New rules will soon go into effect that impact all taxpayers that acquire, produce, or improve tangible property. The most significant tax accounting change in decades, virtually every taxpayer with a building or equipment will need one or more accounting method changes to comply with these new rules. These new rules are very complex and you should start preparing for them NOW - how to take advantage of the rules to accelerate deductions, what new accounting policies need to be established, how these rules impact your financial statements and how you'll need to adapt your accounting systems and procedures

1. Are You Ready for the New Tangible Property Rules?
by
Eustis Corrigan, CPA
Managing Director, CBIZ MHM, LLC
Mike Finnegan, CPA
Managing Director, CBIZ MHM, LLC
Steve Henley, CPA
National Tax Practice Leader, CBIZ MHM, LLC

2. 2
Circular 230 Notice
Any tax advice contained in this program is not intended
to be used and cannot be used for the purposes of
avoiding any penalties that may be imposed by the
Internal Revenue Code.

3. 3
• Area under IRS scrutiny for many years
• Latest attempt to develop some consistency in
treatment of tangible property transactions
– Many favorable changes (i.e. tax deductions available
now)
– IRS wants to make method changes as flexible as
possible
– This is the new law; tax compliance is required
Introduction

4. 4
• IRS has always had interest in the capitalization
vs. deduction of costs related to tangible property
–Original source: Case law
–August 2006: Proposed regulations
–March 2008: Re-proposed regulations
–IRS issued specific audit guidelines for this issue
History and Background

5. 5
• Temporary regulations issued (December 2011)
– Transition guidance issued (March 2012)
• Provides 19 new automatic method changes
• Scope limitations waived for 2012 and 2013
• Required compliance with section 263A
• Large Business & International (LB&I) Directive
issued (March 2012)
– Stand-down order on most repairs and associated
dispositions issues
History and Background, cont.

6. 6
• Final regulations contain the standards for determining
whether and when a taxpayer must capitalize costs
incurred in acquiring, maintaining, or improving tangible
property
– Temp regulations (effective for tax years beg on or after 1/1/12)
– Final Regulations effective for tax years beg on or after 1/1/14
• May be optionally applied for tax years beginning on or after
1/1/12
History and Background, cont.

7. 7
• Proposed Regulations issued 9/19/13 for the
Disposition of Tangible Property portion of these
rules:
– Temporary regulations (currently effective for tax years
beginning on or after 1/1/12):
– Final Regulations to be issued later in 2013
– Effective for tax years beginning on or after 1/1/14
• Proposed regulations may be optionally applied for
tax years beginning on or after 1/1/12
History and Background, cont.

8. 8
• Note that these rules are for “Tangible
Property”
–Not just for tangible personal property
–Improvements to and dispositions of real property
are a significant part of the new rules
–New rules were not designed for intangible assets
• Focus is on depreciable property, materials &
supplies, and repair expenses
History and Background, cont.

9. 9
• Compliance with these new rules may require changes in
methods of accounting for tax purposes
– Transition guidance issued for the Temporary Regulations
• Allows for automatic accounting method changes to get in compliance
with these rules
– Transition guidance expected for the Final Regulations
Accounting Method Changes

10. 10
• Form 3115 is used to request an Automatic Change
– Original Form 3115 is filed as an attachment to the income
tax return and a copy sent to a separate IRS office
– Negative adjustments (decrease to income) are deducted in
year of change
– Positive adjustments (increase to income) are picked up in
income ratably over 4 years
– Transition guidance provides a great deal of flexibility
Accounting Method Changes, cont.

11. 11
• As a result of issuing these new rules, the IRS is expecting
many Forms 3115 to be filed to get in compliance
– IRS stand-down order on audits in this area reflects their
desire to have taxpayers voluntarily make these changes
– Expectation is that after the transition period for making these
changes (tax years beginning 1/1/15) the IRS will begin heavy
examination activity in this area
• Critical to take advantage of the automatic change
provisions now to avoid risk of IRS making changes
• Note that changes in this area may impact other areas and
require further changes (UNICAP, Tax Depreciation…)
Accounting Method Changes, cont.

