Effective from 2014, the Tangible Property Regulations (TPRs) apply to all taxpayers that acquire, produce, or improve tangible property. Among other things, they clarify and expand the present standards, provide new bright-line tests for applying the standards, and provide guidance regarding the accounting for and dispositions of property. The rules aim to provide better and more complete guidance on the existing standards, establish distinct and unambiguous requirements for enforcing those standards, and provide suggestions for managing property accounting and disposal.
The Internal Revenue Service (IRS) has strict rules for capitalization and deduction of expenses related to property. Taxpayers must distinguish between capital and expense expenditures, with regulations varying by property type. The de minimis safe harbor rule allows the deduction of small-dollar expenses, and routine maintenance expenses are deductible. Even the improvements to building property may be deducted by eligible small taxpayers. This article provides guidance and examples to help taxpayers navigate these complex tax rules.
Capitalization(vs expensing/deducting it the right way) rules are straightforward. Any amount incurred while acquiring or improving the property, including transaction costs, should be capitalized. Taxpayers must also capitalize the costs incurred before that unit of property was placed in service. On the other hand, costs attributed to repairs and maintenance, if the property is already placed in service, can be expensed. Under the de minimis rule, all amounts may not be capitalized if they meet certain standards.
A unit of property is related to property that is being improved or repaired. The smaller the unit of property, the more likely the cost will be incurred in connection with it, and it will have to be capitalized. Components of property are functionally interdependent if the placing-in-service of one component depends on the placing-in-service of the other component. If not explicitly classified as a building, all components that are functionally interdependent make up a single unit of property.
For example, working on an engine of a car is more likely to be classified as an expense that must be capitalized if the engine is classified as a separate unit of property. However, if the unit of property is the car, the engine work has a better chance of passing as a repair.
Intangible property other than buildings is considered a single unit of property, even if it consists of multiple components that function interdependently, such that one component cannot be placed in service without the others.
For example, a business purchases a computer for its employees. It buys the monitor and other hardware from one vendor and the CPU from another vendor and then assembles the components. In this case, the computer is the unit of property since the monitor and other hardware cannot operate without the CPU.
In the context of building, each building and its structural components are treated as one unit of property. Also, there are nine specific building systems listed and treated as separate from the building structure. Any improvements to the building are defined by their effect on those systems, rather than on the whole building.
Here is a list of building systems that make up unit of property:
If a taxpayer restores the building by replacing the windows, the expenses are treated as an improvement to the single unit of property, which is the building. If a taxpayer makes an improvement to building systems like heating and ventilation, that expense is also an improvement to the building as a unit of property.
The amounts paid to produce and acquire materials and supplies that are consumed during the year are eligible for deduction. These materials and supplies must fall into five specific categories of property consumed in business operations.
Under this rule, units of property (UOPs) with a useful life of no more than twelve months qualify as materials and supplies. Likewise, some inexpensive items that cost $200 or less to purchase or produce also qualify as materials and supplies.
The De Minimis Safe Harbor Rule is simply an administrative convenience that allows you to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules. Taxpayers can deduct certain limited amounts paid for tangible property if the same expenses are also deducted for financial accounting purposes. The safe harbor amount depends on whether the taxpayer has an applicable financial statement. For applicable financial statements, it can be certified audited financial statements used for credit purposes, for reporting to partners, or for other non-tax purposes.
The business must have accounting procedures at the beginning of the tax year that treat as an expense the amount paid for property which costs less than a specified amount. Typically, for businesses with applicable audited statements, up to $5,000 may elect the rule, and for businesses without audited statements, they are limited to only $2,500.
Routine maintenance is a recurring expense that keeps business property, including buildings, in an ordinarily efficient operating condition. It can include inspection, cleaning, testing, and replacement of damaged or worn parts.
Taxpayers are expected to perform maintenance more than once during the ten-year period that begins when the structure is placed in operation. For property other than buildings, taxpayers must perform the activities more than once during the property's class life for depreciation purposes.
Those with an average annual gross receipt of ten million dollars or less in the three preceding tax years are qualifying small taxpayers who can deduct improvements made to building property with an unadjusted basis of one million dollars or less. However, this only applies if the total amount paid during the tax year for repairs, maintenance, and improvements to the building does not exceed the lesser of ten thousand dollars or two percent of the building’s unadjusted basis.
This election can be made annually on a building-by-building basis by including a statement on the tax return for the year in which the cost was incurred for the building.
We hope this article has provided some information that can be helpful. We at Investor Friendly CPA® have professional experts who can provide you with complimentary counseling to efficiently deduct and capitalize your intangible business property expenses.