By Amber Busch, CPA
At this point, you have likely not only heard about the new tangible property regulations (TPRs), but you have worked with your CPA on the implementation of these rules to your business. If you are like many of our clients, you have received significant tax deductions through a fixed asset review and method changes to comply with the new regulations. However, like many companies I speak with, you may still be confused over what to do now. How do you manage your improvements going forward to maintain compliance with the regulations and maximize current deduction?
The most important thing to remember about these rules is that they are complex! In my career, I have never seen a tax law change that has had a more widespread impact across industries and types of organizations. The regulations do not provide a bright line test to determine if an improvement needs to be capitalized or expensed.
Let’s touch on the basics for a moment:
- If you do not have a capitalization policy in place, take the time before year end to implement one. Once you have your capitalization policy in place, make sure to consistently follow it for both book and tax purposes. We are happy to provide an example of a policy if you need it.
- Use the de minimis election. This election allows you to expense amounts paid for tangible property under a certain dollar threshold. For more information about the de minimis election see Capitalizing on the de minimis election.
- Your capitalization policy is not limited to the de minimis threshold, but it needs to be reasonable and not materially distort income.
For more information on the basics, see The Top Five Things You Need To Know.
Ok, so let’s assume that you have heard all about these TPRs, are familiar with the basics and have your tax records cleaned up and in compliance through 2014. You are off to a fantastic start! You are humming along through 2015, making improvements as usual, but are foggy on how you treat those improvements in the new TPR era. The difference under the new regulations is that you need to think about each improvement and walk through a series of questions, a decision tree of sorts, to determine if the improvement needs to be capitalized or can be currently deducted;
- Is the improvement to correct a material defect or condition that existed before acquisition?
- Does the improvement materially increase the capacity, productivity, efficiency, quality, or strength?
- Are you adding a material addition?
- Are you changing the use of the property from its intended use when originally placed in service?
- Are you rebuilding to a like new condition?
- Are you replacing a major component or substantial structural part?
- Are you improving after allowing the property to deteriorate?
If your answer is “yes” to any of these questions, you likely need to capitalize the improvement. On the flip side, if you do not answer “yes” to any of these questions, you may be able to immediately expense the improvement.
To make the analysis even more complex, you need to walk through these questions in reference to the Unit of Property (UOP). A UOP is essentially a component that is independent. In the case of a building, the IRS has outlined nine individual components/systems that we look at to determine the UOP.
Over the coming years it is more important than ever to maintain consistent communication with your CPA about improvements you are making so that the capitalization vs. deductibility of these improvements can be assessed throughout the year. Do not wait until year end to analyze your improvements, talk with your CPA now so that you can be proactive in recording improvements and take the opportunity to maximize your current deductions.
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