New Capitalization Policies

Abstract 

In the recent times, the Internal Revenue Service (IRS) provided final tangible property capitalization policies. These policies provide clarity to a complicated area of tax regulations for business tax payers who obtain or own tangible property which the repair, maintain, or improve. The final policies cover the proper tax treatment and characterization of expenses related to maintenance, acquisitions, improvement, and repair activities. Typically, under IRC Section 263 (a), money remitted to acquire, improve, or produce intangibles assets must be capitalized. Taxpayers are nonetheless allowed to deduct necessary and ordinary business costs, such as the costs of specific supplies, restoration and maintenance under IRC Section 162 (a). It is in most cases difficult to differentiate between property that has to be capitalized and assets that are material or supply. Additionally, it is not easy to differentiate between repair and maintenance and improvement costs. The finalized policies endeavor to make clarifications when the stated payments are subtracted and when they have to be capitalized. 

De Minimis Safe Harbor Election 

A major provision in the final policies is a revised safe harbor election that allows a deduction for the de minimis totals paid for tangible assets. According to the safe harbor election, a taxpayer may decide to capitalize (deduct) certain amounts remitted in the tax year to produce or acquire tangible assets, if the totals do not exceed applicable thresholds ( Mundstock & Korge, 2015). The sum of the threshold is dependent on whether the taxpayer is in possession of written accounting measures in place and if that is the case, whether the taxpayer contains an applicable financial statement. 

Taxpayers with applicable financial statement and written accounting procedures 

A taxpayer with an applicable financial statement might rely on the final policies’ safe harbor to value an item in accordance with his or her written accounting procedures it applied in the preparation of its financial statements, given the amount remitted for tangible assets does not exceed $5,000 per property. Likewise, the safe harbor additionally applies to a financial accounting procedure that expenses costs paid for assets with an economic life of one year or below, provided the costs are not above the $5,000 threshold ( Mundstock & Korge, 2015). 

Taxpayers without an applicable financial statement 

A person without a n applicable financial statement, but in possession of a written accounting policy in place summoning for expensing money paid for assets less than a particular amount or expensing money for assets with an economic life of a year or less, might be reliant on the de minimis safe harbor provided the costs do not go beyond the $500 mark ( Mundstock & Korge, 2015). 

Taxpayers without either a written accounting policies or applicable financial statement 

The final rules escalate the ceiling for characterizing tangible property as supplies or materials to $200, a figure that formerly stood at $100 ( ( Dennis ‐ Escoffier, 2012). Therefore, taxpayers with no written accounting policies or an applicable financial statement in place of the commencement of the tax year may still expense expenditures for tangible assets with a value of $200 or less. 

Making an election 

To use the safe harbor, a person or business must be in possession of accounting policies on the first day of the tax year. The accounting policies has an obligation to treat as an expense sum paid for assets that cost an amount below a specified dollar or have an economic life of a year or less. A company or individual that fails to provide timely written accounting procedures might result in having to capitalize money that may have been incurred ( Webber, 2010). Moreover, the taxpayer’s submitted original tax return should involve yearly election to expense properties covered by the safe harbor endowment. The yearly election is irrevocable and in most cases applies to all tangible assets involving supplies and materials purchased in the course of the tax year. The regulations are effective to tax years starting on or after January 2014; nonetheless, taxpayers have an option to use the final rules to tax years starting on or after January 1, 2012, and before to January 1, 2014 ( Dennis ‐ Escoffier, 2012). The final principles might be used retroactively, but many individuals might only be able to apply the safe harbor provision in preceding tax fillings since the de minimis sage harbor endowment involves written accounting policies on the first day of the present tax year. 

Tangible Property Regulations 

In addition to making clarifications of the requirements covered in Sections 162 and 263, the tangible property policies include numerous simplifying endowments that are prospective and elective in application, are aimed at easing individuals’ compliance with the rules and lessen administrative burden ( Webber, 2010). Section 1.263(a), for instance, specifies a de minimis safe harbor election that allows a taxpayer to not take advantage or treat as a supply or material, specific amounts remitted for tangible assets that it produces or acquires in the course of the taxable year given the taxpayer accomplishes specific requirements and the assets do not exceed particular dollar limits ( Dennis ‐ Escoffier, 2012). If a taxpayer meets the requirements, totals paid for the qualified assets often might be deducted under Section 162, but the amount should constitute necessary and an ordinary business expense in continuing trade or business. 

Distinguishing capital improvements from deductible repairs 

Step 1: Unit of Property 

For Buildings: The unit of property is typically the entire edifice involving its structural elements. Nonetheless, under the final tangibles provisions and for only these reasons, improvement evaluation applies to the building edifice and all the key construction systems. 

For Non-Buildings: The unit of property in this case refers to all segments that functionally depend on one another. Elements of assets are functionally interdependent if one cannot place in service one asset without placing another one in service to operate concurrently ( Dennis ‐ Escoffier, 2012). 

For Network Assets: A taxpayer’s specific circumstances and facts or circumstance with industry guidance provided by the Treasury Department and the IRS evaluates the unit of property and the use of the improvement analysis. 

For Year Placed In service: These rule meant for non-building assets is triggered at the moment when a taxpayer places a unity of property into operation. 

