The Tangible Property "Repair" Regulations : Amounts Paid to Acquire or Produce Tangible PropertyJune 08, 2012
Crystal Germanese, CPA
A taxpayer must capitalize amounts paid to acquire or produce a unit of real property or personal property, including leasehold improvement property, land and land improvements, buildings, machinery and equipment, and furniture and fixtures. Temporary Regulation 1.263(a)-2T provides guidance on whether to capitalize costs related to the acquisition or production of tangible property including a de mimimis rule. The rules under Temporary Regulation 1.162-3T also provide guidance for the treatment of materials and supplies and rotable and temporary spare parts.
Under the temporary regulations, taxpayers are generally required to capitalize amounts paid to acquire or produce a unit of real or personal property including leasehold improvement property, land and land improvements, buildings, machinery and equipment, and furniture and fixtures. Amounts paid to acquire or produce a unit of real or personal property include the invoice price, costs for work performed prior to the date that the unit of property is placed in service such as installation costs, amounts paid to defend or perfect title to property and transaction costs.
In general, transaction costs must be capitalized if paid to facilitate the acquisition or production of real or personal property. Facilitative costs are defined as amounts paid in the process of investigating or pursuing the acquisition and should be determined based on all facts and circumstances. The fact that the amount would (or would not) have been paid but for the acquisition is relevant but not determinative. In the case of the acquisition of real property an amount paid is not considered facilitative if it relates to activities performed in the process of determining whether to acquire real property and which real property to acquire. Also, in general amounts paid for employee compensation and overhead are not considered costs that facilitate the acquisition but taxpayers can elect to treat amounts as such and therefore capitalize.
The temporary regulations provide the following examples of inherently facilitative costs:
- Transporting the property (for example, shipping fees and moving costs);
- Securing an appraisal or determining the value or price of property;
- Negotiating the terms or structure of the acquisition and obtaining tax advice on the acquisition;
- Application fees, bidding costs or similar expenses;
- Preparing and reviewing the documents that effectuate the acquisition of the property (for example, preparing the bid, offer, sales contract or purchase agreement);
- Examining and evaluating the title of property;
- Obtaining regulatory approval of the acquisition or securing permits related to the acquisition, including application fees;
- Conveying property between the parties, including sales and transfer taxes, and title registration costs;
- Finders' fees or brokers' commissions, including amounts paid that are contingent on the successful closing of the acquisition;
- Architectural, geological, engineering, environmental or inspection services pertaining to particular properties; or
- Services provided by a qualified intermediary or other facilitator of an exchange under section 1031.
The temporary regulations provide for a de minimis rule under which a taxpayer is not required to capitalize amounts paid for the acquisition or production of a unit of property. In order for a taxpayer to apply the de minimis rule the taxpayer must have an applicable financial statement, have a written capitalization threshold at the beginning of the taxable year, must treat the amount as an expense on its financial statements, and the total amount expensed for the taxable year must be less than or equal to the greater of 0.1% of the taxpayers gross receipts for federal income tax purposes or 2% of the taxpayer's total depreciation or amortization expense. An applicable financial statement is defined as a financial statement required to be filed with the SEC or a federal or state government agency or an audited financial statement.
Note: Comments on how the temporary regulations can be improved, in particular, the de minimis rule, have been provided to the IRS. The commentary has included that the calculation is complicated and cannot be calculated until after year-end making it impossible to identify during the year what will be capitalized or expensed; taxpayers with reviewed or compiled statements cannot but should be able to apply this rule; the ceiling should be removed or increased to a higher threshold; and that consolidated groups should be allowed to apply the ceiling based on the worldwide group or at least the U.S. consolidated group as opposed to each member.
Under the temporary regulations, special rules are provided for the treatment of materials and supplies and rotable and temporary spare parts. In general non-incidental materials and supplies are deductible in the taxable year in which they are used or consumed in the taxpayer's operations and amounts paid for material and supplies that are carried on hand and for which no record of consumption is kept or no physical inventories taken are deductible in the taxable year paid. Rotable and temporary spare parts are considered used or consumed in the taxable year in which the taxpayer disposes of the parts.
Materials and supplies are defined as non-inventory tangible property components acquired to maintain, repair or improve a unit of tangible property that the taxpayer owns, leases or services and that are not acquired as part of any single unit of property. Materials and supplies also now include fuel, lubricants, water and similar items. Materials and supplies are further defined as having an economic useful life of 12 months or less, beginning when used in the taxpayer's operations and has an acquisition or production cost of $100 or less.
Note: The IRS and Treasury rejected comments requesting that the de minimis threshold be increased from $100. However, the temporary regulations do give the IRS and Treasury authority to change such amount in future guidance. In addition, taxpayers with an applicable financial statement may be able to deduct higher amounts if they comply with the requirements set forth by the de minimis rule of Reg. section 1.263(a)-2T, as discussed above.
Rotable and temporary spare parts are defined as acquired for installation on a unit of property, removable from that unit of property, generally repaired or improved, and either reinstalled on the same or other property or stored for later installation. Temporary spare parts are materials and supplies that are used temporarily until a new or repaired part can be installed and then are removed and stored for later (emergency or temporary) installation.
A taxpayer may elect to capitalize and depreciate materials and supplies. An election applies to the amounts paid during that taxable year. The election is made by capitalizing the amounts and depreciating and the election must be made on a taxpayer's timely filed (including extensions) original tax return. In the case of a pass-through entity, the election is made at the entity level, and not by the shareholders or partners. The election can be made for each material and supply that qualifies for the election. Once the election is made it cannot be revoked without obtaining consent.
The temporary regulations also provide an optional method of accounting for rotable and temporary spare parts, which may be used as an alternative method to treating the parts as used or consumed in the year of disposition. If the election is made it must be used for all rotable and temporary spare parts. Under the optional method, a taxpayer may deduct the amount paid for a new rotable spare part in the year in which it is installed in equipment; include in income and assign a cost basis equal to the fair market value of the used, non-functioning part; capitalize the cost of repairing the part; and deduct the basis of the part when re-installed if it is later used as a replacement part.
The new regulations require virtually every business to review how repairs, maintenance, improvements and replacements are handled for tax purposes. BlumShapiro will continue to provide additional information as to how this change will affect your business and what steps you need to take.
If you have additional questions, please contact Crystal Germanese at email@example.com or 860-570-6496.
We have compiled a series of additional articles to help taxpayers understand the new rules and understand how they will be implemented.
- Improvement to Tangible Property
- Unit of Property for Purposes of Determining Improvement
- Asset Accounting and Dispositions
- Change In Accounting Method to Comply With the Tangible Property Regulations