The impact of the tangible property regulations on private clubs
On Sept. 13, 2013, the IRS released the final and proposed tangible property regulations (the "final regulations," TD 9636 and REG-110732-13). The final regulations identify rules and safe harbors for the capitalization and deduction of costs related to the acquisition, maintenance, improvement and disposition of tangible assets. With respect to private clubs, these assets include the clubhouse, dining area, golf course and other tangible property.
Clubs are required to be in compliance with the regulations for tax years beginning on or after Jan. 1, 2014. To take advantage of a de minimis safe harbor providing for the deduction of items costing up to $5,000, clubs must have a written capitalization policy in effect as of Jan. 1, 2014.
Because the regulations are more than 200 pages long, below is a brief summary of the guidance set forth in the regulations that may be applicable to private clubs:
- Unit of property defined:
- Generally comprised of all functionally interdependent components
- Special rules for leased property
- Special rules apply to building property
- Although a building (including its structural components) is one unit of property, improvement rules must be applied on a building system and structure basis
- Incidental materials and supplies are generally deductible in the year paid or incurred, while non-incidental materials and supplies are generally deductible in the year the material or supply is first used or consumed in club operations. Materials and supplies are defined as any of the following:
- A component that is acquired to maintain, repair or improve a unit of tangible property, but that is not acquired as part of any single unit of tangible property;
- Fuel, lubricants, water, and similar items reasonably expected to be consumed in 12 months or less;
- A unit of property that has an economic useful life of 12 months or less;
- A unit of property with an acquisition cost of $200 or less; or
- Anything identified in published IRS guidance as materials and supplies
- Maintenance and repair costs are generally deductible in the year the amount is paid or incurred:
- Maintenance and repair activities are those that keep the unit of property in ordinary working condition (i.e., that do not result in an improvement to the unit of property)
- The regulations provide a routine maintenance safe harbor that may allow clubs to treat recurring activities that they reasonably expect to perform more than once during a unit of property's ADS class life (for non-building property) or within 10 years (for building property) to keep the property in its ordinary operating condition.
- New, annual election to capitalize repairs and maintenance costs to the extent such costs are being capitalized for book purposes
- Clubs can elect to capitalize repairs and maintenance costs to keep treatment consistent with book
- Election is made on the timely filed tax return for the year clubs pay or incur the costs (an election statement is required)
- If election is made, clubs will treat the costs as improvement costs (i.e., capitalize and depreciate the expenditures)
- If election is made, clubs must capitalize all repair costs that are capitalized for book purposes
- De minimis safe harbor for costs to acquire or produce tangible property:
- Clubs must generally capitalize amounts paid to acquire or produce a unit of real or tangible personal property
- If clubs have an applicable financial statement (AFS), they may be able to elect to deduct items costing up to $5,000 (on an item or invoice basis) in accordance with financial statement treatment. To qualify for the safe harbor, clubs must have written accounting procedures in place as of the beginning of the tax year that provide for the deduction of items costing less than a certain amount and/or with an economic useful life of 12 months or less, and clubs must deduct such items in their AFS in accordance with the club's written policy
- If clubs do not have an AFS, they may be able to elect the safe harbor for items costing up to $500 (per invoice or item). In this case, clubs must have an accounting procedure in place as of the beginning of the tax year that provides for the deduction of items costing less than a certain amount and/or with an economic useful life of 12 months or less, and they must deduct such items for book purposes in accordance with their policy
- Improvement costs:
- Clubs must generally capitalize amounts paid to improve a unit of property
- Improvements include:
- A betterment to the unit of property
- A restoration of the unit of property
- An adaptation of the unit of property to a new or different use
- Disposition of assets (proposed regulations)
- Proposed regulations may be relied on for tax years beginning on or after Jan. 1, 2012 and before Jan. 1, 2014. The IRS plans on finalizing regulations regarding asset dispositions for use by taxpayers in their tax years beginning on or after Jan. 1, 2014
- Governs treatment of dispositions of assets (including sale, exchange, retirement, physical abandonment or destruction)
- Assets are determined on a facts and circumstances basis; however, a building (including its structural components) is treated as one asset.
- Proposed regulations allow clubs to elect to recognize partial dispositions (e.g., retirements of structural components of buildings) and to recognize gain/loss instead of continuing to depreciate the component, but do not generally require clubs to do so
- A disposal of assets included in a general asset account election is generally not recognized (however, clubs may elect to recognize a qualifying disposition or a disposition of all or the last asset in a general asset account)
Although the final regulations are not mandatory until tax years beginning on or after Jan. 1, 2014 (and, in some cases, for amounts paid or incurred in tax years beginning on or after Jan. 1, 2014) to the extent adoption of one or more provisions constitutes a change in method of accounting, taxpayers may be required to file Forms 3115.
The IRS has promised guidance on how to properly adopt the regulations. Such guidance will provide automatic method change procedures and will be issued in the form of two revenue procedures, the first of which was issued on Jan. 24, 2014 (Rev. Proc. 2014-16). Private clubs should work with their tax advisors to assess the impact of the tangible property regulations and develop an action plan for optimizing their filing positions and ensuring compliance.