Another Form 3115 question

[RightOn]

For tax returns with no 481(a) adjustment, is there any generic language that can be used for Part II Line 12 (b)present method and (c)proposed method?

[BHoffman]

I'm not filing form 3115 unless there is a 481a adjustment.

[RightOn]

I'm not filing form 3115 unless there is a 481a adjustment.

I read on another tax forum that a taxpayer is subject to the risk of a $7,000 fee if he is forced to file a Form 3115 down the road. Is this a valid concern?

[TomJ]

If someone gives you an answer other than "I don't know" to that question, I believe they're lying.

[BHoffman]

I see nothing in the regulations themselves that require the filing of form 3115 in order to be in compliance with the final TPR.

I do see from IRS "Guidance Regarding Deduction and Capitalization of Expenditures Related
to Tangible Property; Final Rule" here: http://www.gpo.gov/fdsys/pkg/FR-2013...2013-21756.pdf

See Section I on page 7: "Change in Accounting Procedures Not Change in Method of Accounting"

See Section X on page 16: "Change in Method of Accounting" and also see on that page 16 "Special Analysis" and especially see:

"Pursuant to the Regulatory Flexibility
Act (5 U.S.C. chapter 6), it is hereby
certified that these final regulations will
not have a significant economic impact
on a substantial number of small
entities."

[BHoffman]

I see nothing in the regulations themselves that require the filing of form 3115 in order to be in compliance with the final TPR.

Let me clarify that - Unless my client has actually adopted a new or different method of accounting created within the final TPR and not a new procedure for accounting, then there is no filing requirement for form 3115. There are no new or different methods of accounting in the TPR that will even remotely apply to my small business and small rental owners.

[ttbtaxes]

It's tough to imagine that, in the past, we defined a client's UOP for real estate purposes the way we have to now. I plan on filing a 3115 for just about every client that has real estate or a business. There will be a few exceptions but not many.

[BHoffman]

It's tough to imagine that, in the past, we defined a client's UOP for real estate purposes the way we have to now. I plan on filing a 3115 for just about every client that has real estate or a business. There will be a few exceptions but not many.

Go here: http://www.gpo.gov/fdsys/pkg/FR-2013...2013-21756.pdf

Go to page 10 and see "E. Safe Harbor for Small Taxpayers". Especially see where it says:

"...the final regulations include a
safe harbor election for building
property held by taxpayers with gross
receipts of $10,000,000 or less (‘‘a
qualifying small taxpayer’’). The final
regulations permit a qualifying small
taxpayer to elect to not apply the
improvement rules to an eligible
building property if the total amount
paid during the taxable year for repairs,
maintenance, improvements, and
similar activities performed on the
eligible building does not exceed the
lesser of $10,000 or 2 percent of the
unadjusted basis of the building.
Eligible building property includes a
building unit of property that is owned
or leased by the qualifying taxpayer,
provided the unadjusted basis of the
building unit of property is $1,000,000
or less. The final regulations provide the
IRS and the Treasury Department with
the authority to adjust the amounts of
the safe harbor and gross receipts
limitations through published guidance.
The final regulations provide simple
rules for determining the unadjusted
basis of both owned and leased building
units of property. In this situation, the
final regulations also eliminate the need
to separately analyze the building
structure and the building systems, as
required elsewhere in the improvement
rules in the final regulations."

[ttbtaxes]

The RMSH and STSH elections are separate from and unrelated to the 3115 filing. Granted, the two elections will help to allow the full deduction of repairs and maintenance for many small rental owners. Neither of those elections will all for the unique opportunity to take a prior year partial asset disposition in 2014. As I understand it, the door to that automatic change closes after the 2014 tax year filings. Somebody please correct me if I'm wrong.

The are probably only a handful people who truly applied the RABI rules in prior years that are now effective in 2014 especially with respect to building. If you didn't, you have to change your accounting method.

Is all this rubbish and ridiculous. Yup, no question about it.

[BHoffman]

If you didn't, you have to change your accounting method.

From my prior post:

"The final regulations permit a qualifying small taxpayer to elect to not apply the improvement rules to an eligible building property if the total amount paid during the taxable year for repairs, maintenance, improvements, and similar activities performed on the eligible building does not exceed the lesser of $10,000 or 2 percent of the unadjusted basis of the building."

