• Repair and Maintenance Regulations S. Andrew Smith Tax Principal June 12, 2014
Overview • • Materials and Supplies • De minimis Safe Harbor • Routine Maintenance Safe Harbor • Small Taxpayer Safe Harbor • Changes to Capitalization Standards • Proposed partial disposition regulations • Compliance Items • 2
Effective Date • • The final regulations (T.D. 9636) are generally effective for tax years beginning on or after January 1, 2014. • Taxpayers that did not file 3115s with their 2014 income tax return to comply to changes are unable to make any retroactive adjustments. • 3115 may NOT be filed with an Amended Return. • 3
• Materials and Supplies • 4
Definition • • Tangible property used or consumed in the taxpayer’s business operations that is NOT inventory and that is: – A component to maintain, repair or improve property – Fuel, lubricants, water, and similar items expected to be consumed within 12 mos. – Property with an economic useful life of less than 12 months – Unit of property that costs less than $200 • 5
• De minimis safe harbor • 6
New Safe Harbor Rule • • May rely on the safe harbor to expense tangible property under a certain dollar threshold. • Must have a written accounting procedure in place at the beginning of the taxable year with a specified dollar amount and does not exceed a per invoice or per item cost. – For taxpayers with an applicable financial statement, the dollar amount is not to exceed $5,000 per item. – For taxpayers without an applicable financial statement, the dollar amount is not to exceed $500 per item. • 7
Applicable Financial Statement • • A financial statement required to be filed with the Securities and Exchange Commission (SEC) (the 10-K or the Annual Statement to Shareholders); • A certified audited financial statement that is accompanied by the report of an independent certified public accountant (or, in the case of a foreign entity, by the report of a similarly qualified independent professional) that is used for: – Credit purposes; – Reporting to shareholders, partners, or similar persons; or – Any other substantial non-tax purpose; or • A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or the IRS). • 8
Election Details • • Safe harbor is elected annually by including a statement on a timely filed original federal return (including extensions) for the year elected. • Must be applied to all amounts paid in the taxable year for tangible property that meet the requirements of the de minimis safe harbor, including amounts paid for materials and supplies. – Except for materials and supplies that the taxpayer elects to capitalize and depreciate; or – Except for where the optional method of accounting is used for rotable and temporary spare parts. • Election is irrevocable. • An election may not be made by filing an application for change in accounting method. • 9
De minimis examples • Taxpayer without AFS Taxpayer with AFS FACTS: - 10 Computers - 1,250 Computers purchased for $600 purchased for $5,000 each - $6,000 Total each, $6.25 Million Total - Accounting policy - Accounting Policy expenses amounts paid expenses amounts paid for property less than for property costing $1,000 $5,000 or less CONCLUSION: - Amount exceeds $500 - Amounts paid meet the per invoice requirements for the de - Does not meet minimis safe harbor requirements for the de minimis safe harbor TREATMENT: Capitalize Expense • 10
• Routine Maintenance Safe Harbor • 11
Routine Maintenance • • Defined as any activity that you can reasonably expect to perform more than once during the useful life of an asset. • Does not actually have to be performed more than once during your ownership. • Must factor in previous ownership for acquisition of used assets. • 12
Routine Maintenance Safe Harbor for Buildings • • NEW:Extend the application of the routine maintenance safe harbor to buildings. • Recurring activities that a taxpayer expects to perform as a result of the taxpayer’s use of the building to keep the building structure or system in its ordinarily efficient operating condition. • The taxpayer must reasonably expect to perform the activities more than once during a 10-year period beginning at the time the building structure or building system is placed in service. • Note: A taxpayer’s expectation will not be deemed unreasonable merely because it does not actually perform the maintenance a second time during the 10-year period — as long as the taxpayer can otherwise substantiate that its expectation was reasonable when the property was placed in service. • Amounts incurred for activities that do not meet the safe harbor are subject to analysis under the general rules for improvements. • 13
Routine Maintenance Examples • Qualifying Routine Maintenance Non-qualifying Routine Maintenance FACTS: - Reasonably expected every 4 -Purchased a used years HVAC system would require machine and expected to maintenance perform maintenance - Contractor paid in Year 4 to every 3 years perform maintenance -At time of purchase, - Maintenance not performed again machine was close to 3 until year 15 year scheduled maintenance CONCLUSION: Amounts paid for maintenance in Costs incurred for years 4 and 15 are qualified because maintenance in year 1 of they were EXPECTED to be ownership do not qualify performed more than once during a as they relate to prior owner’s use. 10 year period TREATMENT: Expense Capitalize • 14
Election to Capitalize Repair and Maintenance Costs • • May elect to treat amounts paid during the taxable year for repair and maintenance to tangible property as amounts paid to improve that property if the taxpayer incurs these amounts in carrying on the taxpayer’s trade or business and if the taxpayer treats these amounts as capital expenditures on its books and records. • Applies to all amounts paid for repair and maintenance to tangible property that it treats as capital expenditures on its books and records in that taxable year. • Annual irrevocable election made by attaching a statement to a timely filed original federal tax return (including extensions) for the taxable year in which the taxpayer pays these amounts. • Must begin to depreciate the costs of improvements when they are placed in service. • 15
• Small Taxpayer Safe Harbor • 16
Definition of Small Taxpayer • • A taxpayer whose average annual gross receipts for the 3 preceding taxable years is less than or equal to $10 Million. • Only applies to Eligible Building Property – Unadjusted basis of $1 Million or less! • 17
Small Taxpayer Safe Harbor Rule • • Qualifying taxpayer may elect to not apply the capitalization rules to eligible building property if the TOTAL amount paid during the taxable year for repairs, maintenance, improvements, and similar activities performed on the eligible building property does not exceed the lesser of: – 2% of the building’s unadjusted basis; or – $10,000 • 18
Small Taxpayer Safe Harbor Election • • Qualifying taxpayers that wish to utilize the small taxpayer safe harbor rule must attach a statement to a timely filed original federal tax return for the year in which the costs are incurred. – Elected annually on a building-by-building basis – Election is irrevocable • 19
Small Taxpayer Safe Harbor Example • Example 1 Example 2 FACTS: - Building has an - 2 rental properties: Buildings A & B unadjusted basis of - Both buildings have an $750,000 unadjusted basis of $300,000 - Costs for repairs, maint, and - Costs of $5,500 for improvements repairs, maint., - Building A: Costs of $5,000 improvements, etc. - Building B: Costs of $7,000 CONCLUSION: Aggregate amount paid Building A: does not exceed: - $6,000 (2% of $300,000) - OR - - $15,000 (2% of $750k - $10,000 unadjusted basis) – OR – Building B: - $10,000 - $6,000 (2% of $300,000) - OR - - $10,000 TREATMENT: EXPENSE Building A: EXPENSE Building B: CAPITALIZE • 20
• Capitalization Standards • 21
RABI Rules • • If a cost represents an Improvement, it must be capitalized! • There are 3 types of improvements as defined by the regulations – Restoration (R) – Adaptation (A) – Betterment (B) • 22
Improvement Standards • Improvement Betterment Adaptation Restoration • 23
How to Apply RABI Rules • • Must be applied to the new Unit of Property standards as defined by the Regs • Complete change from former standards with building being considered one unit of property • Each Unit of Property must be considered by itself when applying the RABI standards • 24
Unit of Property • Non Buildings Buildings Default Plant Network Rule Property assets Industry – specific Functional Discrete and major facts and Interdependence function circumstances Single Unit of Property • 25
Unit of Property for Buildings • HVAC Electrical Plumbing Gas Distribution Systems Building Fire Suppression Structure Elevators Escalators Security • 26
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