Does your business acquire, produce or improve tangible property? Chances are, the answer is yes. If so, then it’s important to know about the regulations the IRS released in September 2013 pertaining to the costs incurred to acquire, maintain and improve tangible real and personal property.

The result of an almost decade-long process, the IRS regulations promulgated in late 2013 were designed to finalize temporary regulations that were issued in late 2011. The goal of the regulations is to provide for clear and proper characterization and tax treatment of expenditures related to the acquisition, improvement, maintenance and repair of property.

Generally speaking, the IRS requires that amounts paid to acquire, produce or improve tangible property must be capitalized. Nonetheless, taxpayers have historically been permitted to deduct what the IRS considers “ordinary and necessary business expenses”, including the costs of certain supplies, repairs and maintenance activities.

However, a problem arises as it can very quickly become difficult to establish what assets must be capitalized vs. property that is material or supply, and between improvement costs and repair or maintenance ones. The goal of the finalized regulations is, in large part, to simplify and clarify these distinctions.

When your business capitalizes the investments made to acquire or produce tangible real or personal property, including leasehold improvement property, land and land improvements, buildings, machinery and equipment, and furniture and fixtures, the costs are recovered under the rules applicable to the specific type of property.

For example, a building or piece of equipment is depreciated over its useful or tax life, whereas a plot of land would be recovered when it is sold or otherwise disposed of. Materials and supplies, including tangible items that are not classified as inventory and have an economic life of a year or less /or/ an acquisition cost of $200 or less, are usually deductible either when you purchase them or when they are used.

What the new regulations clarify is how and when a taxpayer may choose to expense the costs associated with acquiring tangible property where the costs of the acquisition are under a specific amount (referred to as the de minimus safe harbor amount).

However, in order to qualify for the safe harbor election, a taxpaying entity must have a written accounting policy in place on or before the first day of the tax year that establishes the parameters by which the election will be applied. For existing entities, this is generally defined as January 1, 2014.

The safe harbor level for entities with an applicable financial statement (usually an audited financial statement) is $5,000 per item and the safe harbor level for entities without an applicable financial statement but who do possess a written capitalization policy is $500 per item.

Those who failed to create and maintain a consistent, written capitalization policy before January 1 of the applicable tax year may still apply the deduction for expenditures on tangible property up to $200.

There are many other implications and factors associated with the new regulations, particularly pertaining to deduction vs. capitalization for spare parts, materials and other supplies; as well as for deductible routine maintenance to property. In addition, these regulations have an impact on how your business may plan for applicable Section 179 deductions (i.e. first-year expensing).

In order to develop the best strategy for tangible property capitalization and deductions for your business, consult with the team at Haines & Lagerquist CPAs by calling 301-249-0703 or via email to cpa@hainesandlagerquist.com.

Selected Sources:

A Look at the Final IRS Tangible Property Regulations
http://www.mossadams.com/articles/2013/september/a-look-at-final-tangible-property-regulations

IRS Issues New Regulations Requiring a Written Capitalization Policy to be in Place by January 1 to Qualify for Special Tax Treatment
http://www.nonprofitcpa.com/irs-issues-new-regulations-requiring-written-capitalization-policy-place-january-1st-qualify-special-tax-treatment/

How the Final Repair and Capitalization Regulations Will Impact You
http://wblcpa.com/how-the-final-repair-and-capitalization-regulations-will-impact-you/

Section 179: What Every Business Owner Needs to Know About This Depreciation Deduction
http://www.nolo.com/legal-encyclopedia/section-179-what-every-business-owner-needs-know.html

Image Credit: mktduct (Flickr @ Creative Commons)