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Atlanta and San Francisco | 678-964-4721 | hpccpa

Atlanta and San Francisco | 678-964-4721 | www.hpccpa.com. The Final Tangible Property Regulations. An Overview Presented by William C. Harshman. Background. Disputes Between Taxpayers & IRS IRS has lost many of the disputes

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Atlanta and San Francisco | 678-964-4721 | hpccpa

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  1. Atlanta and San Francisco | 678-964-4721 | www.hpccpa.com

  2. The Final Tangible Property Regulations An Overview Presented by William C. Harshman

  3. Background • Disputes Between Taxpayers & IRS • IRS has lost many of the disputes • Beginning approximately 3 years ago IRS issued Temp Regulations • Delayed several times • New Final Regulations effective 1/1/14

  4. Five major areas of change • Treatment of amounts paid for improvements to tangible property • Treatment of expenditures for materials & supplies • Treatment of repair & maintenance expenditures • General rules for capital expenditures • Treatment of amounts paid for purchase/production of tangible property

  5. New Annual Elections • The final and proposed regulations have many new annual elections including • Election to capitalize and depreciate certain materials and supplies (§1.162-3(d) • A TP may elect to treat as a capital expenditure and to treat as an asset subject to the allowance for depreciation the cost of any rotable spare part, temporary spare part, or standby emergency spare part • De minimis safe harbor election (§1.162-3(f)(1) • A TP with and without an AFS may not capitalize any amount paid in the taxable year for the acquisition or production of a unit of tangible property nor treat as a material or supply under §1.162-3(a) any amount paid in the taxable year for tangible property if the amount specified meets the rules ($500 and $5,000 per invoice respectively)

  6. New Annual Elections • Election to capitalize amounts paid for employee compensation or overhead as amounts that facilitate the acquisition of property (1.263(a)-2(f)(iv)(B)) 4. Safe harbor for small taxpayers (1.263(a)-2(h)(1) • A TP may elect not to capitalize improvements or repairs 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 property does not exceed the lesser of— 2% of the unadjusted basis of the eligible building property; or $10,000

  7. New Annual Elections 5. Election to capitalize repair and maintenance costs(1.263(a)-2(n)(1) • A taxpayer may elect to treat amounts paid during the taxable/year for repair and maintenance (as defined under §1.162-4) to/tangible property as amounts paid to improve that property/under this section and as an asset subject to the allowance for depreciation if the taxpayer incurs these amounts in carrying on the taxpayer’s trade or business and if the taxpayer treats these amounts as capital expenditures on its books and records

  8. New Annual Elections • Disposition of a portion of an asset (aka partial disposition • election) (§1.168(i)-8(d)(2) •  A taxpayer may make an election under this paragraph (d)(2) to • apply this section to a disposition of a portion of an asset •  Must make the election by the due date (including extensions) of • the original federal tax return for the taxable year in which the • portion of an asset is disposed of by the TP • This listing does not include the numerous GAA • elections addressed in the PRs

  9. New Provisions Are Not Elections • Most of the new final and PR TPRs are not elections, but rather are method changes first • Example • For the Safe harbor for routine maintenance on property (1.263(a)-2(i)(1) one has to first have the applicable final TPR method change filed first • Change procedures for the final TPRs are expected to be issued in October 2013

  10. The Allowed or Allowable Rule • Points • Section 1.1016-3 remains part of the TPRS – the IRS will use this in their audits of Taxpayers to deny depreciation deductions • Use 2013 (i.e. tax depreciation schedules as of 12-31-2012) to correct any errors in prior year depreciation, and

  11. Errors in Depreciation Fixes • Cannot fix depreciation errors by “catching up” on prior year errors • Only filed one return? The taxpayer has not adopted an accounting method, either • Previously filed return can be amended to make the correction, OR • IRS will allow A CAM by filing a 3115 with the current year’s return WITH A 481(a) adjustment on the current year’s return

  12. Errors in Depreciation Fixes • Filed two (or more) returns? • The taxpayer HAS adopted an accounting method • May only file a 3115 to correct • Incorrect depreciation deduction due to a mathematical or posting error? • A TP is not considered to have adopted an accounting method regardless of the number of returns that have been filed • So … May only file amended returns for open years

  13. Errors in DepreciationGains & Losses • The rule requiring basis reduction for unclaimed (allowable) depreciation applies for purposes of determining gain or loss • When computing depreciation recapture, a TP need not recapture as ordinary income unclaimed depreciation • A TP should, however, amend returns for open years to claim any unclaimed depreciation (or to reduce the amount of depreciation claimed in the open years in the case of a negative 481(a) adjustment

  14. Depreciation Errors and TPR toCheck for that Need Correction • Bonus depreciation (if taken on some, but not on all applicable assets – 3115; if not taken but now want to take = need letter ruling to change; • Improper lives for assets (need 3115) • Depreciation taken on assets now owned or owned (need 3115)

