United States

Guidance released under the final tangible property regulations

INSIGHT ARTICLE  | 

On Jan. 24, 2014 the IRS issued Rev. Proc. 2014-16,[1] the first of two highly anticipated revenue procedures providing automatic accounting method changes under the final (and re-proposed) tangible property regulations. Specifically, Rev. Proc. 2014-16 provides automatic method change procedures to adopt the final regulations governing the treatment of materials and supplies and costs to acquire, maintain and improve tangible property (the final regulations).[2]

Taxpayers should evaluate their current accounting methods and consult with their tax advisors to determine the benefits of early adopting one or more provisions of the final regulations and develop the necessary procedures to adopt or elect such provisions in general. Additionally, taxpayers that have already adopted one or more provisions of the temporary regulations should determine whether additional Form(s) 3115 are necessary under the final regulations.

Rev. Proc. 2014-16 modifies and supersedes Rev. Proc. 2012-19 (the revenue procedure providing transition guidance under the temporary regulations issued in 2011) and provides method changes not only to adopt the final regulations but also to adopt the temporary regulations that were issued in December 2011 for taxpayers that wish to apply the temporary regulations to their tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014. 

Although Rev. Proc. 2014-16 provides automatic method changes similar to its predecessor under the temporary regulations, changes under the final regulations differ in certain respects to account for the modified rules of the final regulations. Additionally, the general procedures for requesting automatic method changes under Rev. Proc. 2014-16 differ in many significant aspects from Rev. Proc. 2012-19.

Rev. Proc. 2014-16 adds appendix section 10.11 to Rev. Proc. 2011-14 (the revenue procedure providing general automatic change procedures and the majority of specific automatic changes).  Appendix section 10.11 provides the following automatic method changes under the final regulations:[3]

  • A change to deducting repair and maintenance costs or a change to capitalizing improvement costs and, if depreciable, to depreciating such property under section 167 or 168 (including a change, if any, in the method of identifying the unit of property (UOP) or in the case of building property, identifying the building structure or building system for purposes of making this change) under Reg. section 1.162-4 and/or Reg. section 1.263(a)-3 (change number 184).
  • Change to the regulatory accounting method under Reg. section 1.263(a)-(3)(m) (change number 185).
  • Change to deduct amounts paid or incurred to acquire or produce non-incidental materials and supplies that are used and consumed in the taxpayer’s business under Reg. section 1.162-3(a)(1) and (c)(1) (change number 186).
  • Change to deduct amounts to acquire or produce incidental materials and supplies in the tax year paid or incurred under Reg. section 1.162-3(a)(2) and (c)(1) (change number 187).
  • Change to deduct amounts paid or incurred to acquire or produce non-incidental rotable and temporary spare parts when disposed of under Reg. section 1.162-3(a)(3) and (c)(2) (change number 188).
  • Change in the optional method of accounting for rotable and temporary spare parts under Reg. section 1.162-3(e) (change number 189).
  • Change by a dealer in property to deduct amounts paid or incurred for commissions and other transaction costs that facilitate the sale of property under Reg. section 1.263(a)-1(e)(2) (change number 190).
  • Change by a non-dealer in property to capitalize amounts paid or incurred for commissions and other transaction costs that facilitate the sale of property under Reg. section 1.263(a)-1(e)(1) (change number 191).
  • Change to capitalizing acquisition or production costs under Reg. section 1.263(a)-2 and, if depreciable, to depreciating such property under section 167 or section 168 (change number 192).
  • Change to deducting certain costs for investigating or pursing the acquisition of real property under Reg. section 1.263(a)-2(f)(2)(iii) (change number 193).

Appendix section 10.11 waives the scope limitations provided in section 4 of Rev. Proc. 2011-14 as long as the year of change is a tax year that begins before Jan. 1, 2015. Thus, taxpayers that would otherwise be scoped out of the general automatic change procedures of Rev. Proc. 2011-14 (e.g., because they are under exam, have made a change in method of accounting for the same item within the past five years, etc.) may nonetheless file one or more Forms 3115 to adopt the final regulations. This is true even if the taxpayer is under exam and the item being changed is an issue being considered as part of the examination.[4] In this case, the taxpayer may file a Form 3115 to put itself on a proper method of accounting for the item under the final regulations and may obtain audit protection for that item (effectively pulling the issue from exam).

A significant change from Rev. Proc. 2012-19 includes the consolidation of the change to capitalize improvement costs with the change to deduct repair and maintenance costs.[5] Under Rev. Proc. 2012-19, taxpayers had the option of early adopting a method for repair costs that was in line with the temporary regulations (which resulted in a favorable section 481(a) adjustment) while deferring the adoption of a permissible method for determining improvement costs (which resulted in an unfavorable section 481(a) adjustment). By combining these two methods into one, Rev. Proc. 2014-16 prevents taxpayers from early adopting the favorable repair component of Reg. sections 1.162-4 and 1.263(a)-3 while deferring the unfavorable improvement component. Thus, to the extent taxpayers are contemplating requesting a change in method for repair costs paid or incurred with respect to a specified UOP, they should also determine whether any costs presently treated as deductible repairs should be reclassed as improvement costs. Taxpayers should also note, however, that because the scope limitations in section 4.02 of Rev. Proc. 2011-14 are waived for changes under appendix section 10.11 for tax years beginning before Jan. 1, 2015, the failure to include all improvement or repair costs in a Form 3115 in one tax year will not disqualify a taxpayer from filing another Form 3115 for the missed costs or UOPs in a subsequent tax year as long as such subsequent year begins before Jan. 1, 2015.

