Final Repair Regulations Have Widespread Impact – Tax Accounting Method Changes Will Be Required
On September 13, 2013, the Treasury Department and the IRS released final regulations on the deduction and capitalization of tangible assets. These regulations update previous guidance available in temporary form, as discussed in our January 2012 BKD Alert. The so-called “repair regulations” are far-reaching and will impact businesses in most industries—especially those with significant real estate portfolios, including banks, manufacturers, food processors, real estate developers/operators, hotels, retail businesses and auto dealerships. The final repair regulations generally will apply to tax years beginning on or after January 1, 2014.
In an effort to reduce controversy between taxpayers and the IRS, the repair regulations are designed to help taxpayers distinguish a current deductible repair from a capital expense. However, the guidance contained under the repair regulations is complex, and the effects do not stop there. Specifically, many taxpayers will be required to change their existing income tax accounting methods for various types of expenditures to comply with the final regulations. The effect of the accounting method change(s) may result in an immediate impact on taxable income. The IRS previously provided accounting method change procedures under the temporary regulations, as discussed in our June 2012 BKD Alert. We anticipate updated accounting method change guidance for the final regulations from the IRS.
Because the repair regulations are so far-reaching and complex, it is vital for businesses and their advisors to become intimately familiar with their content in order to ensure accurate implementation. The following are some key takeaways from the more than 220 pages of final regulations.
Effective Date: The repair regulations generally are effective for tax years beginning on or after January 1, 2014. However, taxpayers may choose to apply the final regulations to taxable years beginning on or after January 1, 2012. In addition, some taxpayers relied on portions of the temporary regulations for years beginning on or after January 1, 2012, and before January 1, 2014, as discussed in our November 2012 BKD Alert. These taxpayers will need to compare the position taken under the temporary regulations to the position available under the final regulations to determine if a subsequent change in accounting method is required in 2014 to comply with the guidance under the final regulations.
Differences in the Final Regulations from the Temporary Regulations: The vast majority of the provisions in the final regulations remained unchanged. However, there are several noteworthy revisions that might affect—and in certain cases, simplify—taxpayers’ implementation of the rules:
- The final regulations adopt a revised and simplified de minimis rule by eliminating the ceiling rule and replacing it with a safe harbor to allow expensing only if the amount paid does not exceed $5,000 per invoice, or per item as substantiated by the invoice. However, the safe harbor was not expanded to taxpayers without audited financial statements. Instead, the final regulations added a de minimis safe harbor for taxpayers without audited financials of $500 per invoice, or per item as substantiated by the invoice.
- The final regulations added a safe harbor to the rules governing improvements to buildings for qualifying small taxpayers—those with gross receipts of $10 million or less.
- The final regulations extend the routine maintenance safe harbor to buildings.
- The final regulations refine several of the criteria for defining betterments and restorations to tangible property.
The 2011 temporary regulations regarding general asset accounts (GAA) and disposition of property subject to Modified Accelerated Cost Recovery System (MACRS) were not finalized. Instead, to address significant changes in this area, the Treasury Department and IRS issued proposed regulations concurrently with the final repair regulations. In general, the proposed regulations provide that a partial disposition of an asset is allowed without making a GAA election, and a GAA election is not required to forgo the loss on a partial disposition of an asset. These regulations are proposed to apply to taxable years beginning on or after January 1, 2014. However, the regulations also permit taxpayers to rely on the provisions of the proposed regulations for taxable years beginning on or after January 1, 2012, and before the applicability date of the final regulations.
With the effective date of the regulations around the corner, taxpayers should begin preparing for the impact of the changes. Additional training for accounting staff and changes to processes may be necessary for full compliance. In addition, early adoption of select portions of the final regulations prior to 2014 may be advantageous, depending on your situation. BKD will continue to provide additional guidance on the in-depth implications of the final regulations and their practical application.
For more information on the new repair regulations, contact your BKD advisor.