Why are the new repair regulations important?
In late 2014, the Internal Revenue Service released final regulations addressing the treatment of repairs and maintenance expenses for federal income tax purposes. The new regulations affect all taxpayers with tangible property. These changes were an attempt by the IRS to bring clarity to a complicated area of the tax law, though, they go way beyond just repairs and change the treatment of repairs and maintenance, materials and supplies, spare parts, and acquisition costs. In order to comply with the new regulations, there will be a significant amount of “one time” work and related tax filings need to occur with the filing of your 2014 tax return.
Is my business required to comply with the regulations?
Yes. Compliance with the new regulations is mandatory for tax years beginning on or after January 1, 2014. Failure to comply with the new regulations can result in the assessment of additional tax, interest and penalties at both a federal and state level. The word “required” used above is very important to us as your tax preparers. As CPAs and tax preparers, we are required to follow the rules and restrictions of our state and federal licensing parameters which can subject us to very large penalties if not followed. These rules prohibits us from preparing and/or signing your 2014 tax return unless the forms required by the regulations are submitted with your tax return.
What aspects of my business are impacted by the new regulations?
The new regulations impact the manner in which your business treats repair and maintenance expenditures for income tax purposes. Items that you have expensed in the past may now be required to be capitalized, and vice versa. However, the impact of the regulations is more far-reaching. They could also change the income tax treatment of materials and supplies, rotatable spare parts, acquisition costs and the accounting for items that you are deemed to dispose when you make significant repairs.
What must I do to comply with the regulations?
The IRS has indicated verbally, that they anticipate most taxpayers with business or rental properties will need to file Form 3115 (Change in Accounting Method) to comply with the regulations or be subject to audit. Most taxpayers will be required to file at minimum one Form 3115. Taxpayers with real estate could be required to file up to three Form 3115s. In addition, annual election statements will be required. Materials and supplies as well as unit of property are now defined by the IRS under the new regulations and are required to be adopted through the Form 3115.
What opportunities are available to my business as a result of the regulations?
Most taxpayers will not look favorably on the required changes. However, there may be opportunities to implement changes that are favorable. For instance, when significant building components are replaced (a roof for example), an opportunity may arise to deduct the remaining basis on the existing roof. The IRS has verbally indicated that 2014 will be the only year in which they will allow accounting method changes to recoup the remaining basis of any “partial disposals” that occurred prior to 2014. In subsequent years, claiming a partial disposition deduction will be done via an annual election.
Other opportunities include the ability to adopt a method that permits the expensing of certain de minimis purchases including computers, chairs, small printers and other items that satisfy certain dollar limitations. Under the new de minimis safe harbor rules, written accounting policies are strongly recommended and in some instances required to be in place for 2014.
Taxpayers who have significant fixed assets with remaining depreciable basis or real property could have current and future tax deductions. The new regulations requires tax preparers or taxpayers to review every asset on their depreciation schedules. Taxpayers have the opportunity to partially dispose of duplicate portions of property, including buildings and their structural components. Historically, for example, if one replaced a roof on a building and capitalized the replacement costs, the taxpayer was not allowed to dispose of the prior roof. Under the new regulations, a taxpayer can elect to dispose of the prior roof. These partial asset dispositions provide an opportunity to write off duplicate assets for tax years prior to 2014 for a current year tax deduction, or the opportunity to write off these items will be lost.
Can you give me some examples of what I can deduct and what I must capitalize under the new regulations?
The new regulations include numerous examples, many of which are highly subjective and complex. Once a unit of property is defined, a taxpayer needs to determine if the amounts paid result in one of the following which are required to be capitalized:
- correct a material defect or condition prior to acquisition
- result in material addition
- result in a material increase in capacity, productivity, efficiency, strength, quality, or output
- Returning the unit of property to its ordinarily efficient operating condition
- Replacement of a component where a gain or loss is recognized
- Rebuilding to a like-new condition after the end of its class life
- Replacement of part(s) that comprise a major component, large physical portion, or substantial structural part
- Adapting to a new or different use if the adaption is not consistent with the taxpayer’s original intended use when acquired
Click here to view a table describing some of the distinctions the new regulations make. New repair regs table
What steps should I be taking?
Proactive compliance with the regulations is critical. The Whitlock Company is available to help you analyze and address these important new regulations in the light of your business situation. Here are some of the things you should be considering:
- What are your current accounting policies? Do they need to be updated and modified?
- Have you implemented a de minimis expense policy?
- Have you engaged in significant repair/remodel projects? Does the opportunity exist to deduct partial dispositions?
- Are you purchasing new real estate? Consideration should be given to a cost segregation study.
- File the Form 3115(s) with the 2014 tax return.