Private clubs and the new tangible property and repair regulations An overview of the temporary repair regulations
ECLUB NEWS |
In the January 2013 issue of eClub News, the article Upcoming articles highlight compliance with the new tangible property and repair rules, offered a brief introduction to the new tangible property and repair regulations (the Repair Regulations) along with a discussion of the related IRS audit moratorium and the need for tax accounting method changes to comply with these new rules.
To offer readers a preview of what lies ahead, below is an outline of the subject matter to be more fully addressed in this series.
- March 2013 – Overview of the Temporary Repair Regulations1
- May 2013 – How the Repair Regulations affect private clubs
- June 2013 – Tax accounting method changes private clubs should consider to comply with the Repair Regulations
- July 2013 – Overview of the Final Repair Regulations (expected to be issued by June 2013)
- September 2013 – Important year-end steps and planning opportunities for private clubs
Taxpayers should not delay planning to comply with the Repair Regulations. Nearly all taxpayers engaged in business activities who own tangible property, incur repairs, or use materials and supplies that will be affected by these regulations. This includes private clubs. The fact that many clubs consistently run tax losses and rarely pay income tax does not exempt them from these regulations.
In addition to their complexity, the Repair Regulations are new, and their use, interpretation, and application are one of first impression. Significant variation in taxpayer compliance is expected, since the regulations are fact sensitive and every taxpayer's situation is unique when it comes to tangible assets and repairs. In addition, the Final Repair Regulations are expected to be issued by mid-2013. While wholesale changes are not anticipated, some important changes from the Temporary Repair Regulations are expected and taxpayers will need to review these changes to determine which ones affect their tax positions and accounting methods.
Overview of the Temporary Repair Regulations
The IRS issued the Temporary Repair Regulations in December 2011.2 The Temporary Repair Regulations were originally generally effective for taxable years beginning on or after Jan. 1, 2012. However, in November 2012 the IRS issued Notice 201273, announcing its intent to extend the effective date until taxable years beginning on or after Jan. 1, 2014, and indicating areas in the regulations that will likely change (i.e., the de minimis rule, disposition rules, routine maintenance safe harbor and some type of relief for small businesses). Subsequently, in December 2012, the IRS and Treasury Department released technical amendments to the Temporary Repair Regulations (TD 9564), officially amending the effective date until taxable years beginning on or after Jan. 1, 2014. These technical amendments also provided rules for flexible early adoption of the regulations, generally for taxable years beginning on or after Jan. 1, 2012.
The IRS is expected to issue the Final Repair Regulations in mid-2013. Given the scope and complexity of the regulations, taxpayers are advised to begin planning their compliance efforts now, since the analysis and necessary compliance steps will take time to complete.
The Temporary Repair Regulations provide guidance in the following four general areas:
- Materials and supplies (collectively supplies)
- Costs to acquire or produce tangible property (including a de minimis rule)
- Costs to improve tangible property
- Dispositions of tangible property, specifically MACRS property3 (including property components) and general asset accounts (GAAs)4
Supplies – The Temporary Repair Regulations define supplies as tangible property that is not considered inventory and is defined and used in one or more of the following manners:
- A component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer, and that is not acquired as part of any single unit of property
- Fuel, lubricants, water and similar items, that are reasonably expected to be consumed within 12 months or less, beginning when used in the taxpayer's operations
- A unit of property that has an economic useful life of 12 months or less, determined beginning with the date the property is first used or consumed in the taxpayer's operations (e.g., fertilizer, seeds, and mulch used for internal operations and not held for sale)
- A unit of property costing $100 or less
- A rotable or temporary spare part
- Is identified in published guidance as supplies
Consistent with longstanding rules, taxpayers may continue to deduct incidental supplies when purchased, and non-incidental supplies when used or consumed. Examples of incidental supplies may include non-inventoried supplies with no record of consumption such as small office supplies or cleaning materials. Non-incidental supplies are typically accounted for as consumed and are usually subject to physical inventory. Examples of non-incidental supplies may include motor oil, toner cartridges and small engine parts such as air filters, spark plugs, etc., for which usage is tracked.
The Temporary Repair Regulations give taxpayers the option of capitalizing and depreciating their supplies or deducting them under the de minimis rules (discussed below). A special method is also available for rotable parts that meet one or more of the supplies definitions above. Rotable part examples include items such as rotors, pumps, engines, compressors and motors, which are stored and used to replace similar items in use when they wear out or break. Each club should review its existing tax accounting practices to determine which available method makes the most sense from a tax accounting and operational perspective.
Costs to Acquire Tangible Property – Taxpayers are required to capitalize amounts paid to acquire or produce tangible property. This includes facilitative costs; however, employee compensation and overhead are excluded from the facilitative cost definition for this purpose and need not be capitalized under these regulations, unless the taxpayer elects to do so. Taxpayers should also be mindful that while certain costs may not have to be capitalized under the Temporary Repair Regulations, capitalization may be required under other parts of the Internal Revenue Code, most notably the Uniform Capitalization rules under Internal Revenue Code section 263A.
