New Regulations on Repair vs. Capitalization question.

[nwtaxlady]

With these new regs for repairs vs. capitalizing, I want to bring up a common situation that we will run into.

Hot Water heaters are a common thing that "goes out" and has to be replaced. So does the New hot water heater be depreciated or expensed?

[nwtaxlady]

90 VIEWS and no one is replying?

Hasn't anyone come across this? There is new rules for Repairs vs. Capitalization!

[Nashville]

Quality versus Quantity of Replies

taxlady, I can write a response but for the topic at hand it is difficult to respond with anything worthwhile. The new stuff is quite voluminous as well.
You could have had 20 responses and none of them helpful.

I will try by stating my approach, which may be loved by many or scorned by many. If a building component qualifies for advantageous treatment for depreciable life under a "building component" arrangement, then a replacement of that component should be re-capitalized instead deducted as a repair. The key word is that "if it qualifies". That means if it qualifies it should be re-capitalized irrespective of how the taxpayer treated it in the past.

For example, your hot water heater. I believe a hot water heater to be a component, eligible for 7 yr life instead of a long life of a depreciable building. I would capitalize it and not deduct it as a repair in light of the new regs. The good news is the item can be depreciated over 7 years and not 27-40 years. I would capitalize it under the new regs even if it was considered part of the building formerly. The "formerly" was before the new regs came out.

[Gretel]

After 1040 update seminars

...we all hopefully know more.

The price for the water heater including installation is also important. If under $500 for a company with non-applicable financial statements AND a written policy was in place at the beginning of the tax year to expense all capital improvements under $500 according to the new rules, then it can be expensed.

[TaxGuyBill]

I'm really not up-to-date with the capitalization rules, but I'll give a few thoughts.


"Plumbing" is specifically a "building system", and is therefore it's own "unit of property - 1.263(a)-3(e).

I would regard replacing the water heater as "restoration" and a "Replacement of a major component or a substantial structural part" of the "plumbing system" - 1.263(a)-3(k)(6).

http://www.irs.gov/irb/2013-43_IRB/ar05.html#d0e3308

http://www.irs.gov/irb/2013-43_IRB/ar05.html#d0e765

IF that is the case, it would be depreciated over the life of the building.



However, you may be able to elect the building "safe harbor" if ALL maintenance and improvements for the year are under $10,000 - 1.263(a)-3(k).

http://tax.cchgroup.com/downloads/files/pdfs/legislation/repair-capitalization-regulations.pdf#page=7

[TaxGuyBill]

I've been reading a bit more on this, and here are some additional thoughts:

#1) Is it a "Betterment"? (Part 1): Is the water heater bigger, more efficient, or in some other way better than the previous one? If yes, it is capitalized over the life of the building.

#2) Is it a "Betterment"? (Part 2): Is it a "betterment" from when the original one was PLACED IN SERVICE? If yes, it is capitalized over the life of the building. The key phrase is "placed in service". In other words, if the water heater was 5 years old when it was "placed in service", a brand new one would be a "betterment" even if it was identical to the original one.

#3) Is it a "Restoration"? Is the water heater a "major component" of the plumbing system? If yes, it needs to be capitalized over the life of the building (see my previous comment as well).

The tricky thing is to determine if it's a "major component". From one perspective, it's only a small portion of the plumbing system. From the other perspective, it's probably the most expensive and largest item of the plumbing system, and 50% of your water goes through it. Personally, I would view it as a "major component", and therefore capitalize it over the life of the building.

[TaxGuyBill]

One more thing: I just found this, which may be helpful.

http://www.kbkg.com/nationwide/brochures/KBKG-repairs-decision-tree.pdf

[Lion]

Wow! Thanks for those links and especially for that decision tree.

[Gretel]

Form 3115

According to the new regs almost everyone who uses depreciation on their tax returns has to file this form, which is ridiculous and congress so far has refused to do something about this. I know gut feelings don't count when dealing with laws and regs but anyway, something always felt wrong about this, thinking of real small, one owner businesses with revenue well under 1 million. I believe I found my solution after reading the opinion of a well versed seminar speaker and tax professional:

Here is the best according to my understanding:

This is the first time that we have very specific laws and regs for depreciation, before these issues were decided by courts. Hence, taxpayers with no applicable financial statements typically never adopted any accounting method in this regard, other than following the existing depreciation methods (that did not change). This is the first time that these taxpayers adopt an accounting method but do not change anything.

Any comments are more than welcome.

[TaxGuyBill]

That would be AWESOME.

