Published February 4, 2013

Comprehensive Repair versus Capitalization Regulations

The Internal Revenue Service ( IRS ) has issued temporary regulations effective for tax years beginning January 1, 2014 (postponed from January 1, 2013), that seek to clarify the complex rules regarding repairs versus capitalization related to tangible property. The IRS is expected to issue permanent regulations that are substantially identical to the temporary regulations. However, many complex questions remain about their interpretation and application. What is certain, though, is that the final regulations will affect all businesses in one way or another.
The following summary provides a general overview of the new regulations:

Materials and supplies

  • Materials and supplies are defined as tangible property used in operations (not inventory) that is expected to be consumed in less than a year and that has a per unit cost of $100 or less.
  • Materials and supplies may be expensed in the year they are used.

De minimis expensing rule

  • Under the new regulations, a taxpayer may expense property (not inventory) up to a total of 0.1% of gross receipts or 2% of total depreciation.
  • To take advantage of the de minimis rule, however, the taxpayer must have properly issued financial statements and a written de minimis expensing policy in effect.

Amounts paid to acquire or produce tangible property

  • The new regulations clarify existing rules to capitalize amounts paid to acquire or produce a unit of property.
  • Amounts required to be capitalized are invoice costs, transaction costs, and costs for work performed prior to the date the property is placed in service.

Amounts paid to improve tangible property

  • The regulations require capitalization of amounts paid to improve tangible property, defined as a betterment, restoration, or adaptation of the property for a new use.
  • Costs incurred to replace minor components and costs of routine maintenance may be expensed. The IRS has not issued a bright-line definition of minor components and/or routine maintenance; thus, the taxpayer must apply a facts-and-circumstances test to determine the proper treatment for each expenditure.

Dispositions of MACRS property

  • Retiring a structural component of a MACRS (Modified Accelerated Cost Recovery System) building may now create a currently recognized gain or loss under the new regulations. Previously, a retired component of a MACRS building would continue being depreciated for the remainder of the building s life.
  • This provision can be retroactive, but it requires a change of accounting method to properly calculate and recognize prior-year losses.

MACRS asset accounts

  • The new regulations provide specific guidance regarding grouping assets under MACRS. Many entities are applying the allowed methods and are already in compliance; as such, the regulations clarify the currently accepted practice.
  • Under MACRS, assets can be depreciated individually, in multiple asset accounts, or in a general asset account. The assets may be grouped in any of these methods, but each group must contain assets that are placed in service in the same year and are depreciated with identical methods (Example: Three years straight-line or five years double-declining balance mid-quarter convention).

In general, these regulations will be favorable to taxpayers and provide clarity that was previously lacking. Some of the regulations could require a change in accounting method that must be calculated and documentation filed with the IRS prior to taking deductions. It is important to review your existing methods of accounting for repairs and capitalization in light of these new regulations.

If you would like to discuss the impact of these regulations on your organization, please contact the expert listed below at PYA, (800) 270-9629.

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