Blog, Recent Taxpayer-Friendly Changes to the Tangible Property Regulations

Last year taxpayers dealt for the first time with massive IRS regulations governing the acquisition of tangible property and capitalizing improvements.  The Regulations contain lengthy and specific rules regarding when to expense and when to capitalize the purchase, repair, and maintenance of property.  Certain safe-harbors and tax elections were provided for administrative ease.

Two recent changes have brought new taxpayer-friendly simplifications.  In IRS Notice 2015-82, the IRS announced the increase from $500 to $2,500 in the “de minimis safe harbor” limit effective for tax years beginning after 2015.  However, the Notice states that the IRS won’t audit expensed amounts in earlier years if at or under the new $2,500 limit.  That statements appears to open the door for taxpayers to change their 2015 expensing policy from $500 to $2,500.  The safe harbor must be elected each taxable year.  The safe harbor allows taxpayers to simply expense the purchase of small-cost assets rather than depreciating them.  In order to use the safe harbor, the taxpayer’s accounting policy statement must state that assets costing no more than the limit be expensed.  The policy must actually be followed, meaning that the financial books and records must show the purchased item as an expense rather than as an asset.  The Regulations do not require the accounting policy to be in writing, but that is a best practice.  There is a higher $5,000 limit available to companies that have financial audits, termed “applicable financial statements” (AFS).  For the $5,000 safe harbor for taxpayers having an AFS, the accounting policy is required to be in writing by the beginning of the tax year.

Revenue Procedure 2015-56 deals with the second recent change, permitting the majority of costs associated with the remodeling or refreshing of retail stores to be deductible under a new safe harbor, effective for tax years beginning on or after January 1, 2014.  Retail stores and restaurants regularly change and improve many aspects of their property to keep up with the competition and with the changing tastes of customers.  Determining which expenditure should be capitalized or expensed is a complicated exercise under the tangible property regulations.  To simplify these complexities, the IRS has created a new safe harbor, but only for “qualified taxpayers.”  Under the safe harbor, a “qualified taxpayer” may deduct 75% of “qualified costs” as business expenses with the other 25% capitalized and depreciated as an improvement to a building.  The 25% portion is termed the “capital expenditure portion” and is itself not eligible for a future partial disposition election.  A qualified taxpayer must have an AFS (audited financial statement) and either (1) sell merchandise to customers at retail (but not car dealers, gas stations, manufactured home dealers, and nonstore retailers), or (2) prepare and sell meals, snacks, or beverages to customers for immediate consumption (but not hotels, civic or social organizations, amusement parks, theaters, casinos, country clubs, and special food services such as caterers and mobile food services), or (3) own or lease a qualified building to a taxpayer qualifying under (1) or (2).  Adopting this safe harbor is an “automatic” change of accounting method (and not an election) requiring the filing of Form 3115.  The method change requires the calculation of a so-called IRC §481(a) adjustment.  If a prior “partial disposition” election was made, a coordinating rule must be followed, revoking the election.  Once adopted, the safe harbor method must be followed for all remodel-refresh projects.  While this safe harbor simplifies the tax accounting of remodel and refresh expenditures, adopting the safe harbor is a complicated process and the Revenue Procedure must be consulted for all of the detailed requirements.