Final Tangible Property Regulations
IRS has finally released final regulations regarding the tax
treatment of expenditures related to tangible property, which
impact all businesses that own or lease tangible
property—including buildings, machinery, vehicles, furniture,
and equipment. Generally applicable to tax years beginning on or
after January 1, 2014, the regulations require the
capitalization of amounts paid to acquire, produce, or improve
tangible property but allow amounts for incidental repairs and
maintenance of property to be deducted. Additionally, the
regulations explain how to distinguish between capital
expenditures and deductible business expenses.
The new regulations have been under development since 2006. At
the end of 2011, the release of temporary regulations provided a
general framework for capitalization. After four attempts, the
final regulations replace those temporary regulations while
retaining many of their provisions, modifying several sections,
and creating many new safe harbors.
Squaring Away Property Improvements
The regulations contain guidance as to how taxpayers must treat
expenditures related specifically to buildings, as well as rules
on all types of property.
For buildings, the applicable rules encompass:
(1) Capitalization of improvements. A
cost that results in an improvement to a building structure or
to any of the enumerated building systems (e.g. plumbing or
electrical system) must be capitalized. A betterment,
restoration, or adaptation of a unit of property results in an
(2) New safe harbor for small businesses.
The regulations add a safe harbor for qualified small
business taxpayers (generally those with gross receipts of $10
million or less). For buildings with an unadjusted basis of $1
million or less, taxpayers may elect to deduct the lesser of
$10,000 or 2% of the adjusted basis of the property for repairs,
maintenance, improvements, and similar activity each year.
(There are special rules for calculating the unadjusted basis of
(3) Restoration test. An amount paid
for the replacement of a major component or substantial
structural part of a property unit is an amount paid to restore
it. These regulations define whether an amount spent on
replacement constitutes a restoration. It is a replacement of a
major component or substantial structural part if it includes a
part or combination of parts that comprises a) a major
component/significant portion of the building structure or any
building system that performs a discrete and critical function
in the operation of the unit of property, or b) a large portion
of the physical structure of the building or any building
For other property, including buildings, the regulations cover:
(1) Routine maintenance safe harbor.
An activity isn’t considered an improvement if the taxpayer
expected to perform it as a result of property use or
maintenance for ordinarily efficient operating condition. If, at
the time the property was placed in service, the taxpayer
reasonably expected to perform the activity more than once
during the property’s life, then the activity is considered
routine. Specific to buildings, the taxpayer must reasonably
expect to perform the building-related activities more than once
in 10 years. The regulations make several additional changes and
clarifications to the routine maintenance safe harbor that
applies to both buildings and other property.
However, amounts incurred for activities outside the safe harbor
don’t necessarily have to be capitalized. These amounts are
subject to analysis under the general rules for improvements.
(2) Betterment test. The final
regulations address the temporary regulations’ test for
determining whether an amount paid results in a betterment. The
“result in” betterment phrase is no longer included; instead, a
taxpayer must capitalize amounts reasonably expected to
materially increase the productivity, efficiency, strength,
quality, or output of a unit of property—or that are a material
addition to a property unit.
Circling Up Materials and Supplies
The final regulations increase the dollar threshold from $100 to
$200 for property that’s exempt from capitalization. Taxpayers
are also allowed to make an election to capitalize certain
materials and supplies but limit it to rotable (parts that need
periodic replacement), temporary, or standby emergency spare
parts. Taxpayers can revoke this election by filing a ruling
The regulations also clarify the optional method in the
temporary regulations, which allowed taxpayers to treat the
rotable and temporary spare parts as used or consumed in the
year of disposition or elect to treat them as depreciable
assets. Taxpayers are no longer required to use the method for
all pools of rotable spare parts used in that trade or business;
they can opt not to use the method for those pools for which
they don’t use the optional method on their books and records.
Triangulating De Minimis Rule for Expensing
The final regulations provide for a new safe harbor determined
at the invoice or item level. The safe harbor is allowed for
taxpayers that produce “applicable financial
statements”—generally a certified audited financial statement or
one that is required to be submitted to a federal or state
government/agency. Such taxpayers can now apply the de minimis
rule to deduct all amounts properly expensed—as long as the
amount paid for property doesn’t exceed $5,000 per invoice or
The final regulations allow taxpayers who are members of a
consolidated group for financial statement purposes—but not
federal income tax purposes—to use the group’s applicable
financial statements and written accounting procedures to
qualify for the de minimis safe harbor.
The regulations also expand the de minimis rule to encompass
amounts paid for property having a useful economic life of 12
months or less as long as the amount per invoice (or item)
doesn’t exceed $5,000. They also add a de minimis rule for
taxpayers without applicable financial statements ($500 per
invoice or item).
Additionally, these regulations provide that the de minimis rule
is an irrevocable elective (not mandatory) safe harbor. If
elected, it must be applied to all amounts paid in the taxable
year for tangible property meeting the requirements, including
amounts paid for materials and supplies.
The final regulations require that the de minimis safe harbor be
applied to all eligible materials and supplies if elected. The
temporary regulations allowed taxpayers to select materials and
supplies for application of the rule.
Dispositions of Tangible Property
In addition the IRS has issued Proposed Regulations for
Dispositions which change the rules for partial dispositions of
assets. They also require making a qualifying disposition
election for certain situations when assets are held in a
general asset account. The IRS has addressed the confusion in
the General Asset Account Election issue as this has been a
source of major confusion for CPAs and taxpayers. The IRS has
made significant changes to allow taxpayers that do not elect
general asset account treatment to have the same flexibility to
forgo a loss upon the disposition of a structural component as
taxpayers that do elect GAA treatment. The IRS plans to issue
final regulations in this area by the end of 2013, with the same
January 1, 2014 effective date.
Creating Tangible Property Stars.
If your business has expenditures related to tangible property,
then these regulations apply to you. Compliance may require
changes to your current capitalization procedures and the filing
of Form 3115: Application for Change in Accounting Method.
CRI with questions regarding the final regulations
and guidance regarding the best steps for proceeding. Our tax
professionals are ready to help you shape your compliance