The Repair Regulations or the Tangible Property Regulations are rules issued by the IRS with regards to the deduction and capitalization of expenditures related to tangible property. The Repair Regulations are applicable to businesses that acquire, produce, replace or improve tangible property. Application of the new Repair Regulations requires an in-depth understanding of various tax cases and circumstances that must be met. Gian Pazzia and Alex Bagne, KBKG’s in house experts in the field of Repair Regulations recently held a webinar and discussed several technical issues. As leading educators in the accounting industry, we are pleased to share our Q&A session.
Q: What was de minimis threshold under prior law? Whatever taxpayer choose or would IRS apply a $200 threshold as under current Regs?
A: The de minimis safe harbor under the Temp Regs was also $5000 with AFS, $500 without. The $200 threshold is for materials and supplies, whereby the IRS will allow a taxpayer to treat anything less than this amount as an immediately deductible material and supply. Under the Temp Regs, this threshold was $100.
Q: Is it advisable to have vendors invoice by building system?
A: If possible, I would recommend it.
Q: Sounds like vendors will have to be on board with this cost segregation. Otherwise, will be difficult to implement?
A: If you can get the vendors to breakout costs, it would be helpful. Of course, cost segregation is an area where we can certainly provide assistance.
Q: Does a compiled or reviewed financial statement count as an AFS?
A: Unfortunately, neither reviewed nor compiled financial statements qualify.
Q: Could you discuss roof replacements or repairs?
A: In brief, retiring a roof as part of its maintenance or installing a new roof membrane would be immediately deductible. If the whole roof is being replaced, it would be capitalized. However, there may be an opportunity to take a loss on the old one if segregated out. For partial roof replacements, it’s a facts and circumstances test. If 10% of the roof is replaced, it’s probably a repair. If 65%, then probably capital.
Q: Want to clarify – if motor replacement is expected every three to five years, still expense even though it betters/restores and motor is about 20% of total value?
A: It’s important to note that the Safe Harbor specifically does not apply to betterment, adaptations, and certain restorations. If the ADS class life is 10 years or more, which is common for many types equipment, and the plan is to replace the motor every 3-5 years (i.e., more than once in the class life), then it does not seem like this would be a betterment or restoration. It would be routine maintenance.
Q: Wouldn’t the segregation hurt in some instances? Breaking out parking lot and making it a separate UOP would then mean that repaving part of it would be significant to the overall value where repaving part of the parking lot when it’s part of the entire building would be a small percent so likely an expense item?
A: If the taxpayer is repaving part of a parking lot, it would be either a land improvement or repair and maintenance item. You cannot combine items with different class lives as one UOP (i.e., land improvement with building). Thus, you cannot factor the whole building cost when deciding whether the repaving is an expense or a capitalized asset.
Q: The primary focus here seems to be on tax; it does not appear there will be discussion of applicability of these rules related to FASB/GAAP. Is that correct?
A: Yes. We’re focusing on tax.
Q: So is a 3115 required for all taxpayers to adopt the new regs?
A: 3115s are required for most taxpayers. Some are to correct items that do not conform to the new regulations (i.e., an expenditure incurred in a prior year that was treated as an immediately deductible repair when it should be capitalized). Other 3115’s are needed to change accounting methods on a go forward basis.
Q: So each building system is to be considered as 1 UOP?
A: For these purposes, yes.
Q: Remediation of contamination stills betterment if seller and buyer totally unaware contamination is present?
A: Without knowing the details, I would expect it to be a restoration, which would require capitalization.
Q: Clear up the material and supplies $200 safeguard threshold, please! Are items as inconsequential as paper towels, rubber bands involved in the $200 threshold?
A: Yes. All of these items are materials and supplies and are deductible. When they are deductible (when purchased vs. when consumed) depends on whether they are tracked. I will discuss this in the presentation.
Q: Lastly, what do you recommend who have not established a policy prior to 1/1/2014?
A: For taxpayers without AFS who are using the $500 threshold, the policy does not need to be in writing. I’d recommend that they establish a policy, implement it from the beginning of the year, and follow it consistently.
Q: $500 question without AFS policy. The preambles state the IRS will not respect backdated or retroactive policies. Do you still suggest making a policy that is retroactive?
A: It’s still early in the year. Has your client established and followed a policy counter to the $500 threshold for this year? If so, then the technically correct answer is to not make the policy retroactive.
Q: Part of that de minimis is to have a non-tax purpose. If it’s a taxpayer without AFS that does everything on a tax basis, how can you utilize the $500?
A: The goal of this rule is consistency between book and tax. If the taxpayer is using tax for book, they still would be able to use the $500.
Q: Who would have a need for cost segregation?
A: Building owners, go to our website to learn more. kbkg.com/cost segregation
Q: If the regs conflict with prior case law on repair vs. capitalization, what is the advice?
A: It’s difficult to answer this without knowing which case and the facts litigated, however, since the regs are more current, we would generally say to follow the regulations.
Q: How soon after an acquisition can a taxpayer do a retirement study?
A: A building that is acquired, immediately renovated and then placed in service would not have any opportunity for a retirement study because the assets removed were never placed in service and have no value.
Q: How does UOP pertain to apartment complexes? Is the UOP the entire complex or each building itself?
A: Each building needs to be examined individually.