After several years of study, the IRS has finalized regulations known as the Tangible Property Regulations or the Repair Regulations.  These regulations will affect the income taxation of property owners and other businesses.  This IRS project also included the promulgation of the Modified Accelerated Cost Recovery System (MACRS) rules in 2014 dealing with the dispositions and MACRS assets, general asset, multiple asset and item accounts.

Materials and Supplies

The final regulations made the following significant changes with respect to the tax treatment of materials and supplies in terms of their immediate expensing or capitalization:

1. An increase in the deductible amount of a unit of property from $100 per item acquisition or production cost up to $200.
2. Standby emergency spare parts are included in the definition of materials and supplies and are deductible in the tax year in they are used or consumed.
3. Rotable, temporary and standby emergency parts are currently deductible unless the optional method of accounting is elected.
4. Currently deducting materials and supplies are subject to deminimis safe harbor.
5. Gains on the disposition of materials or supplies are deemed ordinary income.

In order to comply with the final regulations relating to the changes of treatment of materials and supplies, the taxpayer must file Form 3115, Change of Accounting Method. IRS Rev. Proc. 2014-16 provides that the following changes relating to materials and supplies require the filing of such form:

1. Change to deducting the cost to acquire or produce non-incidental materials and supplies to the year used or consumed.
2. Change to deducting the cost to acquire or produce incidental materials and supplies to the year paid or incurred.
3. Change to deducting the cost to acquire or produce non-incidental rotable and temporary spare parts to the year disposed.
4. Change to the optional method for rotable and temporary spare parts.

Unit of Property

Under the final regulations, types of assets are divided into units of property (i.e., buildings, leased buildings, condominiums, personal and other real property, improvements to unit of property, components with different property classes, plant property and network assets).  Such units of property are further subdivided into major components.  For example, the components of a building include HVAC systems, plumbing systems, etc.  Whether an expenditure is treated as a capitalized improvement or a deductible repair depends on the size of the unit of property involved. 

A taxpayer who uses a unit of property definition that is different from the final regulation definition is using an improper method of accounting and is required to file Form 3115.

Tangible Property Improvements

Taxpayers who previously deducted expenses that should have been capitalized are required to change their method of accounting and calculate IRC 481(a)adjustment.  The adjustment is equal to the difference between the deducted amount and the amount of any depreciation that could have been claimed on the deducted amount if it had been capitalized prior to the year of change.

The final repair regulations allow small taxpayers (defined as a taxpayer with average annual gross receipts of $10 million or less during the preceding three tax years), with buildings to deduct a limited amount of improvement expenditures on qualifying buildings.  Under the safe harbor provisions, a small taxpayer is not required to capitalize improvements if the total amount paid for repairs, maintenance and improvements does not exceed the lesser of $10,000 or two percent of the unadjusted basis of the building.

Deminimis Safe Harbor Election

Changes made by the repair regulations with respect to the deminimis safe harbor election include:

1. Ceiling limitation is replaced with $500/$5,000 per item limit. $500 for taxpayers without an applicable financial statement (AFS).
2. Safe harbor provisions provide that a taxpayer may not capitalize amounts paid or incurred for the acquisition of a unit of tangible property or for the production of a unit of property or materials or supplies that cost $5,000 or less for taxpayers with AFS or $500 or less for taxpayers without AFS.
3. If the taxpayer’s accounting procedure sets a lower limit, then the lower limit applies.
4. If a higher limit is set, then the $5,000 or $500 limit applies.

A taxpayer with an AFS must have a written accounting procedure for non-tax purposes in place at the beginning of the tax year of election that requires book expensing of amounts costing less than a specified amount.  Taxpayers without an AFS must have an accounting procedure in place, but it need not be written.

Under the final regulations, the deminimis rule is a safe harbor that is elected annually by the extended due date of the original tax return.  The election is irrevocable and is made by partnerships or S-Corporations, rather than the partners and shareholders.  A statement described in regulation 1.263(a)-1(f)(5) must be attached to the return.

The rules described above represent only a small part of the final tangible property repair regulations.  The rules are effective for taxable year beginning January 1, 2014.  Many taxpayers with pre-existing properties may have to file Form 3115 to change their methods of accounting to conform to the new regulations.