New rules regarding the capitalization and deduction of expenditures related to tangible property were issued by the Treasury Department in proposed and temporary form on December 23, 2011. All businesses with tangible assets will be affected by these regulations. These new rules attempt to guide taxpayers where previous proposed regulations were not successful. The new rules are effective for taxable years beginning on or after January 1, 2012.
Business leaders should begin a dialogue with their tax professionals sooner rather than later to determine how they might be affected. A review of company policies and procedures will be necessary to maintain tax compliance while minimizing increased administrative burdens.
Smart Business spoke with Josh N. Wheeler, CPA, and Tom Tyler, CPA, a partner with Crowe Horwath LLP, about what taxpayers need to know about the new Treasury regulations.
What is the purpose of the new regulations?
The regulations attempt to provide guidance so that a taxpayer can determine whether expenditures should be expensed, or capitalized and depreciated, for tax purposes. The new regulations apply to expenditures incurred to acquire, produce, repair and improve tangible real property, such as a building, and tangible personal property, such as a copy machine, for example.
What types of items are covered under the new regulations?
The tangible asset regulations cover the treatment of materials and supplies, routine maintenance, costs to improve property, dispositions of property, as well as costs incurred to acquire property, such as employee compensation and overhead costs.
How do the new regulations differ from the ‘old’ regulations?
In certain respects, the new regulations are the same as the old regulations and in other respects they deviate significantly from their predecessor.
One of the most significant differences between these regulations and previous version concerns how taxpayers determine if an improvement has been made to a unit of property. At the core of determining whether expenditures should be capitalized as an improvement, or expensed as a repair, is identifying the unit of property to which the expenditure relates.
The new regulations depart from the old regulations by requiring that taxpayers apply the improvement rules to separate building systems when determining whether expenditures should be expensed or capitalized. Those separate components include HVAC, plumbing and electrical systems; security, fire protection and alarm systems; gas distribution systems; and all escalators and elevators.
Having to apply the improvement rules in this way can increase the likelihood that expenditures will be required to be capitalized.
Another significant addition to the regulations is the treatment of property dispositions. The regulations allow, and in some cases require, a taxpayer to take a loss on the replacement of a component of a unit of property. Taxpayers will need to familiarize themselves with these rules in order to make certain they implement the regulations properly.
Will taxpayers apply the regulations in the same way?
Yes and no. All taxpayers are required to adopt and conform to the new regulations for tax years beginning on or after January 1, 2012. The regulations provide taxpayers many choices for adopting the new rules. What elections are made will depend on each taxpayer’s unique circumstances.
For example, nonincidental materials and supplies may be deducted when used or consumed. Alternatively, a taxpayer may elect to capitalize and depreciate them. Taxpayers who need to generate taxable income to use expiring net operating loss carryforwards might elect to capitalize and depreciate the materials and supplies over a number of years rather than expensing all amounts in the current year.
Another example includes taxpayers who have written accounting policies for expensing capital expenditures under a specified dollar threshold. The new regulations permit expensing for tax purposes consistent with the financial statements, but only for companies who have applicable financial statements. Furthermore, the total amount expensed may not exceed the greater of 0.1 percent of gross receipts determined under federal tax rules or 2 percent of the taxpayer’s total depreciation and amortization expense reported in its applicable financial statement. Not all taxpayers have an applicable financial statement and only those who do may adopt this method
What actions must companies take in order to comply with the new regulations?
As previously discussed, the regulations are effective for taxable years beginning on or after January 1, 2012. However, taxpayers cannot only focus on 2012 and beyond. To comply with the new regulations, taxpayers must assess policies and procedures implemented in prior years and conform those prior years to the new regulations. The result will require a positive or negative adjustment to taxable income.
The Treasury Department is expected to issue two revenue procedures that will provide taxpayers with specific procedures they must follow to obtain automatic consent to change their tax methods of accounting to conform to the regulations. This is typically done by filing form 3115, Application for Change in Accounting Method.
Taxpayers must consider the various elections, safe harbors and thresholds available in the regulations to select the most advantageous methods for their particular situation and to minimize administrative burdens going forward. It is imperative for taxpayers to begin an initial dialogue with their tax professionals to understand the impact of these regulations.
Josh N. Wheeler is a CPA with Crowe Horwath LLP in the Dallas office. He can be reached at (214) 777-5257 or firstname.lastname@example.org. Tom Tyler, CPA, is a partner with Crowe Horwath LLP in the Dallas office. He can be reached at (214) 777-5250 or email@example.com.