The Internal Revenue Service (“IRS”) has been issuing guidance on how to deal with the final Tangible Property Regulations (“Regulations”) recently issued, commonly referred to as the “Repair Regulations.” Considering that the final Regulations are over 200 pages, it is taking time to digest all of their provisions. The application of the Regulations to dealers, in particular their facility upgrades and improvements, will become clearer over time.
The reference to the Regulations as “Repair Regulations” is a misnomer, as the Regulations in fact refer to costs incurred from the point of tangible property acquisition through the property’s operational life until its disposition. The Regulations address three phases from acquisition, maintenance and improvement through disposition.
For acquisition costs, most importantly, the Regulations provide a de minimis safe harbor that allows dealers to adopt a capitalization policy that distinguishes capital expenditures from deductible business expenses. For dealers who issue audited financial statements, the safe harbor is favorable in that in permits an elective $5,000-per-item book conformity deduction. In other words, if you issue an audited financial statement and have a capitalization policy that provides that for book purposes you will expense items, you are permitted to deduct the same amount for tax purposes. The written book policy must be in place as of the first day of the tax year, and it is effective for years beginning on or after January 1, 2014.
For dealers who do not issue audited financial statements, the de minimis safe harbor is reduced to $500. An applicable financial statement does not include reviewed or compiled financial statements. Dealers who report to the manufacturer will be able to expense up to $500 per item.
An opportunity may exist to retroactively apply the de minimis safe harbor provided you have a written capitalization policy for years beginning on or after January 1, 2012. The retroactive use of this safe harbor requires you to amend tax returns for the previous years, provided you do so within 180 days after the original due date of the return, including extensions.
The Regulations further distinguish the cost of repair and maintenance from expenditures for “major components” and “substantial structural” parts. The Regulations provide that a building is its structure and eight separate building systems. These include: HVAC systems, plumbing systems, electrical systems, all escalators, all elevators, fire protection and alarm systems, security systems for protection of the building and its occupants, and gas distribution systems.
The Regulations use a “BAR” test to determine whether the building system needs to be capitalized. For this purpose, B stands for betterment, A stands for adaptation and R stands for restoration. The Regulations provide a series of examples that should be reviewed to determine whether costs should be capitalized or can be expensed. As with the de minimis safe harbor, the Regulations may be applied retroactively. This requires a study so that the changes in the treatment of ”major components” and “significant structural” parts can be substantiated and permits the Section 481(a) adjustment to be computed.
In a prior Insight, the Schneider Downs Auto Advisory Group details how we currenlty apply these final regulations to our clients. Please click on the following link https://www.schneiderdowns.com/next-generation-of-cost-segregation-studies to see how.
More information is scheduled to be released by the IRS that includes the final Regulations regarding dispositions and revenue procedures that will further explain the application of these new Regulations.
The Schneider Downs Auto Advisory Group will provide additional direction regarding the application of these Regulations, particularly in light of the significant facility improvements dealers have made in the most recent tax years.
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