United States: Complying With The Tangible Property Regulations – Procedural Guidance Provides Favorable Rules That Require Immediate Consideration

Last Updated: March 31 2014
Article by Ellen McElroy

Late last year, the IRS and Treasury Department released final and proposed regulations that affect the tax treatment of costs associated with plants, buildings, equipment, and machinery.1 These rules affect the costs attributable to repair, rehabilitation, and dispositions of property. Additionally, the regulations include a new safe harbor allowing the immediate deduction of costs of acquiring certain property (e.g., office equipment and furniture, small tools, computers, certain materials and supplies, etc.).2

Because of the broad scope of companies subject to these regulations and the significant changes to established guidance, most companies are not only subject to these new rules but are required to make changes to established tax treatment to comply with the rules. Also, most changes to comply with the regulations are effected through accounting method changes, which invariably require an income adjustment (either positive or negative) as a result of the required Section 481(a) adjustment when an accounting method change is made.3 Moreover, since these regulations encompass not only de minimis acquisitions, but also the treatment of fixed assets, changes to implement the rules will necessarily affect a taxpayer's compliance burden. A further complication is that although the final and proposed tangible property regulations apply to taxable years beginning on or after January 1, 2014,4 companies are permitted to choose whether to implement the rules in 2012, 2013, or 2014.5

As a result, most companies are required to: (i) evaluate not only when but how they will comply with the new guidance; (ii) establish business procedures to implement and comply with the rules; (iii) file an application(s) with the IRS (a Form 3115); (iv) change various methods of accounting to comply with the new rules; and (v) make an income adjustment in the year that the accounting method change is filed. For these reasons, any change should be carefully considered, and current as well as future implications of the change should be evaluated.

Recent Guidance Addresses Compliance Procedures for the Tangible Property Regulations and Provides that Certain Accounting Method Changes are Available on a Limited Basis.

The final and proposed tangible property regulations apply to tax years beginning on or after January 1, 2014.6 However, the regulations allow companies to choose whether to implement the rules in 2012, 2013, or 2014.7 Taxpayers may continue using existing accounting methods until 2014, adopt the temporary regulations, or adopt the final tangible property regulations. Once a company determines when to begin applying these rules, questions invariably arise regarding how to apply these rules.

Recent guidance describes the requirements for making accounting method changes to comply with the tangible property regulations. Rev. Proc. 2014-16 provides general guidance for taxpayers seeking to make an accounting method change under these rules.8 A second accounting method procedure, Rev. Proc. 2014-17, addresses accounting method considerations for dispositions.9 Certain provisions in this revenue procedure are available on a limited basis and should be considered immediately to ensure timely compliance.

Rev. Proc. 2014-17

Rev. Proc. 2014-17 provides procedures for complying with the proposed disposition rules of the tangible property regulations. The proposed regulations allow taxpayers to recover the costs of structural components of a building that has been disposed of (e.g., replaced or retired as a result of wear and tear or renovation, etc.) through the partial disposition rules. Similar recovery was allowed under the temporary and proposed regulations but required that taxpayers make a General Asset Account (GAA) election. The revenue procedure allows taxpayers to both make a late partial disposition loss election and/or to revoke a GAA election through an accounting method change. However, these accounting method changes are only available for current tax years, and thus, time sensitive.

For the 2013 tax year only, taxpayers may claim a loss for the costs of structural components that were retired or replaced in earlier years. These claims are available because the late partial disposition election is available as an accounting method change via Rev. Proc. 2014-17 and a negative Section 481(a) adjustment is available for such changes. The adjustment is available for the cost of components retired in any tax year prior to the tax year that the accounting method change is filed.

It is important to note, however, that an accounting method change for a late partial disposition election must be made for a tax year beginning on or after January 1, 2012, and before January 1, 2014. Consequently, if this approach is used, it has to be done shortly. For a calendar-year taxpayer, the change must be made no later than the extended due date of its 2013 tax return. Moreover, in future years, partial disposition elections are not available through an accounting method change and must be made on the return for the tax year in which the disposition/retirement occurs.

Rev. Proc. 2014-17 provides rules for revoking GAA elections, whether made as a late election through automatic accounting method changes under Rev. Proc. 2012-20, or as a timely GAA election made on a 2012 return.10 The revocation is only available for the limited time, and for this reason, it is important to carefully consider whether the accounting method changes are required.

