New Capitalization and Repair Regulations Cause Form 3115 Conundrum….Keiter’s Thoughts.
Posted on 02.13.15
By Jennifer F. Flinchum, CPA, CFP® | Tax Partner and Gary G. Wallace, CPA | Tax Partner
We have previously discussed the new Capitalization and Repairs Regulations that Treasury issued in 2013 and 2014. These new regulations which are effective for tax years beginning on or after January 1, 2014 include not only changes to real and tangible property reporting, but also changes to expenses related to materials and supplies. The changes are wide reaching. Many advisors are recommending that every taxpayer will need to file one or more additional forms with the Internal Revenue Service to comply with these new regulations. Additional guidance was issued by the IRS in late 2014, but many questions remain. What we do know is that some of the changes require taxpayers to adopt a new method of accounting. For these changes a Form 3115 (Change in Accounting Method) is required to be filed with the 2014 tax return and also filed with the IRS Office in Ogden, Utah by the due date of the 2014 return (including extensions). Other changes simply require the affirmative election of a certain accounting policy. The new regulations are very complex. We believe that most taxpayers will make at least one new election or method as part of their 2014 tax filing. While the election is an annual election and will require annual compliance, the administrative burden with this portion of the new regulations is not so troublesome. The changes that require a change in accounting method are more time consuming. We believe the Form 3115 should be filed for certain taxpayers to provide either current or future tax benefits or to provide protection from IRS assessments. However, the decision will need to be based on each taxpayer’s facts and circumstances. Generally, we see the taxpayers that will require the filing Form 3115 in 2014, as having the following attributes:
- Real estate – to include real property used in trade or business and owned by such business, residential or non-residential rental property or home office (including significant leasehold improvements)
- A significant amount of materials and supplies expense (example: doctor’s office with significant controlled substance costs)
- Operate in an industry where repair costs are on-going and significant (example: manufacturing plant or trucking industry)
The IRS has stated that the new regulations are intended to be taxpayer friendly to allow for less tracking of property, more immediate expensing or, at a minimum, more guidance on repair vs. capital expenditures. While this may have been the intent, it is not currently the reality. Many practitioners are still awaiting further guidance from the IRS as to how to retroactively apply and document such application of the new regulations. The AICPA and more than 40 state CPA societies have written letters to the IRS requesting that the new regulations be applied only on a go forward basis. Unfortunately, this recommendation has not been accepted to date.
This leaves many taxpayers in a gray area.
- Does a taxpayer incur the costs and effort to file protective elections just to state that the new regulations will be applied going forward?
- If the taxpayer feels as though they have generally been in compliance in prior years, is a Form 3115 required?
- Is the IRS prepared to process potentially millions of Forms 3115 filed for 2014?
- Will the IRS really take harsh stances on the misapplication of the new regulations in a year prior to the enactment?
We are recommending a review of current accounting policies, a review of the current fixed asset listing, a review of current expense items and comparison to the new regulations. Some taxpayers, especially those with real estate, may find significant current tax savings during such a review. If tax savings are to be recognized, the additional compliance is not so burdensome. If the evaluation results in no current tax savings, but potential future savings, then the additional tax filings is “the added burden of the additional form filing.”
One last caveat, the new rules apply to federal income tax, but not necessarily to local property tax. Some of the new rules that provide for more liberal expensing of fixed assets will likely not be adopted by localities assessing personal property tax. Taxpayers now will have to track separately those assets which were expensed as de minimis for income tax purposes so that the local reporting will be complete. Unfortunately another layer of tax compliance has been added. Read more of our articles on this topic.
Please consult your Keiter tax professional with any questions or contact firstname.lastname@example.org | 804.747.0000.
Late Breaking News: February 13, 2015, the IRS issued Rev. Proc 2015-20.
Revenue Procedure 2015-20 permits small business taxpayers to make certain tangible property changes in methods of accounting with a § 481(a) adjustment that takes into account only amounts paid or incurred, and dispositions, in taxable years beginning on or after January 1, 2014. In addition, for their first taxable year that begins on or after January 1, 2014, small business taxpayers are permitted to make certain tangible property changes without filing a Form 3115. The revenue procedure also requests comments on whether it is appropriate to increase the de minimis safe harbor limit provided in § 1.263(a)-1(f)(1)(ii)(D) for taxpayer without an applicable financial statement (AFS) to an amount greater than $500, and, if so, what amount should be used and the justification for considering that amount appropriate.