new repair regulation chapter 10 pp. 349 - 409 2015 national income tax workbook™

New Repair RegulationChapter 10 pp. 349 - 409

2015 National IncomeTAX Workbook™

Rules Proposed and Proposed and Proposed in 2006, 2008, 2011, 2012 AND

Finalized in 2014 Notice 2004-6 asked for comments as to what is:▪ A unit of property?▪ The starting point to see if value or life are increased? ▪ What is a material increase in value? ▪ Etc….Etc…. Etc…

2006 Proposed Regulations - Withdrawn 2008 Proposed Regulations – Withdrawn 2011 Temporary Regulations – Withdrawn 2012 Temporary Regulations – Withdrawn Final Regulations effective for tax years beginning on or

after January 1, 2014 but can elect for years after 12/31/11

Repairs Regulations Chapter 10 p. 349

Improvements to property. Unit of Property.

Materials & Supplies. De Minimis Safe Harbor.

Routine Maintenance Safe Harbor. Small Taxpayer Safe Harbor.

Election to Capitalize Repair & Maintenance Costs. Change in Accounting Method.

Decision Tree.

Repair RegulationsIntroduction p. 349

Final Regulations TD 9636, 2013-43 IRB 331.

Clarify whether costs are currently deductible or need to be capitalized

Provide safe harbor simplifications & implement new rules for small and large businesses.

New Repair RegulationsIntroduction pp. 349 - 350 All Taxpayers must follow the repair Regulations

for years beginning on or after January 1, 2014. Small taxpayers are not exempt. For many the new Regulations formalized what

they have been doing. Taxpayers with assets less than $10M or 3-year

average gross receipts less than $10M can adopt changes in method beginning 1-1-2014 without filing Form 3115.

Observation: 2012 & 2013 Form 3115 Filing Deadline p.

350 Final Regs require making a formal election to use

the safe harbors or to capitalize certain costs. If the safe harbor or capitalization was claimed in an

earlier year and no election was made an amended return with an election is required.▪ Affects years beginning on or after 01/01/2012 and

ending on or before 09/19/2013.▪ Due within 180-days of due date of return

including extensions. This time may have passed but could still be open to

some fiscal year end taxpayers.

Background p. 351

§263 generally requires capitalizing amounts paid to acquire, produce or improve tangible property.

§162 allows a current deduction for ordinary and necessary expenses including materials, supplies, repairs and maintenance.

Background p. 350

Illinois Merchandise Trust Co., 4 BTA 103 (1926) provided the guiding principle:

:To repair is to restore to a sound state or to mend….to keep the property in an operating condition….which are distinguishable from those for replacements, alterations, improvement or additions which prolong the life of property….”

Background and Fig. 10.1 p. 351

Reg. §1.162-3 – Rules for material & supplies. Reg. §1.162-4 – Addresses repairs & maintenance. Reg. §1.263(a)-1 – General rules for capital

expenditures. Reg. §1.263(a)-2 – Rules for acquisition &

production of tangible property. Reg. §1.263-(a)-3 – Rules for improvements to

tangible property. Fig 10.1 Summarizes final Regs and Safe Harbors

Background p. 351- 352

In the past deciding whether an expenditure should be expensed or capitalized depended upon all of the facts and circumstances.

These new Regulations attempt to clarify whether an expenditure is to be expensed or capitalized.

In the future deciding whether an expenditure should be expensed or capitalized depends upon all of the facts and circumstances.

Speaker’s Comment: Wait a minute….what’s changed?

Well there are safe havens & some specific rules.

Improvements to Propertyp. 352

The new Regs provide rules for distinguishing between repairs and capital improvements.

The new Regs rely on past rules & concepts.

There is no bright line and, as in the past, facts and circumstances continue to be the key factor.

Improvements to Propertyp.352

Improvements include:1. Betterment to the unit of property, or2. Restoration of a unit of property, or3. Adapts a unit of property for a new or different

use. All such improvement costs must be capitalized

including:▪ Direct costs, indirect costs that directly benefit

or are incurred for improvement HOWEVER….

Improvements to Property p. 352

The rule now differs from the prior rule that all costs of a general improvement or rehabilitation had to be capitalized.

Now -- Indirect costs of a general improvement plan must be capitalized BUT▪ Indirect costs (such as repairs &

maintenance) not required by the improvement and that do not add to improvement are deductible.

Repairs Completed with ImprovementsEx. 10.1 p.352

The engine, cab and petroleum tank of a truck is replaced by new ones.

The company logo is painted on the new cab and a taillight on the tractor is replaced.

Cost of painting the logo is required by the improvement and so must be capitalized.

Replacing the taillight was not part of or required by the improvement and so is a currently deductible repair.

Presenter’s Comment

The chapter is filled with examples to illustrate the various points.

It is important to note that almost all of the examples are taken from the Regulations.

Regulation citations follow those examples in the text.

Thus, those examples can be relied upon.

Practitioner’s Notep. 353

Federal, State, etc regulatory rules requiring repairs and maintenance at certain intervals is not a controlling factor in deciding to deduct or capitalize.

Betterments p. 353

Capitalization required for amounts that:1.Ameliorate a condition or defect prior to acquisition or production of the unit of property.

2.Are a material addition to the unit of property.

3.Materially increases a unit of property’s capacity such as additional square footage, etc.

