TARS

Article Dean Dorton

Question:

If you spend money to change a capital asset used in your business this year, then is the expenditure a capitalized improvement or an expensed repair?

Answer: 

Under the new Tangible Asset Regulations (TARS), you must capitalize all betterment, restoration, and adaptation expenditures as improvements to the unit of property (UOP). The regulations define these three terms as follows:

  1. A betterment is an expenditure that:
  • Corrects a material condition or defect that existed prior to acquisition or arose during production of the UOP,
  • Results in a material addition to the UOP, or
  • Results in a material increase in strength, capacity, productivity, efficiency, quality or output of the UOP.
  1. A restoration is an expenditure that:
  • Replaces a component of a UOP,
  • Repairs damage to a UOP,
  • Returns UOP to its ordinarily efficient operating condition if it deteriorated to a state of disrepair and is no longer functional for its intended use,
  • Rebuilds UOP to a like-new condition after the end of its ADS class life, or
  • Replaces major component or substantial structural part of UOP.
  1. An adaptation is an expenditure that adapts a UOP to a new or different use that is not consistent with the taxpayer’s intended ordinary use of the UOP when originally placed in service by the taxpayer.

Otherwise, the expenditure is a repair, and you can expense it in the current year.

Contact your Dean Dorton advisor or Faith Crump at fcrump@deandorton.com or 502.566.1025 if you have any questions.

Article Dean Dorton

Question:

At the end of tax year 2015, you still have $900 of unused materials and supplies on hand. Can you deduct the full $900 on your tax return? Or does the IRS require you to capitalize these materials and supplies, deducting them when you use them?

Answer:

Under the Material and Supplies rules, you can expense the cost of qualifying incidental items in the current year, rather than capitalizing them.

Of the materials and supplies on hand at year end, only incidental items – ones not inventoried or tracked – may be deducted in that year.

If an item appears on an inventory or record of consumption that you maintain, then it is considered non-incidental. Non-incidental items are capitalized and deducted when used or consumed, not necessarily in the year acquired.

In addition to being an item you do not inventory or track, an incidental item must also meet one of the five following criteria to be eligible for deduction in the year of acquisition:

  1. A component acquired to maintain, repair, or improve a unit of tangible property that you own, lease, or service;
  2. Fuel, lubricants, water, and similar items that you reasonably expect to consume in 12 months or less, beginning when first used in your operations;
  3. A unit of property that has an economic useful life of 12 months or less, beginning when first used or consumed in your operations;
  4. A unit of property that has an acquisition cost or production cost of $200 or less; or
  5. Identified in published guidance (such as the Federal Register or in the Internal Revenue Bulletin) as materials and supplies.

Of your $900 of unused materials and supplies on hand, the cost of all qualifying incidental items is eligible for deduction. The rest must be capitalized and deducted when used.

Contact your Dean Dorton advisor or Faith Crump at fcrump@deandorton.com or 502.566.1025 if you have any questions.

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Article Dean Dorton

Question:

If you renovate a building used in your business this year, then is the expenditure a capitalized improvement or an expensed repair?

Answer: 

It is important to understand how the “unit of property” concept has changed regarding buildings. Before the new rules, only the building in its entirety was considered one unit of property. Now, as many as nine building systems can make up one building, and each system is its own unit of property.

The nine systems that can make up a building are as follows:

  1. Heating, ventilation and air conditioning (HVAC) systems
  2. Plumbing systems (pipes, drains, sinks, toilets, etc.)
  3. Electrical systems (wiring, outlets, lighting fixtures, etc.)
  4. All escalators
  5. All elevators
  6. Fire protection and alarm systems (sensing devices, computer controls, sprinkler heads, etc.)
  7. Security systems (window and door locks, security cameras, recorder, monitors, motion detectors, etc.)
  8. Gas distribution systems
  9. Other structural components (roof, walls, floors, etc.)

