Analysis of Final Section 263(a) Tangible Property “Repair” Regulations

By: Jeff McGowan, Tax Consultant

As a backdrop to what the new final regulations discuss, consider the dichotomy between the Internal Revenue Code (IRC) Sec. 263(a) which requires capitalization of amounts paid to “acquire, produce, or improve tangible property” and IRC Sec. 162 which allows deductions for all ordinary and necessary expenses paid or incurred during taxable year in carrying on any trade or business, including costs of certain supplies, repairs, and maintenance. The final TPR regulations attempt to provide a framework for distinguishing capital expenditures from supplies, repairs, maintenance, and other deductible business expenses. We will discuss some of the main points discussed in these final regulations below. (Note: a larger analysis is available here.)

Fix Depreciation Schedules 2013 OR 2014

For 2013 and 2014 tax returns, practitioners/taxpayers should review prior year depreciations schedules as of 12.31.12, to determine if a Sec. 481(a) adjustment into income can be taken as additional expense for 2013 tax return.

Materials and Supplies

Practitioners/taxpayers should put into place a written capitalization policy in order to take advantage of de minimis write-offs of materials and supplies for amounts of $500 per invoice/per item without a Applicable Financial Statement (typically an audited statement), or up to $5,000 per invoice/per item with an applicable Financial statement.

Amounts Paid to Acquire or Produce Tangible Property

For amounts other than materials and supplies, an expenditure incurred for amounts paid to acquire or produce tangible property (e.g., repairs) taxpayers can also apply the de minimis rules- $200/$500/$5,000. The final regulations thereby treat expenditures for 1) Non-incidental materials and supplies and 2) Repairs and maintenance in similar fashion utilizing the de minimis limits.

Amounts Paid to Improve Tangible Property – After reviewing expenditure through the materials and supplies/repairs and maintenance filters discussed above, amounts not allowed under those standards require additional steps. These consist of:

• Determine unit of property (UOP)
• Apply improvement standards
• Consider routine maintenance safe harbor

If the expenditures, in excess of the same de minimis limits for material, supplies and repairs, relate to either a Betterment, an Adaptation, or a Restoration, taxpayer likely will have to capitalize the expenditure. However, if such expenditure normally occurs more than one time during the asset’s alternative depreciable life, a taxpayer can deduct such expenditure under the safe harbor for routine maintenance.

New Safe Harbor Provided for Small Taxpayers

Another major change (the last one mentioned in this blog!) is an election to not capitalize repairs, maintenance, or improvements for buildings which applies to taxpayers with 3-year average gross receipts not to exceed $10 million.  This safe harbor applies to owned or leased buildings with an unadjusted basis not to exceed $1 million (per building).  Deductions under this safe harbor equal the total amount paid during tax year for repairs, maintenance, and improvements AND cannot exceed lesser of:

• 2% of unadjusted basis of building, or
• $10,000

In addition to the main points listed in this blog, there remain many more aspects of the final (and re-proposed regulations) issued on that Friday the 13th in September 2013, that we will not cover here. More inquiry into the regulations should include a review of these items:

• Treatment of rotable, temporary, standby emergency spare parts.
• Expenditures related to defense/protection of  title to a unit or real or personal property
• Capitalization election
• Annual election to treat repairs and maintenance as improvement consistent with those capitalized on its books and records.
• Partial Disposition Election (Proposed Regs) in which taxpayers may elect to treat partial disposition of asset as a disposition

Important Dates

The final regulations are required for tax years (or amounts paid or incurred in tax years) beginning on or after Jan. 1, 2014. Taxpayers may early adopt for tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014 and may amend to make certain elections for tax years beginning on or after Jan. 1, 2012, and ending on or before Sept. 19, 2013. Additional guidance needed to implement the final regulations automatic method change consent procedures were expected in October/November 2013 (before the IRS closed down in October).  This guidance should be available soon.

In closing, many TPR experts are suggesting that practitioners/ taxpayers do the following for either the 2013 or 2014 tax returns:

1) “SCRUB” DEPRECIATION SCHEDULES

2) Determine adequacy (or existence!) of written policy for purposes of the de minimis safe harbor BEFORE beginning of 1/1/14

3) Consider making following METHOD CHANGES and elections (MANY HAVE OPTIONS TO ADOPT FOR 2012 AND 2014):
a. Incidental/ non-incidental materials and  supplies using the de minimis safe harbor
b. Routine maintenance safe harbor safe harbors- personal property and buildings.
c. Safe Harbor for Small Taxpayers
d. Recognize gain or loss on partial dispositions

If you have questions regarding final TPR regulations, contact Kruggel Lawton at 574.289.4011 and one of our tax professionals can help. For an expanded analysis of these regulations, click here.