Additionally, the method changes relating to the final regulations that are applicable to amounts paid or incurred in tax years beginning on or after Jan. 1, 2014 (e.g., treatment of materials and supplies) are generally made with a modified section 481(a) adjustment. This means that section 481(a) adjustments will generally only be calculated for tax years beginning on or after Jan. 1, 2014. However, taxpayers have the option of calculating a section 481(a) adjustment that takes into account amounts paid or incurred in tax years beginning on or after Jan. 1, 2012.[6] 

Another significant change from Rev. Proc. 2012-19 is the elimination of the requirement to request concurrent method changes under section 263A (UNICAP) for those taxpayers that are presently on an impermissible UNICAP method. Under Rev. Proc. 2012-19, if the item being changed was required to be capitalized under section 263A and the taxpayer was not presently capitalizing such item, to qualify for the automatic method change, the taxpayer had to file a concurrent method change to put itself on a proper method of accounting for UNICAP purposes.  Revenue Procedure 2014-16 eliminates this requirement altogether, allowing taxpayers to request automatic method changes under the final (and temporary) regulations regardless of whether they are on a proper UNICAP method of accounting for that item. However, to the extent taxpayers must compute a section 481(a) adjustment and can reflect the impact of their present UNICAP method of accounting in such adjustment, taxpayers should do so.  Additionally, while not required, taxpayers do have the option of requesting a concurrent automatic method change for UNICAP.[7] If a taxpayer chooses to request a concurring change, the scope limitations in Rev. Proc. 2011-14[8] are waived if the year of change is a tax year beginning before Jan. 1, 2015.[9]

Rev. Proc. 2014-16 also modifies the existing automatic change for costs incurred in the removal or retirement of a depreciable asset to account for clarifications made in the final regulations, which provide that removal costs may be deducted where the taxpayer recognizes a disposition of the removed asset (or partial asset) for federal income tax purposes. Appendix section 10.03 of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16, now provides that a taxpayer may automatically change to a method of accounting for certain costs associated with the retirement and removal of a depreciable asset to conform with Rev. Rul. 2000-7 or for removal costs incurred in disposing of a depreciable asset, including a partial disposition, as described under Reg. section 1.263(a)-3(g)(2)(i). 

Rev. Proc. 2014-16 generally provides simplified procedures for qualifying small taxpayers, allowing such taxpayers to file one or more Forms 3115 under the final (and temporary) regulations without filling out all required lines of the Form 3115. For this purpose, a qualifying small taxpayer is one with $10 million or less in average annual gross receipts for the prior three tax years.[10]

Although each change identified in appendix section 10.11 is a separate change in method of accounting, by grouping changes made under the final regulations into one appendix section, Rev. Proc. 2014-16 allows taxpayers to request one or more of the changes on a single Form 3115. If more than one change is filed on the same Form 3115, taxpayers must provide a separate section 481(a) adjustment for each separate change. In accordance with the general accounting method change procedures in Rev. Proc. 2011-14, any favorable (i.e., negative) section 481(a) adjustments will be taken into account in full in the year of change, while any unfavorable (i.e., positive) section 481(a) adjustments will be spread ratably over four tax years, beginning with the year of change.[11] Taxpayers wishing to change a method under both the final (or temporary) regulations and UNICAP should file a single Form 3115. Finally, taxpayers are instructed to file a copy of the completed Form(s) 3115 with the IRS in Ogden, Utah[12] no earlier than the first day of the tax year of change and no later than the date the tax return for the year of change is timely filed (including extensions). As with other automatic accounting method changes, a duplicate filing requirement is in effect whereby the original Form 3115 must also be attached to the tax return for the year of change.[13]

Rev. Proc. 2014-16 is effective for Forms 3115 filed on or after Jan. 24, 2014, but does provide transitional guidance for taxpayers that filed one or more Forms 3115 under either Rev. Proc. 2012-19 or the non-automatic method change procedures of Rev. Proc. 97-27 prior to Jan. 24, 2014. In the case of a taxpayer that previously filed a change in accounting method under Rev. Proc. 97-27 requesting consent for a change in method described in Rev. Proc. 2014-16 that is pending with the IRS national office as of Jan. 24, 2014, the taxpayer may instead choose to make the change under Rev. Proc. 2014-16 if the taxpayer is otherwise eligible to do so.[14] Alternatively, if the taxpayer filed one or more Forms 3115 under Rev. Proc. 2012-19 prior to Jan. 24, 2014, the taxpayer may continue with such filing or may file an amended application under Rev. Proc. 2014-16 by the due date of the federal income tax return for the year of change (excluding extensions).[15] 

