The Department of Treasury finally issued their much awaited final treasury regulations governing the proper tax treatment for repair and maintenance expenditures on Friday, September 13th. The final treasury regulations replace the temporary regulations previously issued in December of 2011. As with temporary treasury regulations, the final treasury regulations have the force and effect of law on both taxpayers and the government and any deviation from these treasury regulations will require the filing of Form 8275-R entitled “Regulation Disclosure Statement” for taking a position contrary to a treasury regulation in either temporary or final form. These final treasury regulations are meant to provide further clarity and reduce controversy over the determination of whether an expenditure may be currently deducted as a repair under I.R.C. § 162(a) or must be capitalized under I.R.C. § 263(a). While generally effective for tax years beginning on or after January 1, 2014, taxpayers have the option of applying the final treasury regulations to tax years beginning on or after January 1, 2012.
A Practical Guide to the Scope and Application of the Final Treasury Regulations
The subsequent synopsis will serve as a practical guide to the scope and application of the final treasury regulations governing the proper tax treatment for repair and maintenance expenditures. There are many significant changes in the final treasury regulations which are favorable to taxpayers including, but not limited to:
Materials & Supplies Definition Broadened
In connection to materials and supplies, the final treasury regulations expand the definition of materials and supplies to include property that has an acquisition or production cost of $200 or less (i.e., increased from $100 or less), clarify application of the optional method of accounting for rotable and temporary spare parts, and simplify the application of the de minimis safe harbor to materials and supplies.
Increase of Dollar Thresholds
The final treasury regulations increase the dollar threshold for characterizing a unit of property as a material or supply from property costing $100 or less to property costing $200 or less.
Elect to Capitalize Rule Clarified
While the final treasury regulations retain the rule permitting a taxpayer to elect to capitalize and depreciate amounts paid for certain materials and supplies, they also provide that this rule only applies to rotable, temporary, or standby emergency spare parts.
Elimination of the De Minimis Safe Harbor Ceiling
The final treasury regulations eliminate the de minimis safe harbor ceiling which required taxpayers to capitalize amounts paid to acquire or produce a unit of real or personal property that was over the ceiling amount. Tax lobbyists overwhelmingly indicated that the rule was so arduous that the undue administrative hardship imposed outweighed the cost/benefit ratio. In its place of that rule, the final treasury regulations require taxpayers to use a reasonable, consistent methodology that clearly reflects income for tax purposes. The Department of Treasury replaced the ceiling rule with a new safe harbor determined at the invoice or item level and based on the policies that the taxpayer uses for its financial accounting books and records. A taxpayer with an Applicable Financial Statement (hereinafter “AFS”) may rely on the de minimis safe harbor of the final treasury regulations only if the amount paid for property does not exceed $5,000 per invoice, or per item as substantiated by the invoice. The final treasury regulations give the Internal Revenue Service (hereinafter the “Service”) the authority to change the safe harbor amount through future published administrative guidance.
De Minimis Safe Harbor Scope and Application Modified
The final treasury regulations provide that the de minimis safe harbor also applies to a financial accounting procedure that expenditure amounts paid for property with an economic useful life of 12 months or less as long as the amount per invoice (i.e., or item) does not exceed $5,000. Such amounts are deductible under the de minims rule whether this financial accounting procedure applies in isolation or in combination with a financial accounting procedure for expensing amounts paid for property that does not exceed a specified dollar amount.
Furthermore, the final treasury regulations expand the de minimis rule to not only amounts paid for property costing less than a certain dollar amount but also amounts paid for property having a useful life less than a certain period of time. Thus, the final treasury regulations provide the de minimis safe harbor also applies to a financial accounting procedure that expenditure amounts paid for property with an economic useful life of 12 months or less as long as the amount per invoice (i.e., or item) does not exceed $5,000. Such amounts are deductible under the de minims rule whether this financial accounting procedure applies in isolation or in combination with a financial accounting procedure for expensing amounts paid for property that does not exceed a specified dollar amount. Under either procedure, if the cost exceeds $5,000 per invoice (i.e., or item), then the amounts paid for the property will not fall within the de minimis safe harbor. In addition, an anti-abuse rule is provided to aggregate costs that are improperly split among multiple invoices.
