Repair Reg Relief for Small Businesses? Not So Fast.– February 23, 2015 by Lisa Loychik

Posted by Lisa Loychik, CPA

January 1, 2014, marked the date that the final Repair, Maintenance and Disposition Regulations (Regulations) went into effect and apply to any business with material and supplies, repairs or depreciable fixed assets. Since the fall of 2013, when the final Regulations were first released, accountants have spent countless hours sorting through the complex rules and, based on their findings, added Form 3115 (Application for Change in Accounting Method) to their list of 2014 required filings for many clients.

But the latest update, just out February 13th, came in the form of some relief via Rev. Proc. 2015-20, which allows qualifying small businesses to not file Form 3115. While this relief was long-awaited by many, real estate or other capital-intensive businesses may find more opportunity by foregoing the “relief” and complying with the original Regulations as planned.

Opportunities for Relief
Before Rev. Proc. 2015-20, all taxpayers affected by the Regulations would have been required to file Form 3115 to adopt the new Regulations, beginning on their 2014 tax filings. For everything except materials and supplies, this entailed going back through prior years to make sure repair expenses and amounts capitalized were properly accounted for according to the new rules. While this exercise may afford some new opportunities, it also presents an administrative burden, particularly for small businesses with limited resources. Rev. Proc 2015-20 allows taxpayers who qualify to adopt the new Regulations on a go-forward basis (e.g., “cut-off method”) without the look back.

Relief is available to a taxpayer with one or more separate and distinct trades or businesses and has either:

  1. total assets of less than $10 million as of the first day of the tax year for which a change in method of accounting under the final tangible property regulations is effective; or
  2. average annual gross receipts of $10 million or less for the prior three tax years (as determined under Reg. §1.263(a)-3(h)(3)).

The criteria for relief are applied separately to each of the taxpayer’s trades or businesses. A taxpayer’s separate and distinct trade or business that does not meet one or both criteria does not qualify for relief.

Real Estate Opportunities
As mentioned above, the Regulations may provide additional planning opportunities for real estate or other capital-intensive businesses, but only IF they file Form 3115 and conduct the necessary look-back process. Opportunities could include those related to late partial dispositions, routine maintenance safe harbor for buildings, small building owner safe harbors and the use of GAA accounts where a building is acquired and later demolished. There are also opportunities related to write offs of amounts that may have been capitalized in the past, which under the new rules would be considered an expense especially in the area of tenant improvements made by the lessor. But, again, these opportunities, such as the late partial disposition and repair expense for prior years, are only available if the business files Form 3115, even if it qualifies for the new relief.

Late Partial Dispositions
In August 2014 the IRS issued final regulations on dispositions of tangible depreciable property under IRS Code Section 168. According to Rev. Proc. 2014-54, the taxpayer can make a late partial disposition election by filing an automatic accounting method change to tax years beginning before January 1, 2015. The benefits can be significant for taxpayers who identify building components that have been replaced or demolished in prior years. The IRS now allows them to write off these late partial dispositions in the 2014 year only through the filing of Form 3115. For years beginning in 2014, a one-time “catch up” for the write off of prior dispositions can be made through the automatic accounting method change. The difficult part is determining the cost of the portion of the asset disposed. The Regulations state any “reasonable method” may be used and give three examples:

  1. Producer Price Index (PPI). Taxpayers may use PPI to discount a replacement cost back to the year placed in service. However, this method can only be used if the replacement is considered a restoration. The use of the PPI however, is not a safe harbor and must not grossly overstate the unadjusted basis of the asset disposed. Your accounting team can help determine if the replacement is a restoration and if the PPI results in a reasonable unadjusted basis of the asset disposed.
  2. Pro-rata allocation. Pro-rata allocation of the unadjusted depreciable basis of the asset based on the replacement cost of the disposed portion of the asset and the replacement cost of the entire asset.
  3. Use of a study allocating the asset cost to its individual components.

Taxpayers are not limited to using the three examples listed in the Regulations. Other methods that are reasonable may be used to determine the unadjusted depreciable basis of the asset disposed.

Current Partial Disposition
The final disposition regulations also make available the opportunity to make current year partial dispositions for property replaced/disposed of by the taxpayer. For partial dispositions of property occurring in 2014 and going forward, the taxpayer can choose to make an election to write off the property disposed of. This election is done by reporting the write off on the current year return and no election statement or Form 3115 is needed. (This is unlike late partial dispositions where the taxpayer needs to file a Form 3115 to report the write off.)

Safe Harbors
The Regulations include a routine maintenance safe harbor for buildings as well as for property other than buildings. Routine maintenance is treated as not improving the unit of property and is currently deductible. Routine maintenance related to a building may include activities such as inspection, cleaning and testing of the building structure or each building system, and the replacement of damaged or worn parts with comparable and commercially available replacement parts. The activities are routine if they are reasonably expected to be performed more than once in a 10-year period for buildings and more than once during the class life of property other than buildings. Note that one of the expenses ineligible for the routine maintenance safe harbor include expenses for a betterment of a unit of property. Again, look to your accounting team to determine which expenses do or do not qualify for the routine maintenance safe harbor.

Another opportunity is the per-building safe harbor election for qualifying small taxpayers (those with $10 million or less average annual gross receipts in the three preceding years). These taxpayers can deduct improvements made to buildings with an unadjusted basis of $1 million or less. The new safe harbor election applies only if the total amount paid during the tax year for repairs, maintenance, improvements and similar activities performed on the eligible building does not exceed the lesser of $10,000 or 2% of the building’s unadjusted basis.

The above are just a few of the planning opportunities we currently see related to the Regulations. As the research, understanding and execution related to these 400-plus pages of documents (consisting of two sets of final regulations and five revenue procedures) continue throughout tax season and beyond, please don’t hesitate to contact Lisa Loychik at loychik@cohencpa.com or a member of your service team for assistance sorting it all out. Remember for the late partial disposition, there is a small window of opportunity for the write offs that begins with the 2014 tax year.

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This communication is published by Cohen & Company for our clients and professional associates. Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this publication should be taken only after a detailed review of the specific facts and circumstances.