Implementing the Repair Regulations in your
Transportation Business
Tiffany Piper, CPA
Tax Manager
[email protected]
920-907-2123
For years, taxpayers, along with their accountants, have faced the
challenge of distinguishing between capital improvements and repair and
maintenance expenses. In 2011 the IRS issued temporary regulations that
created guidelines for treatment of these expenditures, along with the
proper treatment of materials and supplies. In addition, the regulations
covered other issues involving the capitalization of tangible property and
also provided the opportunity to write off all or a portion of an asset when
disposed of.
In September of 2013, the IRS issued the final regulations which are effective
for taxpayers with taxable years that start on or after January 1, 2014.
The new regulations provide guidance on materials and supplies, capital
expenditures, repairs and maintenance, improvements to property and
amounts paid to acquire property. On the positive side, we now have some
guidance on how to handle these types of costs, but these new regulations
are very complex and fact specific with no bright line rules. These regulations
will impact almost all taxpayers in any industry, including transportation.
Read on for a summary of the new regulations and how they will impact
your transportation business.
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Implementing the Repair Regulations in your Transportation Business
Materials and Supplies
Materials and supplies are defined as tangible property,
excluding inventory, that are used or consumed in
operations and is:
• A component acquired to maintain, repair or improve a
unit of tangible property
• Fuel, water, lubricants and similar items that are
reasonably expected to be used in 12 months or less
• Unit of property whose useful life is 12 months or less
• Unit of property with a cost less than $200
The regulations further break down materials and
supplies into incidental and nonincidental. What
distinguishes incidental and nonincidental is how
significant the materials and supplies are to your
business. For example, tires and fuel are significant
to a transportation company and therefore would be
considered nonincidental supplies. Incidental materials
and supplies can be deducted when they are purchased
assuming there is no record of consumption or physical
inventory taken. On the other hand, nonincidental
materials and supplies are capitalized and deducted in
the year they are used or consumed. Starting in 2014,
you will be required to keep a physical inventory or a
record of consumption for nonincidental materials and
supplies. An exception to this would be if you choose
to deduct the material and supply under the de minimis
rule, described below.
You will need to address how you are accounting
for materials and supplies to determine if you are in
conformity with the regulations. For instance if you have
a shop that houses parts and tires used for repairing
tractors and trailers, you will need to assess how you
are accounting for these supplies. What supplies are
considered incidental and nonincidental? Do you
maintain an inventory or track any supplies? When do
you expense your supplies? Based on the answers to
these questions, you may be required to change your
method which will require capitalizing these supplies
and accounting for them under the consumption
method. Additionally, if you have your tires recapped
they are considered rotable parts and are subject to a
special set of rules and elections.
you are keeping a physical inventory, and you deduct it
as you use it, then you are following the regulations. On
the other hand, if you purchase a 3-month supply of fuel
and deduct it all upfront, then you may have an issue.
Fuel is considered a nonincidental supply and would
require that you either keep a physical inventory or a
record of consumption.
Capital expenditures
The new regulations provide guidance on what
expenditures need to be capitalized. You must capitalize
any amounts that are paid to improve a unit of property.
You make an improvement to a unit of property if you
make a betterment, a restoration, or adapt it to a new or
different use. This guidance is heavily fact specific with no
bright line test so it requires a thorough review of activity
performed on tractors and trailers.
What is a unit of property?
A unit of property consists of a group of functionally
interdependent components. In other words, if placing
one component in service is dependent on placing
another component in service, then they are functionally
interdependent and considered one unit of property. For
example, a tractor and its components (engine, tires, etc.)
would be one unit of property because each of these
components needs to be placed in service at the same
time in order for the tractor to function. The trailer and its
components would be a separate unit of property even
though the tractor and the trailer are used together.
The regulations separately address what a unit of
property is when it comes to buildings. In general, a
building and its structural components are one unit
of property. Examples of the structural components
would be roofs, walls, floors, ceilings and other items
that relate to the operation of a building. There are also
certain “building systems” that the regulations have
defined as separate units of property. These building
systems include HVAC systems, plumbing, electrical,
escalators, elevators, fire protection, alarm/security and
gas distribution.
Once unit of property is defined, you then need to
determine if amounts paid result in a betterment,
restoration or adaption to new/different use.