  15. Index of Regulation SectionsTemporary • 1.162-3T = rules for materials and supplies • 1.162-4T = rules for amounts paid or incurred for repairs and maintenance • 1.263(a)-1T = general rules for capital expenditures • 1.263(a)-2T = rules for amounts paid or incurred for the acquisition and production of tangible property • 1.263(a)-3T = rules for amounts paid or incurred for the improvement of tangible property • Are effective for taxable years beginning on or after January 1, 2014, with earlier application permitted

  16. Index of Regulation SectionsFinal and Proposed (PRs) • 1.162-3 = “Materials and supplies” • 1.162-4 = “Repairs” (rules for amounts paid or incurred for repairs and maintenance) • 1.263(a)-1 = “Capital expenditures; in general” • 1.263(a)-2 = “Amounts paid to acquire or produce tangible property” • 1.263(a)-3 = “Amounts paid to improve tangible property”

  17. Index of Regulation SectionsFinal and Proposed (PRs) • 1.263(a)-6 = “Election to deduct or capitalize certain expenditures” • 1.168(i)-1 = GAA • 1.168(i)-8 = Dispositions of MACRS property • Are effective for taxable years beginning on or after January 1, 2014, with earlier application permitted

  18. CapitalizationFoundation Rules • Section 263(a) (relating to the capitalization requirement) states that no deduction is allowed for 1. Any amount paid out for new buildings or permanent improvements or betterments made to increase the value of any property, or 2. Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance has been made

  19. Background … • 263(a) Regulations state that capital expenditures include amounts paid or incurred to • Add to the value, or substantially prolong the useful life, of property owned by the TP, or • Adapt the property to a new or different use • Amounts paid or incurred for incidental repairs and maintenance of property (as defined by 162 and §1.162-4 (relating to the deduction for ordinary and necessary trade or business expenses) are not capital expenditures under §1.263(a)-1

  20. Temporary or FinalRegulations Do Not Change • §263(a) • Which requires TPs to capitalize amounts paid to improve tangible property and • §263A and the regulations under §263A • Which require TPs to capitalize the direct and allocable indirect costs, including the cost of materials and supplies, to property produced or to property acquired for resale • §1.471-1 • Which requires TPs to include in inventory certain materials and supplies • §1016 on “use it or lose it” rule

  21. Unit of Property (UoP) • Is a very important element to these and other regulations • Does the client first need to change its Unit of Property before it makes a method change under the new TPRs?

  22. Unit of Property (UoP) • Unit of Property is a very important issued, why? • It is an important criteria in the decision whether a Taxpayer can write off an expenditure as a R& M • Generally • The small the Unite of Property the more likely the expenditure has to be capitalized • This issue should almost always be considered in TR issues, most of the time, early • If your current Unit of Property does not match what you need/want to do-you must ????? an accounting method change to get it corrected (T method 162, F is?)

  23. Rules for Determining a UoP§1.263(a)-3T(e) and -3(e) for Final For property other than buildings, • Defines a UoP as consisting of all the components of the UoP that are based upon the functional interdependent standard, but there are special rules for • Plant equipment, network assets, leased property, and improvements to property • Additional rules if • A Tax Payer has assigned different MACRS classes or depreciation methods to components of property, or • Subsequently changes the class or depreciation method of a component

  24. Unit of Property (UoP) forBuildings 1.263(a)-3(e)(2) • Building Structure • Building Systems (9) Defines building systems to include: • the heating, ventilation, and air conditioning systems (HVAC); • the plumbing systems; • the electrical systems; • all escalators; • all elevators; • the fire protection and alarm systems; • the security systems; • the gas distribution systems; and, • any other systems identified in published guidance.

  25. Building and Structural Components1.263(a)-3T(e)(2) and 3(e)(2) Final General rule that the UoP for a building is • T: comprised of the building and its structural components • F: each building and its structural components

  26. Building and Structural Components1.263(a)-3T(e)(2) and 3(e)(2) Final Improvements to a building • T: Requires that a TP apply the improvement standards separately to the primary components of the building, that is, the building structure or any of the specifically defined building systems • F: Requires that a TP apply the improvement rules separately to the building structure (a building structure consists of the building and its structural components, other than the structural components designated as building systems) or its building systems (these are separate from building structure, and to which the improvement rules must be applied) A UoP is a method of accounting

  27. Building and Structural Components1.263(a)-3T(e)(2) and -3(e)(2) Defines the building structure as • T: the building (§1.48-1(e)(1)) and its structural components (§1.48-1(e)(2)) other than the components specifically enumerated as building systems • F: each building and its structural components (as defined in §1.48-1(e)(2)) is a single unit of property (“building”) A cost is treated as a capital expenditure if it results in an • T: improvement to the building structure or to any of the specifically enumerated building systems • F: improvement to building structure or any of the building systems

