The final tangible property regulations: Laugh all the way to the bank
In September 2013, the Treasury Department and the IRS released the much-anticipated final (and proposed) tangible property regulations. The regulations include several provisions that will have an impact on how banks or other taxpayers in the financial industry account for costs related to tangible property. Specifically, the areas of the regulations that are most likely to affect banks include:
- Provisions governing the treatment of materials and supplies
- A de minimis safe harbor allowing for the deduction of certain "de minimis" purchases of tangible property
- Rules governing the treatment of costs to acquire and improve tangible personal and real property (e.g., ATM machines and building property, such as central offices and bank branches)
- Dispositions of assets and structural components of buildings
The majority of the regulations were issued in final form. However, as expected, regulations surrounding dispositions of tangible property were issued in proposed form, but also as reliance guidance.
These mandatory regulations are complicated and require time and resources to digest, analyze and implement. Although a full discussion addressing all the details of implementing these new regulations, including tax accounting method changes, adoption of capitalization policies and future tax compliance, is beyond the scope of this article, taxpayers within the banking industry, like many other taxpayers, should appreciate the impact of these regulations.
Generally, the final regulations are effective for tax years beginning on or after Jan. 1, 2014. However, taxpayers may early adopt some or all provisions for tax years beginning on or after Jan. 1, 2012.1 The regulations allow for several safe harbors and elections that are applied through annual elections that do not require (or permit) accounting method changes. Other provisions are treated as methods of accounting that must be implemented through one or more Forms 3115. To aid taxpayers in the transition to the final regulations, the government recently released two revenue procedures providing automatic method change procedures under the final and proposed regulations. Revenue Procedure 2014-16 provides automatic method change procedures for the treatment of costs to acquire, repair and improve tangible property, while Rev. Proc. 2014-17 provides automatic method change procedures for the rules governing dispositions of tangible assets.
As discussed below, while some provisions may require the capitalization of costs presently being deducted, other provisions could result in an acceleration of deductions. Early adoption may allow for early implementation of favorable provisions and deferral of unfavorable ones. This opportunity, along with a desire to mitigate the risks associated with noncompliance, should motivate taxpayers in the banking industry to invest the time, effort and resources to understand and comply with these regulations.
Materials and supplies
The regulations define materials and supplies to generally include items that have a useful life of 12 months or less, or an acquisition cost of $200 or less. Incidental materials and supplies (i.e., those for which no record of consumption is kept) are generally deductible in the tax year purchased, while non-incidental supplies are deductible in the tax year first used in a taxpayer's operations.2
The treatment of materials and supplies is considered a method of accounting. Thus, taxpayers will generally need to file a Form 3115 to adopt a proper method of accounting under the final regulations.
De minimis safe harbor
Taxpayers with an applicable financial statement (AFS) may elect to currently deduct the purchase of items costing up to $5,000 if certain conditions are met.3 Applicable financial statements include certified, audited financial statements, financial statements required to be submitted to the Securities and Exchange Commission (SEC), and financial statements required to be submitted to a federal or state agency (other than the IRS or SEC).4For example, since a call report required to be submitted to the Federal Deposit Insurance Corp. (FDIC) will generally qualify as an AFS, taxpayers within the financial industry generally will have a financial statement that qualifies them for this safe harbor.
To elect this safe harbor, a taxpayer must have a written capitalization policy in effect as of the beginning of the tax year of election that provides for the expensing of items costing less than a threshold amount or with an economic useful life of 12 months or less, and such items must be expensed for AFS purposes in accordance with the written policy. If elected, the safe harbor must be applied to all qualifying items (i.e., all items which are expensed for AFS purposes in accordance with the capitalization policy and with a cost of $5,000 or less). The safe harbor is applied through an annual, irrevocable election that must be made with a timely filed tax return (i.e., this is not treated as a method of accounting).5
Costs to improve tangible property
The regulations provide comprehensive rules to determine whether costs incurred with respect to any units of tangible property are deductible repair costs or capitalizable improvement costs. An expenditure will be treated as a capitalizable improvement if the expenditure results in the betterment, restoration or adaptation of a "unit of property".6 Though this analysis is highly factual, the regulations provide numerous examples intended to aid taxpayers in applying each standard to its applicable unit of property.
A unit of property is generally determined by including all components that are functionally interdependent as one unit. In the case of building property, the regulations provide that a building (including all structural components) is treated as one unit of property. However, the improvement standards must be applied separately to one or more of eight defined building systems or the building structure, as applicable.7 Thus, an expenditure is more likely to be treated as an improvement than it otherwise would if the expenditure was analyzed in light of the building as a whole. However, the regulations do provide a routine maintenance safe harbor that allows for certain recurring costs to be treated as deductible repairs if the taxpayer reasonably expects to incur the costs more than once during the 10-year period beginning with the placed in service date of the building structure or applicable system.8
Application of the unit of property and improvement rules (including the routine maintenance safe harbor) is considered a method of accounting, and taxpayers will generally need to file a Form 3115 to adopt a proper method of accounting under the final regulations.
