IRS Releases Final Tangible Property Repair Regulations

IMGCAP(1)]The IRS issued the final tangible property repair regulations for Sections 162(a) and 263(a) last Friday, modifying and superseding the temporary regulations that were issued on Dec. 23, 2011.

While this is the fourth iteration of the repair regulations the IRS has released, it is the first time they have issued them in final form. In addition to these final regulations, they also released proposed regulations for dispositions of tangible property under Section 168. While a formal six-month period for comments will allow taxpayers to provide feedback, these final and proposed regulations are effective for tax years beginning Jan. 1, 2014.

The major changes that CPAs and taxpayers should know about are as follows:

• General Asset Account Election Issue Addressed: This has been a source of major confusion for CPAs and taxpayers. The IRS has taken note and made significant changes to allow taxpayers that do not elect general asset account treatment to have the same flexibility to forgo a loss upon the disposition of a structural component as taxpayers that do elect GAA treatment.

• De Minimis Rule Change: The final regulations eliminate the ceiling in the de minimis rule in the 2011 temporary regulations and allow amounts properly expensed under a taxpayer’s financial accounting policies be deductible for tax purposes. They also provide rules allowing taxpayers without Applicable Financial Statements to take advantage of this rule.

• Routine Maintenance Safe Harbor Rule: The regulations extend the safe harbor to routine maintenance to buildings but require 10 years as the period of time which a taxpayer must reasonably expect to perform the relevant activities more than once.

• Relief for Small Businesses: The final regulations permit a qualifying small taxpayer to elect to not apply the improvement rules to an eligible building property if the total amount paid during the taxable year for repairs, maintenance, improvements and similar activities performed on the eligible building does not exceed the lesser of $10,000 or 2 percent of the unadjusted basis of the building. Eligible building property includes a building unit of property that is owned or leased by the qualifying taxpayer, provided the unadjusted basis of the building unit of property is $1,000,000 or less.

• Changes to Definitions of Betterments and Restorations: In addition, the final regulations change several of the criteria for defining betterments and restorations to tangible property.

• Materials and Supplies: Among several changes to this section, they raise the threshold to $200 for property that is exempt from capitalization.

• Dispositions: The proposed regulations for dispositions change the rules for partial dispositions of assets. These proposed regulations also require making a qualifying disposition election for certain situations when assets are held in a general asset account.

Revenue procedures outlining the administrative process for making the changes are expected to be issued in the coming months. Prior guidance indicates that most of these changes will be considered automatic changes of accounting methods.

Grey Area: If taxpayers file their accounting method changes to comply with the final regulations, it is unclear whether the “five-year rule” under Section 4.02(7)(a) of Rev. Proc. 2011-14 will prohibit future changes to depreciation for assets included in accounting method changes related to these final regulations. I am currently receiving conflicting information from different divisions of the IRS on the application of this rule. If the rule does apply, taxpayers will need to consider implementing any cost segregation studies at the same time as filing changes related to these regulations, or they will have to wait five years to realize the benefits of the cost segregation studies.

Opportunity Insight: One of the most significant rules that did not change from the temporary regulations allows taxpayers to claim retirement loss deductions for structural components that are removed from buildings. Taxpayers that have renovated their buildings in prior years should consider having a “retirement study” performed to quantify the basis of assets demolished. Not only does this allow taxpayers to accelerate deductions that they normally would have continued to depreciate, it can also create a permanent tax savings upon sale of the property. A permanent tax savings would be realized upon sale by avoiding recapture tax on 1245 property that is no longer in the building and the 25 percent tax for depreciated real property. Instead, a higher capital gain will be realized, which is often taxed at a lower rate.

For the full text of the final tangible property repair regulations, click here. For the full text of the proposed regulations for dispositions, click here.

Gian Pazzia, CCSP, is a principal with KBKG and its national practice leader for cost segregation, and is a subject matter expert on repair vs. capitalization issues. He currently serves as the president of the American Society of Cost Segregation Professionals and has previously been chair of their Technical Standards Committee.