Do you own a duplex or other rental property for which you file a Schedule E? Maybe you have a small business where you do minor home repair and report the income on Schedule C? Or maybe you are a farmer that files a Schedule F? Individuals that operate such businesses may be impacted by new rules effective for 2012 regarding tangible property. Many remain optimistic that final regulations may provide additional safe harbors or alternative methods for taxpayers below a certain size. However, such exceptions do not exist today (the date of publication of this article). Therefore, all businesses, including those of individuals, should evaluate the implications of these new rules and determine what steps they should be taking now.
More Than Just Repairs
On December 27, 2011, the IRS issued the long-awaited temporary regulations providing rules for determining when an expenditure with respect to tangible property (such as a repair) must be capitalized (the so-called "repair regulations"). These rules generally impact Internal Revenue Code sections 162(a), 168 and 263(a). The temporary regulations are effective, for the most part, for tax years beginning on or after January 1, 2012. The temporary regulations were nearly 250 pages, and the additional procedural guidance issued in March 2012 (Revenue Procedures 2012-19 and 2012-20) included an additional 100 pages of information on how to comply with the new rules. Although many refer to this guidance as the "repair regs.," it covers much more than just repairs - including the purchase or production of tangible property, the treatment of materials and supplies, and dispositions of MACRS property. As such, the temporary regulations apply to virtually all business taxpayers.
The temporary regulations continue to rely on a "facts and circumstances" test for many of the decisions on whether an expenditure with respect to tangible property may be expensed or must be capitalized as an improvement. The absence of "bright line" tests in this area has historically been a significant source of controversy between the IRS and taxpayers during IRS examinations.
Potential Changes When Regulations Finalized
Although the IRS and Treasury Department initially stated that they hoped to finalize the temporary regulations in late 2012 with minimal changes, the outpouring of comments they have received (including two comment letters in April
from the AICPA and oral testimony
at the public hearing) have led many to believe that the final regulations may include substantive changes, such as favorable provisions for small businesses.
Actions Necessary Now for 2012 or 2013
Regardless of any changes that the IRS may make in the final regulations, it is critical that all
taxpayers, regardless of the business entity's size, become familiar with the new rules and begin implementing, or at least planning how to implement, them immediately.
The IRS is generally waiving certain ordinary scope restrictions for two tax years (first or second tax year beginning after December 31, 2011) so as to allow most taxpayers to automatically change their accounting methods to comply with the new rules. These changes generally will be done either with a section 481(a) adjustment, or on a cut-off basis. It is important to realize that this is NOT a two year "free pass." The IRS can still audit tax years 2012 and 2013 after the fact to ensure that the appropriate changes and accounting adjustments were made.
The temporary regulations potentially change the way businesses have been accounting for tax purposes for everything from purchases of new real and personal tangible property (such as buildings, machinery, and office equipment) to the repair or replacement of a broken window or even a broken computer keyboard to the purchase of copier toner supplies.
These rules can impact many existing tax accounting methods that have been adopted by taxpayers in the past and used to account for transactions in years prior to 2012. For example, the temporary regulations change the tax method of accounting used for dispositions of components of buildings. Businesses will need to go back and review the tax treatment of improvements that were capitalized in prior years without a corresponding write-off of the property that was replaced.
Many commentators believe that most, if not all, businesses, regardless of size, will need to file at least two (and possibly many more, depending on the taxpayer's facts) automatic tax accounting method changes to comply with the new rules. Such changes are typically made by filing Form 3115, Application for Change in Accounting Method
, as provided in the procedural guidance mentioned earlier. As the temporary regulations and other guidance exist today, this would include all individual taxpayers who file a Schedule C for a sole proprietorship, have rental real estate income reported on Schedule E, or file Schedule F for farm income.
Stay tuned for future developments that might further refine or modify who is impacted and what transactions are impacted by these rules. More information and resources on this topic can be found on the AICPA's Tangible Property resources webpage