United States

Forms 3115 may be needed to adopt tangible property regulations

INSIGHT ARTICLE  | 

On March 5, 2014, RSM’s tangible property regulations specialists Kate Abdoo and Kari Peterson hosted a webcast discussing the transitional guidance released under the final (and re-proposed) tangible property regulations. The webcast featured Scott Mackay, a tax specialist from the Treasury Department’s Office of Tax Policy. During the webcast, Mr. Mackay provided valuable insight on Rev. Proc. 2014-16, which provides automatic accounting method changes under the final regulations surrounding the treatment of materials and supplies and costs to acquire, maintain and improve tangible property, and Rev. Proc. 2014-17, which provides automatic accounting method changes under the re-proposed regulations surrounding dispositions of tangible property and the treatment of assets included in general asset accounts. Taxpayers should take time now to determine whether one or more Forms 3115 should be filed with their 2013 tax returns to early adopt portions of the final or re-proposed regulations. Furthermore, taxpayers that decide to wait until their first tax year beginning on or after Jan. 1, 2014, to adopt the final regulations should consider the applicable Form(s) 3115 and the steps that will be necessary to ensure compliance by the effective date of the regulations.

Several thoughts expressed during the webcast may have a direct impact on taxpayers that are contemplating the need to file one or more Forms 3115 to adopt the final (and re-proposed) regulations (either as an early adoption for tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014, or as a timely adoption for the first tax year beginning on or after Jan. 1, 2014). Following are key takeaways and considerations from the webcast:

  1. It is likely that nearly all taxpayers will need to file a Form 3115 to adopt the final regulations governing the treatment of materials and supplies. Because the definition of materials and supplies contained in the final regulations did not exist prior to the release of the temporary regulations issued in December 2011 and was changed slightly with the final regulations, it is unlikely that taxpayers already have an established method of accounting that is in accordance with the final regulations. Thus, taxpayers should carefully consider how they define materials and supplies and the timing of when they deduct the cost of such items. Additionally, it is possible that some taxpayers’ materials and supplies will fall under the de minimis safe harbor. However, even in this case, it may be necessary to file a Form 3115 to put the taxpayer on a proper method of accounting for materials and supplies so that in a later year, if the taxpayer chooses not to elect the de minimis safe harbor (or inadvertently fails to attach the safe harbor election statement), its treatment of incidental materials and supplies as deductible in the year purchased will nonetheless be protected. 

    Additionally, even if a taxpayer determines that its method does accord with the final regulations, it may be beneficial to file a Form 3115 that explains how the taxpayer’s present method of accounting aligns with the regulations. This change may be made automatically under appendix section 10.11 of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16, and is generally filed with a modified section 481(a) adjustment (i.e., the section 481(a) adjustment should take into account only amounts paid or incurred in tax years beginning on or after Jan. 1, 2014, unless the taxpayer elects to take into account amounts paid or incurred in tax years beginning on or after Jan. 1, 2012.) The scope limitations included in Rev. Proc. 2011-14 are waived as long as the taxpayer’s year of change is a tax year that begins before Jan. 1, 2015.

  2. It is possible a taxpayer that has historically overcapitalized repair costs for book purposes and has followed this treatment for tax may not be required to file a Form 3115 to adopt the improvement rules contained in the final regulations as long as the taxpayer will make the election to capitalize repair costs under Reg. section 1.263(a)-3(n) in 2014 (or 2013 for early adopters) and future tax years. However, taxpayers should note that if they decide not to make this election (either in the current or a future tax year), they will likely have to file a Form 3115 to adopt the improvement rules under the final regulations. In this narrow fact pattern, the taxpayer may be able to make this change with a $0 section 481(a) adjustment. Additionally, it may be beneficial for taxpayers to file a Form 3115 for their 2013 or 2014 tax year to adopt the new improvement rules even if they do intend to make the election to capitalize repair costs. In such a case, even if the taxpayer chooses not to make this capitalization election in a future year, it will already be on a proper method of accounting for such costs. A change to adopt the improvement rules of the final regulations may be made automatically under appendix section 10.11 of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16. The scope limitations included in Rev. Proc. 2011-14 are waived as long as the taxpayer’s year of change is a tax year that begins before Jan. 1, 2015.

  3. Although the elections to recognize partial dispositions and qualifying dispositions and to place assets in a general asset account (GAA) are generally not treated as methods of accounting (but, rather, are elections that must be made on a timely filed tax return), for a limited transition period, taxpayers have the option of filing one or more Forms 3115 to recognize a prior-year disposition, make a late partial disposition election, make a late qualifying disposition election (for assets placed in a general asset account), or make a late general asset account election. Specifically, taxpayers are generally able to file a Form 3115 to make such late elections for tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014. Since Forms 3115 for automatic method changes must be filed no later than the date a taxpayer timely files its tax return for the year of change (including extensions), calendar-year taxpayers may presently only file one or more Forms 3115 to recognize a prior-year disposition or make a late election under the proposed disposition regulations for their 2013 tax years. However, it is expected that once the proposed disposition regulations are finalized, Rev. Proc. 2014-17 will be updated to extend the ability to make such late elections through Forms 3115 for a taxpayer’s first tax year beginning on or after Jan. 1, 2014.

Implications

It is expected that the final disposition regulations will be released in the spring of 2014, with Rev. Proc. 2014-17 to be updated shortly thereafter. Taxpayers should take time to determine whether one or more Forms 3115 should be filed with their 2013 tax returns to early adopt portions of the final or re-proposed regulations. Additionally, taxpayers that have disposed of assets or portions of assets in prior years should consult with their tax advisors to determine whether filing a Form 3115 to recognize a prior-year disposition is advisable. In the case of full asset dispositions in prior years that were not recognized for federal income tax purposes, it is advantageous for taxpayers to file a Form 3115 for 2013 to recognize the disposition and thus protect themselves from permanently losing the remaining basis in such asset(s). In the case of partial dispositions in prior years, to the extent the replaced components are required to be capitalized as improvements, taxpayers should consider filing a Form 3115 for 2013 to make the late partial disposition election (and recover the remaining basis in the disposed portion of such assets).

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