Tangible Property Regulation Compliance Audits
In September 2016, the IRS released its Audit Techniques Guide (ATG) on Capitalization of Tangible Property which IRS examiners will use to identify potential tax issues when examining taxpayer compliance with the tangible property regulations. With the release of the ATG, it is fair to say that IRS audits of tangible property will begin soon if not already underway.
The 202-page ATG provides useful insight into the questions that examiners will ask and the documentation that they will request. Each chapter concludes with a list of “Audit Procedures,” including specific questions that examiners should ask about the concepts explained in the chapter.
The guide also includes some new examples that offer additional insights and clarification on certain issues. The ATG gets more specific about the treatment of certain types of repairs, noting for instance that the replacement of a roof membrane is not always a repair. A new example clarifies the treatment of an HVAC unit that is part of a multi-unit system. Previous guidance suggested that replacement of one unit in a three-unit system did not constitute replacement of a substantial portion of the HVAC system. The ATG points out that if each unit serves a different part of the building, the replacement of one unit may constitute an improvement to the HVAC system.
The IRS recognizes the importance of cost segregation and its interaction with the tangible property regulations. Specifically, the ATG recognizes the increased importance of cost segregation studies to identify building systems for purposes of applying the improvement rules. Examiners are instructed to request and review all cost segregation studies, past and present in connection with their examination to make sure the study was conducted properly. This information is needed by the examiner to determine the following:
- Whether the taxpayer changed the classification of property after it was originally placed in service through a cost segregation study
- How the taxpayer determined the unit of property for buildings and building systems
- Whether the taxpayer took into account prior method changes that may affect the calculation of the Section 481(a) adjustment for the year of change
- Whether a prior year cost segregation study was used to determine the adjusted basis of disposed assets
- Whether the taxpayer is consistent in its treatment of the unit of property for both depreciation/disposition and determination as to repair-expense deduction
The ATG highlights the importance of selecting a cost segregation provider who understands how the tangible property regulations interact with cost segregation studies. All prior year and current year studies are now subject to examination by IRS specialists in connection with tangible property regulation compliance audits. In addition, cost segregation reports should always include information the taxpayer needs to comply with the tangible property regulations.
Compliance with the Tangible Property Regulations
All taxpayers are required to comply with the tangible property regulations for tax years beginning on or after January 1, 2014. These regulations address every phase of an assets life cycle from acquisition, to repair and maintenance, to disposition. To comply with the regulations, taxpayers either:
- Filed Form(s) 3115 as required to change accounting methods and received IRS audit protection for all prior years;
- Followed Rev. Proc. 2015-20 making changes in accounting methods for tangible property starting with the 2014 tax year without receiving IRS audit protection for prior years (See our blog post on the topic.); or
- Failed to file required Form(s) 3115 (See our blog post on the topic).
The regulations create new criteria for classifying costs as de-minimis, materials and supplies, and repairs and maintenance, and new rules for the disposition of assets. In addition, the regulations include taxpayer favorable elections and safe harbors. The elections and safe harbors require annual consideration by taxpayers and tax return preparers. Certain elections require a statement to be filed each year with a timely filed tax return and other elections are made by reporting on the tax forms. In addition, certain safe harbors require a change in accounting method to adopt.
How to Prepare for a Tangible Property Regulation Compliance Audit
For many taxpayers and the preparers who serve them, compliance with the tangible property regulations remains a work in progress. With IRS examiners now prepared to begin examining taxpayer compliance starting with the 2014 tax year, it’s time to conduct a tangible property regulation compliance review. We recommend a thorough review of the client’s overall compliance with the tangible property regulations and filing of corrective Forms 3115 in advance of being contacted for audit. The IRS ATG serves as a useful guide for this review.
CSP360, a leading provider of cost segregation and tax minimization services, has developed expert knowledge of the tangible property regulations and implementing procedures, and how the regulations interact with cost segregation studies. Please contact a CSP360 representative for assistance with a 263(a) tangible property regulation compliance review or for IRS audit assistance.