Implications

The transitional guidance provided in Rev. Proc. 2014-16 clarifies and modifies the procedures taxpayers should undertake to change their methods of accounting to comply with the final (or temporary) tangible property regulations governing the treatment of materials and supplies and costs to acquire, maintain or repair, and improve tangible property. The second revenue procedure (Rev. Proc. 2014-17) providing transitional guidance under the re-proposed disposition regulations was released on Feb. 28, 2014, and will be the subject of another article. Rev. Proc. 2014-17 supersedes Rev. Proc. 2012-20 and provides automatic accounting method change procedures to adopt either the re-proposed disposition regulations or the temporary disposition regulations issued in December 2011 (for taxpayers that wish to apply the temporary disposition regulations to tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014). 

In addition to understanding how these two revenue procedures impact the ability to adopt the final and proposed regulations, taxpayers should also keep in mind that several provisions of the regulations are adopted through annual elections that do not permit or require the filing of a Form 3115 (e.g., the de minimis safe harbor or the small taxpayer safe harbor). The procedures to make these annual elections are provided in the final regulations. 

Taxpayers should evaluate their current accounting methods and consult with their tax advisors to determine the benefits of early adopting one or more provisions of the final regulations and the necessary procedures to adopt or elect such provisions (either in tax years beginning on or after Jan. 1, 2012, or years beginning on or after Jan. 1, 2014). Additionally, taxpayers that have already adopted one or more provisions of the temporary regulations should determine whether additional Form(s) 3115 are necessary under the final regulations.

 

[1] Rev. Proc. 2014-16 was published in the Internal Revenue Bulletin (IRB) on Feb. 24, 2014, with slight modifications from the version released on Jan. 24, 2014. The discussion of Rev. Proc. 2014-16 in this article revolves around the version of the revenue procedure published in the IRB.

[2] See TD 9636.

[3] As discussed, Rev. Proc. 2014-16 provides similar automatic changes for taxpayers that wish to adopt the temporary regulations for tax years beginning on or after Jan. 1, 2012, and ending before Jan. 1, 2014. Since we expect changes under the temporary regulations to be rare, this article does not cover such changes in detail. Taxpayers that are considering making one or more changes under the temporary regulations should consult with their tax advisors to determine the advisability of such changes.

[4] For purposes of Rev. Proc. 2011-14, as modified by Rev. Proc. 2012-39 and Rev. Proc. 2014-16, an item is an issue under consideration as part of an exam if the taxpayer receives “written notification (for example, by examination plan, information document request (IDR), or notification of proposed adjustments or income tax examination changes) from the examining agent(s) specifically citing the treatment of the item as an issue under consideration.” Section 3.09 of Rev. Proc. 2011-14.

[5] This consolidation applies to changes under both the temporary and final regulations.

[6] See Appendix section 10.11(6)(b)(i) of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16. For such changes made under the temporary regulations, this modified section 481(a) adjustment must take into account amounts paid or incurred in tax years beginning on or after Jan. 1, 2012. See appendix section 10.11(6)(b)(ii) of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16.

[7] This assumes the UNICAP method change falls within one of the automatic method changes under appendix section 11.01 (certain UNICAP methods used by resellers and reseller-producers), appendix section 11.02 (certain UNICAP methods used by producers and reseller-producers), newly added appendix section 11.09 (change to a reasonable allocation method described in Reg. section 1.263A-1(f)(4) for self-constructed assets), or newly added appendix section 11.10 (real property acquired through foreclosure) of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16.

[8] As modified by Rev. Proc. 2012-39.

[9] As with the waiver of the scope limitations for the changes made under the final regulations, this provides taxpayers that are under exam with the ability to acquire audit protection for any UNICAP issues being looked at as part of the exam.

[10] The determination of whether the taxpayer has $10 million or less in average annual gross receipts for the prior three tax years is made in accordance with the rules under Reg. section 1.263(a)-3(h)(3).

[11] See appendix section 10.11(6)(c) of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16 (as published in the IRB on Feb. 25, 2014).  Prior to publication, appendix section 10.11(5)(b) provided the ability to net multiple section 481(a) adjustments relating to a single identified UOP. However, in response to taxpayer confusion, this provision was eliminated in the version of Rev. Proc. 2014-16 that was published in the IRB on Feb. 25, 2014.

[12] However, the change for removal costs under appendix section 10.03 of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16, should still be filed with the IRS national office.

[13] See appendix section 10.11(7) of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16.

[14] See section 4.02(1) of Rev. Proc. 2014-16 for specific procedures relating to a request to return and resubmit a Form 3115 in this case.

[15] See section 4.02(2)(b) of Rev. Proc. 2014-16 for specific procedures relating to an amended Form 3115 in this case.

AUTHORS