IRS Issues New Tangible Property Rules

The IRS has issued new temporary regulations that will affect virtually all taxpayers that acquire, produce or improve tangible property.

Businesses can currently deduct a repair expense if the cost is incidental in nature and the repair neither materially adds to the value of the property nor appreciably prolongs its useful life. Costs also are currently deductible if they are for materials and supplies consumed during the year.

Expenses must be capitalized if they are for permanent improvements or betterments that:

  • Increase the value of the property
  • Restore its value or use
  • Substantially prolong its useful life
  • Adapt it to a new or different use

To claim a tax deduction for capitalized costs, businesses generally have to apply the tax depreciation rules.

In 2008, the IRS issued comprehensive proposed regulations on when amounts must be capitalized because they are treated as paid to acquire, produce or improve tangible property. These proposed regulations included many new rules.

The 2008 regulations made significant changes to the rules relating to unit of property and restorations. And they allowed for industry-specific repair allowance methods in future published guidance.

Now, the new temporary regulations adopt and refine many of the rules contained in the 2008 proposed regulations but also modify certain provisions and provide additional rules.

Some of the specific retained or changed rules include the following:

  • Materials and supplies - The new temporary regulations modify and expand the definition of "materials and supplies" set out in the 2008 proposed regulations, provide an alternative optional method of accounting for rotable, or exchangeable, and temporary spare parts, and provide an election to treat certain materials and supplies as relatively insignificant under de minimus rules.
  • Repairs - The new temporary regulations retain the rule from the 2008 proposed regulations and clarify that a taxpayer is permitted to deduct amounts paid to repair and maintain tangible property, provided such amounts are not required to be capitalized under any other provision of the IRS Tax Code or regulations.
  • Leased property - The new temporary regulations retain the rule allowing a taxpayer to amortize the costs of acquiring a leasehold over the term of the lease. They make only minor revisions to the rule that provides that the cost of erecting a building or making a permanent improvement to property leased by the taxpayer is a capital expenditure and is not deductible as a business expense.

However, the temporary regulations provide that a lessee or lessor must depreciate or amortize its leasehold improvements under the cost recovery provisions of the Tax Code applicable to the improvements, without regard to the term of the lease. They also remove the rules permitting amortization over the shorter of the estimated useful life or the term of the lease.

The temporary regulations are generally effective on Jan. 1, 2012, so businesses will need to be prepared to apply them immediately.

Read more in td-9564.

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