In addition, the final treasury regulations add a de minimis rule for taxpayers without an AFS, if accounting procedures are in place to deduct amounts paid for property costing less than a specified dollar amount or amounts paid for property with an economic useful life of 12 months or less. The de minimis safe harbor for taxpayers without an AFS provides a reduced per invoice (i.e., or item) threshold because there is less assurance that the accounting procedures clearly reflect income. A taxpayer without an AFS may rely on the de minimis safe harbor only if the amount paid for property does not exceed $500 per invoice, or per item as substantiated by the invoice. It should be duly noted that if the cost exceeds $500 per invoice (i.e., or item), then no portion of the cost of the property will fall within the de minimis safe harbor.
De Minimis Rule is Elected Annually by Attaching a Statement to a Timely Filed Tax Return
The final treasury regulations also provide that the de minimis rule is a safe harbor, elected annually by including a statement on the taxpayer’s timely filed original federal tax return for the year elected. The final treasury regulations provide that, if elected, the de minimis safe harbor must be applied to all amounts paid in the tax year for tangible property that meet the requirements of the de minimis safe harbor, including amounts paid for materials and supplies that meet the requirements.
To streamline the application of the de minimis safe harbor, the final treasury regulations require that the de minimis safe harbor be applied to all eligible materials and supplies (i.e., other than rotable, temporary, and standby emergency spare parts subject to the election to capitalize or rotable and temporary spare parts subject to the optional method of accounting for such parts) if the taxpayer elects the de minimis safe harbor.
Improvements to a Building Envelope by Qualifying Small Taxpayers
While the temporary regulations did not provide any special rules for small taxpayers to assist them in applying the general rules for improvements to buildings, the final treasury regulations permit a qualifying small taxpayer to elect to not apply the improvement rules to an eligible building property if the total amount paid during the tax year for repairs, maintenance, improvements, and similar activities performed on the eligible building does not exceed the lesser of $10,000 or 2 percent of the unadjusted basis of the building. Eligible building property includes a building unit of property that is owned or leased by the qualifying taxpayer, provided the unadjusted basis of the building unit of property is $1,000,000 or less.
Safe Harbor for Routine Maintenance
Also not included in the temporary regulations, but added in the final treasury regulations, is a safe harbor for routine maintenance for buildings. The inclusion of a routine maintenance safe harbor for buildings is aimed at alleviating some of the difficulties that could arise in applying the improvement standards for certain restorations to building structures and building systems. The final treasury regulations use 10 years as the period of time in which a taxpayer must reasonably expect to perform the relevant activities more than once.
Clarity of the Rules Governing Betterments
The final treasury regulations reorganize and clarify the types of activities that constitute betterments to property. Also, the final treasury regulations no longer phrase the betterment test in terms of amounts that “result in” a betterment. Rather, the final treasury regulations provide that a taxpayer must capitalize amounts that are reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of a unit of property or that are for a material addition to a unit of property. Eliminating the “results in” standard is aimed at reducing controversy for expenditures that span more than one tax year or when the outcome of the expenditure is uncertain when the expenditure is incurred.
The final treasury regulations expand, modify and clarify the scope and application governing I.R.C. § 162(a) and § 263(a) and affects all taxpayers that acquire, produce or improve tangible property. Please only consult a true subject matter expert in this area of the tax law to best ensure a sustainable tax return filing position as the rules are multifaceted and onerous.
Peter J. Scalise serves as the National Partner-in-Charge and the Federal Tax Practice Leader for Engineered Tax Services. Peter is a highly distinguished BIG 4 Alumni Tax Practice Leader and has approximately twenty years of progressive public accounting experience developing, managing and leading multi-million dollar tax advisory practices on both a regional and national level.
Peter is also a renowned keynote speaker and author on specialty tax incentives, tax controversy matters, and legislative updates from Capitol Hill for NAREIT, USGBC, AICPA, ASTP, NATP, ABA, AIA, TEI and serves as a volunteer member of the iShade Tax Faculty. Peter serves on both the Board of Directors and Board of Editors for The American Society of Tax Professionals (“ASTP”) and is the Founding President and Chairman of The Northeastern Region Tax Roundtable, an operating division of ASTP.