Further, the revenue procedure includes periods for certain Section 481(a) adjustments, which are different from those typically available, which allow a four-year spread for positive adjustments. An example of a divergence from the usual four-year spread policy involves a situation in which a taxpayer filed an accounting method change under temporary regulations to recover basis on the disposition of a structural component of a building.11 As a result of a change in the definition of an asset that was included in the re-proposed regulations,12 the taxpayer is unable to claim a disposition or basis recovery without availing itself of the partial disposition rules included in the proposed disposition provisions.13

Consequently, the taxpayer seeking to make this change must first reverse the disposition taken previously and then make an accounting method change to the proposed disposition provisions. The revenue procedure allows this accounting method change, but requires a one-year spread of any positive Section 481(a) adjustment. Generally, positive Section 481(a) adjustments are taken into account over a four-year period. The policy behind the change in spread period is that the original accounting method change allowed a one-year spread on a negative adjustment associated with the original accounting method change and thus, a similar spread period on the corresponding accounting method change creates parity.

It has been noted that the government anticipates that taxpayers seeking certain accounting method changes under the temporary regulations (i.e., making a GAA election) will also seek certain changes under the re-proposed rules (i.e., a change to take advantage of a partial disposition). Because such changes could result in offsetting positive and negative Section 481(a) adjustments, a taxpayer could end up with no Section 481(a) adjustment, which would not accurately reflect the taxpayer's change.14

Finally, the guidance will also likely include guidance for accounting method changes required by IRS-imposed repair determinations. Taxpayers are permitted to file an accounting method change to make a late partial disposition election when the IRS determines in an Exam context that that a taxpayer improperly claimed a repair deduction for expenses that should have been capitalized.

Rev. Proc. 2014-16

Rev. Proc. 2014-16 requires that a taxpayer clearly articulate any accounting method change being made under the tangible property regulations. As such, companies are required to describe the change being made, including all relevant facts and legal support for the accounting method change. Additionally, Rev. Proc. 2014-16 requires that the accounting method change specify the controlling regulatory provision from the temporary or final regulations, which is the subject of the change. Further, Rev. Proc. 2014-16 permits a modified Section 481(a) adjustment for certain changes (for example, materials and supplies and transaction costs changes).

Importantly, Rev. Proc. 2014-16 eliminates the requirement that a repair accounting method change be accompanied by a concurrent uniform capitalization (UNICAP) accounting method change. The requirement was initially required because of government concern that there was widespread noncompliance with Section 263A. However, with this guidance, the government has chosen an approach to encourage broad compliance. It has been suggested, however, that the current terms and conditions available under Rev. Proc. 2014-16 may be available on a limited basis and that IRS agents will begin questioning compliance with Section 263A. For this reason, taxpayers should evaluate compliance with Section 263A when considering an accounting method change under the repair regulations.

Accounting method changes addressed by Rev. Proc. 2014-16 include the following:

Description of Change

Regulation Cite

A change in repair costs (to deduct costs of repair and maintenance or a change to capitalize same) and, if depreciable, to depreciate such property under sections 167 or 168. Includes a change in the method of identifying the unit of property, or in the case of a building, identifying the building structure or building systems for the purpose of making this change.

§§ 1.162-4, 1.263(a)-3;§§ 1.162-4T, 1.263(a)-3T

Change to the regulatory accounting method.

§ 1.263(a)-3(m);§ 1.263(a)-3T(k)(2)

Changes in the treatment of materials and supplies.

§§ 1.162-3(a)(1)/(2)/(3), (c)(1)/(c)(2)/(e); §§ 1.162-3T(a)(1)/(a)(2)/(a)(3); (c)(1)/(c)(2)/(e)

Change by a dealer in property to deduct commissions and other transaction costs that facilitate the sale of property.

§ 1.263(a)-1(e)(2);§ 1.263(a)-1T(d)(1)

Change by a non-dealer in property to capitalize commissions and other costs that facilitate the sale of property.

§ 1.263(a)-1(e)(1); § 1.263(a)-1T(d)(1)

Change to capitalize acquisition or production costs and, if depreciable, to depreciating such property under sections 167 or 168.

§ 1.263(a)-2; §1.263(a)-2T

Change to deduct certain costs for investigating or pursuing the acquisition of real property.

§ 1.263(a)-2(f)(2)(iii)

Change to applying the de minimis rule

§§ 1.263(a)-2T(g), 1.263A-1T(b)(14)

Change to deducting certain costs for investigating or pursuing the acquisition of real property.

