IRS Finally Does the Right Thing: Eases Application of the Tangible Property Regulations for “Small” Taxpayers

On Friday, February 13, 2015, the IRS issued Revenue Procedure 2015-20 to simplify the application of the tangible property regulations (TPRs, sometimes called the “repair regs”) for small taxpayers.  Accountants and industry organizations told the IRS months ago that its implementation rules were too onerous and impractical for small taxpayers to follow.  Now in the middle of tax season the IRS provides relief, but only after tax preparers and taxpayers have already spent many hours of effort trying to make the old rules work.

What is a “small” taxpayer?  A small taxpayer has either less than $10 million of assets on the first day of the 2014 tax year OR has average annual gross receipts of $10 million or less for the three prior tax years.  These tests are applied separately for each separate and distinct trade or business of the taxpayer.  Special rules exist for taxpayers having less than three full prior tax years.  Gross receipts include gross sales less sales returns and allowances, all receipts for services, investment income, but only the gains from the sale of investments and property used in a trade or business (other than inventory). 

The IRS eased two major problems.  First, the TPRs do not have to be retroactively applied to past tax years.  It was ridiculous for the government to require taxpayers to apply today’s tax rules to all previous tax years.  Second, the 8-page Form 3115 (plus attachments) is not required to be completed to tell the IRS that its TPRs are now being complied with.  However, the IRS says this simplification comes at a cost.  The IRS says that there is no audit protection for years earlier than 2014.  Because small taxpayers can use the “cut-off” method and just start complying with the TPRs in 2014, the IRS states that it can still require compliance in past years in the event of an audit.  Most small taxpayers will ignore this threat and avoid the costs and hassles of retroactively applying the rules and filing multiple Forms 3115.

The IRS points out that any tax benefits that would have come from retroactive application of the TPRs won’t be available unless the small taxpayer does in fact retroactively apply the TPRs and file Form 3115.  One example is the “late partial disposition election.”  This “election” is made by filing Form 3115 for prior dispositions of components or structural parts of assets.  For example, for a building, the tax code does not allow for separate depreciation of building components or systems.  Therefore, the building cost is often recorded on the depreciation schedule as a lump-sum number.  The IRS is now permitting the deduction of the undepreciated cost of the portion of the building previously disposed, such as a roof.  When a new roof was put on in the past, the cost of the old roof was not broken out from the building cost and written off.  Now, the IRS is permitting this write-off, and to do so, Form 3115 must be filed with an estimate of the cost of the old roof.  Doing so is an election and not a requirement.  A second example of lost tax benefits if there is no retroactive application of the TPRs deals with prior capitalized repairs that would clearly be deductible under the TPRs.  Filing a Form 3115 allows a current deduction for any remaining undepreciated capitalized cost.  In addition, if the capitalized repairs are not written-off, there is a chance the IRS would deny future depreciation deductions by asserting that the repairs should have been expensed in the prior year and that there is no legitimate asset to depreciate.