The new tangible property regulations that became effective on or after January 1, 2014, are complex, to say the least, and have caused an enormous amount of confusion in tax preparation for do-it-yourselfers and professionals alike. Many taxpayers failed to adopt the regulations on their 2014 returns. But it is not too late to get it right, which was the subject of a recent article in an AccountingToday that outlines a three-step approach to complying with the new regulations as long as it is accomplished before the extended due date of the taxpayer’s 2014 return.
Background: Since 2006 the IRS has struggled to develop regulations related to capitalizing and repairing tangible property, i.e., when to capitalize and when to expense. Their focus was on larger companies, but they did not consider that the issue roped in smaller businesses and rentals as well. They issued and withdrew proposed regulations in both 2006 and 2008. Finally, they issued temporary regs effective for tax years beginning on or after January 1, 2012, but then they not only changed the effective date to tax years beginning on or after January 1, 2014, but also allowed taxpayers the option to retroactively apply the regulations to tax years after January 1, 2012, the original effective date (Notice 2012-15).
Subsequently, the IRS issued Notice 2015-20, which provided simplified filing for small businesses and allowed them to apply the regulations prospectively, but forced them to give up retroactive audit protection and the ability to make retroactive adjustments based on the new regulations. Those taxpayers adopting the simplified method are permitted to make certain tangible property changes without filing a Form 3115 (used to make accounting method changes), but they must give up Sec 481(a) adjustments for the prior years (Sec 6 of Rev. Proc. 2015-20).
There are two ways for taxpayers to comply with these regulations:
1) By filing appropriate documents with their 2014 extended return, or if they have already filed, by submitting a 2014 amended return filed before the extended filing date (whether or not they filed an extension) or
(2) By doing nothing and thereby electing the IRS’s simplified method (available to small businesses1 only). Business taxpayers that elect the simplified method:
a) Forego the ability to retroactively apply the new regulations, thus giving up the ability to expense certain items that were previously capitalized.
b) May not report for years after 2011 retroactive partial dispositions2 that were not previously allowed and are now allowed under the new regulations.
c) Lose the potential audit protection related to capitalization decisions made in years prior to 2014 per Rev. Proc. 2015-13.
If your client is a small business and qualifies to elect the simplified procedures, it is important that you bring to their attention the benefits and risks associated with this alternative carefully before they make their final decision.
To assist you with documenting your client’s decision, you may wish to send them a letter outlining their options. ClientWhys has prepared a suggested New Cap & Repair letter template that you can modify for that purpose.
ClientWhys has also prepared a New Cap & Repair client notice reminding your business clients of the need to adopt an accounting procedure before year-end if they want to take advantage of the de minimis safe harbor expense provisions.
1 A small business is a business entity, including sole proprietors filing a Schedule C and landlords filing a Schedule E, with total assets of less than $10 million or average annual gross receipts of $10 million or less for the prior three taxable years. If a taxpayer has more than one business, the limitations apply separately to each business.
2 Under the latest regulations, business taxpayers can report a partial disposition, such as when the roof on a building is replaced, and thus avoid leaving a “stranded basis” on the tax return. In other words, the remaining basis (cost) of the old roof can be reported as a sale (which would result in a deductible loss) instead of continuing to depreciate at the same time that the cost of the new roof is being depreciated.
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