As tax return preparers know, tax season never truly ends. That promises to be the case for 2016, after the latest round of changes for tangible property regulations, or TPRs.
TPRs determine whether expenses for assets should be capitalized under the rules of Section 1.263(a)-1, -2, or -3, or written off under the rules of 1.162-3 or -4. The IRS issued the rules in 2006, and to the agency’s credit, it has been responsive to several opportunities over the years for public comment.
The upshot, however, is that the rules have been somewhat of a moving target. They were reissued in 2008 and changed several more times, either on a temporary or permanent basis.
Below is a discussion of a few key issues that are likely to affect many Lugenbuhl clients. Keep in mind, however, that the changes are numerous and go far beyond those summarized in this article. The volume of changes underscores an even greater need for tax preparers to ready themselves.
Materials and supplies
Section 1.162-3 provides that expenditures for materials and supplies carried on hand should include the charges only in the amount that is actually used during the taxable year. As far as what qualifies as materials and supplies, the current rules generally maintain what was established in 2008: property used in the taxpayer’s operations and not acquired as part of a single unit of property; has a useful life of 12 months or less, starting when the property was used; costs no more than $100 to buy or produce; or is identified as a material and supply in future published guidance.
In response to comments, however, the latest changes modify and expand the definition. They also provide an alternative with handling rotable and temporary spare parts, allow certain materials and supplies to fall under the de minimis rule of 1.263(a)-2T and allow an election for capitalizing certain materials and supplies.
There’s also a new category for fuel, lubricants, water and similar items reasonably expected to be consumed in 12 months or less, beginning when they’re used in operations.
Other changes create exceptions on safe harbor revenue procedures when treating certain property as materials and supplies. These exceptions might allow, for example, smallwares to be treated as materials and supplies, or small businesses to treat certain inventoriable items in the same manner as materials and supplies that are not incidental.
The 2008 rules allowed a taxpayer to deduct the cost of rotable spare parts when the parts are discarded. Alternatively, the taxpayer could elect to capitalize and depreciate rotable spare parts over the parts’ recovery period.
But some public commenters complained that deferring the deduction until disposal was inconsistent with the method many taxpayers use. The latest rules were changed, therefore, to generally conform with the more common method – the cost of a new rotable part is deducted in the taxable year it gets installed.
The taxpayer includes in income and assigns a cost basis equal to the fair market value of the used, nonfunctioning part and capitalizes the costs of repair. If the repaired part is used later, the basis of the part is deducted in the taxable year it gets reinstalled, and the cycle continues until the part is disposed.
The earlier rule – deduction when the rotable parts are discarded – is still allowed as an alternative method. This can be used to treat the parts as used in the year in which they’re disposed of, or the taxpayer can elect to treat the parts as depreciable assets. If this method is chosen, it must be used for all of the taxpayer’s rotable and temporary spare parts in the same trade or business.
De minimis rule
The latest rules reflect regulators’ attempt to clarify whether the de minimis rule in 1.263(a)-2 can be applied to property that is also treated as materials and supplies under 1.162-3.
Under the earlier rules, a taxpayer was not required to capitalize the cost of property if certain requirements were met. But some commenters complained that this essentially forced separate accounting for materials and supplies that qualified for the de minimis rule. Regulators agreed, therefore, to allow an election to apply the de minimis rule of 1.263(a)-2 to the cost of property that meets the definition of materials and supplies.
The de minimis rule of 1.263(a)-2T(g) can be applied to the cost of any type of material or supply defined in 1.162-3T if the cost meets the requirements of the de minimis rule. In other words, the taxpayer can apply a single timing rule to any unit of property, including materials and supplies, to the extent the aggregate amount does not exceed the limit set in 1.263(a)-2T(g)(1)(iv).
Cassie Felder’s primary areas of practice include tax law, corporate and commercial transactions, estate planning, and litigation. With experience spanning multiple areas of business law, she has represented clients in real estate and commercial transactions, as well as facilitated mergers and acquisitions. She also has handled tax disputes against the Louisiana Department of Revenue and Internal Revenue Service. More information about Cassie is available here.
The content of this article is not intended to serve as an exhaustive review of the laws, statutes or issues related to tangible property regulations and is not intended to provide legal advice. The opinions expressed through this article may not reflect the opinions of the firm, individual attorneys or clients.