Pub. 4 2015-2016 Issue 2

14 San Diego Dealer T he IRS has spent much of the last 10 years drafting new rules that affect any taxpayer who owns or leases any type of tangible property. These regulations are a significant step forward by the IRS in its effort to bring consistency and clarity to the rules regarding how to treat costs incurred to acquire, maintain, and improve property. This topic has historically been an area of contention and litigation between taxpayers and the IRS. The new regulations are generally effective for tax years beginning on or after January 1, 2014, which means tax returns being prepared and filed right now are impacted. Scope of Regulations All taxpayers that own or lease tangible property are affected by the regulations. If you have depreciable fixed assets, repairs expenses, or materials and supplies, you are impacted by these regulations. The regu- lations’reach isn’t limited to a certain type of taxpayer or industry—they affect a dealership as well as the entity or individual that dealership may lease its facility from. Additionally, the regulations’ reach isn’t limited to only large taxpayers. However, as discussed later, simplified compliance procedures are available for qualifying small taxpayers. People often refer to the new rules as the so-called repair regulations. Unfortunately, doing so understates the breadth of the regulations because they’re relevant at every stage of the life cycle of property—from acquisition to improvement to disposition. Taxpayers who fail to recognize the full extent of the tangible property regulations may find themselves out of compliance or overlook material opportunities, some of which only are available for the 2014 tax year. Potential Opportunities Many are surprised to learn that several provisions in the tangible property regulations are actually taxpayer friendly and may result in tax deferral and/or savings opportunities for those taxpayers who choose to take advantage of them. Four of those opportunities are outlined below. De Minimis Safe Harbor A taxpayer who elects to use the de minimis safe harbor for a tax year is permitted to expense items for tax in line with its capitalization policy used for financial reporting purposes if certain requirements are met. The safe harbor limit is either $500 or $5,000 depending on if an audited financial statement is in place for the taxpayer. Overcapitalized Repairs The regulations define an improvement as a betterment, adaptation, or restoration of a unit of property. The details of each of these are beyond the scope of this article. However, as a starting point, taxpayers should ensure they fully understand the concept of a unit of property, particularly when it comes to building property. For example, if a taxpayer incurs costs for manufacturer mandated facility improvements, there’s a chance that a portion of these costs can be expensed, while a portion will need to be capitalized under the new regulations. As a general rule, if a taxpayer has strictly followed book when making repair versus improvement determinations for tax, overcapitalization has likely occurred. The 2014 tax year provides taxpayers with a chance to review their tax fixed asset ledgers, identify any capitalized repairs, and recover the remaining basis of those repairs immediately. Partial Dispositions Under one of themore (if not most) favorable provisions in the tangible property regulations, a taxpayer may elect to dispose of a portion of an asset prior to the asset itself being completely removed from the taxpayer’s books and records—the roof of a building, for example, as illustrated below. This is referred to as a partial disposition. EXAMPLE In 1995, a dealership purchased a facility for $4 million. In 2010, the dealership replaced the entire roof of the facility for $400,000. The remaining tax basis of the original roof was determined to be $200,000. The dealership capitalizes the $400,000 for the new roof and elects to claim a partial disposition loss of $200,000 for the old roof. This entire loss may be claimed in the current tax year. Absent a partial disposition election, the dealershipwould end upwith two roofs on its books, claiming depreciation on both at the same time. Partial disposition opportunities generally follow a capitalized improve- ment, particularly one related to building property given its long recovery period. For the 2014 tax year only, taxpayers are permitted to look back in time, perhaps even 20 years, at their historical remodels and other improvements to determine whether a partial disposition loss is appropriate. After 2014, taxpayers may only claim a partial disposition loss if the property disposal took place in the current year. Exposure Mitigation Upon review of the new regulations, some taxpayers may identify areas of exposure in prior tax years for their treatment of tangible property. Perhaps they have been aggressive in their repair versus improvement determinations or have expensed materials and supplies earlier than was appropriate. Procedures in place to comply with the regulations may benefit these taxpayers by providing audit protection for open tax years or the ability to take unfavorable adjustments into taxable income over four years. If the procedures aren’t followed and the exposure area is identified by the IRS during an examination, unfavorable adjustments would be fully taken into taxable income in the earliest open tax year, and interest and penalties could be assessed. Relief for Small Taxpayers Compliancewith the new regulations can be complex andmay require a combination of elections and accountingmethod changes from taxpayers. NEW TANGIBLE PROPERTY RULES MAY BENEFIT TAXPAYERS By Kristen Yergler, CPA, Tax Senior Manager, Dustin Marciniak, CPA, Tax Senior Manager, Sid Tobiason, CPA, Tax Partner, Moss Adams LLP