Tax executives are uncertain about the potential impact on their businesses of the “repair regulations” recently issued by the Internal Revenue Service, according to a new survey by KPMG.

The IRS and the Treasury Department released temporary and proposed regulations on December 23 that would significantly change the rules pertaining to the capitalization of costs incurred to acquire, maintain or improve tangible property (see IRS Issues Regulations on Tangible Property Repairs).  Utilities, telecommunications companies, manufacturers, retailers and real estate companies are among the industries that could be affected.

KPMG surveyed 1,900 tax executives during a recent Webcast on the repair regs, and 62 percent said they were unsure about whether to view the new rules as favorable or unfavorable. Another 23 percent perceived the new regs as favorable and 15 percent viewed them unfavorably.

Forty-two percent of the executives said they expect the new rules to be harder to administer or comply with in practice. But 27 percent anticipated nothing would change and 22 percent said they were uncertain of the impact of the new regulations on their processes.  Only 10 percent of the survey respondents said they would be less difficult to administer or apply.

“The repair regs affect most industries and corporate taxpayers -- from store remodelling in the retail industry, to the repair of engines in a trucking fleet, to a new roof on a manufacturing facility,” said Eric Lucas, a principal in KPMG’s Washington National Tax practice and a former Treasury Department official, where he was a member of the Repair Regs team.

“The new regulations are quite extensive, so the uncertainty around their impact on tax operations is not surprising,” he added. “Regardless, they are effective in the 2012 tax year and taxpayers will need to get up to speed and prepare quickly.”

Lucas recommended that tax executives think about performing an asset repair study at their businesses. “Given the comprehensive nature of the repair regs, tax executives should consider conducting an asset repair study or closely review historical and current-year asset records and capital improvement projects to help analyze the impact the new rules will have on their businesses,” he said.  “It’s also important to note that many parts of the regulations require a Section 481(a) adjustment, which will require taxpayers to adjust all of their opening accounts as if they had been on the new regulations—which can have a negative or positive impact on a company’s tax position.”

According to the KPMG survey, 49 percent of the respondents said their company had never conducted an asset repair study, while 28 percent said their company had conducted such a study and 23 percent said they were unsure.

One significant change in the latest version of the regulations involves the application of the improvement standards to building property. Forty-six percent of the tax executives surveyed by KPMG were unsure whether to view the new rules related to building property as favorable or unfavorable for taxpayers, while 35 percent viewed them as favorable and 19 percent said unfavorable.

“Under the new rules, the improvement standards have to be applied to the major systems within a building—such as the heating and air conditioning system, the plumbing system, the electrical system, escalators and elevators—rather than applying them to the entire building, which is what the 2008 proposed rules did,” Lucas pointed out. “This may result in more capitalization of these costs by taxpayers compared with the 2008 rules. On the favorable side, taxpayers also can now take retirement losses on components of the building such as an old roof that is replaced.”

Another significant change in the new repair regs involves the de minimis expensing rule, which enables a taxpayer to deduct the acquisition cost of property for tax purposes up to a specified amount, as long as it was originally tabulated as an expense for financial reporting purposes and the taxpayer had a written policy in place to account for the acquisition in this way.

“The new repair regs allow all categories of materials and supplies to be deducted in the year of purchase rather than the year they are used or consumed if they qualify under the de minimis expensing rule,” said Lucas. “This change could help improve near-term cash flow.”

The KPMG survey found that 43 percent of the respondents said the de minimis rule provides for sufficient flexibility for taxpayers to account for smaller items of property such as materials and supplies under the new repair regs, but 25 percent said the overall cap or ceiling is not sufficient to account for smaller items. Another 32 percent said they were unsure.

A replay of the KPMG Webcast on the repair regs can be found here, while a brief video featuring Eric Lucas discussing the new regulations may be viewed here.

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