4.Materially increases a unit of property’s productivity, efficiency, strength, quality or output of a unit of property.

Preexisting Material ConditionEx 10.2 p. 353

Fast Food bought a store located on top of gasoline storage tanks left by prior owner.

The gas tanks leaked before the purchase but Fast Fresh did not know this until a year after the purchase.

Costs to deal with damage must be capitalized since incurred to ameliorate a material condition or defect prior to acquisition.

Absence of Material ConditionEx 10.3 pp. 353 - 354

Turner owns a building insulated with asbestos NOT known to be a problem when the building was built.

Insulation began to deteriorate and was replaced years after building was in service.

New Regs follow a Tax Court decision in an old case. Cost of removing & replacing insulation are a currently deductible

repairs because the costs did NOT:1. Ameliorate a condition or defect prior to acquisition, or2. Add to the unit of property, or3. Increase a unit of property’s capacity or size, or4. Materially increase a unit of property’s productivity, efficiency, strength,

quality or output of a unit of property.

Regulatory Requirement Not a Betterment Ex. 10.4 p. 354

Lamb Chops owns meat processing plant. Gov’t found that oil was seeping thru concrete floors. Gov’t required Lamb Chop to stop oil seepage. Lamb Chop added concrete lining to walls & concrete to

floor. Lamb Chop can currently deduct the costs even though

required by the Gov’t. Walls & floors were functional prior to seepage. Seepage was not a pre-existing condition. Costs did not increase effectiveness and were not a

material addition to the existing building.

Relocation and Reinstallation of Equipment Ex. 10.5 p. 354

Jazz operates a manufacturing facility in Bldg A. Jazz decided to expand by relocating a machine to

Bldg B. The new configuration and addition of

components increased the capacity of the machine.

Jazz must capitalize the cost of disassembling, moving and reinstalling the machine because capacity was increased.

Relocation and Reinstallation of Equipment Ex. 10.6 pp. 354 - 355

Peek owns bldg. used in its real estate business. The first floor has a drop ceiling. Peek removed the drop ceiling and repainted the

original ceiling. Peek can currently deduct the cost of removing

the drop ceiling or painting the old ceiling. No material addition or increase in capacity or

efficiency..


Star found it could reduce its energy costs by adding insulation to its building’s attic, walls, and crawl space.

The insulation is expected to lower the energy costs by 50%.

Star must capitalize the costs since they make the building more efficient.

Question #1: Suppose the insulation was expected to lower

energy cost by 30%?


Star found it could reduce its energy costs by adding insulation to its building’s attic, walls, and crawl space.

The insulation is expected to lower the energy costs by 50%. Star must capitalize the costs since they make the building more efficient.

Question #1: Suppose the insulation was expected to

lower energy cost by 30%? According to the text this would not be a

material increase in efficiency and would be deductible as a repair.

Comparison of Property Condition p. 355

Comparing condition before & after expenditures helps in deciding if there was a betterment that requires capitalization.

There is no betterment if the property’s condition after a repair is either its:▪ Condition after the last time normal wear

and tear were corrected, or its▪ Condition is the same as when the asset

was placed in service, if there were no prior corrections for normal wear & tear.

Comparing the Property Condition Ex. 10.8 pp. 355 - 356 Roover’s bldg. has 10 roof mounted heat & air

conditioning units. The system includes a control system and duct

work with the units making up the HVAC system. After many years two of the units were replaced. The new units correct climate control problems

and are 10% more efficient than the old units. Replacement is deductible as a repair because

replacement of two units in the entire HVAC system and 10% is not a material increase in efficiency.

Damage to Unit of Property p. 356

If a unit of property is repaired as a result of damage to the property its condition for comparison is its condition before the damage occurred.

Practitioner’s Note: No betterment if damaged property is restored to

its condition before damage happened.▪ Exception: Cost of restoring property damaged

by casualty must be capitalized to the extent the property’s basis is reduced for a casualty loss.

Refreshing a Building p. 356

Costs of “refreshing” a building are currently deductible.

Tres. Regs give examples distinguishing repairs from capital expenditures.▪ Examples 6, 7, 8 from Tres Reg

§1.263(a)-3(j)(3) are illustrative of when costs are deductible “refreshing” or “improvements” that must be capitalized.▪ See 2014 text book pages 328 – 329 on CD

Restorations pp. 356 - 357

Capitalization required for amounts for:1.Replacements where deduction was properly taken for non-casualty loss of a component.2.Replacement where gain or loss was properly taken on disposition of the unit of property.3.Repair of damage where basis was properly adjusted as result of a casualty.4.Return of property to use after not functional.5.Rebuilding to like new after end of its class life.6.Replacement of a major component.

Restore Deteriorated Unit of Property p. 357

If a unit of property deteriorates to where it is no longer fit for use:▪Cost of returning the unit of

property to its ordinary state of operating is a capital cost.

Return to Like-New Conditionp. 357

Cost to bring property to “like new” condition after its class life are capital.

Similar work before end of property’s class life can be deductible repair if not a replacement of a major component of a unit of property.

A comprehensive maintenance program does not return a building to “like new”.

Replace a Major Component or Substantial Structural Part

pp. 357 -358 Must capitalize as restoration expenses

placements of parts that are a major component of a unit of property or a substantial structural part of a unit of property.