12. 12
•2 Primary Subject Areas Covered
1) Capitalization and Expensing
• Improvements to Tangible Property
• The de minimis safe harbor election
• Materials & Supplies
2) Dispositions of Tangible Property
• General Asset Account Elections
2 Primary Areas for tax savings and compliance

13. 13
• Critical tax compliance area
• What is a Capitalized Improvement vs. a Deductible
Expense?
Improvements to tangible property
Improvement
Betterment
Restoration
Adapt to new
or different
use

14. 14
• Betterment: In general, an expenditure is a Betterment
and must be capitalized if it has a “material” impact on
the property
– Improves a material defect, is for a material addition, or a
material increase in capacity or quality
• Restoration: In general, an expenditure is a Restoration
and needs to be capitalized if:
– It is for the replacement of a component or returns the property to
its ordinarily efficient operating condition after its class life
• Facts & Circumstances, no bright-line tests but many
examples in the Final Regulations
Improvements, cont.

15. 15
• Key Concept is the Unit-of-Property (“UOP”)
• Taxpayers need to apply the Improvement
Standards to an expenditure made to the UOP
and capitalize the expenditure if it results in a:
– A Betterment to the UOP;
– A Restoration to the UOP;
– Adapts the UOP to a new or different use
Improvements – Unit of Property

16. 16
• Regulations attempt to make the UOP as small as
possible and splits the UOP into 2 main parts:
1. For property other than buildings -- adopts the functional
interdependence standard
• Plant property further broken out based on “discreet and
major function”
2. For Buildings and its Structural Components -- defines the
UOP as the building structure but further breaks the
structure into specified building systems which are
separate UOP’s
• Building systems are a new concept under these rules
Improvements – Unit of Property, cont.

17. 17
• Building Systems are the following building structures:
– (1) HVAC
– (2) Plumbing systems
– (3) Electrical systems
– (4) Escalators
– (5) Elevators
– (6) Fire protection and alarm systems
– (7) Security systems
– (8) Gas distribution systems
– (9) Other structural components identified in published
guidance
What is a Building System?

18. 18
• To determine if an expenditure must be capitalized as an
improvement to a building look at whether the expenditure
improves a building system, if not, then whether it
improves the building and its structural components
– Building systems are simply building structural components
that need to be considered independently in determining if an
expenditure needs to be capitalized as an “improvement”
– Effectively results in a smaller “unit-of-property”
– Taxpayer may have difficulty breaking out the appropriate
“building system” from its records if only the total building
cost is recorded
Improvements to Buildings

19. 19
• Example of applying the improvement standards to the
roof of a building:
– A building structure is a single unit of property: whether the
replacement of certain roof components constitutes a
capitalized improvement is determined by considering the
effect on the building structure, rather than the effect on the
roof
– The roof is part of the building structure, it is not a building
system, therefore the entire building structure is the
appropriate UOP to apply the improvement standards
Example: Improvements to a Building - Roof

20. 20
• Example of applying the improvement standards
to an elevator in the building:
– If a taxpayer performs maintenance on one or more of the
building's elevators, whether those costs are deductible
repairs or capital improvements depends on the
expenditures' effect on the building's elevator system, not
on their effect on the entire building
– The elevator system is a building system, therefore the
elevator system is the appropriate UOP to apply the
improvement standards
Example: Improvements to a Building - Elevator

21. 21
• The safe harbor election is for building property held by
taxpayers with gross receipts of $10 million or less
• A qualifying small taxpayer can elect to not apply the
improvement rules to an eligible building property (basis
of $1 million or less) if the total amount paid during the
taxable year for repairs, maintenance, improvements, etc.
does not exceed the lesser of:
– $10,000 or
– 2 percent of the unadjusted basis of the building
Safe harbor for small taxpayers

22. 22
• The safe harbor is elected annually on a building-by-
building basis by including a statement on the taxpayer’s
timely filed original Federal tax return for the year the
costs are incurred for the building
• Amounts paid by the taxpayer to which the taxpayer
elects the safe harbor are not treated as improvements to
the building, provided the amounts otherwise qualify for
deduction
• Should prove a popular election with rental properties
Safe harbor for small taxpayers, cont.

