Blake Christian
Blake Christian

Repairs and Maintenance New Temporary Regulations

New standards for capitalizing and deducting tangible property expenditures.

January 26, 2012
by Blake E. Christian, CPA, MBT

The IRS issued the much anticipated repair and capitalization temporary regulations on Dec. 23. (T.D. 9564). According to the IRS, these regulations are intended to clarify and expand existing standards for capitalization of specific expenditures associated with tangible property and provide some bright-line tests for applying the new standards. The temporary regulations are binding on both taxpayers and the government, and are generally effective for taxable years beginning on or after Jan. 1, 2012.

Unit of Property
The landmark, taxpayer-friendly case of FedEx Corporation, 291 F. Supp. 2d 699 (W.D. Tenn. 2003), helped taxpayers determine the relevant unit of property based on functional interdependence. The district court held that an aircraft, as a whole, including its engines and auxiliary power units (APUs), was the appropriate “unit of property,” and that the airframe, engines, and APUs were not separate units that should be treated independently. The lack of a robust market for separate engines suggested that the relevant unit of property was the airplane.

The temporary regulations clarify the unit of property and define “functional interdependence.” In general, all components of property that are functionally interdependent comprise a single unit of property. Components are functionally interdependent if the placing in service of one component is dependent on the placing in service of the other component (Temp. Regs. Sec. 1.263(a)-3T(e)(3)(i)).

Some key rules outlined in the temporary regulations include:

  • Each building and its structural components is considered a single unit of property (Temp. Regs. Sec. 1.263(a)-3T(e)(2)(i)).
  • Building systems and certain significant and specifically defined components (i.e., heating, ventilation, and air conditioning (HVAC), plumbing, electricity, escalators, elevators, etc.) are separate from the building structure and can require the buildings to be broken down into as many as nine separate components (Temp. Regs. Sec. 1.263(a)-3T(e)(2)(ii)(B)).
  • Leasehold improvements are treated as a separate unit of property (Temp. Regs. Sec. 1.263(a)-3T(f)(1)).
  • A unit of property for machinery and equipment is one that performs a discrete and major function or operation (Temp. Regs. Sec. 1.263(a)-3T(e)(3)(ii)(B)).

Functional interdependence is not determinative for “network assets” (i.e., railroad tracks, oil and gas pipelines, water and sewage pipelines, telephone and cable lines, etc.) and the preamble to the temporary regulations points to the Industry Issue Resolution Program for guidance. Other examples are provided in the temporary regulations.

Generally, taxpayers are required to capitalize amounts paid for improvements. A unit of property is improved if it:

  • Results in a betterment to the unit of property;
  • Ameliorates a material condition or defect that existed prior to the acquisition;
  • Results in a material addition;
  • Results in a material increase in capacity;
  • Restores the unit of property; or
  • Adapts the unit of property to a new or different use (Temp. Regs. Secs. 1.263(a)3T(d) and 1.263(a)-3T(h)).

A lessee or lessor must capitalize amounts paid to improve a unit of leased property; however, the amount paid is not a unit of property separate from the unit of property being improved.

Safe Harbor and De Minimis Rule
Routine maintenance, such as cleaning, testing, and reasonable replacement of parts, is not considered an improvement to a property and is currently deductible. If the maintenance is expected to be performed more than once during the lifetime of the property, it is considered to be routine. Industry standards and GAAP treatment of such expenditures may also be used to support the classification as routine maintenance. The temporary regulations revise this safe harbor to apply only to property other than buildings (Temp. Regs. Secs. 1.263(a)-3T(g)).

Under a de minimis rule, materials and supplies, including certain spare parts, are not considered to be a unit of property, and will generally be deductible to the extent the items are less than $100 and reasonably expected to be consumed in 12 months or less (Temp. Reg. Secs. 1.162-3T(c)).

Accounting Method Change
Under Rev. Proc. 2011-14, changing a method from capitalizing to expensing is considered an automatic method change, meaning advance consent from the IRS is not required and Form 3115, Application for Change in Accounting Method, can simply be filed with the tax return for the year of change. A duplicate of the form is also filed with the Ogden, UT, IRS office. Changing a method for determining the unit of property is also considered an automatic method change.

Two related revenue procedures are expected to be issued soon regarding the automatic consent to change accounting methods to be filed beginning with the taxpayer’s 2012 returns. Taxpayers may not request a change to a method described in the temporary regulations on their 2011 returns or prior years. In other words, the temporary regulations are not expected to be retroactive.

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Blake Christian, CPA, MBT is a tax partner in the Long Beach office of Holthouse Carlin & Van Trigt LLP and is co-founder of National Tax Credit Group, LLC. He can be reached at (562) 216-1800.