As previously reported in our Special Alert issued in December of 2013 (reproduced below for your convenience), the IRS and the U.S. Treasury have issued final tangible property regulations (TPRs) that govern when taxpayers must capitalize and when they can deduct expenditures for acquiring, producing, or improving tangible property. These regulations generally apply to business taxpayers (including exempt organizations with unrelated business income and taxable subsidiaries of exempt organizations).
These regulations are fully effective for tax years beginning on or after January 1, 2014. Under certain circumstances, however, these regulations may also be applied retroactively and are required to be applied to items on the taxpayer’s tax depreciation schedule or that should be on the taxpayer’s depreciation schedule based upon the criteria contained in the final TPRs. The final regulations have created new annual elections, and while certain safe harbors and elections are implemented through filing statements or treatment of an item on a timely filed federal tax return (such as the de minimis safe harbor outlined in our December 2013 alert reproduced below), the IRS considers the remaining provisions to be a change in the method of accounting, which may require a taxpayer to file one or more Forms 3115, Application for Change in Accounting Method, depending on the situation.
As an alternative, the IRS announced on February 13, 2015, new simplified procedures that will allow a small business (defined as a business, including sole proprietors, with total assets of less than $10 million or average annual gross receipts of $10 million or less for the prior three taxable years) to change a method of accounting under the final tangible property regulations on a prospective basis for the first taxable year beginning on or after January 1, 2014. In determining whether a taxpayer qualifies as a “small business,” the “total assets” test and the “gross receipts” test are applied to each separate and distinct trade or business of the taxpayer. The IRS is also waiving the requirement to complete and file IRS Form 3115 for small business taxpayers that choose to use this simplified procedure for 2014. In general, the simplified procedures provide an efficient way for small businesses to comply with the new regulations. However, please be aware that if the simplified procedures are elected, the taxpayer does lose certain opportunities that might exist to write off assets that were capitalized in prior years that could have been expensed, or to report a late partial disposition. In addition, a taxpayer will also lose the potential audit protection related to capitalization decisions made in prior years.
If you choose to apply the simplified procedure, you should consider including, but are not required to include, a statement on your 2014 tax return indicating that the qualifying trade or business is utilizing the simplified procedure of Rev. Proc. 2015-20. (BMWL will consider attaching the statement to the returns that we prepare for your organization.)
For your convenience, we have reproduced below the text of our 2013 Special Alert, which briefly outlines the tangible property regulations, including the de minimis safe harbor election to expense items whose costs are under certain thresholds.
Due to the complexity of these regulations, we encourage our clients to let us know if you have questions about the content of this Special Alert.
Below is the Special Alert that was released on December 19, 2013:
IRS Issues New Regulations Requiring a Written Capitalization Policy to be in
Place by January 1 to Qualify for Special Tax Treatment
Recently, the Internal Revenue Service issued final tangible property capitalization regulations. These regulations provide clarity to a complex area of tax law for business taxpayers (including exempt organizations with unrelated business income and taxable subsidiaries of exempt organizations) who acquire tangible real or personal property or who own tangible real or personal property which they improve, maintain, or repair. The final regulations address the proper characterization and tax treatment of expenditures related to these acquisitions, improvement, maintenance, and repair activities.
Organizations must take certain actions BEFORE JANUARY 1, as described further below, in order to qualify for certain tax benefits available under the new regulations.
BACKGROUND
Generally, under IRC §263(a), amounts paid to acquire, produce, or improve tangible property must be capitalized. However, taxpayers are permitted to deduct ordinary and necessary business expenses, including the costs of certain supplies, repairs, and maintenance, under IRC § 162(a). It is often difficult to distinguish (1) between assets that must be capitalized and property that is a material or supply, and (2) between improvement costs and repair or maintenance costs. The finalized regulations attempt to clarify when such payments may be deducted and when they must be capitalized.
In general, taxpayers must capitalize amounts paid to acquire or produce a unit of tangible real or personal property, including leasehold improvement property, land and land improvements, buildings, machinery and equipment, and furniture and fixtures. Once capitalized, the costs are recovered under the rules applicable to that type of property (e.g., land would be recovered when disposed of, while a building or machinery and equipment would be depreciated over its useful or tax life). Materials and supplies (which includes tangible items that are not inventory and have an economic useful life of 12 months or less or an acquisition cost of $200 or less) are generally deductible either when paid or incurred or when they are consumed. In certain circumstances, a taxpayer may elect to capitalize and depreciate the cost of materials and supplies.
ELECTION TO EXPENSE ITEMS WHOSE COSTS ARE UNDER CERTAIN THRESHOLDS
The new regulations allow taxpayers meeting certain criteria to elect to expense the costs of acquiring tangible property whose acquisition costs are under a de minimis safe harbor amount. If the election is made, taxpayers must also expense all materials and supplies whose costs are under the de minimis safe harbor amount (i.e., the taxpayer may not elect to capitalize materials and supplies costs).
To qualify for the safe harbor election, an organization must have a written accounting policy in place on the first day of the tax year calling for: (1) expensing amounts paid for property less than a specified amount, and/or (2) expensing payments for property with an economic life of 12 months or less.
An organization with an “applicable financial statement” (which generally means an audited financial statement) may rely on the final regulations’ safe harbor to expense an item in accordance with the organization’s written capitalization policy utilized in preparing its financial statements, provided the amount paid for tangible property does not exceed $5,000 per item. In addition, the safe harbor also applies to a financial accounting policy that expenses amounts paid for property with an economic useful life of 12 months or less, provided the costs don’t exceed the $5,000 threshold. An organization which does not have an applicable financial statement, but which does have a written capitalization policy, may rely on the de minimis safe harbor as long as the costs do not exceed $500 per item.
In order to use the safe harbor election for 2014 and subsequent years, organizations must have a written capitalization policy in place on the first day of 2014. The new regulations do not require Board level approval of the adoption of or changes to an organization’s written capitalization policy; therefore, organizations may follow their own internal policies with respect to proper approval of any accounting policy changes/adoptions necessary to address these new rules.
Assuming the capitalization policy is properly in place by January 1, the safe harbor election is then made annually at the time the taxpayer files its tax return for the year.
Organizations that do not have a written capitalization policy in place may still deduct expenditures for tangible property costing $200 or less.
WHAT YOU MUST DO TO QUALIFY FOR THE SAFE HARBOR ELECTION
BEFORE JANUARY 1:
- If your organization currently has a written capitalization policy in place:
- Review the policy to ensure that it calls for: (1) expensing amounts paid for property less than a specified amount, and (2) expensing payments for property with an economic life of 12 months or less.
- Consider adopting a capitalization threshold that coincides with the de minimis thresholds contained in the new regulations (i.e., $5,000 for organizations with an applicable financial statement (i.e., generally an audited financial statement), or $500 for organizations without an applicable financial statement). This will minimize any tax adjustments necessary when preparing the organization’s income tax return.
- If your organization does not currently have a written capitalization policy, adopt a policy similar to the sample policy available here before January 1, 2014.
WHEN YOUR TAX RETURN (FORM 1120 OR 990-T) IS FILED
- Notify your tax preparer that you wish to make the safe harbor election, and make sure your tax preparer attaches the necessary election to your tax return when it is filed. (BMWL will attach the necessary election to the returns that we prepare for your organization.)