As you may be aware; the IRS has issued final repair regulations regarding the capitalization and depreciation of tangible property. The rules contained in these regulations are required to be reflected on your 2014 income tax return. Originally these regulations would have required the filing of several Forms 3115 to apply these changes by any taxpayer owning tangible property; no matter their size. Filing the Forms 3115 would require an analysis of the taxpayer’s fixed assets to determine potential changes to prior year transactions. However, on February 13, 2015 the IRS finally issued a Revenue Procedure which exempted taxpayers with less than $10 million of assets or less than $10 million of gross receipts (average of prior three years) from these filing requirements.
The issuance of this Revenue Procedure is welcome news to many taxpayers who do not want to incur the cost of applying these regulations to prior period transactions. If you elect to follow this new Revenue Procedure then you will only be required to apply the rules established under these regulations on a going forward basis.
However it is important that you understand the implications of choosing to follow the simplified procedures for implementing these regulations. There are several potential benefits to filing the Forms 3115 which you would not be able to take advantage of if the simplified procedures are followed. These benefits include:
1.) Electing to take a “partial asset disposition” for portions of assets that have been replaced in a prior year with an expenditure that has been capitalized.
a. i.e. If the roof of a building which has been capitalized in 2000 was replaced in 2011 than a portion of the original building cost may be deducted by filing a Form 3115
2.) The ability to deduct removal costs for prior period asset improvements.
3.) Reclassifying prior capitalized expenditures as a repair under the “routine maintenance safeharbor”.
a. i.e. the painting of the interior of a building was capitalized more than one time within ten years this would potentially fall under the routine maintenance safe harbor and would be deductible
4.) Receiving “audit protection” from the IRS on certain prior year adjustments relating to fixed asset and repair & maintenance issues.
5.) The opportunity to define “units of property” on your own terms.
a. The concept of a unit of property is important under the new regulations because the determination of whether an expenditure is a deductible repair or a capitalizable improvement is made in reference to the Unit of Property.
6.) The ability to remove previously depreciated assets from your depreciation schedule.
a. This can be important if the asset is later sold at a gain because the amount of depreciation previously taken may be taxed at a higher rate under a concept known as “depreciation recapture”.
There are additional taxpayer favorable provisions of these regulations including:
1.) The ability to utilize a “de minimis safeharbor” capitalization policy to deduct anything costing $500 or less for any taxpayer (or$5,000 or less if the company has an audited financial statement)
2.) The ability to deduct repairs and maintenance under the “routine maintenance safeharbor”.
3.) The ability to make a “small taxpayer safe harbor” election to expense certain building repairs without regard to an analysis of a requirement to otherwise capitalize and depreciate those costs
4.) The ability to take a partial asset disposition relating to an improvement capitalized in the current year.
It is important to be aware that while you may chose not to file the Forms 3115 to apply these regulations to prior transactions; you are still required to apply them in 2014 and in to the future.
The downside of filing non-required Forms 3115 (or being subject to required filing) is that it may require significant effort in analyzing the prior year transactions regarding fixed assets and repair and maintenance cost. Filing these forms will require additional compliance cost of working with your tax consultants and more demand on your staff for producing the information.
Due to the potential benefits and costs of complying with these regulations, as well as the need to create an audit proof strategy going forward, it is important that you consult with your tax professional as soon as possible if you have not already.
While the requirements to comply with these regulations will continue into the future; 2014 is the last opportunity to correctly file a Form 3115 in order to claim prior year benefits such as the prior year partial asset disposition. As a reminder Forms 3115 are due by their due date for timely filing your tax return. This means Forms 3115 for the 2014 tax year must be filed by October 15, 2015 (the due date of your return with an automatic six-month extension). For more details on filing Form 3115, see IRS Revenue Procedures 2014-16 and 2014-17. As always, please reach out to your tax advisor for assistance in understanding the implication and potential opportunities of Forms 3115 and the new repair regulations have created.
Article Provided By: Tim Stolz, CPA MKS&H Tax Manager
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture and your business goals. This approach enables our clients to achieve their greatest potential.