23. 23
• The Safe Harbor for Routine Maintenance applies to
expenditures to keep the property in its ordinary and
efficient operating condition (i.e. does not result in a
betterment)
• Applies to personal property and buildings
• Qualifying expenditures can be deducted currently
• A Routine Maintenance expenditure qualifies as routine if
the taxpayer reasonably expects to perform the activities:
• For personal property more than once during the life of
the property
• For buildings, more than once over a 10 year period from
when the building is placed in service
Safe Harbor for Routine Maintenance

24. 24
• Apply the new UOP rules to existing capitalized assets
– There is a method change to write off prior capitalized
assets that would not need to be capitalized under these
new rules
– Note: for open tax years need to consider whether
expenditures that were deducted should have been
capitalized (method change is available to capitalize)
• Consider if the safe harbor for small taxpayers will apply
– This is new to the Final Regulations so we need to see the
transitional guidance to see how this is implemented
– May require an accounting method change
Improvements: Tax savings opportunities

25. 25
• For capitalized maintenance expenditures to personal
property and buildings, consider if the Routine
Maintenance Safe Harbor would apply
– Look at Restoration-type expenditures
– There is a method change to write off prior capitalized assets
that would not need to be capitalized under these new rules
• Final Regulations added an election to capitalize otherwise
deductible repairs & maintenance
– New to the Final Regulations; need to see the transitional
guidance
Improvements: Tax savings opportunities, cont.

26. 26
• With the change in the tax rules for what is capitalized, will the
book accounting policies need to be changed?
– Will the write-off of prior capitalized amounts also be reflected on
the books?
– Will the Routine Maintenance Safe Harbor be followed for book
purposes?
– Increased scrutiny of repairs & maintenance expenses is required
• The Improvement rules are the new tax law in this area and
future expenditures need to be applied to the appropriate UOP
to determine if there is a capitalized improvement or a
deductible expense
– Taxpayers must have a methodology for breaking out the “building
system” in order to apply the improvement standards
Improvements: compliance considerations

27. 27
• The Code or Regulations have never condoned the
use of a de minimis rule for expensing costs that
were otherwise required to be capitalized
• Most taxpayers relied on agreements from prior IRS
audits
• The new de minimis safe harbor applies to:
– Amounts paid to acquire or produce a unit of real or
personal property
– Materials & supplies (discussed later)
The De minimis safe harbor election

28. 28
• De minimis safe harbor -- an annual election that permits
a taxpayer to currently deduct otherwise capital
expenditures (including materials & supplies) if the
taxpayer:
– (1) has an “accounting policy” (at the beginning of the tax
year) that requires expensing of items that cost no more than
a specified dollar amount for book purposes, and
– (2) consistently applies that policy for book purposes.
• Critical that book and tax treatment of small dollar items be
understood
De minimis safe harbor, cont.

29. 29
• Both requirements must be satisfied to deduct
amounts otherwise required to be capitalized
• The ceiling for the de minimis safe harbor depends
on whether the taxpayer has an Applicable Financial
Statement “AFS”
– AFS is an Audited statement
– AFS is also a financial statement required to be
provided to the Federal or State government or their
agencies (consider bonding agencies for
contractors????)
De minimis safe harbor, cont.

30. 30
• The de minimis safe harbor uses an invoice test:
• Taxpayers with an AFS: A taxpayer may rely on the de
minimis safe harbor only if the amount paid for property
does not exceed $5,000 per invoice or per item as
substantiated by the invoice;
– Note accounting policy must be written
• Taxpayers without an AFS: A taxpayer may rely on the
de minimis safe harbor only if the amount paid for
property does not exceed $500 per invoice or per item
as substantiated by the invoice;
– Note accounting policy just needs to “exist”
De minimis safe harbor, cont.

