Regulations Issued on Repair Expenditures

http://www.journalofaccountancy.com/Web/20114952.htm
On Friday, the IRS issued long-awaited temporary and identical proposed regulations (T.D. 9564; REG-168745-03) regarding the treatment of expenditures incurred in selling, acquiring, producing, or improving tangible assets, including rules on determining whether costs related to tangible property are deductible repairs or capital improvements. The temporary regulations affect all taxpayers that acquire, produce or improve tangible property.

The temporary regulations clarify and expand the standards in the current regulations under Secs. 162(a) and 263(a) and provide rules for applying these standards. They also provide guidance on accounting for, and dispositions of, property subject to Sec. 168 and amend the general asset account regulations.

Distinguishing between expenditures for capital improvements or for deductible ordinary repairs is a highly factual determination, and a number of court cases have set out tests for making the distinction. Because it has been difficult for taxpayers to apply the standards set out in case law, the regulations, and IRS guidance, the IRS issued proposed regulations in 2006 (later withdrawn) and 2008. Friday’s temporary and proposed regulations respond to comments received in response to the prior proposed regulations.

The temporary regulations provide a general framework for capitalization and retain many of the provisions of the 2008 proposed regulations, which in many instances incorporated standards from existing authorities under Sec. 263(a).

Among the changes introduced by the temporary regulations, they revise the rules for determining whether an amount is paid for an improvement to a building, and they revise the rule for determining whether an amount is paid for the replacement of a major component or substantial structural part of a unit of property. The temporary regulations also provide several new rules that were not in the 2008 proposed regulations.

Materials and Supplies

The temporary regulations generally retain the framework in the 2008 proposed regulations for materials and supplies. In response to comments, however, the temporary regulations modify and expand the definition of materials and supplies, provide an alternative optional method of accounting for rotable and temporary spare parts, and provide an election to treat certain materials and supplies under a de minimis rule in Temp. Regs. Sec. 1.263(a)-2T. The temporary regulations also allow a taxpayer to elect to capitalize certain materials and supplies.

Repairs

Under the 2008 proposed regulations, amounts paid for repairs and maintenance to tangible property are deductible if the amounts paid are not required to be capitalized under Regs. Sec. 1.263(a)-3. The temporary regulations retain this rule and clarify that a taxpayer is permitted to deduct amounts paid to repair and maintain tangible property provided such amounts are not required to be capitalized under Sec. 263(a) or any other provision of the Code or regulations.

Rentals and Leased Property

The temporary regulations make minor revisions to the rule in Regs. Sec. 1.162-11(b) that provides that the cost of erecting a building or making a permanent improvement to property leased by the taxpayer is a capital expenditure and is not deductible as a business expense.

The temporary regulations amend the rules in Regs. Sec. 1.162-11(b) and 1.167(a)-4 to provide that a lessee or lessor must depreciate or amortize its leasehold improvements under the cost recovery provisions of the Code applicable to the improvements, without regard to the term of the lease. They also remove the rules permitting amortization over the shorter of the estimated useful life or the term of the lease.

Amounts Paid to Acquire or Produce Tangible Property

The temporary regulations retain the rules from the 2008 proposed regulations on capitalization of amounts paid to acquire or produce units of tangible property. These include a general requirement to capitalize acquisition and production costs and a requirement to capitalize amounts paid to defend and perfect title to property. Responding to comments, the temporary regulations clarify how the rules apply to moving and reinstallation costs. They also retain the rule for costs incurred prior to placing property into service, add and clarify certain rules with respect to transaction costs, and modify and refine the de minimis rule.

The de minimis rule under the temporary regulations retains the requirement that a taxpayer may deduct certain amounts paid for tangible property if the taxpayer (1) has an applicable financial statement, (2) has written accounting procedures for expensing amounts paid for such property under certain dollar amounts, and (3) treats such amounts as expenses on its applicable financial statement in accordance with such written accounting procedures. However, the temporary regulations replace the “no distortion” requirement in the proposed regulations with an overall ceiling that generally limits the total expenses that a taxpayer may deduct under the de minimis rule.

Under the new criteria, the aggregate of amounts paid and not capitalized under the de minimis rule for the tax year must be less than or equal to the greater of (1) 0.1% of the taxpayer’s gross receipts for the tax year as determined for federal income tax purposes; or (2) 2% of the taxpayer’s total depreciation and amortization expense for the tax year as determined in its applicable financial statement.

Amounts to Improve Property

The temporary regulations retain the basic framework of the 2008 proposed regulations for determining the unit of property and for determining whether there is an improvement to the unit of property. They also retain many of the simplifying conventions set out in the 2008 proposed regulations, including the routine maintenance safe harbor and the optional regulatory accounting method.

The 2008 proposed regulations provided a safe harbor from capitalization for the costs of performing certain routine maintenance activities. Under the safe harbor, an amount paid was deemed not to improve the unit of property if it was for ongoing activities that a taxpayer (or a lessor) expected to perform as a result of the taxpayer’s (or the lessee’s) use of the unit of property to keep the unit of property in its ordinarily efficient operating condition. The activities count as routine only if, at the time the unit of property was placed in service, the taxpayer reasonably expected to perform the activities more than once during the class life of the unit of property. Despite receiving numerous comments on this safe harbor, the IRS has retained it in the temporary regulations, but it is modified so that it will not apply to buildings.

Accounting and Disposition Rules for MACRS Property

The temporary regulations also revise the rules for accounting for MACRS property (i.e., assets to which Sec. 168 applies) and the rules for determining gain or loss upon the disposition of MACRS property.