To do this use facts and circumstances. The Regs try to distinguish “major” and

“incidental” components….both being parts that perform a critical function of the unit of property.

Significant Portion of a Major Component

Ex 10.9 p. 358 Building has 300 windows making up 25% of its

total surface. Year 1 – 100 windows are damaged and replaced. The windows are a major component of the

building. But, 100 windows is not a significant portion of the

window component. So the cost of replacing 100 is not capital. Treas Reg §1.263(a)-3(k)(7), Ex 25. But….How about if 200 windows are replaced?.....


Ex 10.9, Question 1 p. 358 Building has 300 windows making up 25% of its

total surface. Year 1 – 200 windows are damaged and replaced. The windows are a major component of the bldg. 200 windows is a significant portion of the window

component. So the cost of replacing 200 is a capital expense. Treas Reg §1.263(a)-3(k)(7), Ex 26. But….How about 125 windows? 150? 175? And

does the size of the windows make a difference?...


Ex 10.9, Question 2 p. 358 Yes, Size can matter and make a difference. Building has 300 windows making up 90% of its

total surface. Year 1 – 100 damaged and replaced. The windows are a major component of the

building and because they make up 90% of the building surface they are a substantial structural component.

So replacing 100 windows is replacing a substantial structural component of the building and the cost of replacing 100 is a capital expense.

Treas Reg §1.263(a)-3(k)(7), Ex 27. (60%, 70%, ??)

Replacement of Furnace Not a Major Component

Ex 10.10 pp. 358 - 359 Master’s bldg.’s HVAC is comprised of 3

furnaces, 3 air conditioning units and duct work.

One furnace breaks down and is replaced. One furnace unit is not a substantial

structural part of the VAC system. Replacing the one unit is a deductible repair

expense.

Replacement of Furnace Not a Major Component

Ex 10.11 p. 359 Nimble’s bldg. has an HVAC that is made up

on one chiller unit, one boiler, pumps, duct work, diffusers, air-handlers, etc, etc.

The chiller unit includes compressor, evaporator, condenser, & expansion valve.

Replacing the chiller unit is a capital expense.

The chiller unit is a major component of the HVAC system -- It cools the entire system.

Replacement of Plumbing System is a Major Component

Ex 10.12 p. 359 Star’s 3 story bldg. has men and women

restrooms on two floors. Star replaces all of the toilets and sinks but

not the plumbing pipes. The restoration must be capitalized because

all of the toilets and sinks are a major component of the plumbing system.

Question: Supposed only 8 of 20 sinks were replaced?

Replacement of Plumbing System is a Major Component

Ex 10.12, Q1 p. 359 Star’s 3 story bldg. has men and women restrooms on two floors. Star replaces all of the toilets and sinks but not the plumbing pipes. The restoration must be capitalized because all of the toilets and sinks are a major

component of the plumbing system.

Question: Suppose only 8 of 20 sinks were replaced? 8 sinks out of 20 are not a significant

portion of a major component of the plumbing system and so the cost is deductible as a repair.

Flooring Replacement Not a ComponentEx 10.13 pp. 359 - 360

Victor owns a hotel & decided to refresh the lobby by replacing the lobby floors.

The lobby makes up only 10% of bldg. The replacement of the flooring is a

deductible repair since it is not a significant portion of a major component of the bldg. and not a structural part of the bldg.

Question #1: What if all public area flooring is replaced?

Flooring Replacement Not a ComponentEx 10.13, Q #1 pp. 359 - 360

Question #1: What if all public area flooring is replaced? The public areas make up 40% of the hotel

flooring. Changing all public area flooring is a capital

expense because it is 40% (a significant portion a major component) of flooring.

Question #2: Supposed public areas make up 30% of flooring?

Flooring Replacement Not a ComponentEx 10.13, Q #2 pp. 359 - 360

Question #2: Suppose public areas make up 30% of

flooring?

The replacement of the flooring would be a deductible repair.

At 30% the public area flooring is not considered a significant portion of a major component.

Partial Disposition Election p. 360

Disposition of an asset can result from a sale or exchange, abandonment, contribution.

A taxpayer can election to report a gain or loss on disposition of a portion of certain assets if the taxpayer classifies the replacement portion of the asset under the same asset class as the disposed portion of the asset.▪ Taxpayer gets to deduct the portion of an asset

abandoned in exchange for capitalizing the replacement portion of the asset.


In certain instances the elect must be made:1.Disposition of a portion of the asset was due to

casualty.2.Disposition where gain is not recognized under

1031.3.Certain transfers of assets.4.A sale of a portion of an asset.Thus, under these circumstances the taxpayer

reports the gain or loss on disposition and capitalizes the replacement asset.


A taxpayer may use any reasonable method to determine the adjusted basis of the disposed portion of the asset.

Permissible methods include:1. Producer Price Index (PPI) rollback.2. Cost segregation studies.3. Factorial comparisons.

Computations are demonstrated on pages 361 and 362.

Page 362 lists changes that cannot use the PPI.

Removal Costs p. 363

Removal cost of a part of a unit of property may be deductible or capital costs if disposal is not a disposition of the unit of property.

Capitalization is not required if removal costs of a capital asset are taken into consideration in gain or loss of the asset.

Ex 10.18, page 363 explains…..