31. 31
• Under the Temporary Regulations, the de minimis rule
required an accounting method change
• Under the final regulations, it is an annual election
• The implementation guidance will let us know if a method
change is required
• Since the de minimis rule requires the policy to be in
existence at the beginning of the tax year, to utilize this rule
the policy needs to be prepared in 2013 for 2014 tax years
– For an AFS and the $5,000 ceiling it must be written
– Without an AFS and the $500 ceiling it just must be in place
De minimis safe harbor, cont.

32. 32
• Elect the de minimis safe harbor
– Will provide some protection during an IRS exam for the
deduction taken on small dollar items
– Can still deduct amounts above the safe harbor ceiling
amount, but will not have the same protections
– Book ceiling can be larger than allowed for tax, but the
safe harbor protection is limited to the ceiling provided in
the Regulations
– Annual election to be attached to return
De minimis safe harbor: Tax savings opportunities

33. 33
• Use of the de minimis safe harbor requires that the
taxpayer have an accounting policy (at the beginning of
the tax year) that requires expensing of items that cost no
more than a specified dollar amount for book purposes and
that it is followed consistently (written policy for an AFS)
• Need to be aware of the various P&L general ledger
accounts (including materials & supplies) that are impacted
by the de minimis safe harbor to ensure all applicable
expenditures are considered
• Note that the book policy of deducting amounts below the
policy ceiling needs to be followed consistently
De minimis safe harbor: compliance considerations

34. 34
• Same distinction must still be made:
– Non-incidental materials and supplies
• deductible in the taxable year in which the materials and
supplies are used or consumed in the taxpayer's operations
– Incidental materials and supplies
• no record of consumption or physical inventory kept
• deductible in the taxable year in which these amounts are paid,
provided taxable income is clearly reflected
• Materials & supplies generally must be treated as
non-incidental, unless they are “incidental”
Materials & Supplies

35. 35
• The regulations have provided a specific definition of
materials & supplies
– The regulations do not provide a definition of incidental or
non-incidental
• Taxpayers can use this definition to avoid capitalizing and
depreciating as a UOP
– Under the Final Regulations, cannot elect to capitalize and
depreciate materials & supplies
• Records must be kept to determine year of consumption
(i.e. the year deductible)
– Year of deduction may be impacted by UNICAP
Materials & Supplies, cont.

36. 36
• Definition -- Tangible property (other than inventory) used
or consumed in a taxpayers operations and that:
– Are components acquired to maintain, repair, or improve a UOP;
– Consists of fuel, lubricants, water, and similar items, that are
reasonably expected to be consumed in 12 months or less,
beginning when used in taxpayer's operations;
– Is a UOP that has an economic useful life of 12 months or less,
beginning when the property is used or consumed in the
taxpayer's operations;
– Is a UOP that has an acquisition cost or production cost of $200 or
less; or
– Is identified in published guidance as materials and supplies for
which treatment is permitted under this section
Materials & Supplies, cont.

37. 37
• Coordination with the de minimis safe harbor:
–The final regulations require that the de minimis
safe harbor be applied to all eligible materials and
supplies if the taxpayer elects the de minimis safe
harbor
–Exception for rotable, temporary, and standby
emergency spare parts that are subject to a
separate election to capitalize
Materials & Supplies, cont.

38. 38
• Automatic accounting method changes are
available to change the treatment of materials and
supplies to incidental from non-incidental, and
vice-versa
• If the de minimis safe harbor is elected –
beneficial if taxpayer treats all materials &
supplies as incidental
Materials & Supplies: Tax savings opportunities

39. 39
• IRS will utilize the definition of materials and supplies and
may determine incidental supplies are non-incidental
(issue if de minimis safe harbor is not elected)
• Consumption records need to be kept for non-incidental
supplies
• Tax accounting treatment may differ from book accounting
• Coordination with UNICAP is needed since materials and
supplies generally are subject to UNICAP
• Recordkeeping considerations if materials & supplies are
included in the de minimis safe harbor
Materials & Supplies: compliance considerations

40. 40
•2 Primary Subject Areas Covered
1) Capitalization and Expensing
• Improvements to Tangible Property
• The de minimis safe harbor
• Materials & Supplies
2) Dispositions of Tangible Property
• General Asset Account Elections
2 Primary Areas for tax savings and compliance

