1. Tax Insights:
IRS releases long-awaited
‘repair’ regulations
On Dec. 23, 2011, new regulations proposed regulations. The revenue Betterments
were issued addressing when costs are procedures contain transition rules and The regulations provide specific rules for
required to be capitalized to tangible procedures for changing to the methods determining whether expenditures result
property or may be deducted as repair and described in the regulations. in a betterment of a unit of property and
maintenance costs. The new regulations therefore would result in capitalization of
replace proposed regulations issued in Units of property costs. Of note, the regulations specifically
March 2008. The regulations provide detailed rules for provide that an amount results in a
On March 7, 2012, the IRS issued two determining the proper unit of property. betterment to a building if it results in
revenue procedures (Rev. Procs. 2012-19 Although these rules generally provide that a betterment to a structural component
and 2012-20) that provide taxpayers with a building and its structural components or a building system. The regulations
rules for filing method changes under the are a single unit of property, the tests to contain a number of examples to illustrate
new “repair” regulations. determine if property has been improved the application of the betterment rules.
This document provides a summary of must be applied to the building structure Included in the examples are three fact
some of the highlights of the regulations (which is defined as the building and situations involving costs incurred by retail
and revenue procedures. its structural components other than stores that the regulations label as:
specifically identified building systems) and (1) building refresh,
What was issued each of the following building systems: (2) building refresh with limited
Treasury and the IRS issued temporary (1) Heating, ventilation and air improvement, and
regulations (regulations) that provide conditioning (HVAC) systems (3) substantial remodel.
guidance on amounts paid to improve (2) Plumbing systems
tangible property (commonly referred to (3) Electrical systems
as the repair regulations). The regulations (4) Escalators
also provide guidance on amounts paid to (5) Elevators
acquire or produce tangible property, as (6) Fire-protection and alarm systems
well as guidance regarding the disposition (7) Security systems
of property. The regulations are generally (8) Gas distribution systems
effective for taxable years beginning
on or after Jan. 1, 2012. The text of the The regulations also provide expanded
regulations was simultaneously issued as rules for determining the unit of property
proposed regulations and the previous in situations where property is leased
proposed regulations were withdrawn. and provide special rules for determining
The regulations include rules that are improvement costs in lease situations.
significantly different from current
regulations and the previously issued

2. IRS releases long-awaited ‘repair’ regulations
The examples conclude that: The regulations instead provide a facts- Plan of rehabilitation
(1) none of the building costs are required and-circumstances test for determining The regulations do not provide for a plan
to be capitalized in the building refresh whether a major component or substantial of rehabilitation doctrine as described
example; structural part is replaced. The regulations in case law. Instead, the regulations
(2) some of the building costs are required also provide that a major component or incorporate the Section 263A standard for
to be capitalized in the building refresh substantial structural part includes: the treatment of repair and maintenance
with limited improvement example; (1) a “large portion” of the physical costs performed during an improvement
and structure of the unit of property, or and require capitalization of all indirect
(3) all of the building costs are required (2) a part or combination of parts costs that directly benefit or are incurred
to be capitalized in the substantial that perform a discrete and critical by reason of an improvement. The
remodel example. function in the operation of the unit preamble to the regulations provides
These three examples illustrate the general of property that is more than a “minor that the plan of rehabilitation doctrine
rule in the regulations that a determination component.” is obsolete to the extent that the court-
of whether costs result in a betterment created doctrine provided different
depends on the facts and circumstances The regulations also contain the standards for determining whether an
related to the costs. requirement that costs expended for the otherwise deductible indirect cost must be
replacement of a component of a unit capitalized as part of an improvement.
Restorations of property must be capitalized if the
The regulations also address whether taxpayer has properly deducted a loss for Routine maintenance safe harbor
an amount is paid to restore a unit of that component. The regulations introduce a routine
property and therefore would result The regulations contain examples to maintenance safe harbor rule. If, at the time
in capitalization of costs. These rules illustrate the restoration rules. Included are the unit of property is placed in service, it is
specifically provide that an amount is examples of costs related to the structural reasonably expected that the maintenance
paid to restore a building if it restores components of a roof, a roof membrane, activities will be performed more than once
a structural component or a building an HVAC system, a fire protection during the class life of the unit of property,
system. Unlike the rules in prior proposed system, an electrical system, a plumbing the maintenance is deemed to not improve
regulations, the regulations fail to provide system, windows and floors. The examples the unit of property. The regulations,
a bright-line test for determining whether illustrate that the determination of whether however, specifically provide that the safe
the costs result in a replacement of a major costs are required to be capitalized harbor does not apply to work performed
component or a substantial structural part depends on the nature and extent of the on buildings.
of a unit of property. The prior proposed costs relative to the property.
regulations defined replacement of a major
component or substantial structural part to
mean either:
(1) costs that comprise 50 percent or more
of the replacement costs of the unit of
property, or
(2) replacement of 50 percent or more of
the physical structure of the unit of
property.
