Progress always requires change, and progress in the way we tax tangible property is no exception. The tangible property rules have long been one of the murkier areas of the federal tax code. But new regulations — the last piece of which was issued in September — clarified the rules for acquiring, improving, maintaining and disposing of tangible property used in a trade or business.
These complex regulations are first effective for fiscal years beginning on or after January 1, 2014 and they apply to virtually all businesses and landlords that own or use tangible property. They include rules for acquisition costs and improvements, capitalization vs. repair issues, depreciation, treatment of materials and supplies, and write-offs for all or a portion of a disposed-of asset, to name a few.
If your family business owns significant fixed assets or real property, these rules offer potential tax benefits and a number of planning opportunities.
However, implementing them requires a fairly complex and time-consuming one-time transition process. This process typically includes potential changes in recordkeeping, a review of capitalized costs for current and prior years, new and revised calculations, various elections on tax returns and one or more applications for a change in accounting method.
Among the more significant transition-related activities potentially affecting family businesses are the following:
Review of Current (2014) and Prior Years’ Capitalized Costs
The family or its tax advisors should review each of the business’ assets on the depreciation schedules in light of the new capitalization rules. Based on retroactive aspects of these rules, certain previously capitalized assets may actually be deductible repairs.
All such deductible assets should be written off on the 2014 tax return as the IRS may disallow future depreciation.
Analysis of Partial Asset Dispositions for Current and Prior Years
The family or its advisors should also review any partial asset dispositions from prior years — including those that arise from asset replacements — to uncover possible tax benefits. The new regulations generally allow businesses to elect to recognize gain or loss on a partial disposition or to ignore the disposition and continue depreciating the asset, determined on a disposition-by-disposition basis. The ability to recognize gains or losses from prior-year partial dispositions is not available after the 2014 tax year, so it’s important to analyze the potential tax benefits before filing the family business’ 2014 federal return.
Preparation of Forms 3115, Application for Change in Accounting Method
Under the IRS’ automatic consent procedures, a business will need to file at least one Form 3115 — and potentially more than one — to comply with and benefit from the new regulations. For example, a business will need to file Form 3115 to adopt the new materials and supplies and the repair vs. capitalization rules.
Form 3115 is a lengthy form to prepare and the IRS generally requires a separate Form 3115 for each category of election and each entity and trade or business.
Fortunately, not all of the changes in the regulations are considered to be changes in accounting method. Some only require an election statement, but they still need careful consideration to determine the most advantageous approach, plus preparation of the election statement itself. For example, a business may need to revisit its capitalization policy in light of a new de minimis safe harbor.
Consequences of Noncompliance
In general, if a family business doesn’t comply with the new regulations, it could lose valuable deductions and safe harbors.
It also runs the risk that the statute of limitations remains open, its tax elections are deemed invalid, the IRS doesn’t consider the 2014 tax return to be valid, certain depreciation deductions are denied, and additional tax assessments may be subject to a 20 percent accuracy-related penalty.
You may wish to consult your tax professional for guidance in implementing the new regulations to ensure compliance and to maximize the potential tax benefits.