Subsequent change in production: These are regulations for both non-building and building property that is triggered when a person makes a subsequent alteration in the classification of property ( Mundstock & Korge, 2015). In all taxable years, following the time the unit of property is placed in operation, the unit of property determination for the asset is changed under this rule to conform to conversion in treatment for purposes of depreciation. 

Step 2: Improvement of Unity of Property 

A unit of tangible property is improved only if the sums paid are: 

For betterment to the unity asset, 

To restore unit of property, 

To adapt the unit of property to a different or new use. 

Betterment refers to the amounts submitted to fix a material condition or defect that was present before the purchase in the course of manufacture of the unit of property. The term may also refer to the sum paid for a commodity addition, involving a physical expansion, enlargement, addition of a principal component, or extension of the current property. 

Restoration of a unit property entails the replacement of a principal element or a significant part. This includes the amounts remitted for the procedure. 

Adapts the unit of property refers to the amount that is paid to acquire a property ( Mundstock & Korge, 2015). For instance, a taxpayer who possesses a manufacturing building used for manufacturing commodities for several years starting when the building was placed in service by the current user may decide to pay amounts to convert the building into a showroom through modifying the structure. Expenses to convert the building into a showroom are improvements since the systems and structure are converted to a different user. 

Alternatives to the facts and circumstances 

Safe Harbor Election for Small Taxpayers 

Taxpayers are not required to take advantage as an improvement, and thus may be permitted to subtract the expenses of work conducted on owned or leased buildings, such as repairs, improvements, maintenance, or similar costs, that are categorized under the safe harbor election for minor taxpayers. Some of the provisions under the act include: 

Mean expenses gross receipts of $10 million or below, 

Leases or owns building property with no adjusted basis of below $1 million ( Mundstock & Korge, 2015). 

Safe harbor for routine maintenance 

Taxpayers are urged to capitalize as an improvement, and thus may deduct, amounts involve the following criteria: 

Money paid for recurring activities that one expects to undertake 

As a result of a taxpayers use of property in trade or business 

To maintain the asset in its original efficient operating condition 

Election to capitalize maintenance and repair costs 

To lessen the complexity with applying the circumstances and facts to determine tax treatment of expenses and to attain simpler administration by allowing taxpayers to follow financial accounting rules for purposes of federal tax, the final tangibles rules involve an election to capitalize maintenance and repair costs as improvements, if one treats such expenditures as capital costs for purposes financial accounting ( Mundstock & Korge, 2015). 

Tangible Assets 

Nothing in the final tangibles provisions under section 263 alters the treatment of any amount that is particularly covered in any provision of Treasury of IRC regulations other than section 162 (a). For instance, the final tangibles provisions do not eradicate the requirements of section 263A that typically provides that a taxpayer must capitalize the allocable indirect and direct costs of producing tangible or real personal assets and purchasing assets for sale. In most cases, final tangibles apply to taxable periods starting on or after 1-1-2014 on in other circumstances, involve costs incurred or paid in taxable years commencing on or after 1-1-2014 ( Dennis ‐ Escoffier, 2012). The IRC stipulates that a change in accounting methods includes an alteration in the treatment of an asset impacting the timing for including the property in income or taking the asset for deduction. For instance, a taxpayer changing methods of accounting if he or she had been capitalizing specific amounts were classified as improvements and would like to presently subtract the amounts as maintenance and repairs expenses pursuant to the concluding tangibles regulation. 

Simplified processes for small business taxpayers 

To ease the governing burden small business taxpayers face that want to proactively use the final tangibles regulation, and have no desire to calculate a section 481(a) adjustment, the IRS has given a simplified process that taxpayers may have used for their first taxable year commencing 2014. Covered in the provision, people with small businesses are allowed to convert to specific accounting methods as portrayed by the final tangibles regulation by considering amounts incurred or paid in taxable years starting on or after 1-1-2014 ( Dennis ‐ Escoffier, 2012). If a taxpayer used this procedure for a small business, then the business lacked a section 481(a) adjustment for the first taxable year starting 2014. 

In summary 

Section 162 of the Internal Revenue Code (IRC) permits individuals subtract all the necessary and ordinary expenses incurred in the course of the taxable year in conducting businesses or trade, involving the cost of specific materials, maintenance, repair, and supplies. Nonetheless, section 263(a) of the IRC necessitates taxpayers to capitalize the expenses of producing, improving, and acquiring tangible assets regardless of the cost incurred or size. The tax has for many years encouraged people to determine if expenditures associated to tangible assets are presently deductible operational cots or capital expenditures classified as non-deductible. Before final asset property regulations were published in September 17, 2013, decisions were influenced by many years of often conflicting case laws, in addition to administrative judgments on specific factual decisions. 

References  

Dennis ‐ Escoffier, S. (2012). IRS issues regulations on repair and capitalization rules.    Journal of Corporate Accounting & Finance ,    23 (5), 81-85. 

Mundstock, G., & Korge, T. J. (2015). Distinguishing Deductible Repairs from Capitalized Improvements: An Expectations Approach to the New Repair Regulations.    Akron L. Rev. ,    48 , 641. 

Webber, S. (2010). Thin capitalization and interest deduction rules: a worldwide survey.    Tax notes international ,    60 (9), 683-708.