§ 1.263(a)-2T(f)(2)(iii)

Rev. Proc. 2014-16 supersedes Rev. Proc. 2012-19,15 which was released following the issuance of the temporary and proposed repair regulations in 2011. Rev. Proc. 2014-16 also modifies Rev. Proc. 2011-14,16 which provides general guidance for automatic accounting method changes. As a result of these modifications, the Service waived the scope limitations of Rev. Proc. 2011-14 for taxpayers seeking a change under Rev. Proc. 2014-16. Ordinarily, the scope limitations prevent taxpayers from making accounting method changes in certain circumstances, for example, when the company is under exam or when a company has made a similar change within the last five years. As a result of the waiver provisions, accounting method changes are available for tax years beginning before January 1, 2015.

Importantly, Rev. Proc. 2014-16 provides that the accounting method changes required under the repair regulations are available automatically and thus, the Commissioner's prior consent is not required. As such, an automatic method change may be attached to a timely filed federal income tax return although the method is effective as of the beginning of the tax year.

Pepper Perspective

Most taxpayers will be required to file one (or more) accounting method change(s) to comply with the tangible property regulations. Because of the consequences of implementing the rules through an accounting method change, as well as the risks of failing to properly specify the accounting method changes that are being made, it is important to carefully consider several things. First, taxpayers should consider how each change to comply with these regulations will be implemented, including the financial and administrative complexities of implementation. Second, the specific accounting method changes that are required as a result of any changes should be carefully evaluated. To the extent that a taxpayer seeks to make a late partial disposition election, the required accounting method change must be filed shortly. Third, taxpayers should consider how each accounting method change is described in required filings. Should a taxpayer be subject to examination, the IRS will rely on the accounting method changes to evaluate how the taxpayer has implemented the rules. The description of both the accounting method change and how it was implemented may affect whether an Exam is successfully resolved. More importantly, the description serves as a roadmap for future compliance requirements, so each method used should be both carefully considered and accurately described.

Footnotes

1 See T.D. 9636 (Sept. 13, 2013). These regulations are frequently referred to as the "repair regulations" or the "tangible property regulations." These regulations modified temporary and proposed regulations that were issued in 2011. See T.D. 9564, 2012-14 IRB 614, 76 Fed. Reg. 81060. See also, T.D. 9636 (Sept. 13, 2013); and REG-110732-13, which includes Prop. Reg. §§1.168(i)-1, 7, and 8.

2 Treas. Reg. § 1.263(a)-1(f). The regulations provide a de minimis exception for certain amounts paid to acquire or produce a unit of tangible property. As a result, amounts qualifying under this exception are exempted from the general capitalization requirement. These regulations abandoned the ceiling approach used in previous regulations, and instead made the determination at the item or invoice level, based on a taxpayer's written accounting policies. As such, taxpayers with an applicable financial statement are entitled to use this exception if the amounts paid for such property do not exceed $5,000 per invoice, or per item. Additionally, these regulations also permit the exception to apply in situations where the taxpayer's accounting procedures expense amounts paid for such property with a useful life of 12 months or less, so long as the amount does not exceed the $5,000 threshold.

3 The final tangible property regulations specify that generally a change to comply with the repair regulations is a change in method of accounting. Whenever an item is characterized as an accounting method change, a taxpayer must file an application (Form 3115) during the first taxable year in which the new accounting method will be used. If an application is not completed properly or if the application fails to include all of the required information, the Service may deny the change or require the taxpayer to return to its prior method or even another method, or make adjustments necessary to bring the accounting method change into compliance. Additionally, a Section 481(a) adjustment (e.g., an income adjustment reflecting changes from one method to another) is also required when an accounting method change is made.

4 Treas. Reg. § 1.263(a)-1(h)(1) (generally, the final regulations apply to taxable years beginning on or after January 1, 2014); see also, Treas. Reg. 1.263(a)-1(h)(2), which allows for early implementation of the regulations for taxable years beginning on or after January 1, 2012. Also, certain provisions apply only to amounts paid or incurred in taxable years beginning on or after January 1, 2014. See, e.g.,Treas. Reg. §§1.162-3(j), 1.162-4(c), 1.162-11(b)(2), 1.165-2(d). Taxpayers may continue using existing accounting methods until 2014, adopt the temporary regulations, or adopt the final tangible property regulations.

5 T.D. 9636. Rev. Proc. 2014-17 explains that the 2013 proposed regulations, when finalized, will apply to tax years beginning on or after January 1, 2014, and will permit a taxpayer to choose to rely on them for tax years beginning on or after January 1, 2012, and before January 1, 2014. Alternatively, the 2013 proposed regulations, when finalized, will permit a taxpayer to apply the temporary disposition regulations to tax years beginning on or after January 1, 2012, and before January 1, 2014.