Reroofing an Apartment ComplexEx. 10.18 p. 363

Apple owns 10 separate bldgs. Roofs on each deteriorated after owned by Apple. New shingles were put on top of the old in 2 bldgs. Roof structure needed no work. Cost are deductible repair and NOT capital exp. Exceptions: Taxpayer would have to capitalize costs if work

was due to casualty loss or if taxpayer elected to deduct cost of old shingles using the partial asset disposition rules.

Reroofing an Apartment ComplexEx. 10.18, Q1 p. 363

Apple owns 10 separate bldgs. Roofs on each deteriorated after owned by Apple. New shingles were put on top of the old in ALL 10

bldgs. Roof structure needed no work. Because deterioration occurred while Apple owned

the bldgs. there is no adaption, betterment or improvement and cost are still a deductible repair.

Question # 2 -- But suppose deterioration was only after Apple owned bldgs. for 1 or 2 years?

Reroofing an Apartment ComplexEx. 10.18, Q2 p. 363

Apple owns 10 separate bldgs. Roofs on each deteriorated 1 or 2 years after Apple

acquired the bldgs. New shingles were put on top of the old in ALL 10

bldgs. Roof structure needed no work. Because deterioration probably occurred before

Apple owned the bldgs. there is “restoration” and cost should be capitalized.

Taxpayer should probably elect partial disposition & deduct adjusted basis of old shingles as a loss.

Reroofing an Apartment ComplexEx. 10.18, Q3 pp. 363 - 364 Apple owns 10 separate bldgs. Roofs on each deteriorated while after Apple


bldgs. Roof structure needed no work. How should removal cost be treated if removal is a

repair? Taxpayer must deduct the removal costs.

Reroofing an Apartment ComplexEx. 10.18, Q4 pp. 363 - 364

Apple owns 10 separate bldgs. Roofs on each deteriorated while after Apple


bldgs. Roof structure needed no work. How should removal cost be treated if removal is a

capital cost and taxpayer elected a partial disposition?

Taxpayer must deduct the removal costs of the old shingles.

Component Removed during Improvement

Ex. 10.19, Q #1 p.364 Xavior owns bldg. with storage on 2nd floor. Replaced columns and girders to support 50%

more weight in 2nd floor storage area. Replacement is an improvement and a capital cost How are cost of removing old columns & girders

treated? Because this was an improvement the cost of

removing the old and installing the new are capital costs.


Ex. 10.19, Q #2 p.364 Xavior owns bldg. with storage on 2nd floor. Replaced columns and girders to support 50%

more weight in 2nd floor storage area. Replacement is an improvement and a capital cost How are cost of removing old columns & girders

treated if “partial disposition” treatment is elected?

The cost of removing the old are a deductible repair.

Cost of installing the new are capital costs.


Ex. 10.19, Q #3 p.364 Xavior owns bldg. with storage on 2nd floor. Replaced columns and girders to support

25% more weight instead of 50% in 2nd floor storage.

Replacement may not be a “material increase” in capacity.

The costs are a deductible repair.

How about 30%, 40%, 49%?

Component Removed during Repair or Maintenance

Ex. 10.20 pp. 364 - 365 Shingles cover a retail building’s roof. The roof begins to leak. New shingles replaced the old shingles. The new shingles stop the leaks but are not a

betterment or a restoration and do not adapt or change the buildings use.

Cost of removing the old shingles and installing the new are a currently deductible repair.

BUT….Suppose the owner deducts the adjusted basis of the old shingles as a disposition of a unit of property?

Component Removed during Repair or Maintenance

Ex. 10.20, Question p. 365 If the owner deducts the adjusted basis of

the old shingles as a loss on disposition of a unit of property the replacement costs is considered a restoration which must be capitalized as an improvement of the unit of property.

The cost of removing the old shingles is still treated as a currently deductible expense.

Adaption to a New or Difference p. 365

Cost of adaption to a new or different use must be capitalized.

Combining Three Leased SpacesEx. 10.21 p.365 Broadstone owns bldg. & leases 20 retail

spaces in the bldg. Bldg was designed so that spaces could be

adjusted within the bldg. A tenant renting one space expanded &

wanted the business to have 3 spaces. Broadstone removed walls and made

adjustments to increase tenants space. Costs are a deductible repair.

Preparing Building for Sale Not an Adaption

Ex. 10.22 p.365 Crystal owns bldg. & leases 20 retail spaces

in the bldg. and decided to sell the bldg. To sell bldg. the walls were painted and

flooring was refinished. Costs are not preparing for a different use. Costs are a deductible repair.

Modifying Part of BuildingEx. 10.23 pp. 365 - 366

General Hospital owns a hospital bldg. General decided to modify the emergency

room to also do outpatient surgery. It moved walls, added wiring & outlets,

replaced flooring & doors, repainted, & added equipment.

Ordinary use of building did not change. Renovation costs a repair. Cost of new equipment are capital expense.

Unit of Propertyp. 366

Replacement of a major component or substantial structural part of a unit of property must be capitalized.

Other than buildings use a:▪ “Functional Interdependence” standard:

Placing one component in service is dependent on placing other components in service.

Functional interdependent components are one single unit of property.