I read this to mean that I do not have to change my accounting method and am not required to file form 3115. I have no clients who erroneously expensed any repair amounts over the stated safe harbor of $10k or 2% of unadjusted basis in any open year, or any year for that matter.

"In this situation, the final regulations also eliminate the need to separately analyze the building structure and the building systems, as required elsewhere in the improvement rules in the final regulations."

Since all of my clients are under $10m in revenue and none of their rental properties are over $1m, I read this to mean that I am not required to separately analyze the building structure and the building systems, as required elsewhere in the improvement rules in the final regulations.

Someone please correct me if I'm wrong, but I'll need to see the actual cite and not hearsay, rumors, myths, opinions, articles, etc. The IRS Guidance comes from the horse's mouth and that's the one I'm betting on for this tax season.

[ttbtaxes]

The STSH is available if the taxpayer is a small taxpayer (less than $10 million). However, you have to employ the RABI rules in any year, starting in 2014, that repairs and maintenance exceed the 2%/$10,000. This election has nothing to do with years before 2014.

There are two things that people are frequently getting wrong:

1) The $500 DMSH (De minimus safe harbor) election
2) The 2%/$10,000 STSH election

Both of these elections are for transactions in 2014 and years going forward. They can NOT be used to measure compliance in years prior to 2014. You can't look at 2010, for example, and determine what the Schedule E would look like if those two elections were in effect. Let's say in 2010 you have a window in a rental property that was capitalized and now sits on the depreciation schedule. That's an item that needs to be removed from the depreciation schedule and the remaining basis written off in 2014 via Form 3115.

Just so people are clear, there is no statute of limitations with regards to a change in accounting method. That means if a taxpayer deducted, as a repair, a "roof" in 1990 on their Schedule E, and it should have been capitalized using the RABI rules, the statute is still open with respect to that roof. The IRS can go back and capitalize it, calculate depreciation that would have been allowable and add the net amount to income in the earliest year still open by statute.

In order to properly prepare a 3115 for 2014, we would have to review a taxpayer's depreciation schedule from Day 1 and remove all items from it that should have been expensed given the new regulations and rules now in effect (but not the two elections) . The remaining basis gets deducted in 2014 by means of reporting them as a negative 481(a) adjustment on the 3115. Then, we're supposed to review a taxpayer's records for all of those years to determine if they expensed something that should have been capitalized. That gets reported as income as a positive 481(a) adjustment on the 3115 and spread over 4 years.

Here is a fantastic discussion about this subject. There are over 730 posts to this thread.

http://www.taxprotalk.com/forums/viewtopic.php?f=8&t=1621

[ttbtaxes]

From my prior post:
Since all of my clients are under $10m in revenue and none of their rental properties are over $1m, I read this to mean that I am not required to separately analyze the building structure and the building systems, as required elsewhere in the improvement rules in the final regulations.

Someone please correct me if I'm wrong, but I'll need to see the actual cite and not hearsay, rumors, myths, opinions, articles, etc. The IRS Guidance comes from the horse's mouth and that's the one I'm betting on for this tax season.

That's not correct. In 2014 and years forward, if you qualify as a small taxpayer (all of my clients do) then you can make the STSH election in any year it is applicable. That only means you are not subject to the RABI rules IF the total repairs, maintenance and supplies are less than 2% basis/$10,000 criteria for that particular year. If you do not meet that criteria for that year, then you are subject to the RABI rules.

Let's say you have a building with a basis of $300,000 and in 2014 a taxpayer has:

1) 6 windows replaced $4,000 (total of 20 windows in building)
2) Entire roof reshingled $4,000
3) New furnace $9,000

The total of the three, $17,000, exceeds the 2%/$10,000 threshold so you can not use the STSH election. Now you must use the RABI rules to determine which to capitalize and which to expense. I believe in my example, #1 and #2 are repairs and #3 is capitalized.

