30
Wisconsin Community Banker
July/August 2014
Another safe harbor under the
new regulations is for qualified small
businesses (defined as businesses with
gross receipts of $10 million or less).
For buildings with an initial cost of
$1 million or less, small businesses
may elect to deduct repairs, mainte-
nance, and improvements if the costs
do not exceed the lesser of $10,000 or
2 percent of the adjusted basis of the
property during the tax year.
There is also a de minimis rule for
expensing repairs. Taxpayers may
follow their book capitalization policy
for tax purposes if there is a writ-
ten accounting procedure in place
at the beginning of the taxable year
and the policy includes a specified
dollar amount. For taxpayers with
an applicable financial statement
(which includes call reports), the
dollar amount cannot exceed $5,000.
For taxpayers without an applicable
financial statement, the dollar amount
is not to exceed $500. The policy (and
dollar amount) should be renewed
annually and cannot be changed dur-
ing the year. The de minimis rule must
be applied to all amounts expensed
under the book policy including
materials and supplies. That means the
businesses can deduct the full pur-
chase price of tangible property (for
example, laptops or monitors) in one
year if they meet these requirements.
Establishing a formal capitalization
policy annually will be the key to max-
imizing the benefits of the de minimis
rule and can provide for some poten-
tial tax planning opportunities.
Besides the regulations that were
finalized in September 2013, the IRS
proposed significant changes to the
rules for dispositions and retirements
of tangible property. The proposed
regulations provide that disposition
rules apply to a partial disposition of
an asset. This change allows taxpayers
to claim a loss on the disposition or
replacement of structural components
of a building. The proposed rules also
allow taxpayers to assign a reasonable
value to those structural components
that are included in existing build-
ing costs and write them off when
replaced instead of continuing to
depreciate them over the life of the
building. This includes items with a
39-year tax life such as lighting, roofs,
HVAC systems, windows, and interior
and exterior walls. This will increase
the importance of cost segregation
studies, since the study will provide
solid evidence of the cost of specific
structural components within the total
cost of a building.
What Does All This Mean?
In the past, a building and its
structural components were treated as
a single asset as long as the taxpayer
owned it. Now, as explained above,
a building consists of its structure
and as many as eight other specific
building systems. The new regulations
require that the decision of whether
to capitalize or deduct an expendi-
ture as an improvement be made as
if the components are separate units
of property. This change is generally
not a taxpayer-friendly develop-
ment. Because the improvement test
is applied at a smaller level, it is more
likely that an expense will have to be
capitalized, and the deduction for the
expenditure will be delayed to future
tax years through depreciation.
On the other hand, the new
unit-of-property approach, along
with revised disposition rules in the
proposed regulations, creates a new
opportunity, especially for taxpayers
with significant investments in build-
ings. With this combination, taxpayers
may now recognize a loss if they have
replaced a structural component of
a building. In the past, for example,
when taxpayers replaced the roof of a
building, they generally had to capital-
ize the cost of the new roof. The cost
of the old roof would continue to be
depreciated over the entire life of the
building even after it was replaced.
This meant that the cost of the old
roof and the cost of the new roof were
being depreciated simultaneously!
Now, if the roof has been replaced, the
IRS is allowing taxpayers to estimate
the basis of the old roof and recognize
a loss on the disposition. However, it
is expected that this opportunity to go
back in time to identify and recog-
nize losses on previously replaced
components will not be available after
the extended due date of the 2014 tax
return.
Almost all taxpayers with tangible
assets will be required to file at least
one request for a change in accounting
method in 2014. This is because the
IRS will not allow the use of a cut-
off method in determining whether
expenditures were appropriately
capitalized or deducted. (If a cut-off
method applies, taxpayers continue to
use their existing accounting method
for amounts paid before the effec-
tive date and change their accounting
method for amounts paid on or after
the effective day.) Because the cut-off
method does not apply, a review of
the treatment of all expenses related
to each asset that is not fully depreci-
ated for tax purposes on December 31,
2013, will be required. The adjustment
that is the result of this analysis will
need to be considered in the 2014 tax-
able income. Generally, a change that
decreases taxable income can be taken
entirely in 2014, whereas an adjust-
ment that increases taxable income
can be spread over a four-year period.
One of the advantages of filing
for a change in accounting method
is that taxpayers receive retroactive
protection from IRS examination
adjustments for items included in
the method change starting on the
date the change is filed. The request
for change can be filed any time after
December 31, 2013, and does not
need to wait until the 2014 tax return
is filed.
These new regulations provide a
massive revision to the rules on capi-
talizing and deducting costs incurred
with respect to tangible property. They
are intended to eliminate confusion
over which expenditures must be
deducted immediately and which
must be capitalized! Given the poten-
tial financial impact, businesses may
need to make some changes in the
way they account for these expendi-
tures and may find some important
tax planning opportunities. Taxpayers
probably may not feel the impact of
these new IRS regulations immedi-
ately, but the sooner they start plan-
ning, the better equipped they will be
to manage the change.