Dispositions of tangible property
The proposed disposition regulations provide guidance on recognizing dispositions of tangible assets. For purposes of determining when an asset has been disposed of, a building (including all of its structural components) is treated as one asset.9 However, for assets not included in general asset accounts, the disposition of a portion of an asset (e.g., the retirement of a structural component of a building) may be treated as a disposition for federal income tax purposes if the taxpayer elects to recognize the partial disposition.10 This partial disposition election may prove beneficial to taxpayers that are undergoing capitalizable renovations of buildings (such as bank branches) by allowing an immediate write-off of a retired or abandoned component's basis.
The partial disposition election is generally not treated as a method of accounting, but rather is made by electing to recognize the disposition in accordance with the proposed regulations in the year the disposition occurs. However, for a limited period of time, taxpayers may request an automatic accounting method change (through a Form 3115) to make a late partial disposition election (and recognize a partial disposition from a prior tax year). The ability to file such a Form 3115 is presently limited to tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014 (although it is expected that this will be extended to the first tax year beginning on or after Jan. 1, 2014, with the finalization of the proposed regulations).11
What you should be thinking about now
Most taxpayers will need to change one or more of their present tax accounting methods to comply with the regulations. Depending on the change being made, the computation of a section 481(a) adjustment to account for the cumulative effect of adopting a new accounting method may be required. However, the implementation of certain provisions (such as the de minimis safe harbor and partial disposition election) will require an annual election in lieu of the filing of a Form 3115. A clear understanding of which provisions are applied through elections and which provisions are considered methods of accounting is imperative, as most elections must be made on a timely filed return and are generally irrevocable.
The good news is that generally all changes requiring a Form 3115 to adopt the final (or proposed) regulations may be made automatically under the procedures of Rev. Proc. 2014-16 and 2014-17.12 Automatic Forms 3115 must be filed no later than the time the taxpayer timely files their return for the year of change. Thus, calendar-year, extending taxpayers wishing to early adopt certain portions of the regulations for their 2013 tax year may have until Sept. 15, 2014, to file one or more of the required Forms 3115.
Taxpayers should begin the implementation process now, as gathering and analyzing the required data to determine which method changes and elections that will apply (and to calculate section 481(a) adjustments as necessary) may be time- and resource-consuming. While many of the provisions in the final regulations may require tax accounting and internal process changes, the regulations also provide several opportunities to accelerate deductions, decrease administrative burdens and increase book-tax conformity going forward. Taking time now to determine the best way to apply these regulations and changes may provide an opportunity for your banking business to structure tax accounting methods or annual elections in a way that will optimize the impact of the final regulations.
These mandatory regulations are complicated and require time and resources to digest, analyze and implement. More information can be found in RSM's tangible property regulations resource center.
1 The proposed disposition regulations may be relied on for tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014. It is expected that the proposed regulations will be finalized with minimal changes for use in tax years beginning on or after Jan. 1, 2014.
2See generally Reg. section 1.162-3.
3Taxpayers without an AFS may still qualify for the safe harbor; however, the applicable limit is reduced from $500 to $5,000 in this case.
4 See Reg. section 1.263(a)-1(f)(4).
5 See generally Reg. section 1.263(a)-1(f).
6 See generally Reg. section 1.263(a)-3.
7 The eight building systems are as follows: (1) HVAC systems; (2) plumbing systems; (3) electrical systems; (4) all escalators; (5) all elevators; (6) fire protection and alarm systems; (7) building security systems; and (8) gas distribution systems. See generally Reg. section 1.263(a)-1(e)(2).
8 See Reg. section 1.263(a)-3(i). The regulations also provide for a small taxpayer safe harbor that will allow qualifying taxpayers to elect not to apply the improvement standards to eligible building property. A detailed discussion of this safe harbor is beyond the scope of this article. However, qualifying small taxpayers are generally those with $10,000,000 or less in average annual gross receipts for the prior three years, and eligible building property generally includes buildings with an unadjusted basis of $1,000,000 or less. See generally Reg. section 1.263(a)-3(h).
9 See Prop. Reg. section 1.168(i)-8(c)(4)(ii)(A).
10 See Prop. Reg. section 1.168(i)-8(d)(1),(2).
11 See appendix section 6.33 of Rev. Proc. 2011-14, as amended by Rev. Proc. 2014-17.
12 Further, for a specified period of time, both of these revenue procedures waive the typical scope limitations that would otherwise limit the ability to file for automatic method changes. These scope limitations are found in section 4.02 of Rev. Proc. 2011-14, as modified by Rev. Proc. 2012-39, and generally apply where the taxpayer (or certain related parties) is under exam, has engaged in a section 381 transaction during the year of change or has requested a method change within the past five years for the item being changed. See appendix section 10.11(2)(a) of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-16. See also, e.g., appendix section 6.29(2) of Rev. Proc. 2011-14, as modified by Rev. Proc. 2014-17.