capitalized and depreciated
simultaneously. In general, the partial disposition rule is elective. However, the rule is required to be
applied to dispositions of a portion of an asset as a result of:
1. a casualty event as described in IRC Section 165;
2. a disposition of a portion of an asset for which gain is not recognized in whole or in part under
IRC Sections 1031 or 1033;
3. a transfer of a portion of an asset in a step-in-the-shoes transaction described in IRC Section
168(i)(7)(B) (i.e.. tax free contributions to a corporation, tax free liquidations of a corporate
subsidiary, corporate reorganizations, tax free contributions to a partnership, partnership
distributions of property); or
4. a sale of a portion of an asset, even if the taxpayer does not make the Partial Disposition
Election (discussed below).
For other transactions, a disposition includes a disposition of a portion of an asset only if the taxpayer
makes the Partial Disposition Election (discussed below).
New Annual Elections
In general, the Partial Disposition Election allows taxpayers to dispose of a portion of an asset and take a
loss on the adjusted basis. This annual election is made on an asset by asset basis. A taxpayer may make
the partial disposition election for the disposition of a portion of any type of MARCRS property. A
taxpayer making the partial disposition election for the disposition of a portion of an asset must classify
the replacement portion of the asset under the same asset class as the disposed portion of the asset.
A taxpayer makes the partial disposition election by reporting gain, loss, or other deduction for the
taxable year in which a portion of an asset is disposed of by the taxpayer. The election must be made
with a timely filed (including extensions) original Federal tax return. Note that if a taxpayer has deducted
the amount paid or incurred for the replacement of a portion of an asset as a repair and as a result of an
examination of the taxpayer's return, the IRS disallows the taxpayer's repair deduction for the
replacement of the portion of the asset under the new Regulations, the taxpayer can make a partial
disposition election for the portion of the asset to which the IRS adjustment relates by filing an
accounting method change.
The IRS will only allow taxpayers to make late partial disposition elections (i.e. for assets placed in
service in prior years) via the accounting method change discussed above. The late partial disposition
accounting method change will only be available to taxpayers for their first taxable year beginning
before 2015. Going forward, taxpayers will only be permitted to claim a partial disposition by making the
partial disposition election in the year in which the portion of the asset is disposed.
Form 3115 - Application for Change in Accounting Method
The IRS has stated that the final repair, capitalization, and MACRS Regulations will, more often than not,
require taxpayers to change their method of accounting related to these areas by filing Form 3115 Application for Change in Accounting Method. The IRS's position is that even if you have followed the
applicable accounting methods in the past and have been in compliance with all income tax rules and
regulations, these new TPR's are so different that the method of accounting that you had in place prior
to the Regulations could not have been in agreement with the new Regulations and Forms 3115 are
expected. However, Forms 3115 filed for these changes will be submitted under the automatic consent
provisions, which means that there will not be a fee associated with the additional filings when filed
timely (including extensions). Finally, many of these Forms 3115 will need to be filed with a Section
481(a) adjustment, which is simply an adjustment calculated as if the new accounting method was
always used.
The IRS has written language into the new Regulations that may indicate that on audit in certain
circumstances the IRS may try to permanently disallow deductions and assess additional penalties under
the "use it or lose it" rules of depreciation. Basically, taxpayers are required to capitalize assets and
claim depreciation on property in the year it is placed in service and expense repairs and maintenance in
the proper period. If not done properly, the IRS, on audit, may assert that the "use it or lose rule" results
in a permanent disallowance, not just deferral, of deductions. As of yet, we don’t know how IRS auditors
will actually use this in the field – but beware the risk.
With that in mind, Andrew Keyso, Jr. (the IRS Associate Chief Counsel (Income Tax and Accounting)) and
Scott Dinwiddie (Special Counsel, IRS Office of Associate Chief Counsel (Income Tax and Accounting))
have both gone on record to alleviate the anxiety for taxpayers and preparers alike. Keyso stated on
November 5, 2014 at the fall AICPA Tax Division meeting that the government will likely respect a
taxpayers Form 3115; even though it might include a zero Section 481(a) adjustment that is incorrect,
unless, it is clear that an adjustment was much different than what was reported. He went on to
elaborate that the error would have to be egregious to attract IRS attention and that the IRS is most
interested in ensuring that taxpayers apply the Regulations correctly going forward. Dinwiddie was also
quoted at that meeting as saying that barring a situation where the taxpayer has taken an aggressive
position in the past or has in no way applied a proper capitalization method, the IRS is unlikely to have
much interest in examining a taxpayers zero Section 481(a) adjustment.
Most Forms 3115 must be filed before the 2014 tax return is filed, but a copy must also be attached to
the 2014 tax return. Therefore, all 3115's must be completed and mailed before the 2014 tax return is
filed with the IRS. While the IRS instructions gives some guidance as to the time requirements of filing
Forms 3115 in general (e.g. 26 hours to prepare, 42 hours for recordkeeping, etc.), there is not and likely
will not be any specific guidance related to how long implementing these new Regulations will take,
because every Form 3115 will depend on each taxpayers specific facts and circumstances. As tax
professionals, we know the applicable laws and can help complete the form(s) and work paper(s), but
most of the time burden and variances will depend on each taxpayer's files and records, their individual
accounting method changes, and their annual elections. As such, it would be impractical to provide a
general estimated time frame with such a large range of discrepancies in taxpayer facts and
circumstances. But, please don't hesitate to contact us to discuss any specific questions or concerns that
you may have regarding the new Regulations, Form 3115, or anything else.
Please note that this guide has not been intended as a comprehensive summary of all the rules and
regulations related to the changes made by the Treasury Department in 2013 and 2014 relating to
tangible assets. Instead, we have tried to summarize and highlight some points that taxpayers need to
consider and apply going forward. If you have any questions, please contact our office at 865-769-0660.