The new tangible property regulations from the IRS are some of the most dramatic tax law changes to affect businesses since the 1986 Internal Revenue Code overhaul. These rules are complicated and require immediate action from all businesses that own tangible property, as they are effective now. Lack of action could mean lost opportunity to take advantage of these rules to your favor.
The IRS created these new rules to provide clearer guidelines for how to treat repairs and improvements of a business’s tangible property (equipment, buildings, etc.) for tax purposes. The IRS’s intent is to resolve conflicts with taxpayers over which expenditures related to tangible property are direct write-offs versus those that must be capitalized and depreciated.
The rules provide “bright-line” tests and “safe-harbors” intended to minimize confusion. However, there still may be some confusion in instances. For example, where a repair to tangible property that was treated as an immediate write off in the past is now required to be capitalized and depreciated over a period of time, and vice versa.
A Silver Lining?
On the positive side, there could be potential write off opportunities, or tax savings, for businesses under these rules. Business owners may be able to expense greater amounts for certain repairs, materials and supplies than they had in the past. For instance, some previously capitalized items may now be considered “repairs” and thus deductible.
Items that had previously been capitalized may be eligible under the new rules for a current write-off of the un-depreciated balance of the original cost. For example, an expenditure to re-roof a building by adding new roof material over the existing roof could be considered a replacement of the original roof “component” of the building. This would require capitalization of the cost of the new roof and write-off of the un-depreciated original cost of the “old” roof. The challenge here is identifying the cost of the original roof; how many building owners know the breakout of the cost of just the roof on a building they purchased or built years ago?
Complying with the new rules in order to see these tax savings opportunities will be burdensome. Most businesses will have to modify internal processes that will require accounting method changes. Here’s the kicker … these accounting method changes cannot be done without requesting the change from the IRS.
This will force most businesses to file one or more applications for an accounting method change (IRS Form 3115). In fact, we anticipate that most business taxpayers will have to file multiple 3115s. What’s worse, not only will these taxpayers be required to file for each accounting method change, a filing will also be needed for each separate entity, or trade or business. For example, an individual filing a Form 1040 that owns three rental properties held in separate LLCs will be required to file three (or more) separate 3115s.
It does not matter what form a business operates under; a “C” corporation, an “S” corporation, a partnership, an LLC, a sole proprietorship (Schedule C on individual return) or a rental (Schedule E on individual return); these new rules and requirements apply.
Failure to follow these new rules could cause taxpayers to lose current and future tax depreciation or the potential write-off of previously capitalized expenditures. Simply put, filing all the required 3115 forms is critical for tax savings, and planning for these changes is imperative.
We anticipate that the final version of these regulations (due out later this year) will permit taxpayers to “pick and choose” which accounting method changes to adopt in any of the tax years 2012, 2013 or 2014. Taxpayers will want to adopt those methods first that provide the greatest write off, and defer to a later year those method changes that result in taxable income increases.
It goes without saying that these new rules are extremely complicated. The unique circumstances of each business will need to be analyzed to determine the best accounting methods that will maximize tax savings.
Tanya LaCosse, CPA, shareholder with Johnson Jacobson Wilcox CPAs.