In September 2013, the IRS released its final tangible property regulations (known as the repair regulations) which are effective for years beginning on or after January 1, 2014. These regulations clarify and expand the rules for determining the timing of tax deductions for expenditures connected with repairs and maintenance of both real and personal property. They also cover costs incurred in connection with the acquisition, production, or improvement of tangible property.
Construction companies typically have a significant amount of property and equipment that requires ongoing repairs and maintenance to keep it in working condition, and they regularly incur costs associated with the acquisition of such property. Therefore, you need to consider how these new regulations will impact your business.
The final regulations are similar to the temporary regulations issued in December 2011, but there are some differences to consider. Some of the changes include:
- A simplified de minimis safe harbor
- Refined criteria for defining betterments and restorations to tangible property
- A safe harbor for routine maintenance on buildings
- A proposed set of rules related to disposition of tangible property
One of the most significant changes is the simplification of the de minimis safe harbor, in which the ceiling on aggregate de minimis deductions has been replaced by a $5,000 per invoice or per item rule if substantiated by an invoice or equivalent document. In order to take advantage of the $5,000 threshold, companies must have an audited financial statement (or equivalent financial reporting to governmental agencies) and a written accounting policy must be in place as of the first day of the tax year for which this rule will be applied. Absent audited financial statements, a lower $500 threshold is available.
For example, a company with audited financial statements and a $5,000 written policy would currently deduct the cost of 10 computers worth $4,000 each whereas, absent the application of these provisions, such cost would be capitalized and written off over time via depreciation deductions.
Here’s the catch: the $40,000 overall cost must also be treated as an expense in connection with financial reporting. The latter may not be the best answer to meet expectations of credit and bond sources. Should historical favorable tax provisions be extended to 2014 and beyond, allowing certain capitalized costs to be expensed (Section 179 deduction) and/or materially written off in the year of acquisition (bonus depreciation), a better overall answer may lie in not having such a policy and taking advantage of differences between available financial and tax reporting options.
On January 24, 2014, the IRS issued a revenue procedure outlining transition rules for taxpayers choosing to change their historical accounting practices to conform to the new regulations. Another revenue procedure addressing proposed disposition regulations is expected to be issued in the near future.
We are prepared to help you understand the impact of the new regulations, evaluate the pros and cons of how such rules will potentially impact your financial and tax reporting, and assist with any accounting method changes that may be appropriate.
For more information, contact Mark A. Guillaume, Manager, Audit & Accounting and member of Kreischer Miller’s Construction industry group at Email or 215.441.4600.
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