By now you have likely heard about the new tangible property regulations. These new rules, which were a decade in the making and are almost 400 pages long, are expected to affect every taxpayer that uses tangible property in its business.
The rules are complex and their impact is widespread. We at Clark Nuber are evaluating our clients and the impact of the implementation of the rules in each client situation. Below are the top five things you should know to prepare for a conversation with your CPA.
1. Capitalization Policy
Do you have a capitalization policy for your business? Is it in writing? Do you consistently follow the policy? These are questions that your CPA will be asking.
Specifically, your policy should note that you treat as an expense:
- Amounts paid for property costing less than a specified dollar amount, or
- Amounts paid for property with an economic useful life of 12 months or less.
If you have not already done so, provide your CPA with a copy of your written capitalization policy. If you would like an example of a capitalization policy, just let us know.
2. De Minimis Rule
Under the de minimis safe harbor election, taxpayers may elect to expense amounts paid for tangible property, up to $5,000 per item or invoice. To qualify for the $5,000 de minimis exception you must have an applicable financial statement (AFS), which is defined as follows:
- A financial statement filed with the Securities and Exchange Commission;
- A certified audited financial statement;
- A financial statement required to be provided to the federal or state government or agency (other than the SEC or IRS)
You must also have, as of the beginning of the tax year, written accounting procedures outlining your capitalization policy for non-tax purposes (see #1 above).
If, for non-tax purposes, your capitalization policy is in excess of $5,000, only property that does not exceed $5,000 per invoice (or per item, if substantiated on the invoice) will qualify for the de minimis exception.
For taxpayers that do not have applicable financial statements, the de minimis exception is reduced to $500. There is some uncertainty as to whether the IRS requires a written accounting policy in these situations. We do know that they require that you have an accounting policy in place; therefore, our recommendation is to put your policy in writing.
One important item to note, your capitalization policy may be higher than the de minimis amounts as long as it does not materially distort income and you can support the reasoning for a higher policy upon an IRS examination.
3. Materials and supplies
How do you currently treat materials and supplies? Are you using the incidental method, writing off when purchased? Or do you use the non-incidental method, writing off when placed in service?
Under the new rules, the incidental method is allowed as long as materials and supplies are not kept track of or counted in any way, and taxable income is not materially distorted. The non-incidental method requires that you write off the materials and supplies when placed in service.
It is likely that materials and supplies were never discussion points with your tax CPA in the past; this all changes under the new rules. Make sure that your CPA is aware of your policy for accounting for materials and supplies so that they can properly apply the new rules to your business.
4. Late Partial Dispositions
Under the new rules, taxpayers can write off retired, replaced or abandoned building components. However, the IRS is giving taxpayers a small window (2014) to write off any replaced items that were incurred in previous tax years.
For example, assume you purchased a building in 1995. In 2005, you replaced the original roof and capitalized the cost. Under the old rules, you would be simultaneously depreciating two roofs. Under the new rules, you are allowed to write off the remaining tax basis of the 1995 roof that was replaced. However, as noted above, these prior year dispositions need to be reported on the 2014 tax returns.
Going forward you can write off the remaining tax basis of disposed building components in the year they are disposed.
In addition, starting in 2014, taxpayers can now write off removal costs related to dispositions rather than capitalizing these costs as part of the new asset. We are finding this to be a great benefit to clients and encourage you to have your contractor separately break out the demolition and removal costs from the new construction costs.
5. Prior year capitalized items that should have been expensed
We are finding many of our clients previously capitalized items that under these new rules would have been expensed as repairs. Taxpayers are allowed to write off these previously capitalized items by filing a change in accounting method. Through application of these new rules we have been able to identify many opportunities for our clients to reduce their 2014 taxable income.
If you have capitalized any 15-year or longer life property in the year besides the year the original building or improvement was placed in service, these additions should be analyzed under the new law to determine if capitalization is appropriate.
As I noted earlier, these new rules are complex. There is no easy, one-size-fits-all way to analyze these rules and apply them to taxpayers. We encourage you to talk with your CPA to see how these rules will affect you specifically not only historically, but on a go-forward basis. If you have any questions, do not hesitate to reach out to a Clark Nuber team member.
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