Another Form 3115 question

[TaxprepP]

Change 186 is the definition for supplies.

Change 184 is a whole other matter.

It looks as though 186 and 187 both have definition of materials and supplies.

[TXEA]

Thanks for the input. I will add the wording to the 187. Hows this: Adopting the definaition of materials and supplies and deducting incidental materials and supplies when paid or incurred.

Your suggestion for 184, do you mean to add the verbage?

Change 186 is the definition for supplies.

Change 184 is a whole other matter.

[TXEA]

B Hoffman - I really do respect your position. I do not think the majority of small taxpayers need to file a Form 3115. I truly think this whole Form 3115 issue is a waste of time for most taxpayers.

Adopting change 186 and 187 in no way impacts the ability to make any of the new elections. You don't need a Form 3115 to make the election and adopting changes 184, 186, 187, or 192 does not keep you from making the election.

I am simply doing them, holding on to them, and just praying the IRS comes out and says in the next few weeks, small taxpayers do not have to file. I may be naïve, but I really think we will get an announcement in the next couple of weeks granting regulatory relief to small taxpayers (1 Million Rev, 10 Million - I don't know).

I am ONLY filing the Form 3115 so my inaction does not cause my client or me problems down the road. And, because there can be changes in accounting methods from applying the Regs (e.g. Routine Maintenance, definition of supplies, de minimis amounts, dispositions, improperly handling non-incidental supplies, UOP's, etc. ). Yes, preparing them will cost my clients a little, and cost me some time that I will probably have to eat; however, I can sleep at night.

Your posts are well researched and your conclusions are logical.

In summary, you are probably right, but I am not going to take the risk that you are wrong.

[BHoffman]

I realize that many people have committed a lot of time and money regarding the form 3115 issue, and I don't mean to be contrary or critical. I especially owe Lion an apology for being snippy, and I am sorry. This will be my last post on this subject. I'm excerpting for ease of reading.

Regarding, for example, DCN 186. The citations are Reg. sec. 1.162-3(a)(1) and Reg. sec 1.162-3(c)(1). The first sentence in 1.162-3(a)(1) starts off with 'Except as provided in paragraph (f)' and then goes on to describe when you can deduct materials and supplies.

What does the "except for" paragraph (f) say? The title is: Application of de minimis safe harbor. This paragraph cites 1.263(a)-1(f)(5) for the time and manner of making the election.

1.263(a)-1(f)(5) says the DMSH election cannot be made through the filing of change in accounting method.

So, by selecting the DCN 186 are you changing to an accounting method that will not allow your client to make the safe harbor election under 1.263(a)-1(f)? Does the DCN 186 cite 1.162-3(a)(1) specifically exclude the safe harbor election? Probably not. If all you are doing is making the DMSH election 1.263(a)-1(f), do you have to file form 3115? The Regs say not only are you not required to file form 3115, it is improper to file form 3115 if your intent is merely to take the annual election. Could any harm be done? I'm not sure.

Let's look at 1.162-3(c)(1).

(c)Definitions—

(1)Materials and supplies. For purposes of this section, materials and supplies means tangible property that is used or consumed in the taxpayer's operations that is not inventory and that—

(i) Is a component acquired to maintain, repair, or improve a unit of tangible property (as determined under § 1.263(a)-3(e)) owned, leased, or serviced by the taxpayer and that is not acquired as part of any single unit of tangible property;

1.263(a)-3(e) determines a "unit of property". By filing form 3115 with DCN 186, is your client required now to perform a cost segregation study and list out the building components and structures? I don't know the answer.

1.263(a)-3(h) is the STSH election. We may not make this election by filing for a change of accounting method, so if all you are doing is making the election would filing form 3115 be improper? The answer is clearly yes, it would be wrong. Would it cause any harm? I'm not sure.


I'm not sure whether filing form 3115 when all I'm doing is making elections 1.263(a)-3(f) and 1.263(a)-3(h) will do any harm to my qualifying small taxpayer clients.

I am positively sure that filing form 3115 when all I'm doing is making those elections would be the wrong thing to do.

[TaxprepP]

That looks fine except you have no change for 187 - your present and proposed method is the exact same. I would also recommend under change 186 adopting the definition of materials and supplies. Unless you always consider supplies as items costing $200 or less. Otherwise, I have been doing much the same thing on lines 12b and 12c for materials and supplies.

You might also want a change 184 to preserve the ability for the routing maintenance safe harbor (at a minimum).

Thanks for the input. I will add the wording to the 187. Hows this: Adopting the definaition of materials and supplies and deducting incidental materials and supplies when paid or incurred.