6 Treas. Reg. § 1.263(a)-1(h)(1) (generally, the final regulations apply to taxable years beginning on or after January 1, 2014); see also, Treas. Reg. 1.263(a)-1(h)(2), which allows for early implementation of the regulations for taxable years beginning on or after January 1, 2012. Also, certain provisions apply only to amounts paid or incurred in taxable years beginning on or after January 1, 2014. See, e.g.,Treas. Reg. §§1.162-3(j), 1.162-4(c), 1.162-11(b)(2), 1.165-2(d).

7 T.D. 9636. Rev. Proc. 2014-17 explains that the 2013 proposed regulations, when finalized, will apply to tax years beginning on or after January 1, 2014, and will permit a taxpayer to choose to rely on them for tax years beginning on or after January 1, 2012, and before January 1, 2014. Alternatively, the 2013 proposed regulations, when finalized, will permit a taxpayer to apply the temporary disposition regulations to tax years beginning on or after January 1, 2012, and before January 1, 2014.

8 Rev. Proc. 2014-16, 2014-9, I.R.B. 606, modifying Rev. Proc. 2012-19, 2012-14 I.R.B. 689, and Rev. Proc. 2011-14, 2011-4 I.R.B. 330, regarding certain changes in method of accounting for amounts paid to acquire, produce, or improve tangible property. This revenue procedure supersedes Rev. Proc. 2012-19 and provides the procedures by which a taxpayer may obtain the automatic consent to change to the methods of accounting provided in Treas. Reg. §§ 1.162-3, 1.162-4, 1.263(a)-1, 1.263(a)-2, and 1.263(a)-3 and Temp. Reg. §§ 1.162-3T, 1.162-4T, 1.263(a)-1T, 1.263(a)-2T, and 1.263(a)-3T. This revenue procedure also modifies Rev. Proc. 2011-14 and provides the procedures by which a taxpayer may obtain the automatic consent to change to a reasonable method described in Treas. Reg. § 1.263A-1(f)(4) for self-constructed assets and to change to a permissible method of accounting under Section 263A(b)(2) and Treas. Reg. § 1.263A-3(a)(1) for certain costs related to real property acquired through foreclosure, by deed in lieu of foreclosure, or in another similar transaction. Finally, Rev. Proc. 2014-16 modifies Section 3.09 of the APPENDIX of Rev. Proc. 2011-14 regarding a change to the method of accounting described in Rev. Proc. 2011-43, 2011-37 I.R.B. 326, for taxpayers in the business of transporting, delivering, or selling electricity.

9 Rev. Proc. 2014-17, 2014 I.R.B. Lexis 166, modifying Rev. Proc. 2014-20, 2012-14 I.R.B. 700, and Rev. Proc. 2011-14, 2011-4 I.R.B. 330, regarding certain accounting method changes for dispositions of tangible depreciable property. It also supersedes Rev. Proc. 2012-20, providing that a taxpayer may obtain automatic consent to change methods of accounting to comply with Treas. Reg. §§ 1.167(a)-4 and 1.168(i)-7, Temp. Treas. Reg. §§ 1.167(a)-4T, 1.168(i)-1T, 1.168(i)-7T, and 1.168(i)-8T, and Prop. Treas. Reg. §§ 1.168(i)-1, 1.168(i)-7, and 1.168(i)-8. This revenue procedure also modifies Rev. Proc. 2011-14 and allows a late partial disposition election under Prop. Reg. § 1.168(i)-8 or a revocation of a general asset account election under § 1.168(i)-1T or Prop. Reg. § 1.168(i)-1 to be made as an accounting method change.

10 The revenue procedure permits the revocation of a GAA election under Temp. Reg. §1.168(i)-1T or Prop. Reg. §1.168(i)-1 to be treated as a change in method of accounting.

11 T.D. 9564 (Dec. 23, 2011).

12 T.D. 9637 (Sept. 13, 2013).

13 Prop. Reg. § 1.168(i)-8. See REG-110732-13.

14 The revenue procedure allows a taxpayer to file an accounting method change procedure to elect the late partial disposition provided in Proposed Reg. §1.168(i)-8(d)(2)(iii) in Section 6.35 of the APPENDIX of Rev. Proc. 2011-14, as added by Rev. Proc. 2014-17.

15 2012-14, I.R.B. 689.

16 2011-4, I.R.B. 330.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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