Buildingsp.366 - 367

A building is a single unit of property. But, for purposes of improvement rules:▪ The building structure is a unit of property and▪ Building systems are each a separate unit of property

including: Heat, ventilation & air conditioning Plumbing systems (pipes, sinks, etc) Electrical systems (wiring, outlets, lighting, etc) Escalators Elevators Fire protection systems. Etc

Building Structurep.367

Except for “building systems” the building structure is the building including:▪ Walls▪ Partitions▪ Floors▪ Ceilings▪ Windows and Doors▪ Components relating to the building’s

operation and maintenance.

Leased Buildingsp. 367

Only part of a building is leased:▪ Unit of property is the portion of the

building covered by lease. Where a whole building is leased:▪ Improvement rule is same as if the

building is owned: Improvement rules apply to building

structure and separately to building systems.

Alterations to RestroomEx. 10.24 p. 367 - 368

Lessee rents space in a large office building If the Lessee pays to have new toilet and sink

installed in a restroom for its employees:▪ Cost is capital expenditure because the work is

on a major portion of plumbing system in lessee’s restroom.

If Lessor pays cost:▪ Cost could be a deductible repair since it only

affects a small portion of the buildings entire plumbing system.

Building Improvement by LessorEx. 10.25 p. 369

Teddy leased a bldg. from Landmark. Landmark provided to Teddy a construction

allowance used to add to warehouse space. Landmark is owner of addition and:▪ Must capitalize the “betterment” costs.▪ The addition is not a separate unit of property

but part of the building

Question / Answer: If Landmark were to remodel 2 of 6 restrooms next

year the cost would be a repair.

Property Other Than Buildings &Ex. 10.26 p. 369 Assets used together are not always

functionally interdependent.

Ex. 10.26 Laptop computer and printer bought for use

by employees. The computer and printer are separate units

of property because one can be placed in service without the other.

Functionally Interdependent Components

Ex. 10.27 p.369

A train locomotive is comprised of an engine, generators, batteries, chassis, etc.

The locomotive is a single unit of property.

Its parts are functionally interdependent.

Plant Propertyp. 369

Means functionally interdependent machinery or equipment (not including network assets) used in manufacturing, warehousing, distribution, etc.

The unit of property is divided into smaller units.

Let’s see example 10.28…..

Discrete and Major FunctionsEx 10.28 pp. 369 - 370

A laundry plant treats and launders rental uniforms. It has two lines of operation. Each line has a sorter, boiler, washer, dryer, ironer, folder &

waste water treatment system. General rule – ▪ Each line is a separate unit of property.▪ Under functional interdependence.

Plant Property rule -▪ Each line is further divided into units of property.▪ Each sorter, boiler, washer, dryer, etc is a separate unit of

property.▪ Replacing a dryer in either line is a capital expenditure.

Network Assetsp. 370

Functional interdependence test is NOT controlling for Network Assets

Unit of property for Network Assets is determined by fact and circumstances.

Network Assets Include - Railroad track; oil & gas pipelines; water & sewage pipelines; power transmission & distribution lines; and telephone & cable lines......Excluding buildings & building systems.

See what a good lobbyist can do for an industry.

Limit for Lease Property and Improvements and Different Depreciation Schedules p. 370

A unit of property cannot be larger than the property subject to a lease.

Improvements to a unit of property do not become separate units of property.

Components of a unit of property with a different depreciation methods or recovery periods are separate units of property.

Components with Different Depreciation Classes

Ex 10.29 p. 370 Truck company bought a tractor. Treated tractor as 3-year property. Treated tractor tires as 5-year property. General rule – Tractor and tires are a unit of

property. BUT – Because tractor and tires are

different classes of property they are two separate units of property.

Improvements with the Same Depreciation Method

Ex 10.30 p. 371

Additions to buildings are not separate units of property from the building if the same depreciation method & period are used.

Makes no difference that the placed in service dates are different.

Cost Segregation Ex 10.31 p. 371

If the depreciation method for a portion of a building or components of a building changes that portion becomes a separate unit of property.

Ex 10.31 Depreciating building & parking lot as 39-year

property and as one unit of property. Cost segregation study done and as a result

parking lot changed to 15-year property. Parking lot is now a separate unit of property.

Cost Segregationp. 371

Practitioner Note:▪ Cost segregation change assets into separate

units of property.▪ This is a change in method of accounting requiring

Form 3115 and IRS consent. Planning Pointer:▪ Cost segregation may provide larger depreciation

deductions BUT▪ Because the unit of property is smaller what might

have been a repair later may be a capital expenditure.

Materials and Suppliesp. 372

Materials & Supplies are tangible property used or consumed in a business that are not inventory and are either:

1. Costing $200.00 or less, or(Increased from $100.00 under the temporary regs.)

2. A component acquired to maintain or repair tangible property, or

3. Fuel, lubricants, etc to be consumed in 12-months, or

4. A unit of property with useful life less than 12-months, or

5. Any other tangible property so designated by IRS.

Bulk PurchaseEx. 10.32 p. 372

Buys 10 toner cartridges for $500. 8 will be used within 12-months & 2 are stored. Since each cartridge cost less than $200 those to

be used within 12-months are currently deductible. So $400 can be deducted currently.▪ 8 cartridges X $50 cost for each.

The remaining $50 for each cartridge can be deducted when each remaining cartridge is used.

Improvements Using Materials and Supplies p. 372

Costs of material and supplies used to improve a unit of property must be capitalized and depreciated as part of the unit of property.▪ §1.263-3(h), Ex 10

Costs of material and supplies used to repair a unit of property can be deducted as a repair expense. ▪ §1.162-4 - See Ex 10.33, Text Page 372.