41. 41
• There are new proposed regulations and older temporary
regulations that deal with this area
• The proposed regulations appear to be similar to the
temporary regulations
• Issue: there is not any form of implementation guidance
for the proposed regulations
• Taxpayers can rely on the proposed regulations starting
in tax years beginning 1/1/12
• The Final Regulations may be issued by the end of the
year
Dispositions of tangible property

42. 42
• *** This is the biggest opportunity for tax savings***
• The Proposed Regulations define a disposition similar to the
Temporary Regulations but include a concept called a
“Partial Disposition”
• There is an election that can be made where the loss on the
partial disposition is taken and the replacement expenditure
is capitalized
• The loss is allowed on:
1. A structural component (or a portion thereof) of a building, or
2. The disposition of a major component (or a portion thereof) of
any other asset
Dispositions of tangible property, cont.

43. 43
• There are many examples in the proposed regulations
illustrating the impact of the Partial Disposition Election
– Included in the examples are the replacement of an
elevator, the replacement of aircraft engines and the
replacement of truck engines.
• The Partial Disposition Election is made on the
taxpayer’s timely filed original Federal tax return,
including extensions, for the taxable year in which the
portion of the asset is disposed of by the taxpayer
Dispositions of tangible property, cont.

44. 44
• If the partial disposition election is not made, the original
component continues to be depreciated
– The replacement expenditure needs to be reviewed under
the betterment and restoration improvement standards to
determine if it needs to be capitalized
– Under the temporary regulations, the original, replaced
component cannot continue to have depreciation taken
• In no case can a taxpayer take the loss on the component
disposition and also deduct the replacement expenditure
• In effect, cannot take a repair expense and a disposition loss
Dispositions of tangible property, cont.

45. 45
• How is the adjusted basis of the disposed component
determined?
– Typically, taxpayers include only a single asset in their fixed
asset systems for a building and for most personal property
assets leaving them with no way to determine the cost basis
of a certain component of those assets
– The Temporary Regulations provided that, if the taxpayer
cannot determine the unadjusted depreciable basis from its
books and records, the taxpayer may use any reasonable
method that is consistently applied
Dispositions of tangible property, cont.

46. 46
• The Proposed Regulations provide more guidance on
reasonable methods:
– A study (including a “cost-seg”) allocating the cost of the asset
to its individual components;
– Discounting the cost of the replacement asset to its placed-in-
service year cost using the Consumer Price Index; and
– A pro rata allocation of the unadjusted depreciable basis of the
general asset account or multiple asset account, as
applicable, based on the replacement cost of the disposed
asset and the replacement cost of all of the assets in the
general asset account or multiple asset account, as applicable
Dispositions of tangible property, cont.

47. 47
• The Temporary Regulations had the individual building
structures as the asset for disposition purposes
• Under the Proposed Regulations, the building is the asset
for disposition purposes
– This has the same practical impact as the GAA
election had from the Temporary Regulations in that it
allows for disposed structures to continue to be
depreciated;
• Therefore the GAA election is likely not needed under the
proposed regulations
General asset accounts (“GAA”)

48. 48
• Opportunity: The implementation guidance issued for the
Temporary Regulations, allowed for accounting method
changes to be filed to write off prior year building structure
dispositions
– This would be consistent with the goal of stopping the
depreciation of an asset and its replacement
– The temporary regulations only apply to building structures
• There will likely not be implementation guidance issued for
the proposed regulations, so it is unclear how the final
regulations will treat prior year dispositions, but
conceptually this should be allowed
Prior year dispositions of building structures

49. 49
• To take advantage of this opportunity under the
temporary regulations, an analysis must be made of the
real property assets on the tax depreciation schedule to
determine if there was a prior year disposition of a
building component
– If so, figure out the loss or stop depreciating
– In most cases, taking the loss deduction is preferable
to losing depreciation
Dispositions in prior years, cont.