As defined above, fuel is considered a material and a
supply. If you purchase a 3-month supply of fuel, in which
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Implementing the Repair Regulations in your Transportation Business
Betterment
Amounts paid for a unit of property are a betterment if
they:
• Correct a material defect/condition that existed prior
to the acquisition of a unit of property (even if you
were not aware of it);
• Result in a material addition to the unit of property (i.e.
enlargement, expansion or extension); or
• Result in a material increase in capacity, productivity,
efficiency, strength, quality or output of the unit of
property.
Restoration
A restoration of a unit of property will occur if an amount
paid is for:
• Returning the unit of property to its ordinarily efficient
operating condition if the property was in disrepair
and no longer functional;
• Replacement of a component of a unit of property
where a gain/loss is recognized on the component
(including casualty losses);
• Rebuilding the unit of property to a like-new condition
after the end of its class life; or
• The replacement of part(s) that comprise a major
component or substantial structural part of the unit of
property.
New/Different Use
Amounts paid that adapt a unit of property to a new or
different use if the adaption is not consistent with your
original intended use of the unit of property when you
acquired it.
Let’s apply the concepts to some examples. For example,
you purchase a tractor in 2008. In 2014, you pay $30,000
to have the engine rebuilt. Under the new regulations,
this cost would fall under the restoration category
discussed above and would be required to be capitalized.
The class life of a tractor is four years and in this example
you are rebuilding the tractor to a like-new condition
after the end of its class life.
Let’s assume the same facts but the tractor was
purchased in 2010. In this case the class life of the tractor
(4 years) does not end until 2014. Even though the class
life is still in effect, this expenditure would be required
to be capitalized because you are replacing a major
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component of the tractor (the engine) which qualifies
as a restoration. However, there may be instances where
certain rebuilds can be deducted. Inquiry of these types
of expenditures will need to be done to determine how
they can be deducted.
If an amount paid for a unit of property falls under any
of the three categories above, then the improvement
must be capitalized, but the regulations offer some relief
to taxpayers by adding the Routine Maintenance Safe
Harbor.
Routine Maintenance Safe Harbor
The regulations acknowledged that taxpayers incur
expenditures that assist in keeping a unit of property
in its efficient operating condition. As a result, the IRS
created a safe harbor that allows taxpayers to expense
certain maintenance costs that are routine and reoccur
during the use of a unit of property. An activity is
reoccurring if you expect to do it more than once during
the class life (not the depreciable life) of the unit of
property.
This safe harbor rule also applies to buildings and their
structural components. In the case of a building and its
components, an expenditure can be treated as a repair/
maintenance if you reasonably expect to perform it more
than once over a 10 year period of time.
With the routine maintenance safe harbor, certain
expenditures that relate to maintaining tractors and
trailers can be expensed as repairs and maintenance.
With a tractor’s class life of four years, any routine
maintenance (i.e. oil changes, filters, tune ups, minor
repairs) will be expensed because you expect to do
these activities more than once over four years. Another
item that can qualify as routine maintenance would be
replacement tires. Tires can be replaced a number of
times over the class life of tractors (4 years) and trailers
(6 years) and therefore can be expensed under this safe
harbor when purchased and used immediately. On
the other hand, activities like rebuilding engines and
replacing transmissions are not expected to be done
more than once over a four year tractor class life and
therefore do not qualify under this safe harbor rule.
De Minimis Safe Harbor to acquire property
In general, when you purchase a unit of property, you
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Implementing the Repair Regulations in your Transportation Business
are required to capitalize it. With the new regulations the
IRS provided some relief for this general rule by creating
a de minimis exception. This exception allows a taxpayer
to immediately deduct amounts they pay to acquire or
improve property. Taxpayers who have an applicable
financial statement (AFS) can deduct up to $5,000 of the
cost of an item of property (per invoice). For purposes of
the regulations, an AFS is one that is audited or filed with
the SEC. For those who do not have an AFS, the $5,000
limit is reduced to $500.
Another requirement that needs to be in place before
applying the safe harbor is that you need to have a
written book capitalization policy in place by the start
of 2014. This policy must specify that you will expense a
certain dollar amount (up to $5,000 or $500). An example
of a capitalization policy is included.