Incidental Materials and Suppliespp. 372 - 373

If no record is kept the costs are deductible in the year paid if income is clearly reflected.

Planning Pointer: Under a “Safe Haven” an election can be

made to deduct material and supply costs limited by a safe harbor amount.

To be covered next.

De Minimis Safe Harbor p. 373

Deduction allowed for units of property that are normally capitalized if:

▪ Useful life is less than 12 months OR

▪ Cost does not exceed a ceiling amount. < $500.00 where Applicable Financial

Statements are not prepared and < $5,000 where Applicable Financial

Statements are prepared.

De Minimis Safe Harbor Rules p. 373 - 374

Amounts deducted under Safe Harbor are an ordinary §162 deduction.

A later sale of a Safe Harbor item results in ordinary income.

If elected Safe Harbor applies to all applicable cost items.

Exceptions to the De Minimis Rule:▪ Certain rotable, temporary or emergency spare

parts that are capitalized and depreciated. ▪ Property intended for inventory.▪ Land.

De Minimis Safe Harbor Applied to Materials and Supplies

Ex. 10.34 p.374 TPs financial system requires a taxpayer to treat items

costing $500 or less as an expense. TP bought 1,000 calculators costing $100 each. Life expectancy is more than 12-months. Since each calculator cost less than $200 they can be

treated as materials and supplies and deducted in the year used or consumed.

OR Since the calculators cost less than $500 the cost can be

deducted under the De Minimis Safe Harbor in the year the taxpayer paid or incurred the cost.

De Minimis Safe Harbor Applied to Materials and Supplies

p. 375

Planning Pointer:▪A §179 deduction could be taken

instead of the Safe Harbor deduction.▪Under §179 a later gain on

disposition could be a capital gain.

De Minimis Safe HarborEx 10.35 p. 375

TP does not have AFSs but does have a policy of expensing property costing $500 or less.

Buys 100 heifers that cost $400 each. Each heifer is a separate unit of property costing

less than $500. TP can deduct the $40,000.

Practitioner Note: Subsequent sale of the heifers would be ordinary

income instead of capital gain.

Qualifications for Election p. 375

To use the De Minimis Safe Harbor the business must have a policy in place for expensing units of property costing a certain amount.

Policy must be in writing if have AFSs. Text suggests having a written policy even

if don’t have AFSs. Fig 10.2, page 377 provides a sample format

to establish an accounting practice.

Useful Lifep. 375

In determining whether an item will last more or less than 12-months consider all of the facts, circumstances, experiences, etc.

Class life and recovery period of an asset are not determinative.

Applicable Financial Statement p. 376

Applicable Financial Statements (AFS)▪ Those filed with the SEC.▪ CPA Certified statements▪ Those required by a Federal or State or

an agency other than the SEC or the IRS.The Safe Harbor limits are lower if the TPs accounting procedures set a lower limit.Fig 10.2 provides a sample format to establish an accounting practice.

Taxpayers With and Without an AFSEx 10.36 and 10.37 p. 377

Ex. 10.36: TP has AFSs and written policy to expense amounts up to $5,000.

Buys 1,250 computers for $6.25M. Each is a separate unit of property & each cost no more

than the $5,000 limit. TP can deduct the $6.25M. Ex. 10.37: TP does not have AFSs but does have a policy

of expensing property costing $500 or less. Buys 10 printers for $2,500. Each printer is a separate unit of property costing less

than $500. TP must deduct the $2,500

Economic Useful LifeEx 10.38 p.377 - 378

No AFS but policy is to deduct property costing $300 or less AND expense any property with a useful life of 12-months or less.

Bought a $400 device & a $600 computer both having a useful life of less than 12-months.

Can expense both items for accounting purposes AND

Can deduct the $400 for tax purposes BUT Must capitalize & depreciate the $600 for tax

purposes because it exceeds the safe harbor limitation.

Transaction & Other Additional Costs p. 378

In determining if $500 or $5,000 safe harbor limit is met or exceeded:

Costs of acquiring property are included in the cost of a unit of property ONLY if the additional costs and property cost are on same invoice.

If invoice includes multiple units of property and the additional costs (shipping, etc) is on the invoice the additional costs must be allocated to the different units or property.

See Exs. 10.39 and 10.40, text page 378.

De Minimis RulesAnnual Election p. 379

Elect to come under safe harbor using the De Minimis Rule:

Irrevocable election is made for each year.Attach statement to original tax return.▪ See Fig 10.3, text page 379.

Must be filed by due date including extensions.Need to state: “Section 1.263(a)-1(f) de minimis safe harbor election.”S Corps and P/Ss make election on their return… Not SH or Partner’s return.

Antiabuse Rulep. 379

If an invoice is divided for abuse of the rule the safe harbor does not apply.

If you purchase a truck that exceeds the safe harbor limitation you cannot come under the safe harbor by asking for and getting separate invoices for the motor, cab, tires, transmission, seats, etc.

IRS can make adjustments to correct.

Routine Maintenance Safe Harbor Nonelctive p. 380 - 381

Deductible Routine Maintenance includes:

Inspecting, cleaning, testing and replacing damaged or worn parts.

Other than buildings & structural components:▪ Activities to be performed more than once

during the assets ADS class life.

