The IRS and Treasury Department have released final regulations that affect the treatment of materials and supplies, capitalization of amounts paid to acquire or produce tangible property, and the capitalization and deduction of expenditures relating to the repair or improvement of tangible property. These regulations will have an impact on most taxpayers regardless of industry and the application is mandatory for tax years beginning after December 31, 2013.
The De Minimis Expensing Rule has been changed to include a safe harbor provision which requires the taxpayer to have a written policy (examples following this article) at the beginning of the taxable year to expense amounts paid for property under a certain dollar amount or that has a useful life of 12 months or less. The expense must also be included in the taxpayer’s applicable financial statement (AFS), in accordance with the written policy, and not exceed $5,000. However if the taxpayer does not have an AFS then the dollar limitation is reduced to $500. Taxpayers without either an Applicable Financial Statement or written accounting procedure in place at the beginning of the year may still deduct expenditures for tangible property costing $200 or less.
An applicable financial statement includes:
- A financial statement required to be filed with the SEC
- A certified audited financial statement that is accompanied by the report of an independent certified public accountant
- A financial statement (other than a tax return) required to be provided to the federal or state government or any federal or state agency (other than the IRS)
This safe harbor provision requires the taxpayer to make a yearly irrevocable tax return election that is attached to a timely filed tax return (including extensions).
Materials and supplies are included with the de minimis safe harbor and are defined in the temporary and final regulations as tangible property that is used or consumed in the taxpayer’s business operations that is not inventory and that is:
- A component that is acquired to maintain, repair, or improve a unit of tangible property that is owned by the taxpayer
- Fuel, lubricants, water, and other similar items that are reasonably expected to be consumed within 12 months
- A unit of property that has an economic useful life of 12 months or less
- A unit of property with an acquisition or production cost of less than $200
- Identified by the IRS in published guidance
Rotable and temporary spare parts, which now includes stand-by emergency parts, will be deducted as materials and supplies in the year used or consumed unless the taxpayer elects an optional method of accounting for the parts.
- Rotable spare parts are materials and supplies that are installed on tangible property with the ability to be removed, repaired or improved, and reinstalled on the same or other property
- Temporary spare parts are installed temporarily until a new or repaired part is installed and then is stored for later use
- Standby emergency parts are acquired for a particular piece of machinery or equipment so as to avoid downtime. These parts are typically expensive, not subject to replacement, are not ordered in quantity, and repaired and reused
Standby emergency parts are not includible in the optional accounting method. However they are includible with the election to capitalize and depreciate as separate asset amounts along with rotable and temporary spare parts. The final regulations also included requirements regarding consistency with a taxpayer’s book treatment of rotable and temporary parts.
Repairs and Maintenance
The cost of certain routine maintenance need not be capitalized so long as the taxpayer reasonably expects to incur these costs more than once over the class life of the property. Under a routine maintenance safe harbor an amount paid is deductible if it is for recurring activities that a taxpayer expects to perform to keep a unit of property in its ordinarily efficient operating condition. The final regulations have expanded the safe harbor to include routine maintenance activities of a building and its’ structural components. These activities are only covered if a taxpayer reasonably expects to perform such maintenance more than once over a 10-year period. The final regulations also remove the consideration for how these costs have been treated on their financial statements to determine whether or not the costs are routine.
Continued requirement to capitalize amounts paid to improve a unit of tangible property. Improvements result in:
- Betterment to the property
- Restoration of the property
- Adaption to a new or different use
The final regulations have included an annual safe harbor election for buildings owned or leased by small taxpayers.
- Unadjusted basis of the building no greater than $1MM
- Average annual gross receipts of $10MM or less during three preceding tax years
- No capitalization requirement if repairs, maintenance, and improvements do not exceed $10,000 or 2% of the unadjusted basis of the building
Please contact EHTC for assistance in complying with these new regulations.
Examples of Written Accounting Policies
Taxpayers with Applicable Financial Statements
The general capitalization policy is that all tangible property and other fixed assets purchased costing in excess of $5,000 will be recorded as an asset with all other items costing less than this amount being expensed to the appropriate account. To determine if a repair or improvement will need to be capitalized, the consideration will need to be made if the expenditure extends the useful life of the asset repaired or improved only if the dollar value exceeds $5,000. All capital assets will be capitalized and depreciated over their estimated useful lives. The straight line basis will be used with depreciation being charged beginning with the month that the asset is placed in service.
Taxpayers without Applicable Financial Statements
The general capitalization policy is that all tangible property and other fixed assets purchased costing in excess of $500 will be recorded as an asset with all other items costing less than this amount being expensed to the appropriate account. To determine if a repair or improvement will need to be capitalized the consideration will need to be made if the expenditure extends the useful life of the asset repaired or improved only if the dollar value exceeds $500. All capital assets will be capitalized and depreciated over their estimated useful lives. The straight line basis will be used with depreciation being charged beginning with the month that the asset is placed in service.