2015 Compliance with the Tangible Property Regulations
As tax advisors begin working with the new rules introduced with Revenue Procedure 2015-20, it’s important to review 2014 returns to understand the choices made by taxpayers, either by filing required Forms 3115 for specific method changes, or adopting all applicable method changes incorporated in Rev. Proc. 2015-20. This post is the third and final of our series on this issue:
- The first post focused on the method changes that each qualifying taxpayer who followed Rev. Proc. 2015-20 adopted and whether they are in compliance with the regulations.
- The second post examined the consequences for those taxpayers who were required to file Form(s) 3115 and did not.
- This post will focus on issues related to complying with the tangible property regulations in 2015.
A Quick Look Back at 2014
Beginning with the 2014 tax year, taxpayers may no longer claim depreciation for repairs and maintenance expenses capitalized in prior tax years. These amounts should have been included in a Section 481(a) adjustment for the 2014 tax year. The election to capitalize and depreciate repairs and maintenance in accordance with book procedures is only available beginning with the 2014 tax year. In order to elect into this treatment each year going forward, taxpayers must file an election statement with the tax return. A failure to file the election statement may result in the loss of depreciation claimed for repair expenditures in the event of an IRS examination.
Likewise, beginning with the 2014 tax year, taxpayers may no longer depreciate assets disposed of in prior tax years that were not removed from the fixed asset records. Treasury Regulation 1.1016-3 provides the authority for the IRS to deny these deductions.
Businesses with tangible property fall into one of the following categories:
- Small business under Rev. Proc. 2015-20 and did not opt out (Please see Post 1 for discussion.)
- Properly filed required Forms 3115 for 2014
- Improperly filed or missed filing a required Form 3115 (Please see Post 2 for discussion.), or
- Did not file required Forms 3115 for 2014
Tax return preparers who work with businesses that filed Forms 3115 with their 2014 tax returns should review these forms and confirm that the client’s fixed asset records have been updated accordingly. it's also important to make sure that the Form 3115 wasn’t missing information and that the taxpayer didn’t erroneously report a $0 Section 481(a) adjustment. Corrections to Forms 3115 should be made ASAP before discovery by IRS examiners. Otherwise, the taxpayer may have made an impermissible change in accounting method that could result in an additional tax liability as well as potential penalties and interest.
Tangible Property in 2015 and Beyond
Each year, tax advisors serving clients with tangible property will need to review the taxpayers’ treatment of the following:
- Costs to acquire or produce tangible property,
- Materials and supplies,
- Repairs & maintenance,
- Improvements, and
- Dispositions of property (including removal costs).
The new methods of accounting required by the tangible property regulations change the way that many businesses treat these types of expenditures beginning in 2014. These changes should be reflected in the 2014 return and all future year returns.
In addition, return preparers should maintain a list of the elections made by the taxpayer each year. The regulations offer a variety of elections that require an annual review, such as:
- Elections to expense tangible property under the de minimis and small taxpayer safe harbors,
- Election to capitalize repair & maintenance costs in accordance with book treatment,
- General asset account elections,
- Partial disposition elections,
- Elections to capitalize employee compensation and/or overhead costs as facilitative costs, and
- Elections to capitalize and depreciate rotable, temporary and/or emergency spare parts when the alternative method of accounting is not used.
Cost segregation plays an important role in a business’ compliance with the new tangible property regulations. A cost segregation study identifies the appropriate unit of property needed to apply the new improvement rules to each building system and the major components of the building itself. Any costs incurred to improve real property must be segregated between real and tangible personal property before applying the improvement rules. In addition, cost segregation is necessary to recognize partial dispositions of building structures and systems, and to segregate removal costs from acquisition or production costs.
As we’ve noted before, it has been clear from the start that these tangible property regulations would have a significant impact on tax accounting methods for businesses. As time passes, we continue to learn even more about how the new rules and the efforts of the IRS to implement them affect small businesses.
To consult with a CSP360 professional about the effect of the rules on your clients in 2015 and beyond, please contact us.