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3. Tax Insights: IRS releases long-awaited ‘repair’ regulations
Dispositions General asset account election New automatic changes
The regulations also provide new rules for The regulations also expand the rules The new revenue procedures modify the
determining gain or loss on the disposition related to general asset accounts (GAA), comprehensive list of automatic method
of depreciable property. Of significance is which allow taxpayers to group one or changes in Rev. Proc. 2011-14 by deleting
that the regulations expand the definition many assets in a GAA for depreciation several method changes and adding 19 new
of disposition of property to include the purposes. Under the general rule, no gain automatic method changes, including the
retirement of a structural component of a or loss is recognized upon the disposition following:
building. This requirement will cause any of an asset from a GAA. Special elections • Deducting de minimis amounts
amount expended to replace a structural allow taxpayers to recover the basis of • Changing to the safe harbor for routine
component of a building to be capitalized, disposals from the GAA at their discretion. maintenance on property other than
even if the component is minor, because buildings
of the restoration rules requiring Amount paid to acquire or • Capitalizing improvements to tangible
capitalization if a loss on a component is produce property property
properly deducted. To avoid burdensome The regulations also contain rules for • Disposing of a building or structural
results under this rule, taxpayers will need amounts paid to acquire or produce component
to understand and apply new rules relating property. These include rules related to • Disposing of tangible depreciable
to general asset accounts as discussed in material and supplies and rotable spare assets (other than a building or its
the following. The regulations do not parts. In addition, the regulations contain structural components)
require componentization of property a de minimis rule that allows a taxpayer • Electing general asset account
other than buildings, but will allow such in certain situations to deduct amounts treatment
componentization if the taxpayer is under a certain dollar amount if that is
consistent in identification of the asset. consistent with a written policy used for The new method changes are generally
financial accounting purposes, provided made using a Section 481(a) adjustment.
that amounts under this rule do not exceed However, the adjustment for method
certain annual thresholds. The annual changes relating to the acquisition of
threshold amount is the greater of: tangible property is made using a modified
(1) 0.1 percent of the taxpayer’s gross cut-off approach, which means that only
receipts for the taxable year as amounts paid or incurred after Jan. 1,
determined for Federal income tax 2012, are included in the Section 481(a)
purposes, or adjustment. In addition, certain of the
(2) 2.0 percent of the taxpayer’s total disposal and depreciation changes are
depreciation and amortization expense made using a modified cut-off approach.
for the taxable year as determined in its The new revenue procedures specifically
applicable financial statements. allow statistical sampling for certain
method changes. The new revenue
procedures do not, however, allow
taxpayers to extrapolate data to an earlier
taxpayer year.
For all of the new method changes,
certain scope limitations under the general
automatic method change procedures are
waived for the taxpayer’s first and second
taxable year beginning after Dec. 31, 2011.
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4. Tax Insights: IRS releases long-awaited ‘repair’ regulations
General asset account late Next steps
election relief Taxpayers will want to determine how
Most taxpayers have not previously made the new rules provided in the regulations
a general asset election under Section 168(i) may affect their current methods of
(4) for their assets, including buildings and capitalizing or deducting costs to acquire
structural components. or improve tangible property. Taxpayers
will also want to determine the timing
Under these new rules, however, it is for making automatic method changes
anticipated that all taxpayers who own to comply with the new rules under the For more information, contact:
or lease buildings will want to make such revenue procedures. It is expected that Scott Hamilton
an election for previous and future years. most taxpayers will need to file method Strategic Federal Tax Group
The revenue procedures allow taxpayers changes to make the late general asset Director, Southern California
T 213.596.8426
to make a retroactive general asset election account election and to change their
E scott.hamilton@us.gt.com
for years prior to Jan. 1, 2012, by filing an methods of accounting for disposition of
automatic method change, but only for the property and capitalization of amounts Rich Shevak
Strategic Federal Tax Group
taxpayer’s first two taxable years beginning paid to improve property. Although
Senior Manager, Seattle
after Dec. 31, 2011. It is important for method changes cannot be filed for years T 206.398.2489
taxpayers to be aware of this limited time beginning prior to Jan. 1, 2012, taxpayers E rich.shevak@us.gt.com
frame for making the retroactive election will want to understand as soon as possible
www.GrantThornton.com/tax
through the automatic method change. how adjustments relating to method
After this time, retroactive elections will changes will affect financial accounting About Grant Thornton LLP
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