It cannot be put off any longer. We have known about the new repair regulations in one form or another for several years now. We have had proposed and then temporary guidance that we could choose to follow or not follow. Now the guidance is finalized and complete. Tax years beginning on or after Jan. 1, 2014, must comply with the guidance.
For most taxpayers affected by the repair regulations, the tax return for the 2014 year will require the submission of multiple Form 3115s to report changes of accounting methods. Taxpayers must also choose whether to adopt the final regulations or the temporary regulations for the 2012 and 2013 tax years. The IRS has relaxed restrictions on changes of accounting methods to permit these filings in 2014. Filing these changes for the 2015 year may be too late, as these relaxed restrictions will have expired. Taxpayers may also permanently lose tax deductions if the complete Form 3115s are not filed with the 2014 tax return.
Gathering the necessary information to properly file the Form 3115s will frequently be time-consuming and will require close coordination between the tax return preparer and the taxpayer. An incomplete Form 3115 will frequently be treated as if no Form 3115 has been filed. In addition to the Form 3115s, the repair regulations also anticipate a number of annual elections that the taxpayer can make, some just by the way the tax return is prepared and others by making an affirmative statement with the return that the election is being made. The tax return preparer may have responsibility under Circular 230 for failure to properly prepare a tax return with the necessary Form 3115s. Preparing in advance for these new requirements will be essential to submit correct 2014 tax returns.
BACKGROUND
The IRS first announced a repair regulation project in 2004. Proposed regulations were issued in 2006 and then withdrawn and reproposed in 2008. Temporary regulations were issued in 2011. The final repair regulations were issued over a year ago in September 2013. Additional guidance has come out during 2014. Revenue Procedure 2014-16 details accounting method changes required by the regulations. Rev. Proc. 2014-17 addresses accounting method changes under the Modified Accelerated Cost Recovery System regulations. Additional final regulations address dispositions of property. Rev. Proc. 2014-54 addresses automatic accounting method changes for dispositions of property.
Taxpayers who have depreciable assets, materials and supplies, rotable and temporary spare parts, repairs and maintenance, property improvements (which might be categorized as a betterment, a restoration, or an adaption to a new use), or property acquisitions or dispositions are likely to be affected by these regulations and required to submit accounting method changes with their 2014 returns.
Fundamental to the repair regulations is determining the unit of property to which the new rules are to be applied. This in itself can be a complicated and time-consuming process.
FORM 3115
The typical taxpayer affected by the repair regulations will be required to file multiple Form 3115s for 2014. The form goes on for eight pages. Although certain accounting method changes may be combined on one Form 3115, many others require a separate form. Supplemental statements are also likely to be necessary.
One of the most difficult parts of the form may be calculating the Sec. 481(a) adjustments. Overall, the adjustments are likely to be favorable to the taxpayer, permitting the write off of items that were previously capitalized. However, the information on the prior treatment of the property and adjustments for items recategorized by the repair regulations necessary for calculating the 481(a) adjustment may be difficult to assemble, with client depreciation schedules being a crucial part of the process. The final regulations assign a number to the accounting method changes being granted automatic approval. The Form 3115 is to include that number, as well as a citation to the relevant regulation section.
ACCOUNTING METHOD CHANGES
Some accounting method changes are required and others are optional. Some of the required accounting method changes that are most likely to be encountered for 2014, with the number assigned by the regulations, are:
- No. 7: Impermissible to permissible depreciation methods.
- No. 184: Unit of property; Repairs and maintenance; Restorations, adaptations, betterments and improvements.
- No. 186: Materials and supplies.
- No. 187: Materials and supplies.
- No. 192: Acquisition of property.
- Many other accounting method changes can apply in certain situations. Some of the more common optional accounting method changes with automatic approval are:
- No. 21: Removal costs.
- No. 184: Routine maintenance safe harbor.
- No. 196: Partial dispositions of property.
- No. 205: Partial dispositions of property.
- No. 206: Partial dispositions of property.
Some of these accounting method changes can be applied retroactively. Some have different assigned numbers under the temporary regulations for 2012 and 2013.
ELECTIONS
In addition to the accounting method changes, taxpayers have the option to make a series of elections under the repair regulations. These are a small taxpayer safe harbor, a de minimis safe harbor, an election to capitalize materials and supplies, an election to capitalize repair and maintenance costs, a partial asset disposition election, and an election to capitalize amounts paid for employee compensation or overhead in conjunction with a property acquisition.
The de minimis safe harbor and the small-taxpayer safe harbor require a specific statement claiming the safe harbor with the return.
The other elections are claimed just by including them in the way the tax return is prepared.
PLANNING ISSUES
There are a number of issues that can come up in dealing with these complicated regulations. One will be whether to use the temporary or final regulations for 2012 and 2013. For determining the proper write-off for an asset disposition, the guidance initially identified CPI adjustments as an acceptable method. Later guidance, however, shifted to PPI and determined that CPI was not an acceptable method, requiring a taxpayer who had relied on the initial guidance to make a further change. The initial guidance seemed to encourage the creation of general asset accounts for groups of similar property. Subsequent guidance made these less attractive and provided for the unraveling of those GAAs, although a GAA may still be attractive to permit a demolished property to continue to be depreciated, rather than have its remaining basis applied to the underlying land.
GEARING UP FOR TAX SEASON
The repair regulations are likely to require considerable additional time and effort in the return preparation process for the 2014 tax year for those taxpayers affected. Tax return preparers and their clients should prepare in advance for these problems by identifying taxpayer activities likely to be impacted by the repair regulations and working together to start assembling the required information. Failure to adequately address the repair regulations on the 2014 return could result in lost tax breaks for taxpayers and Circular 230 exposure for tax return preparers. The burden of proof will be on the taxpayer to support the Code Sec. 481(a) adjustments claimed on the Form 3115s. Assembling depreciation schedules and performing 481(a) calculations will be an essential part in preparing timely filed Form 3115s. Taxpayers will have until the extended due date, Sept. 15, 2015, or Oct. 15, 2015, for filing 2014 tax returns with the required Form 3115s.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst at the Tax and Accounting group of Wolters Kluwer, CCH.