The Temporary Repair Regulations also include special rules for real property acquisition. Investigative and pursuit related costs are not required to be capitalized, if they are incurred while the taxpayer is determining whether to acquire real property, and which real property to acquire. However, as noted above, taxpayers must still address whether section 263A or other tax law provisions could require capitalization of these costs.
The de Minimis Rule – Many taxpayers have historically deducted asset purchases where the individual assets purchased cost at or below a fixed amount. For example, a taxpayer may deduct purchases of individual assets costing $250 or less. This practice is commonly used to reduce the administrative burden of tracking many small assets. The Temporary Repair Regulations include a de minimis rule that sets limits on this practice.
Under the de minimis rule, the Temporary Repair Regulations allow taxpayers that meet the following requirements to deduct an aggregate amount of small asset purchases.
- The taxpayer must have an Applicable Financial Statement (AFS). An AFS may be an audited financial statement, or a financial statement filed with a non-tax regulatory body.
- The taxpayer must have at the beginning of the taxable year written accounting procedures treating as an expense for non-tax purposes the amounts paid for asset purchases costing less than a certain dollar amount.
- The taxpayer may then deduct an aggregate amount of asset purchases less than or equal to the greater of: (1) 0.1 percent of gross receipts; or (2) 2 percent of depreciation and amortization on the AFS.
- Amounts exceeding the de minimis limit that do not constitute otherwise deductible materials and supplies or repairs must be capitalized.
- Taxpayers without an AFS cannot currently use the de minimis rule.
The de minimis rule has been controversial, especially for taxpayers with no AFS. As indicated by Notice 2012-73, the Final Repair Regulations should favorably revise this rule.
Costs to Improve Tangible Property – The Temporary Repair Regulations contain rules for determining which property improvement costs must be capitalized, and which costs may be deducted as repairs. To apply these rules, the Temporary Repair Regulations provide guidelines for determining the unit of property. A unit of property is defined as the item of property against which improvement costs are measured. Generally, the larger the unit of property, the more likely the activities performed after the property is placed in service by the taxpayer constitute repairs. Special unit of property determination rules exist for the following asset types:
- Building structures
- Building systems (e.g., HVAC, plumbing, elevators)
- Leased property
- Plant property
- Network assets
Taxpayers are required to analyze improvement costs against their units of property to determine which costs must be capitalized under the Temporary Repair Regulations. Improvements that fall within one of the three categories below are generally required to be capitalized.
- Betterment – Improves the property's functionality, value, output or similar metrics.
- Restoration – Restores deteriorated non-functioning property to a working condition, replaces a major functional component or substantial structural part or other comparable improvement.
- Adaptation – Adapts the property to a new or different use.
Expenditures that do not fall under one of the above categories may be deductible as repairs. Taxpayers should be cautious however, since determining deductibility versus capitalization is often a facts and circumstances exercise. Taxpayers should always retain factual support for larger repair expenditures, as they are common targets for IRS audit inquiries.
The Temporary Repair Regulations also include a safe harbor that allows deductibility of certain routine maintenance expenditures for non-building properties. This is another rule that should be favorably expanded by the Final Repair Regulations.
Property Dispositions – Finally, the Temporary Repair Regulations contain provisions addressing asset dispositions. Under the regulations, taxpayers are currently required to claim a loss on the disposition of a structural component of a building. This requirement has a corollary effect; when a taxpayer claims a loss on the disposition of a building's structural component, the expenditures for the replacement must be capitalized as a restoration. The Temporary Repair Regulations do provide taxpayers some flexibility with retirement losses and repair deductions through favorable changes to the general asset account (GAA) rules. The Final Repair Regulations will likely provide additional flexibility with respect to the disposition rules.
As previously discussed, taxpayers may choose to selectively early adopt provisions of the Temporary Repair Regulations. The ability to early adopt combined with the information provided by Notice 2012-73 regarding which areas in the regulations will likely favorably change (i.e., the de minimis rule, disposition rules, and routine maintenance safe harbor) should assist taxpayers in making decisions as to which of the current automatic method changes to go ahead and implement for taxable years beginning after Dec. 31, 2011. This provides a great opportunity for taxpayers to optimally plan for compliance with the Final Repair Regulations by their 2014 tax years.
1 The information contained in this article is general in nature and is based on authorities that are subject to change. Please consult with your tax advisor to determine how the information in this article might apply to a particular situation.
2 For income tax compliance purposes, temporary regulations carry the same weight as final regulations.
3 The Modified Accelerated Cost Recovery System (MACRS) is the current tax depreciation system applied by the Internal Revenue Code.
4 The General Asset Account (GAA) election allows taxpayers to group and depreciate certain MACRS property categories. The GAA election often makes MACRS tax depreciation calculations simpler and less burdensome, especially for larger groups of assets.