Building & structural components:▪ Activities to be performed more than once in a

10-year period.

Routine Maintenance plus UpgradesEx 10.41 p. 381

Boats class life is 18 years. Routine repairs & maintenance done every 4

years. At 8th year boats were also upgraded. The routine repairs and maintenance done

at 8th year directly benefitted the upgrades. None of the costs in the 8th year qualify as

routine maintenance and repairs and must be capitalized.

Maintenance for Prior Owner’s UseEx 10.42, Q #1 pp. 381 - 382

Bell bought a machine with 10 ADS life. Routine maintenance set for every 3-years by mfr. When the machine was bought it was due for 3-years maintenance work.

Q#1 -- Do the costs qualify for the routine maintenance safe harbor?

No. Work was due to prior owner’s use. Costs must be capitalized if resulted in

betterment, improvement or ameliorated a defect.

Maintenance for Prior Owner’s UseEx 10.42, Q #2 p. 382

Bell bought a machine with 10 ADS life. Routine maintenance set for every 3-years by mfg. When the machine was bought it was due for 3-years maintenance work. 3-years later Bell did the next mfg suggested work.

Q#2 -- Do these subsequent costs qualify for the routine maintenance safe harbor?

Yes and the costs are a deductible.

Escalator SystemEx. 10.43 p. 382

40 escalators in a mall. Estimate replacing handrails every 4 years. At 4th year the handrails were replaced. The cost is a currently deductible expense. Done to keep the escalator system in

operating condition. Reasonably expected to change the steps

during the 10 year period. How about if steps are replaced in 9th year?

Escalator SystemEx. 10.43, Question p. 382 Again, we have 40 escalators in a mall. Estimate replacing steps every 18-20 years. At 9th year the steps of the escalators need to be

replaced. Replacement not eligible for routine maintenance

safe harbor & must be capitalized IF replacement improves the building system.

BUT, may be deducted as a repair if replacement does not result in building system improvement.

HVAC System(Heat, Ventilation & Air Conditioning)

Ex. 10.44 p. 383 Estimated work every 4 years to keep HVAC

systems running properly. Work done in 4th year but not done again

until year 11. If TP can show that expectation of work

every 4 years was reasonable it can deduct the work that was postponed until year 11.

Planning Pointer – Need to document maintenance plan.

Small Taxpayer Safe HarborEligible Building Property pp. 383 - 384

Small qualifying taxpayers (including renters):▪ Those with 3-year average receipts < $10M.

Can elect (annually) to deduct building repairs, maintenance, improvements & similar activities if the cost of these is the lesser of: $10,000 or 2% of property’s unadjusted basis for an eligible

building property which is: One owned or leased by small qualifying TP. With unadjusted basis < 1M.

If the expenses exceed the safe harbor limit the general rules apply to the expenses….Capitalize improvements.

If the expenses exceed the above limit the general rules apply.

Observation P. 384

2% x $500,000= $10,000 So if a buildings unadjusted basis is:▪ More than $500,000 the lower limit is

$10,000.▪ Less than $500,000 the 2% limit will

be lower and apply.

Safe Harbor Applied to LessorEx. 10.45 p. 385

Rita owns rental house. Her 3-year average gross receipts are less

than $10,000,000. She elected no safe harbor. Let’s look at the facts and what happens….

Safe Harbor Applied to LessorEx. 10.45, Fig 10.4 p. 385

Unadjusted basisLand $10,000Building Unadjusted Basis 99,500Prior Bldg Improvements 20,100Lawn Mower 1,450Appliances 1,700Total Unadjusted Basis $132,750

Current Yr Improvements $ 2,000Current Yr Repairs & Main 3,275Current Yr Expenses $ 5,275

Has she met the safe harbor? Can she deduct the improvements?

Safe Harbor Applied to LessorEx. 10.45, Fig 10.4 p. 385

Unadjusted basis Bldg Only Result

Land $10,000 Repairs, Maintenance,Building Unadjusted Basis 99,500 $ 99,500 and Improvements arePrior Bldg Improvements 20,100 20,100 less than $10,000 BUTLawn Mower 1,450 they exceed the 2% ofAppliances 1,700 ________ the BuildingsTotal Unadjusted Basis $132,750 $119,600 Unadjusted basis. So,

X 2% the Small TP Safe Limitation $ 2,392 Harbor is NOT met.Current Yr Improvements $ 2,000 = Must be CapitalizedCurrent Yr Repairs & Main 3,275 = Can Currently DeductCurrent Yr Expenses $ 5,275

Safe Harbor Applied by LesseeEx 10.46 pp. 385 - 386 Unadjusted basis for the small taxpayer safe

harbor in a lease situation is the rent to be paid over the life of the lease.

Monthly rent of $4,000 over a 20-year lease gives unadjusted basis of $960,000 ($4,000 x 240 Mos).

Unadjusted basis is therefore less than $1M so property qualifies as an eligible building.

Current yearly maximum repair, maintenance & improvement deduction under the building safe harbor is the lesser of $10,000 or 2% X $960,000.

Taxpayer may be able to deduct $10,000.

More Than One BuildingEx 10.47 p. 386

If a taxpayer has more than one building the Safe Harbor limitations are applied to each building, separately.

Taxpayer owns 2 buildings with unadjusted basis of $300,000.