[TomJ]

TTB Taxes - Your understanding on this is the exact same as mine. Consider this though... the new RABI rules are, in general, more expense friendly than the rules (accounting methods? - I have a hard time calling them that) conservative taxpayers have used in the past. So, especially for the small taxpayer with a rental or a service-related side business, it seems the majority of the lookback would find things that have been capitalized and could have been expensed, not the other way around. So, if the taxpayer doesn't file 3115, doesn't take a 481(a) adjustment that would have been in his/her favor, there seems to be little risk here. Would an auditor waste his/her time calculating a 481(a) adjustment in the taxpayer's favor? Even if he/she did, that would be done in the most recent open year, thereby providing a refund (no penalties, no interest, etc.) right? I'm starting to think this exercise is intended more to force aggressive taxpayers to self-report and correct their errors of the past (expensed when they should have capitalized) than it is trying to nitpick Grandma Jones and her conservatively treated rental property.

I think what I'm planning to do is to craft a document that explains to clients that the IRS made changes to the way tangible property is treated (defining repairs vs. improvements - clients get that concept in general) and is providing new taxpayer-friendly safe harbor elections that we can use going forward to treat more things as repairs and less as improvements. I'll also explain that we're supposed to apply the new rules (not he safe harbors) retroactively, and adjust anything that we treated as an improvement that could have been a repair and vice versa. I'll also explain the opportunity surrounding the partial disposition rules, but I don't think those will apply in most cases. Then I'll give them a choice to either file for an extension and pay me or another tax preparer to file Form 3115 with any 481(a) adjustments (all of which should be in their favor, but magnitude unknown until the exercise is completed), or leave the past as is, potentially risk audit, but with what should be little/no downside if audited. I don't know any better option than to leave it up to them since they're the ones that would have pay for the work.

Should it be a choice? As I understand the rules, no it should not. But, in the real world, we can only do what we're capable of doing. I think this approach informs the taxpayer and provides him/her with the ability to make a choice given the risks, costs, etc. 730 posts on that other message board still have not come to a conclusion, which tells me that there is some grey area and interpretation in how to transition into the new rules. I can't imagine every taxpayer with a rental property or a side business that uses retail tax prep software or the mass preparers like HRB and Jackson Hewitt is going to come out of there with a 3115 filed. In most cases, they're probably not even going to get the option or the explanation. I think that puts my approach ahead of the pack. And, you don't have to outrun the bear.... you only need to outrun the slowest person being chased. If the IRS wants to pick apart 75% of tax preparers over this, I suppose that's their prerogative. I have some faith in humanity that they'll use a different approach.

I welcome comments, attempts to rip this approach to shreds, agreement, etc. I'm going to sleep on this over the weekend and make a final decision early next week. It's time to stop for me to stop debating this and to move forward with action that is in the best interests of my clients and keeps my business running.

[BHoffman]

That's not correct. In 2014 and years forward, if you qualify as a small taxpayer (all of my clients do) then you can make the STSH election in any year it is applicable. That only means you are not subject to the RABI rules IF the total repairs, maintenance and supplies are less than 2% basis/$10,000 criteria for that particular year. If you do not meet that criteria for that year, then you are subject to the RABI rules.

Let's say you have a building with a basis of $300,000 and in 2014 a taxpayer has:

1) 6 windows replaced $4,000 (total of 20 windows in building)
2) Entire roof reshingled $4,000
3) New furnace $9,000

The total of the three, $17,000, exceeds the 2%/$10,000 threshold so you can not use the STSH election. Now you must use the RABI rules to determine which to capitalize and which to expense. I believe in my example, #1 and #2 are repairs and #3 is capitalized.

ttbtaxes - I didn't say the RABI rules didn't apply. I said "Since all of my clients are under $10m in revenue and none of their rental properties are over $1m, I read this to mean that I am not required to separately analyze the building structure and the building systems, as required elsewhere in the improvement rules in the final regulations."

I meant: I do not have to perform a cost segregation study on every one (or any) of my small clients' rental properties as per the IRS guidance. I'm allowed to do this, but my fee is going to be extremely high for the time and effort this will take, and probably higher than any immediate tax saving. Perhaps they will choose to retain the basis in order to lower the capital gain upon disposition.

I agree: The RABI rules apply if the expenditure exceeds the safe harbor amount.

[Lion]

That small business that conservatively depreciated, or maybe depreciated when it needed the deductions more in future years than current, who has items of under $500 or under $200 on their depreciation schedules and finds themselves in an audit -- now it's too late to file Form 3115 or compute the 481(a) adjustments. So, those items get removed from the depreciation schedule and the remaining depreciation is lost to your client. Unless purchased in an open year, it's also too late to amend and claim as supplies. Now you have an angry client.