In September 2013, the IRS issued regulations on how to deal with the capitalization and deduction of expenses that are related to tangible assets. These regulations came into effect on January 1st, 2014. For accounting purposes, amounts that have been paid to produce, acquire or improve tangible assets should be capitalized, not deducted. However, expenses incurred in the tax year for carrying out business should be deducted. The tangible property regulations provide guidance to taxpayers on how they should treat expenditures, touching on the following items:
- Materials and supplies
- Repairs and maintenance
- General rule on capital expenditure
- Amount for acquisition or the production of tangible property
- Amounts for improvement of tangible property
Materials & Supplies
Materials and supplies can be defined as units of property that cost the business $200 or less, having an economic useful life of less than 12 months. These can also be units used to repair, improve or maintain property, such as lubricants, fuel and water that is expected to be consumed within 12 months.
The amount that is paid to purchase incidental supplies is deducted in the year that they are paid, while those paid to purchase non-incidental materials are deducted in the year that the supplies are first consumed.
Repairs & Maintenance
The amounts paid for repair or maintenance of tangible property may be deducted. However, routine maintenance performed during the lifetime of the property does not count as property improvement. The regulations have an elective safe harbor for routine maintenance. Under this, it is possible to deduct expenditures for activities that are expected to incur more than once in the life of the asset.
Amounts paid for new buildings or to permanently improve the property that might lead to an increase in the value of the asset should not be deducted. Deductions should also not be made for amounts that have been used in restoring the property.
Tangible Property Acquisition or Production
A taxpayer should capitalize amounts that they pay for the acquisition of tangible property. However, there are rules that determine the extent to which they can capitalize the transaction costs that are related to the acquisition of the property. It is important to consult a professional on these rules and limitations to ensure you are going about this the correct way.
An amount can be considered an improvement if it results in the restoration or betterment of the property. These amounts must be capitalized. Property is defined as buildings or other structural components and must be identified first before capitalizing amounts. Direct costs as well as indirect costs incurred in the improvement of property are also taken into consideration.
The regulations also touch on the disposition of Modified Accelerated Cost Recovery System (MACRS) assets, which are gains or losses realized by the taxpayer when they permanently withdraw assets from their business or from production of income. Disposition refers to sale, retirement, physical abandonment, destruction or exchange of an asset. It could also refer to when an asset is transferred to scrap or supplies; however, if the asset is disposed by converting it into personal use, no loss or gain can be recognized.
The regulations on tangible property affect many taxpayers, and the taxpayer has the burden of implementing the procedures. The first step should be gaining an in-depth understanding of the regulations. The experts at Bodine Perry are ready to help. Call (855) 851-8318 or visit www.bodineperry.com to learn more.