The temporary regulations eliminate group accounts, classified accounts, and composite accounts under Regs. Sec. 1.167(a)-7. Instead, each multiple asset account must include, in most cases, assets that have the same depreciation method, recovery period, and convention, and that are placed in service in the same tax year. The temporary regulations also provide rules for determining gain or loss upon the disposition of MACRS property that are consistent with the disposition rules under Prop. Regs. Sec. 1.168-6 of the proposed ACRS regulations.

Effective Date

The temporary regulations are generally effective tax years beginning on or after Jan. 1, 2012. A change to conform to the temporary regulations will be a change in method of accounting under Sec. 446(e), and, in general, a taxpayer seeking a change in method of accounting to comply with the temporary regulations must take into account an adjustment under Sec. 481(a). The IRS will provide procedures under which taxpayers may obtain automatic consent for a tax year beginning on or after Jan. 1, 2012, to change to a method of accounting provided in the temporary regulations.

Stock Sale Tax Rules Force Make-or-Break Choices

http://www.accountingtoday.com/news/Stock-Sale-Tax-Rules-Force-Make-or-Break-Choices-57187-1.html
BY ROGER RUSSELL, SENIOR EDITOR, ACCOUNTING TODAY

The new cost basis reporting rules won’t affect this year’s returns, but they are already in effect.

Beginning on Jan. 1, 2011, it became mandatory for brokers and other financial intermediaries to report cost basis information on Form 1099-B to investors and to the Internal Revenue Service for equities acquired on or after that date. The new requirements, spelled out in the Emergency Economic Stabilization Act of 2008, also will cover mutual funds acquired on or after Jan. 1, 2012, and debt securities, options and private placements acquired after Jan. 1, 2013.

The rules take aim at the practice of deciding after the fact what stock was sold where an investor holds different lots of the same stock, each with a different cost basis. For example, an investor holds three lots, with a cost basis of $40 for the first lot, $60 for the second lot, and $100 for the third lot. If shares are sold for $90, the investor might decide at a later date which ones were sold—those with a high cost basis, creating a loss, those with a medium cost basis, creating a small gain, or those with a low cost basis, creating a larger gain.

“Starting this year investors have to decide what they’re selling, and communicate this to the broker immediately,” said Stevie Conlon, CPA, Esq., senior director and tax counsel at Wolters Kluwer Financial Services. “You can’t do it later. You have to identify lots that were sold no later than the settlement date of sale. Before this, people would look at the stock they had sold at the end of the year or at the end of every month and determine which were the best lots to have sold.”

“The final regulations are clear that the taxpayer must select the lot that was sold no later than the settlement date, which would be the date of the trade plus three days,” she said. “This is probably what the law was before, but the law and the new regulations make it specific. In the old days it wouldn’t be obvious to the IRS that you changed something later. Now, the broker must issue a Form 1099-B for the stock sold this year that was bought after January 1 of this year.”

“Next February investors will receive a Form 1099-B showing the cost basis under that rule,” she said. “It will show the cost basis that was communicated to the broker by the settlement date, or the broker will be required to use FIFO. If what you put on your tax return doesn’t match, it will be obvious that you picked a different method after the fact. There will be taxpayers that are unsatisfied with both their broker and their tax adviser.”

This is a momentous issue due to the way that taxpayers normally interact with their advisers, Conlon indicated. “It requires getting tax advice on a recurring basis, almost in real time. That’s very different from an adviser’s normal involvement with a client at year-end planning sessions and tax return time,” she said. “Under the new rules, you’re locked in by whatever you select. It forces you to make an analysis about what’s the right lot to sell on an ongoing basis. The adviser has to be involved at the time of the trade, and that’s significant.”

Conlon advised tax preparers to explain the new rules to their clients during tax season, if they haven’t already. “The sooner you can educate your clients about the new rules, the better it will be at the end of the year,” she said.

Capitalization vs Repairs

The IRS recently issued an audit guide on capitalization vs repairs
http://www.irs.gov/businesses/article/0,,id=231440,00.html

From KBKG, Inc:
Author: Gian Pazzia, CCSP - Principal

The IRS recently released its Audit Techniques Guide related to issue of Capitalization vs. Repairs. This issue has received a significant amount of attention by the IRS over the last couple of years as many taxpayers have filed for Changes in Accounting Method to take advantage of missed deductions. Because the amount of deductions can be significant and because the determination of appropriate treatment involves intense evaluation of facts and circumstances, the IRS raised this to a "Tier 1" audit issue.

The current IRS proposed regulations have broadened and clarified the definition of "repair and maintenance" costs. Application of the existing law requires an in-depth understanding of the various tax cases and "tests" that must be met. Thorough documentation is necessary to sustain audit and must show the application of existing law for each asset reclassified.

Currently, this opportunity relates to all prior, current, and future tax years. However, in order to take advantage of the tax laws for prior years, taxpayers should act quickly as the IRS is considering rules that would limit the opportunity for prior years.

Taxpayers utilizing the book method of accounting - with respect to (Repair and Maintenance) R&M - should consider the potential to accelerate cash flow by 1) changing their method of accounting and 2) engaging in an R&M study. By using the book method, taxpayers miss out on the opportunity to accelerate cash flow through the current-year deduction for R&M expense.

It is important to note that under Rev. Proc. 2009-39, the change in accounting method of reclassifying previously capitalized repair and maintenance expenses as deductions is now considered automatic. In order to implement the automatic method, a section 481(a) adjustment is needed, along with specific representations in an attachment to Form 3115. This change in accounting method can be filed any time before the extended tax return due date in the year of change.