Late in 2011, the IRS issued long-awaited temporary and identical proposed regulations (T.D. 9564; REG-168745-03) regarding the treatment of expenditures incurred in acquiring, producing or improving tangible assets, including rules on determining whether costs related to tangible property are deductible repairs or capital improvements.
The temporary regulations clarify and expand the standards in the current regulations under Secs. 162(a) and 263(a) and provide rules for applying these standards. They also provide guidance on accounting for, and dispositions of, property subject to Sec. 168 and amend the general asset account regulations.
Distinguishing between expenditures for capital improvements or for deductible ordinary repairs is a highly factual determination for which a number of court cases have set out tests. The IRS first issued proposed regulations on the subject in 2006 and later withdrew them. The latest temporary and proposed regulations respond to comments received in response to reproposed regulations issued in 2008.
Changes introduced by the temporary regulations include revised rules for determining whether an amount is paid for an improvement to a building and a revised rule for determining whether an amount is paid to replace a major component or substantial structural part of a unit of property.
Materials and supplies. The temporary regulations generally retain the framework in the 2008 proposed regulations for materials and supplies. In response to comments, however, the temporary regulations modify and expand the definition of materials and supplies, provide an alternative optional method of accounting for rotable and temporary spare parts and provide an election to treat certain materials and supplies under a de minimis rule in Temp. Regs. Sec. 1.263(a)-2T. The temporary regulations also allow a taxpayer to elect to capitalize certain materials and supplies.
Repairs. Under the 2008 proposed regulations, amounts paid for repairs and maintenance to tangible property are deductible if the amounts paid are not required to be capitalized under Regs. Sec. 1.263(a)-3. The temporary regulations retain this rule and clarify that a taxpayer is permitted to deduct amounts paid to repair and maintain tangible property, provided such amounts are not required to be capitalized under Sec. 263(a) or any other provision of the Code or regulations.
Rentals and leased property. The temporary regulations amend the rules in Regs. Secs. 1.162-11(b) and 1.167(a)-4 to provide that a lessee or lessor must depreciate or amortize its leasehold improvements under the cost recovery provisions of the Code applicable to the improvements, without regard to the term of the lease. They also remove the rules permitting amortization over the shorter of an improvement’s estimated useful life or the term of the lease.
Amounts paid to acquire or produce tangible property. The temporary regulations retain most of the rules from the 2008 proposed regulations on capitalization of amounts paid to acquire or produce units of tangible property. These include a general requirement to capitalize acquisition and production costs and a requirement to capitalize amounts paid to defend and perfect title to property. Responding to comments, the temporary regulations clarify how the rules apply to moving and reinstallation costs. They also retain the rule for costs incurred before placing property into service, add and clarify certain rules with respect to transaction costs and modify and refine the de minimis rule.
The de minimis rule under the temporary regulations retains the requirement that a taxpayer may deduct certain amounts paid for tangible property if the taxpayer (1) has an applicable financial statement, (2) has written accounting procedures for expensing, for nontax purposes, amounts paid for such property under certain dollar amounts, and (3) treats such amounts as expenses on its applicable financial statement in accordance with such written accounting procedures. However, the temporary regulations replace a fourth “no distortion” requirement in the proposed regulations with an overall ceiling that generally limits the total expenses that a taxpayer may deduct under the de minimis rule.
Under the new criteria, the aggregate of amounts paid and not capitalized under the de minimis rule for the tax year must be less than or equal to the greater of 0.1% of the taxpayer’s gross receipts for the tax year as determined for federal income tax purposes or 2% of the taxpayer’s total depreciation and amortization expense for the tax year, as determined in its applicable financial statement.
Amounts to improve property. The temporary regulations retain the basic framework of the 2008 proposed regulations for determining the unit of property and whether it has been improved. They also retain many of the simplifying conventions set out in the 2008 proposed regulations, including the optional regulatory accounting method and the routine-maintenance safe harbor. However, the latter is modified so that it will not apply to buildings.
Accounting and disposition rules for MACRS property. The temporary regulations also revise the rules for accounting for modified accelerated cost recovery system (MACRS) property and the rules for determining gain or loss upon its disposition. The temporary regulations eliminate group accounts, classified accounts and composite accounts under Regs. Sec. 1.167(a)-7. Instead, each multiple asset account must include, in most cases, assets that have the same depreciation method, recovery period and convention and that are placed in service in the same tax year. The temporary regulations also provide rules for determining gain or loss upon the disposition of MACRS property that are consistent with the disposition rules under Prop. Regs. Sec. 1.168-6 of the proposed ACRS regulations.
Effective date. The temporary regulations are generally effective for tax years beginning on or after Jan. 1, 2012. A change to conform to the temporary regulations is a change in method of accounting under Sec. 446(e), and, in general, a taxpayer seeking a change in method of accounting to comply with the temporary regulations must take into account an adjustment under Sec. 481(a). The IRS said it would provide procedures under which taxpayers may obtain automatic consent for a tax year beginning on or after Jan. 1, 2012, to change to a method of accounting provided in the temporary regulations.
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