It has been a long time coming. In fact, it has taken over ten years, but the tangible property regulations have finally been finalized. Why is this important for you and your business? In short, the new regulations will have a far-reaching impact because they affect every taxpayer whose business uses tangible property. If this applies to you, it is important to understand the new regulations and what they mean for you with regards to implementing them. The reality is that the rules are complex and comprehensive. They will require careful consideration of your circumstances and may necessitate new collection procedures in order to have the necessary data captured to use in implementing the regulations. Let’s take a closer look at the history that got us to where we are today and an overview of the new regulations to help you gain a better understanding of them.
The History of Regulations Past that Led us to Where We are Today:
First, understanding the background of these regulations and their history is essential. These regulations come as a result of a long-standing debate over the distinction between deductible repairs and capital improvement and whether tangible property is deductible or must be capitalized and recovered through depreciation. Until now, the rules were that deductible repairs included expenditures that restore the property to its operating state. On the contrary, capital expenditures were those that provide a more permanent increment in longevity, utility, or worth of the property. The IRS has announced various proposed regulations in the past decade but has turned around and withdrawn those a couple years later time and time again.
Finally, in September of 2013, the IRS issued final regulations for tangible property applicable to tax year 2014 and beyond. Now, the regulations state that all tangible property that is not inventory must be capitalized and depreciated unless there is an exception. Let’s take a closer look at how to understand the new rules.
Understanding the New Tangible Property Rules and Regulations:
-Materials and supplies are an exception if they cost $200 or less or have a life of use less than one year. In this case, the item is considered a deduction not a capitalized cost.
-When acquiring property, taxpayers are required to capitalize the amount paid to acquire or produce tangible property. This includes transaction costs.
-A unit of property is defined by how the final regulations establish a single asset for capitalization purposes. Once established, then the improvement standards are applied to the unit to see if the expenditures improve the property and require capitalization. A unit of property includes all functionally interdependent components.
-In terms of improvements, an expenditure must be capitalized if it results in betterment (B) to the unit of property, adapts (A) the unit of property to a new or different use, or results in a restoration (R) of the unit of property. This is called the “BAR” test. Expenditures on existing assets are deductible repairs only if they do NOT meet the BAR test.
-The rules regarding disposition assets have been expanded. A disposition includes the sale, exchange, retirement, physical abandonment, or destruction of an asset. This also includes when an asset is transferred to a supplies or scrap account including the retirement of building structural components. It is now the case that a gain or loss must be recognized when assets are permanently withdrawn from either use in the business or from the production of income.
-There are variations that depend on the use of a building, but in general, a building is considered a unit of property.
-Routine maintenance is covered through a safe harbor within the new regulations. In this case, expenditures may be able to be deducted for activities that would likely occur more than once during the class life of an asset that don’t result in its betterment.
In summary, the final rules and regulations classify property as deductible materials and supplies and provide guidelines for identifying costs of acquiring tangible property. This includes determinations for what a unit of property is versus what a component is, along with implications for determining depreciation class life. Capitalized improvements to property are now more defined. They include expenditures that result in a betterment of property, adapt the property to a new or different use, or restore it to a like-new or working order state after the end of its deprecation class life.
There is so much more to understand about the rules and regulations of tangible property. They pose considerable risks to your businesses if they are not correctly carried out and thoroughly assessed. Beck and Company Certified Public Accountants and Business Advisors are here to help! Please contact us for more information about your specific business regarding tangible property. We are happy to help your business to be successful on their tax filings. For further information, read this datasheet that summarizes the new and final regulations.