50. 50
• Dispositions of prior year building structures under the
temporary regulations:
– Review tax depreciation records for clients with multiple
year 27.5-year or 39-year real property additions
• Could be evidence of a replacement of a structural
component and a loss can be taken (or depreciation must
be stopped)
– Also, look for multiple year 15-year land improvement
additions
• Could be evidence of a replaced land improvement and a
loss can be taken (or depreciation must be stopped)
Dispositions: Tax savings opportunities

51. 51
• Since the partial disposition removes that part of the
depreciable asset from the tax depreciation records, an
opportunity for future tax savings exists:
– The accumulated depreciation of the disposed asset is
no longer on the tax depreciation schedule;
– In a future sale of the property at a gain, this will
remove some future potential depreciation recapture
(§1250 or §1245) and more of the gain could be taxed
at the more favorable long-term capital gains rate
• This could be very valuable to pass-through entity owners
Dispositions: Tax savings opportunities, cont.

52. 52
• Remember that these disposition rules apply to many
types of businesses, as well as individuals that own
rental properties
– This could be an instance where individual taxpayers
file an accounting method change with their personal
return (i.e. an individual that has rental properties)
• These rules apply to capitalized leasehold
improvements if you do not own the building
Dispositions: Tax savings opportunities, cont.

53. 53
• With the change in the tax rules allowing for building
structure and significant component dispositions, will
the book accounting policies need to be changed?
– How will the tax law change to “componentizing” fixed
assets be treated under GAAP
– Will the write-off of prior year building structure
dispositions also be reflected on the books?
• Need to come up with the adjusted basis of the asset
disposed under the partial disposition election
Dispositions: compliance considerations

54. 54
Closing

55. 55
• In order to be compliant with these new rules a
review of the following is required
– Tax Depreciation records
– Repair & maintenance account detail
– Materials & supplies expense detail
– Book capitalization policy
– UNICAP calculations
– Prior 3115’s impacting the above
– Prior cost-segregation studies
Taxpayer records to be reviewed

56. 56
• Section 263A UNICAP conformity requirement
• Optional application of temp/final/proposed rules
– 2012, 2013, 2014
• Repairs studies have been a Tier 1 issue; will continue to
receive IRS exam focus
• Prior repairs studies need to be evaluated
• IRS will continue to address industry-specific issues via
Industry Issue Resolution (“IIR”) process
Priority Considerations

57. 57
• Impact on DPAD deduction
• For individuals, deduction may decrease passive income
or increase passive losses (3.8% tax to be considered)
• Fixed assets/cost segregation
• State and Local Tax
– Apportionment factors
– Personal property taxes
• Impact on systems and processes
– G/L accounts
– Coding
Other Collateral Considerations

58. 58
• Tax savings are a likely result
• Effective for years beginning on or after 1/1/14, but early adoption is
possible
• 2 Primary Subject Areas
1. Capitalization and Deduction:
• Improvements to Tangible Property (incl. Routine maintenance safe
harbor)
• The de minimis safe harbor
• Materials & Supplies
2. Disposition of Tangible Property
• Automatic method changes available to assist in getting compliant
with these rules
Recap

59. 59
Summary/Key Takeaways
• Be aggressive in applying these rules:
– Tax savings opportunities -- Many changes will result in a
reduction to income
– Compliance and Risk Management – Taxpayers need to be
aware of tax return positions and risks
– Always consider UNICAP impact
• Learn the rules – the changes required are fact-based so taxpayers
and practitioners will need to be well versed in order to apply them
• Understand the impact these rules will have on accounting systems –
most tax accounting follows book accounting where capitalization is
concerned
– These rules may change a taxpayer’s book accounting or cause a
book versus tax difference

60. 60
QUESTIONS?

61. 61
Upcoming Webinars – Save the Date
Eye on Washington: Quarterly Business Tax Update (3rd Quarter) on
Wednesday, October 30th from 2:00 – 3:00 ET
Registration will be available closer to webinar date.

62. 62
CBIZ MHM, LLC Contact Information
Eustis Corrigan
Managing Director
 901.842.2876  ecorrigan@cbiz.com
Mike Finnegan
Managing Director
 602.650.6205  mfinnegan@cbiz.com
Steve Henley
National Tax Practice Leader
 770.858.4443  shenley@cbiz.com

63. 63
Thank You