Tangible Property Regulations continue to be applicable in 2015 and beyond

Andy Smith, Tax Principal
December 2015

2014 may have been the year of the Horse according to the Chinese Zodiac, but to many accounting professionals it was the year of the Tangible Property Regulations (TPR). While the majority of the benefits and work related to the TPR changes have passed, they remain applicable for 2015 and subsequent tax years.

The final regulations redefined the standards as to whether or not certain expenses should be capitalized and depreciated or simply expensed (RABI Rules). Several “safe harbor” rules were also created to simplify this process and may be adopted by making an annual election:

  • De minimis Safe Harbor Election to expense items below a certain per item cost
  • Election to Capitalize Repair and Maintenance Expenditures
  • Safe Harbor Expensing Rule for Small Taxpayers (Average Annual Receipts < $10 million)

De Minimis Safe Harbor Election

Taxpayers with a written fixed asset accounting policy in place at the beginning of the tax year may expense certain tangible property additions provided they fall beneath a certain dollar threshold. Many taxpayers were probably already doing this but the final regulations now give them a justifiable tax position for doing so. Taxpayers can choose the dollar threshold for their policy but in order for it to qualify for the safe harbor, the per item amount being expensed must not exceed $5,000 provided the taxpayer has applicable financial statements. Taxpayers that do not have audited (or otherwise qualifying) financial statements cannot rely on a safe harbor amount greater than $500. Any items expensed for tax purposes under this election must also be expensed for financial statement purposes.

Election to Capitalize Repairs and Maintenance

Taxpayers may not want to deal with the different capitalization standards between book and tax. In order to promote simplicity and reduce book to tax differences, taxpayers may choose to elect to follow book treatment for capitalization purposes. If a cost would qualify as a repair under the tangible property regulations but must be capitalized under GAAP, a taxpayer can make this election to capitalize and depreciate the cost for tax.

Small Taxpayer Safe Harbor Expensing Election

A taxpayer whose average annual gross receipts for the 3 preceding taxable years is less than or equal to $10 million may apply this election to buildings with an unadjusted tax basis of $1 million or less. The election allows taxpayers to disregard all capitalization rules as long as the total amount paid during the tax year for repairs, maintenance, and improvements performed on the building property does not exceed the LESSER of 2% of the building’s unadjusted basis; or $10,000. This election is made on a property by property basis, so taxpayers must list all eligible or electing properties on their election statement.

Each of the aforementioned elections is both annual and irrevocable and is made by attaching a statement to the taxpayer’s timely filed income tax return.

Safe Harbor Rule for Routine Maintenance

The routine maintenance safe harbor allows a taxpayer to deduct the costs associated with any activity that you can reasonably expect to perform more than once during an asset’s useful life. For buildings, rather than using the building’s useful life, the taxpayer should use a 10 year period. CPAs should encourage their clients to document the expectations associated with all maintenance activities in order to support their belief that the activity will be performed more than once during the asset’s useful life. Allowances must be taken into consideration for the acquisition of used assets. There is no election statement required.

Costs qualifying for any of the aforementioned rules or elections allow the taxpayer to avoid considering the rather in depth RABI (Restoration, Adaptation, Betterment, Improvement) rules outlined in the final regulations. Costs that do not qualify for the safe harbor treatment, must then be evaluated to determine if they adapt, better, or improve a unit of property. Analysis of the RABI rules can be complex, confusing, and time consuming. CPAs need to consider the facts and circumstances to determine whether the costs must be capitalized and depreciated over the asset’s useful life.

Partial Asset Disposition Rules (PADS)

The final regulations also allow taxpayers to make partial dispositions of tangible property. The dispositions allow taxpayers to deduct a “part” of an asset currently listed on their depreciation schedule when it is replaced by a new, capitalized item. An example of this is as follows:

  • Taxpayer purchases a residential rental property for $2.5 million in 2005.
  • In 2015, the taxpayer replaces the entire HVAC system for $200,000.
  • The taxpayer can deduct the remaining depreciable life relating to the original HVAC System.
  • BNN tax professionals are able to determine (using any reasonable method) that $175,000 of the original $2.5 million purchase price was related to the original HVAC system. Accumulated Depreciation related to the original HVAC system prior to disposal was $60,000.
  • Taxpayer capitalizes and depreciates the new HVAC system over 27.5 years but also is entitled to claim a $115,000 deduction relating to the disposal of the old HVAC system!

Taxpayers are not required to take advantage of the partial disposition rules. There are also no elections or filing requirements associated with the election. The election is deemed to have been made by simply reporting a gain or loss on disposition on the appropriate tax form.

The tangible property regulations have created a whole new set of standards that we need to apply when considering whether or not items should be capitalized or expensed as well as a variety of elections that may be utilized to the taxpayer’s benefit. This article was designed as a quick refresher of the highlights but if you would like a more thorough review of the standards involved I invite you to review this article from February of 2015.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.