  28. Building and Structural Components forPartial Dispositions (1.168(i)-8(d)(2) • The proposed regulations (PR) change the unit of property rule in Temp Reg. §§1.168(i)-1T and1.168(i)-8T that each structural component of a building, condominium, or cooperative is the asset for tax disposition purposes • The PR provide that a building (including its structural components), a condominium (including its structural components), or a cooperative (including its structural components) is the asset for disposition purposes

  29. Further Review of theFinal TPR Issues • §1.162-3 Rules for materials and supplies; • §1.162-4 Repairs and maintenance; • §1.263(a)-1 General rules for capital expenditures; • §1.263(a)-2 Rules for amounts paid for the acquisition or production of tangible property; • §1.263(a)-3 Rules for amounts paid for the improvement of tangible property

  30. Material and SuppliesReg. §1.162-3 • The F TPRs expand the definition of M & S to include property that has an acquisition or production cost of $200 or less (increased from $100), clarify application of the optional method of accounting for rotable and temporary spare parts, and simplify the application of the de minimis safe harbor to M & S • Add a new definition for “standby emergency spare parts” • Add a new election to capitalize and depreciate M & S but limit that capitalize choice to only rotable, temporary and standby emergency spare parts

  31. Material and SuppliesReg. §1.162-3 • Election to capitalize and depreciate is made on Taxpayer’s timely filed original tax return • Taxpayer can make that election item by item • Final TPRs coordinate the de minimis rules for unites of property (§1.162-3(f)) and M & S (Reg. §1.162-3(f)) • The Taxpayer must apply the de minimis safe harbor to amounts paid for all M & S, except for those M & S that the Taxpayer elects to capitalize and depreciate • Non-incidental and incidental M & S rules of the temporary TPRs remain • All final M & S require a method change filing

  32. Material and SuppliesReg. §1.162-3 • If a Taxpayer choses to make the election to capitalize and depreciate certain M & S for its tax year 2012 and 2013, the Taxpayer can still make the election by filing an amended return on or before 180 days after the extended due date, even if the return was not extended • A Taxpayer may choose to apply the temporary M & S rules for §1.162-3T for 2012 and 2013 • See Appendix ????? For Final TPR examples, list 1

  33. Repair—Reg. §1.162-4 • Is a simple, straight-forward rule, that is the opposite of capitalization • Amounts paid for repairs and maintenance to tangible property are deductible if the amounts paid are not required to be capitalized under Reg. §1.263(a)-3 • Same rule as from temporary TPRs • A change to comply with this is a change in method of accounting to which the provisions of §§446 and 481 and the accompanying regulations apply • No examples in Final TPRs

  34. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4 • Prior (can apply to 2012 and 2013) de minimis was not a “safe harbor” • Taxpayer could deduct certain amounts paid for tangible property if the Taxpayer had an AFS, had written account policies for expensing amounts under specific dollar amounts, and treated those amounts as expenses on its AFS • Ceiling was the great of • 0.1 percent of the Taxpayer’s gross receipts for the tax year as determined for tax purposes; or • 2 percent of the Taxpayer’s total depreciation and amortization expense for the tax year as determined on the Taxpayer’s AFS

  35. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4 • Final (can apply to 2012 and 2013 but must apply 2014 and after) de minimis safe harbor • Ceiling has been eliminated • New safe harbor determined at invoice item level, but same on policies for books and records • If AFS, Taxpayer may rely on the de minimis safe harbor only if the amount paid for property does not exceed $5,1000 per invoice or per item as substantiated by the invoice • This amount is subject to change by the IRS in future guidance

  36. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4 • The de minimis safe harbor has been expanded to include amounts paid for property having an economic useful life or less than 12 months, provided the amount per invoice or item does not exceed $5,000 • A $500per item de minimis rule is also included for taxpayers without an AFS, but still have to have accounting procedures in place to deduct amounts paid for property costing less than specified amount or amounts paid for property with life of 12 months or less • If cost exceeds $500 per invoice, no portion will qualify for the safe harbor

  37. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4 • Same rule as in the temporary TPRs • The de minimis safe harbor does not precluded a Taxpayer from reaching an agreement with the IRS that the examining agents will not review certain items • Examining agents do not need to revise their materiality thresholds in accordance with the safe harbor limitation • The de minimis safe harbor is elected annual by including a statement on the Taxpayer’s tax return for the year elected • An election to use the safe harbor may not be made through the filing of an application for change in accounting method

