A Capitalizable Christmas Present

Just before the New Year, the IRS released much-anticipated temporary and proposed regs on the capitalization of tangible property (so-called "repair regs"). The regs, the IRS explained, are intended to clarify and expand existing standards for capitalization of specific expenses associated with tangible property and provide some bright-line tests for applying the standards.  Many taxpayers will not consider the new definitions of a unit of property to be much of a Christmas present.  Much analysis of these regs will be needed are they are implemented in 2012.

 Background

Under Code Sec. 263(a), amounts paid to acquire, produce, or improve tangible property generally must be capitalized. The IRS issued proposed regs in 2006 that attempted to carve out certain repairs and maintenance exceptions. Those proposed regs were further refined in 2008. Now, the IRS has issued new regs, not only making further changes but also making the regs "temporary regs," binding on both taxpayers and the government. The temporary regs are generally effective for expenditures made in tax years beginning on or after January 1, 2012.

Materials and supplies

The temporary regs generally track the definition of materials and supplies in the 2008 regs and provide an alternative optional method of accounting for rotable and temporary spare parts, along with an election to treat certain materials and supplies under the de minimis rule of Reg §1.263(a)-2T.

Repairs

The temporary regs also generally track the treatment of repairs under the 2008 regs. A taxpayer is permitted to deduct amounts paid to repair and maintain tangible property provided such amounts are not required to be capitalized under Code Sec. 263(a) or any other provision of the Tax Code or regs.

To determine whether payments are repairs or capital expenditures, taxpayers must first look at the unit of property. The regs add clarity regarding a unit of property.

Rentals/leased property

The temporary regs reflect the existing rule in Reg. §1.162-11(a) that provides a taxpayer may amortize the cost of acquiring a leasehold over the term of the lease. The temporary regs also revise the rule in Reg. §1.162-11(b) that provides that the cost of erecting a building or making a permanent improvement to property leased by the taxpayer is a capital expenditure and is not deductible as a business expense.

Acquire/produce tangible property

The temporary regs generally track the 2008 regs in the treatment of amounts paid to acquire or produce units of tangible property. Generally, acquisition and production costs must be capitalized. The temporary regs also address moving and reinstallation costs; work performed prior to placing property into service; and transaction costs. Additionally, the temporary regs modify the de minimis rule in the 2008 regs.

Amounts to improve property

The temporary regs retain the approach in the 2008 regs for determining the unit of property and for determining whether there is an improvement to the unit of property. The temporary regs also retain some of the simplifying conventions in the 2008 regs.

Accounting method

The IRS reported it anticipates issuing additional guidance to advise taxpayers regarding how to obtain automatic consent to change to a method of accounting provided in the temporary regs for tax years beginning on or after January 1, 2012. These automatic consent requests may be filed beginning with taxpayers’ 2012 returns. Taxpayers may not request a change to a method described in the temporary regs on their 2011 returns, the IRS advised.