Effective January 1, 2014 the IRS issued final regulations that completely revamped the way a business must evaluate certain expenditures…
in order to determine whether the costs represent immediately deductible repair expenses or capital improvements that must be depreciated over time.
In addition new guidance was issued on when a business may deduct material and supplies.
There are different types of material and supplies, and it is the nature of the item that drives when it may be deducted under the new regulations.
In the first category, we have “incidental material supplies;” those items with a cost of less than $200 that are so small and insignificant, it is impossible to trace when they are consumed by the business. These expenses may be deducted immediately upon purchase.
In the next category, we have “non-incidental materials and supplies,” these items with a value of $200 or less that are a bit more substantial , and we can trace when they are being used for the business. These materials and supplies can only be deducted when consumed by the business.
Lastly, there is what is called “rotable and emergency spare parts,” which are much bigger, more costly supplies, generally well in excess of $200 cost. These parts are used to avoid production down time by keeping them on hand until they are used to avoid production down time. As a result the cost is not permitted to be expensed until these parts are finally disposed of.
This new rule which is effective January 1, 2014 basically means that non incidental supplies cannot be deducted until they are used.
The regulations also define and adopt new criteria related to repair costs incurred to maintain an asset.
Basically the old rules determined that if an asset is purchased it was to be depreciated over its useful life. The grey area dealt with how to treat cost incurred to repair the asset. The rules basically provided that if expenditure increased the value of an asset or extended its useful life, the costs had to be capitalized as part of the asset cost rather than be deducted as a repair. Since there was not much guidance and much abuse of these rules the IRS developed new rules, regulations.
The new regulations require that repair costs must first be evaluated utilizing the safe harbor de minims tests, and if they meet these tests the repair costs may be deducted as opposed to capitalized as part of the asset. If the repair does not qualify for the safe harbor exceptions, than the repair costs must be evaluated through a multi step process to determine its treatment; expense or capitalization.
The costs must be evaluated as to whether the costs represent a Betterment, Restoration, or Adaptation for a new and different use, The BRA Tests.
In order to make this determination a new criteria was develop by the regulations called a “unit of Property” the Denominator. The unit of property must first be defined before the repair cost can be evaluated. For example; if you were required to compare the $20,000 cost to replace an eight of ten HVAC units to the cost of the entire building, there’s virtually no chance the BRA Test would conclude that the costs would be capitalized. Under the unit of property rules, however, the comparison is not made to the building, but rather to the “building system” that is comprised solely of the ten HVAC units. As a result, replacing 80% of the building system will require capitalization under the BRA Test.
A brief explanation of what a Betterment, Restoration or Adaptation represents is follows.
There are essentially six types of betterments; repair costs to property prior to acquisition must be capitalized as betterment. The remaining five types of betterments are all interrelated. Any costs that represent a material increase to size , capacity , efficiency , strength or quality of a unit of property , a building system , or a segment or a unit of property that performs its own critical and discrete function must be capitalized as part of the property.
Restoration can be divided into three buckets; simply the first situation is the capitalization of repair costs related to the taxpayer taking a loss on the property due to abandonment or casualty. The second situation is where the property does not function for its intended use or is so run down that it can no longer function; the repair costs must be capitalized. The third relates to replacing part of a unit of property e.g. a building system , a portion of a unit of property that performs its own discrete function, the taxpayer replaces a chiller unit in the HVAC. The Regulations have numerous examples for a detailed explanation of the BRA TEST.
In summation, a company must request to change its method of accounting for materials and supplies and repair costs unless the company has been applying these rules. For the majority, in order to come into compliance with these rules, a change in accounting method request must be filed with the IRS notifying them of the change commencing with tax year 2014 and making the necessary adjustments to prior tax years. Revenue Procedure 2015-20 has given relief to certain taxpayers that qualify them from having to file requests with the IRS and to apply the new Regulations commencing 2014 on a going forward basis.
Business tax planning involves, not only economic planning for that year, but also making wise tax decisions that will benefit the business for years to come.
Tax-saving strategies must take into account short-term and long-term goals so that decisions made for the current tax year also represent sound tax decisions in the following years.
Often, because business planning opportunities must be viewed in conjunction with personal tax planning, a taxpayer should also consider planning tips affecting their individual return and investment considerations when making business decisions.
Please call our office at (732) 531-8000 for an appointment to discuss the 2014 tax planning strategies that may apply to you.