Repairs, maintenance and improvements to one are $5,000 and are $7,000 to the second building.

Let’s see if the Safe Harbor applies……

More Than One BuildingEx 10.47 p. 386

Leased Bldgs Bldg #A Bldg #BUnadjusted Basis $300,000 $300,000Limitation % X 2% X 2% 2% Limitation $ 6,000 $ 6,000 Maximum $ Limitation $ 10,000 $ 10,000Lesser of 2% or $10,000 = $ 6,000 $ 6,000Repairs & Improvements $ 5,000 $ 7,000 Repairs are Currently

DeductibleCurrently Deductible

Improvements are Currently Deductible

To Be Capitalized

Annual ElectionEligible Building Safe Harbor p. 386

To elect to come under safe harbor using the Eligible Safe Harbor for a Building:

Attach statement to original tax return.▪ See Fig 10.5, text page 386.

Must be filed by due date including extensions.Need to state: “Section 1.263(a)-3(h) Safe Harbor Election for Small Taxpayers.”S Corps and P/Ss make election on their return… Not SH or Partner’s return.

Election to Capitalize Repair & Maintenance Costs p. 387

Can elect to capitalize and depreciate repairs and maintenance. See sample Fig 10.6, page 388.

Known as “Book Conformity”. Attach statement to original tax return. Must be filed by due date including extensions. Need to state: “Section 1.263(a)-3(n) Election”. S Corps and P/Ss make election on their return… Not SH or

Partner’s return. Can still use De Minimis Safe Harbor; Safe Harbor for Small

Taxpayers; and deduct Routine Maintenance that are not capitalized on the return.

Change in Method of Accounting pp. 388 - 389

Here is where the confusion has been. When does a change in method Form 3115 need to

be filed. IRS issued Rev Proc 2014-16 to clarify. IRS then issued Rev Proc 2014-54 to further clarify IRS then issued Rev Proc 2015-13 to help. Finally, IRS issued Rev Proc 2015-20 stating that

“small taxpayers” could adopt the final regulations on a prospective basis without filing a Form 3115, or attaching a disclosure statement to the return……………SO…….

Change in Method of Accounting p. 389

Revenue Procedure 2015-20, 2015-9 IRB 694:Taxpayers with less than either:▪ $10M in assets OR▪ $10M in a 3-year average of gross receipts

Do NOT have to file Form 3115 to use the final repair regulations for tax years starting on or after January 1, 2014 andDo NOT need to attach a disclosure statement to the tax return.Small taxpayers are “deemed “ to have filed a 3115

Section 481(a) Adjustment & Practitioner Note p. 389 The Section 481(a) adjustment

usually made with a change in method of accounting is -0- for small taxpayers using the new repair Regulations on or after tax years beginning January 1, 2014.

Separate Trade or Business p. 389

If the trades and businesses are separate and distinct the assets and incomes of the businesses do not need to be combined for purposes of the $10M tests for being a small taxpayer.

Consequences of Deemed Filing of Form 3115 Under Rev Proc 2015-20

pp. 390 - 391

Pages 390 – 391 list the accounting changes that:▪ Can be made without filing Form

3115 for small taxpayers “Deemed” to have file Form 3115, and ▪ Cannot be made without filing Form

3115 for small taxpayers “Deemed” to have file Form 3115.

To File or Not To File Form 3115 pp. 392 - 393

Form 3115 is not required by “Small Taxpayers”.

The potential missed opportunities and recommendations for when the Form 3115 should be filed are listed on pages 392 - 393.

Concurrent Automatic Changes and Signing & Filing the Form 3115

pp. 395 - 396 One Form 3115 can be filed for several

changes to the new rules. Original goes with tax return. A signed copy must be sent to IRS, 1973

Rulon White Blvd., Mail Stop 4917, Ogden, UT 84201-1000.▪ Address in several Rev Procs is incorrect.

Signing instructions are on Form 3115 instructions and in Rev Proc 2015-13.

Extension of Time to File Form 3115 p. 396

There is an automatic 6-month extension to file Form 3115.

Must file 3115 within 6-months of due date excluding extensions.

In addition, taxpayer must:▪ Timely file return for change year (including

extensions),▪ Attach a statement that the Form 3115 is being:

“Filed Pursuant to 301.9100-2(b) of Procedure and Administrative Regulations”

▪ See page 396 for further details.

Sample of a Completed Form 3115pp. 396 - 402

Sample of a Form 3115 completed for a small business taxpayer choosing to formally file accounting method changes with a zero section 481(a) adjustment.

List of Changes Not Considered a Change in Method p. 403

Safe Harbor Form 3115NOT

Required

ElectionRequired

De Minimis Safe Harbor:< $500 & < $5,000

No Yes

Small Taxpayer Building: Lesser of $10,000 or 2%

No If Exceed Limits

For Others See Text Page 403

Summary of Method Changes Reported on Form 3115 pp. 404 - 407

These pages provide a summary of the accounting method changes that may be made as a result of the new repair regulations.

Decision Tree pp. 408 - 409

New Regs have a lot of twists and turns

But there is HELP!The Decision Tree on pages 408 &

footnotes on page 409 walk you through the maze in deciding whether

an expenditure can be deducted or should be capitalized.

new repair regulation chapter 10 pp. 349 - 409 2015 national income tax workbook™

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