To illustrate how the de minimis safe harbor works, let’s
look at an example. Assume that a taxpayer does not
have an AFS and has a written policy in place that states
they will expense property that costs $500 or less. They
purchase 20 office chairs that cost $400 each and pay
$8,400. Since the taxpayer has a written policy in place
and each office chairs (unit of property) is $500 or less,
the taxpayer could expense the full $8,400 paid for the
office chairs.
Although the regulations state the $5,000/$500 limits,
your capitalization policy can be set to an appropriate
level for your business. In the case of an IRS audit, it
would be the taxpayer who has the burden of proving
to the IRS that the amount paid was reasonable and it
clearly reflected income.
Although the de minimis safe harbor now allows the
taxpayer to make these immediate deductions, this
may be challenging to the transportation industry as it
relates to tires. As we stated earlier, if you are purchasing
replacement tires and are using them right away, these
would be expensed under the routine maintenance safe
harbor. But, what if you purchase extra tires that will be
used at a later date? We can first apply the de minimis
safe harbor rules to determine if we can deduct them.
On average, let’s say that a new tire cost approximately
$550. If you have an AFS, this should not be an issue and
you can expense it under the de minimis safe harbor.
However, many taxpayers in the transportation industry
will face the $500 limit. As a result, the purchase of new
tires may exceed this limit and you would no longer be
eligible for safe harbor treatment.
Even though the safe harbor is not available, you could
still deduct the tires by increasing the limit in your
capitalization policy. But as stated above, the burden
would be on you to demonstrate to the IRS that such a
deduction clearly reflects income under your facts and
circumstances. Alternatively, you could capitalize the tires
and deduct them as consumed.
An example of a capitalization policy (which you should
print onto your corporate letterhead) is included. For an
electronic version of the capitalization policy, visit
www.schencksc.com/truckingrepairregs.
Disposals
The regulations allow taxpayers the opportunity to
partially dispose of duplicate portions of property,
including buildings and there structural components. For
example, in the past if you replaced a roof on a building,
the cost of the new roof was capitalized but you were
not allowed to dispose of the prior roof. With the new
regulations, you can elect to dispose of the prior roof. The
regulations illustrate reasonable methods that taxpayers
can use to identify the disposed asset. Generally, when
you have to replace a component of a tractor, trailer or
even a building you will capitalize the new item but elect
to dispose of the replaced component.
Transportation companies typically face major
expenditures in the upkeep of their tractors and trailers.
In the past, some taxpayers may have been aggressive
in expensing the majority of their repairs to tractors and
trailers. However starting in 2014, these expenditures
must be revisited to determine what changes are
necessary to adopt the new regulations. It is important
that you review your repair and supply expenditures and
make sure capitalization policies are in place. Overall the
new regulations are very complex, but they can provide
benefits to your business if implemented correctly.
It will be vital for you to meet with your Schenck
advisor to address how these new regulations will
affect your business.
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Capitalization Policy
This document sets forth the capitalization/expensing policy of ___________________________ for financial accounting
purposes with respect to amounts paid to acquire or produce tangible property, including property used to repair, maintain, or improve other tangible property.
Tangible Property defined
All tangible personal and real property acquired or produced by the company for use in carrying on its trade or business,
including machinery, equipment, furniture, fixtures, computers, vehicles, tools, materials, supplies, land, buildings,
leasehold improvements, and other real property.
Capitalization threshold and procedure
___________________________ will treat as a current expense for financial accounting purposes, except as provided
below, amounts paid for the acquisition or production of:
• Each item of tangible property costing $___________ or less; and
• Tangible property with an economic useful life of 12 months or less regardless of cost.
The cost of an asset shall be determined on a per item, per invoice basis. Costs of items shall be recorded at historical cost
as of the acquisition or production date.
Amounts spent on repairs, additions, and improvements to land, buildings, other real property, and personal property
may be expensed under this policy unless an alternative treatment is required under the company’s applicable financial
standard.
Capital Asset Defined and Amounts
A “Capital Asset” is defined as a unit of property that:
(1) has an economic useful life that extends beyond 12 months; and
(2) is acquired or produced for a cost of more than $___________. Capital Assets must be capitalized and depreciated
for financial accounting purposes.
Other
This policy does not apply to inventory items and items includible in inventory.
Effective Date: January 1, 2014
Signed _______________________________________