  38. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4 • For consolidated groups, if a Taxpayer’s financial results are reported on the AFS for a group of entities, then the group’s AFS may be treated as the AFS of the Taxpayer • A Taxpayer is not required to include in the cost of the property the additional costs if these costs are not included on the same invoice as the tangible property • However, a Taxpayer electing the de minimis must included in the cost of the property all additional costs (for example, delivery fees, installation services, or similar costs) of acquiring or producing the property if these costs are included on the same invoice with the tangible property

  39. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4 • If an invoice includes amounts paid for multiple tangible property and the invoice includes additional invoice costs related to the multiple property, then the taxpayer must allocate the additional invoice costs to each property using a reasonable method • The de minimis safe harbor must be applied to all eligible M & S (other than rotable, temporary, and standby emergency spare parts subject to the election to capitalize or to rotable and temporary spare parts subject to the optional method of accounting for such part(s) if the Taxpayer elects the de minimis safe harbor

  40. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4 • Taxpayers that do no elect the de minimis safe harbor must treat amounts paid for materials and supplies in accordance with Reg. §1.162-3 • Taxpayers subject to 263A can not avoid those provision by using the de minimis • Safe harbor does not apply to inventory, land items it capitalizes, and the optional method of rotable parts • Safe harbor is deducted as ordinary and necessary expense

  41. De Minimis Safe Harbor-Reg. §§1.162-3(f) and 1.263(a)-1(f) Repairs-Reg. §1.162.4(Effective Dates) • Except for the de minimis election, changes apply to taxable years on or after 1-1-14 • If doing the de minimis election, it will only apply to transactions after 1-1-14 • Even for the de minimis election, a Taxpayer may choose to adopt to amounts paid or incurred in taxable years on or after 1-1-12 • Transition rule for de minimis election on 2012 and 2013 returns apply • A Taxpayer may choose to apply the temporary de minimis rules for Reg. §1.263(a)-1T for 2012 and 2013

  42. Amounts Paid to Acquire or ProduceTangible Property-Reg. §1.263(a)-2 • Temporary TPRs provided rules for 263(a) to amounts paid to acquire or produce a unit of real or personal property • These rules are generally retained in the final TPRs • Requirements to capitalize amounts paid to acquire or produce, • To capitalize amounts paid to defend or perfect title and • The de minimis safe harbor was moved to §1.263(a)-1(f) to reflect its broader application amounts paid to tangible property, including amounts paid for improves and M & S, except for those subject to 263A

  43. Amounts Paid to Improve TangibleProperty-Reg. §1.263(a)-3 • This final TPR section covers the following sections • Provides the requirement to capitalize amounts paid to improve tangible property and provides the general rules for determining whether a unit of property (UoP) is improved • Rules for determining the UoP • Rules for leasehold improvements • Rules for determining improvement costs in particular contexts, including indirect costs incurred during an improvement, removal costs, aggregation of related costs, and regulatory compliance costs

  44. Amounts Paid to Improve TangibleProperty-Reg. §1.263(a)-3 • This final TPR section covers the following sections • Safe harbor for small taxpayers • Safe harbor for routine maintenance costs • Whether amounts are paid for betterments to UoP • Whether amounts are paid to restore the UoP • Rules for amounts paid to adapt the UoP to a new or different use • An election to capitalize R & M consistent with books and records • an (o) the treatment and recovery of amounts capitalized under this section • and (q) accounting method changes and state the effective/applicability date for the rules of this Section

  45. Amounts Paid to Improve TangibleProperty-Reg. §1.263(a)-3(d) • Requirement to capitalize amounts paid for improvements • A Taxpayer generally must capitalize the related amounts paid to improve a UoP owned by the Taxpayer • A UoP is improved if the amounts paid for activities performed after the property is place din service by the Taxpayer − • Are for betterment to the UoP • Restore the UoP or • Adapt the UoP to a new or different use

  46. Amounts Paid to Improve TangibleProperty-Reg. §1.263(a)-3(e) • Determining the UoP • UoP determination is based upon the function interdependence standard • Special rules are provided for: • Buildings • Plant property • Network assets • Leased property (leased buildings and leased property other than building), and • Improvements to property

  47. Amounts Paid to Improve TangibleProperty-Reg. §1.263(a)-3(e) • Additional rules are provided if a Taxpayer has assigned different MACRS classes or depreciation methods to components of property or subsequently changes the class or depreciation method of a component or other item of property.

  48. Amounts Paid to Improve TangibleProperty-Reg. §1.263(a)-3(e) • Determining the UoP − Leased Building • In the case of a Taxpayer that is a lessee of all or a portion of a building such as an office, floor or certain square footage), the UoP is each building and it structural components or the portion of each building subject to the lease and the structural components associated with the leased portion

  49. Amounts Paid to Improve TangibleProperty-Reg. §1.263(a)-3(e) • An amount is paid to improve a least building property if the amount is paid for an improvement, to any of the following • Entire building, portion of a building • Other than a building • All the components that are functionally interdependent comprise a single UoP

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