To follow the new Building Systems rules, you may have to plan more carefully before you renovate and keep detailed records during each project. However, these rules may also provide more certainty that an expenditure appropriately expensed as a repair will pass IRS scrutiny.

Contact your Dean Dorton advisor or Faith Crump at fcrump@deandorton.com or 502.566.1025 if you have any questions.

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Article Dean Dorton

Question:

Last year we heard about the new tangible asset regulations and how they would impact prior years in addition to tax year 2014. What about 2015? Is “TARS” still an issue for 2015?

Answer:

These new rules created a new method of determining whether changes to tangible assets should be capitalized or expensed. The major conceptual change is the new “unit of property” concept. The unit of property differs for buildings and non-buildings, and provides more clarity than previous IRS regulations.

The regulations state that a single Unit of Property includes components that are functionally interdependent. (There are specific rules for buildings which will be addressed in our next enewsletter.) Two components are functionally interdependent when one component’s in-service date depends on another component’s in-service date. In other words, you cannot use the first component without the second.

Improvements to a Unit of Property are NOT a separate Unit of Property, unless a lessee makes the improvements. There are special rules for plant property, leased property, and network assets.

Grasping the Units of Property rules can help you maintain appropriate fixed asset records for tax purposes. Having such records can make it easier to decide whether payments are for improvements or repairs.

The smaller the Unit of Property, the more likely the costs incurred to change the Unit of Property will be capital.

Contact your Dean Dorton advisor or Faith Crump at fcrump@deandorton.com or 502.566.1025 if you have any questions.


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REMINDER!

To qualify for expensing items under the new de minimis safe harbor regulations, you must have a written capitalization policy in place on the first day of your taxable year. If you do not have a written capitalization policy in place already, you should consider having one in place by January 1, 2015!

For more detailed information, view our recent e-newsletter series regarding Tangible Asset Regulations (TARS).

If you would like additional information or have questions, please contact Faith Crump at fcrump@deandorton.com or by calling 502-589-6050.

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Article Dean Dorton

This week concludes our six-part email series on the new tangible asset regulations which are generally effective for tax years beginning after 1/1/14 and impacts any taxpayer with capitalized assets or supplies.  The following is a summary of the five areas we previously discussed which may impact you.

De minimis Safe Harbor Rule
The de minimis safe harbor rule allows taxpayers to annually elect to expense certain expenditures, if a written policy is in place at the beginning of the tax year, when you spend less than a certain dollar amount on tangible property.

Materials & Supplies
Through the materials and supplies rules, incidental items meeting certain criteria may accelerate deductions by expensing items in the current year, rather than maintaining an inventory and deducting when used. Non-incidental (inventoried) items  are required to be capitalized and deducted when used or consumed, not necessarily in the year acquired.

Unit of Property: Building Systems
The new rules for building systems places the building components into nine different units of property to determine whether an expenditure is a capitalized improvement or a deductible expense.  These components include HVAC, electrical systems, plumbing, escalators, elevators, fire protection & alarm, security, gas distributions or other structural components.

Unit of Property: Non-Building
To determine whether property is subject to capitalization or expense, you must look at the Unit of Property rules.  For non-building property, you must determine if the components are functionally interdependent, and placing one component in service is reliant on placing other components in service.

Repairs vs. Improvements: 3 Tests
The new regulations implement three new tests to determine whether expenditures related to a unit of property should be capitalized or expensed. The three tests are the betterment test, the restoration test, and the adaptation test. If the expenditure meets any of the tests, the cost should be capitalized as an improvement to the unit of property.  All three tests must be done in succession before determining that expensing the cost is appropriate.

Additional guidance was also released that allows for a late partial disposition election in 2014 to claim  a loss on the cost of the component that was replaced, removed or disposed of in prior years.

As the new regulations are complex, we highly recommend that you address these required changes prior to year end and assess any planning opportunities available.

If you would like additional information or have questions, please contact Allison Carter at alcarter@deandorton.com or Faith Crump at fcrump@deandorton.com or by calling 502-589-6050.

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