Vernoia, Enterline + Brewer, CPA LLC

Posts tagged ‘tangible property’

IRS provides repair regulations relief for small businesses

In Rev. Proc. 2015-20, the IRS substantially simplified the requirements for small businesses to adopt the tangible property regulations (the “repair regulations”) for 2014. The relief allows small businesses to change their accounting methods, to comply with the regulations, without having to apply Code Sec. 481 and without having to file Form 3115, Application for Change in Accounting Method.

The repair regulations are broad and comprehensive, applying to any business that uses tangible property. The regulations totally redo the rules for deducting and capitalizing expenses associated with fixed assets. IRS adopted final regulations in September 2013, effective for tax years beginning on or after January 1, 2014. Taxpayers also have the option of applying the final regulations in 2012 and/or 2013.

Change of accounting method

Taxpayers ordinarily have to file Form 3115 to request IRS consent to change a method of accounting. The IRS provided automatic consent for taxpayers to change their accounting methods to comply with the repair regulations, but this did not relieve taxpayers of the requirement to file Form 3115. Furthermore, taxpayers changing their accounting method must apply Code Sec. 481(a), which requires them to calculate an adjustment to their accounting treatment of the same items for prior years, as if the new method were used in the prior years.  Code Sec. 481 is designed to prevent any duplication of deductions or omission of income upon a change in accounting method.

Small businesses in particular had complained to the IRS about the burden of implementing the regulations with a full Code Sec. 481 adjustment. Taxpayers would be required to go back in time (as far back as their books allow) and redo their analysis of prior year tangible property costs.

Relief

The IRS has now responded by providing relief from the requirements for changing an accounting method. Small business taxpayers can make the change without filing Form 3115 and without having to make a 481 adjustment. Instead, taxpayers can make the change on a “cutoff” basis, by taking into account only amounts paid or incurred, and dispositions of property, in their 2014 tax year. In effect, small business taxpayers can make the change prospectively.

The relief applies to a taxpayer that has one or more separate and distinct trade(s) or business(es) with either total assets under $10 million at the start of the 2014 tax year, or that has average annual gross receipts of $10 million or less for the prior three years.

Claiming relief

Because the IRS provided automatic consent, taxpayers making the change for 2014 would not have to file Form 3115 until the deadline for their 2014 income tax return, either March 15 or, with an extension, September 15. So taxpayers (and their tax representatives) are right in the middle of the process to comply with the regulations for 2014. The timing of the IRS’s relief, in February 2015, is opportune, and gives small businesses plenty of time to comply with the regulations for 2014.

The relief is elective. Small businesses can follow normal change of accounting procedures, or can use the relief provided in Rev. Proc. 2015-20. There are trade-offs to claiming the relief. For some taxpayers, there may be tax savings from applying Code Sec. 481 to prior years, regardless of the burden involved to make the calculations. Furthermore, taxpayers that do not file Form 3115 will not get audit protection for tax years before 2014. For more information, call our office at (908) 725-4414.

Rev. Proc. 2015-20, IR-2015-29

How do I? Compute depreciation for tax purposes

The simple concept of depreciation can get complicated very quickly when one is trying to determine the proper depreciation deduction for any particular asset. Here’s only a summary of some of what’s involved.

Identifying the asset

The modified accelerated cost recovery system (MACRS) is generally, but not always, used to depreciate tangible depreciable property placed in service after 1986. The MACRS deduction is computed on Form 4562, Depreciation and Amortization.

Intangible property may not be depreciated under MACRS, but it may be amortized in certain situations. Real estate may not be depreciated, but buildings situated on it may. Sound recordings, films, and videotapes are specifically excluded from MACRS, but may be depreciated using the income forecast method. Deprecation for financial accounting book purposes is generally not the same as tax depreciation. Under MACRS, property placed in service and disposed of in the same tax year is not depreciable. Property converted from business use to personal use in the tax year of acquisition is not depreciable.

The cost of tangible depreciable property also may be deducted immediately if the business and the asset qualifies for Code Section 179 expensing. Bonus depreciation, in years that Congress makes it available, is also available, taken first before the asset’s remaining value is depreciated under MACRS.

Computing depreciation under MACRS

In order to compute depreciation under MACRS, the asset’s MACRS property class must be determined. The asset’s recovery period (i.e., its depreciation period), applicable depreciation method, and applicable convention depend on the asset’s property class. Under MACRS, an asset’s property class is based on either the type of asset or the business activity in which the asset is primarily used. The key resource for determining an asset’s property class is the asset classification table contained in Revenue Procedure 87-56.