I've been wondering about this over the past weeks weeks. There have been several credible sources that indicate that they think EVERY business would need to file a Form 3115. From a logistical standpoint, that would be absolutely ridiculous. The do-it-yourselfers and Turbo-Taxers don't even know the form exists, much less want to file it.

I am hoping to see more of that opinion over the next month!

[Lion]

I have been in a few classes that remind us that more than one 3115 may be due for each return, as certain types of changes cannot be lumped together (three forms, usually). Also, what I have heard from instructors who talked with IRS agents, up to and including the author of the regs, and from those of you who attended IRS forums on the topic, is that the IRS is threatening to audit every return with a C, E, &/or F but without a 3115. Low hanging fruit. My latest instructor where I took two, two-hour courses, urges 60 or more hours of study, even 80 or 100. This is our last year (2013 was another) for us to "reboot" our clients' depreciation schedules.

By the way, that instructor is already serving as an expert witness for businesses suing their tax preparers!

[TaxGuyBill]

Was that in the 2014 IRS Forums? Do you remember which presentation it was? I am wondering if that is available for replay or at least to get the Powerpoint of that part.

http://www.irstaxforumsonline.com/

http://www.irs.gov/Tax-Professionals/Presentations-from-the-2014-IRS-Nationwide-Tax-Forums

Do they really want a Form 3115 with change #186 (Change to deducting non-incidental materials and supplies when used or consumed) and #187 (Change to deducting incidental materials and supplies when paid or incurred) with NO 481(a) adjustment just to say 'yes, I'll follow the revised/clarified rules'? It seems ridiculous to me.

I DO understand the need for some other ones, such as #184, IF you are actually changing anything with a 481(a) adjustment.

http://www.irs.gov/pub/irs-drop/rp-14-16.pdf#page=19

[New York Enrolled Agent]

Also, what I have heard from instructors who talked with IRS agents, up to and including the author of the regs, and from those of you who attended IRS forums on the topic, is that the IRS is threatening to audit every return with a C, E, &/or F but without a 3115.

Obvious hearsay - IMO utter nonsense - the IRS doesn't have the resources to even scratch the surface of trying to audit every C,E and F.

[Lion]

The comments from the IRS forums were made by someone else. I thought they might be overly dramatic until I started taking courses myself. The instructor who's now an expert witness thinks, after talking to IRS people in power, that they'll get more bang for their buck by concentrating on Schedules C, E, and F. Just passing along the warning. I have no first-hand knowledge, but by the time I might it'll be too late! And, yes the instructor said that even if a taxpayer will not have a 481(a) adjustment, still must file a 3115. He quoted IRS's MacKay speaking at a KPMG LLP webinar, "The more you evidence on a 3115, the better off you are prospectively. I think the best position you can put yourself in is to come forth and explain how you're applying the final rules." Circular 230 refers to "intentional disregard of rules or regulations by the practioner." My latest course referred to four typical TPR method required filings: #184, 186, 192 combined, #7 for impermissible depreciation methods, #21 for removal costs, and #205, 206 &/or 196. I have two sets of texts to reread and more upcoming classes. I find this much scarier than ACA.

[New York Enrolled Agent]

Gretel - this is from the preamble of the final regulations. Is this of help? I'm sure all your clients had written policies at the beginning of 2014 - I read this to say that no Form 3115 is necessary to take advantage of the $500 safe harbor. Am I reading that correctly? Of course, the safe harbor election must be made on the return but I'm sure the software providers have a "check the box" in their software.

I. Change in accounting procedures not change in method of accounting

Several commenters questioned whether a change in a taxpayer's financial accounting procedures (for example, its financial accounting capitalization policy) is a change in method of accounting for de minimis expenses to which the provisions of sections 446 and 481 and the accompanying regulations apply. The final regulations provide that the use of the de minimis safe harbor is a taxable year election and may not be made by the filing of an application for a change in method of accounting. Thus, if a taxpayer meets the requirements for the safe harbor, which requires, in part, having written accounting procedures in place at the beginning of the taxable year and treating amounts paid for property as an expense in accordance with those procedures, then a change in the procedures, by itself, is not a change in accounting method. For example, if a taxpayer's written financial accounting capitalization policy at the beginning of 2014 states that amounts paid for property costing less than $200 will be treated as an expense, and the taxpayer changes its written policy as of the beginning of 2015 to treat amounts paid for property costing less that $500 as an expense, the taxpayer is not required to file an application for its 2015 taxable year to change its method of accounting for applying the de minimis safe harbor or determining amounts paid to acquire or produce tangible property under § 1.263(a)-1(f).