Your suggestion for 184, do you mean to add the verbage?

[TXEA]

Here is a sample of what I am using, a template from material in the NATP webinar "The ABCs of form 3115" and tweeking it to fit each taxpayer who needs the form. The firm I work is preparing one for each taxpayer who has tangible property to accept the new regulations.
Hope this helps.

Statement 2
Form 3115, part II, Line 12

12a Item being changed: Change 184: Adopting the definition of repair and maintenance or a change to capitalizing amounts for improvements to tangible property.

Change 186: Adopting the timing for deduction of non‐incidental materials and supplies.

Change 187: Adopting the timing for deduction of incidental material and supplies.

12b Present method: Change 184: Capitalizing items per temporary regulations.

Change 186: Deducting all supplies when purchased.

Change 187: Deducting all supplies when purchased.

12c Proposed method: Change 184: Adopting the definition under final tangible property regulations.

Change 186: Deducting non‐incidental supplies when consumed.

Change 187: Deducting incidental supplies when paid or incurred.

12d Present overall method: Cash.

That looks fine except you have no change for 187 - your present and proposed method is the exact same. I would also recommend under change 186 adopting the definition of materials and supplies. Unless you always consider supplies as items costing $200 or less. Otherwise, I have been doing much the same thing on lines 12b and 12c for materials and supplies.

You might also want a change 184 to preserve the ability for the routing maintenance safe harbor (at a minimum).

[Lion]

Thank you, P, for sharing your template. I also took that course. You summed it up nicely. I printed out your list to have on my desk.

[Lion]

I don't like leaving those items on the depreciation schedule as low-hanging fruit, a red flag that there might be more non-compliance in a return. And, in the half dozen courses I've taken from the IRS and Eric Wallace of Boyer & Ritter and others, it's been stated that a 3115 after the 2014 tax year has a user's fee ($7,000?) so that 481(a) adjustment might not happen. At the very least, the auditor would suspect that the supplies/material/repairs accounts might yield some money to the IRS and look more closely there or in all the usual places, such as mileage, M&E,.... I'm looking at this as much as a personal CYA as it is a stay-out-of-audit help to my clients.

[TomJ]

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.

Lion - back when I was beginning to research this, I thought the same thing. A seemingly very knowledgeable person (Coddington at TaxProTalk) posted this in response to someone on another board... "Under Rev Proc 2002-18, the only way you get to that result is if the examining agent cannot reasonably estimate the section 481(a) adjustment and is permitted to use a cut-off method. The amount capitalized on the fixed asset schedule seems to provide an amount that would allow the agent to easily calculate the section 481(a) adjustment." And that makes sense. An auditor can't just trash an item on your depreciation schedule because it should have been expensed in a prior, closed year. He'd have to calculate what the 481(a) adjustment should have been and force the taxpayer to take it. But again, that's in favor of the taxpayer so a) the IRS wouldn't bother and b) even if they did, the taxpayer gets a positive adjustment in the first open year available. At worst, the taxpayer is delaying a deduction he/she could have had earlier.

[TaxprepP]

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?

Here is a sample of what I am using, a template from material in the NATP webinar "The ABCs of form 3115" and tweeking it to fit each taxpayer who needs the form. The firm I work is preparing one for each taxpayer who has tangible property to accept the new regulations.
Hope this helps.

Statement 2
Form 3115, part II, Line 12

12a Item being changed: Change 184: Adopting the definition of repair and maintenance or a change to capitalizing amounts for improvements to tangible property.

Change 186: Adopting the timing for deduction of non‐incidental materials and supplies.

Change 187: Adopting the timing for deduction of incidental material and supplies.

12b Present method: Change 184: Capitalizing items per temporary regulations.

Change 186: Deducting all supplies when purchased.

Change 187: Deducting all supplies when purchased.

12c Proposed method: Change 184: Adopting the definition under final tangible property regulations.

Change 186: Deducting non‐incidental supplies when consumed.

Change 187: Deducting incidental supplies when paid or incurred.

12d Present overall method: Cash.

[BHoffman]

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.

IF an auditor went back beyond the SOL to examine depreciated items under $500 or under $200 and sought to recharactize them to expense and then I was unable to defend that those items should have been capitalized and then the auditor decides because the transactions were recorded outside of any open period to disallow any deduction at all and then unless there were a whole big slew of them that add up to a big bunch of tax then it might not even be worth going to appeals.

Otherwise, you are correct.

[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.

[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.

[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.

[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.