The cost of property in the 3-, 5-, 7-, and 10-year classes is recovered using the 200-percent declining-balance method (i.e., the applicable depreciation method) over three, five, seven, and ten years, respectively (i.e., the applicable recovery period), and the half-year convention (unless the mid-quarter convention applies), with a switch to the straight-line method in the year that maximizes the deduction.

Hispanic couple outside home for rentThe cost of 15- and 20-year property is generally recovered using the 150-percent declining-balance method over 15 and 20 years, respectively, and the half-year convention, with a switch to the straight-line method to maximize the deduction. The cost of residential rental and nonresidential real property is recovered using the straight-line method and the mid-month convention over 27.5-  and 39-year recovery periods, respectively.

For more specific information on the amount of depreciation you may take for any business asset you own or plan to purchase, please feel free to contact this office.

Questions remain about “repair” regulations

More than six months after the IRS issued temporary “repair” regulations (T.D. 9564), many complex questions remain about their interpretation and application. These regulations are sweeping in their impact. They have been called game-changers for good reason, affecting all businesses in one way or another and carrying with them both mandatory and optional requirements. Many of these requirements also carry fairly short deadlines.

The new regulations are generally effective for tax years beginning on or after January 1, 2012. However, certain portions are effective for amounts paid or incurred in tax years beginning on or after January 2, 2012, a subtle but important difference. To complicate matters further, the regulations are, in effect, retroactive insofar as accounting method changes are needed to be filed with the IRS in many cases and adjustments made to reflect these changes.

The new regulations are called “temporary” only because the IRS reserves the right to fine-tune them and issue “final” regulations – the IRS may do this before year end, but it has a three year deadline to do so. In the meantime, the “temporary” regulations stand in as the law.

Highlights

The new regulations present both compliance challenges and planning opportunities. The major take away from examining these new regulations is that it is to the advantage of virtually all businesses to reconsider how they treat certain repairs and improvements for tax purposes.

The following highlights cover only some of the many changes made by the new repair regulations:

Materials and supplies. The definition of materials and supplies has been revised along with the rules for determining the proper tax year for a deduction. The new regulations allow an election to capitalize materials and supplies, and contain special rules for rotable spare parts.

De minimis expensing. Taxpayers with an “applicable financial statement,” such as a certified audited financial statement, may now claim a current deduction for the cost of acquiring items of relatively low-cost property, including materials and supplies, if specific requirements are met. Under the general rule, materials and supplies are usually deducted in the tax year used or consumed. The new election to deduct materials and supplies under the de minimis rule is particularly helpful if the tax year in which the cost of the materials and supplies is paid or incurred occurs before the tax year of use or consumption.

Amounts paid to acquire or produce tangible property. This portion of the regulations explains which costs associated with the acquisition or production of real or personal property must be capitalized to the basis of the property and which costs may be claimed as a current deduction.

Amounts paid to improve tangible property. This is the heart of the new regulations which provides rules for distinguishing repairs from capital expenditures. It divides capital expenditures into three categories of improvements: betterments, restorations, and adaptations. Generally, whether an expenditure is an improvement is based on facts and circumstances. A safe harbor rule is provided for routine maintenance activities. Also, certain regulated taxpayers may elect to use their regulatory accounting method to distinguish between repairs and capital expenditures.

Unit of property defined. The “unit of property” is a critical concept in determining whether an expenditure is a repair or capital expenditure. Generally, the larger the unit of property, the more likely that work on that property will be considered a deductible repair. The regulation contains detailed rules for determining the size of a unit of property in the case of buildings and other types of property. Planning opportunities present themselves within this framework.

MACRS general asset accounts. MACRS stands for modified accelerated cost recovery system, which is the basis system now used for the tax depreciation of most assets. Importantly, an election to recognize gain or loss by reference to the adjusted basis of an asset disposed of from a GAA now applies to virtually any asset disposed of. Previously, a taxpayer was usually required to recognize the entire amount realized upon a disposition as ordinary income, and no loss deduction was allowed. Bottom line: A taxpayer may now place an asset, such as a building, in a GAA and—whenever an asset, such as a structural component, is retired—choose whether to follow the GAA default rule that no loss is recognized or elect to recognize a loss equal to the adjusted depreciable basis of the asset.

Businesses that previously retired a structural component which is currently still being depreciated will need to change accounting methods to bring the treatment of the structural component into compliance with the new rules. For most taxpayers, the change in method will involve making a retroactive MACRS general asset account election and then deciding whether to claim a loss on the retired component through a so-called 481(a) adjustment or to continue to depreciate the retired component.