Alert - Final Tangible Property Regulations Require Filing Application for Change in Accounting Method for 2014 Tax Year

Since the time this Alert was written, the AICPA has announced that the IRS and Treasury are considering the AICPA’s recommendations to provide relief from the reporting requirements related to the repair regulations. The AICPA stated that it is “hopeful” that the IRS and Treasury “will release some form of relief for small businesses in the next couple of weeks."

The AICPA posts special news updates at: http://www.aicpa.org/publications/newsletters/aicpanewsupdate/pages/20100210-specialnewsupdate.aspx.  It also has a TPR page at: http://www.aicpa.org/interestareas/tax/resources/specializedguidance/pages/tangibleproperty.aspx.

CAMICO will keep you apprised of updates as well. Stay tuned.

In September 2013, the IRS issued final tangible property regulations providing guidance on the capitalization and depreciation of capital expenditures, treatment of materials and supplies, and disposition of tangible depreciable property. The regulations are applicable to tax years beginning on or after January 1, 2014, and to some extent may be applied retroactively to taxable years beginning on or after January 1, 2012.

For many taxpayers it will be necessary to file Form 3115 (Application for Change in Accounting Method) under the tangible property regulations in order to file a complete and accurate 2014 federal income tax return. In fact, most taxpayers with depreciable capital assets will be required to make accounting method changes to comply with the final regulations. These changes contain specific rules as to which methods can and must be filed on the same 3115.

In order to comply with the tangible property regulations, work must be performed to: a) determine which required accounting method changes apply for a given taxpayer; b) determine which optional accounting method changes could benefit the taxpayer; and c) prepare and timely file matching Form(s) 3115 to change tax accounting methods and correct the difference, if any, between methods (e.g., § 481(a) adjustment).

Because of the amount of additional time and expense involved, taxpayers may choose not to file Form 3115 even where required and even though some taxpayers may receive a tax benefit by making required and/or elective changes (e.g., taxpayers with real property or significant fixed assets may be able to accelerate expenses). Such non-filing situations would run afoul of Treasury Circular 230 and could subject practitioners to preparer penalties. In addition, as part of the tangible property regulations, new section 1.1016-3 was released. Under this section, the taxpayer could lose tax deductions permanently under the “use it or lose it” rules should certain aspects of the regulations not be properly followed.

Section 10.34 of Circular 230 prohibits a preparer from willfully, recklessly, or through gross incompetence, signing a tax return or claim for refund containing a position that the practitioner knows, or reasonably should know, lacks a reasonable basis. Unreasonable tax positions taken on a tax return could also subject taxpayers and their preparers to penalties (e.g., IRC §§ 6662 and 6694).

Under the tangible property regulations, if an accounting method change is required and the taxpayer does not take the necessary steps to make the change (e.g., filing Form 3115 with the proper IRS National Office and also with their tax return), that position would presumptively lack a reasonable basis. Note: Client size is irrelevant for Circular 230 purposes (i.e., the prohibition does not contain a materiality or de minimis threshold), so a relatively small item could trigger a potential Circular 230 violation for the tax preparer. This should dispel the notion that practitioners can ignore the regulations for small clients or small items.

Guidance

Since the impact of these regulations may be significant to your business clients (including trusts, 990Ts, and individuals with a business or rental property), CAMICO encourages practitioners to make their business clients aware of the implications of the new tangible property regulations to the 2014 tax filings. Your firm might choose to incorporate information on this issue in your engagement letters and/or other client communications (newsletters, blogs, etc.). For example, consider adding the following clause to your engagement letters:

The IRS and U.S. Treasury have issued final tangible property regulations (TPRs) that govern when taxpayers must capitalize and when they can deduct expenditures for acquiring, producing or improving tangible property. These regulations are fully effective for tax years beginning on or after January 1, 2014. Under certain circumstances, however, these regulations may also be applied retroactively back to the start of 2012 and are required to be applied to items on taxpayer’s tax depreciation schedule or should be on the taxpayer’s depreciation schedule based upon the improvement criteria in the final TPRs. The final regulations have created new annual elections, and while certain safe harbors and elections are implemented through filing statements or treatment of an item on a timely filed federal tax return, the IRS considers the remaining provisions to be a change in accounting method which may require a taxpayer to file Form 3115, Application for Change in Accounting Method. In order to make an election on a timely filed federal tax return and/or properly complete IRS Form 3115, additional time may be required by our firm to analyze your current and prior acquisitions and improvements. By your signature below, you agree to accept ultimate responsibility for your capitalization analyses and decisions, and agree to provide us with the information we deem necessary to prepare the appropriate elections and/or IRS method change form(s). If you have any questions regarding the application of these new regulations to your company, or your company’s specific qualifications for one of the safe harbors or new method changes, please ask us for advice in that regard.

Note: For individual tax return letters, change the first sentence to read: If your individual return includes business activities or rental property, please note that the IRS and U.S. Treasury have issued final tangible property regulations (TPRs) that govern when taxpayers must capitalize and when they can deduct expenditures for acquiring, producing or improving tangible property.

Given Circular 230 requirements and the potential for preparer penalties, tax practitioners should:

  1. Have or obtain the knowledge necessary to correctly prepare and properly submit Form 3115 and determine which required and optional accounting method changes are applicable to each tax client;
  2. Perform additional work as part of their general tax preparation services in order to determine whether a change in accounting method is required and whether the change requires an adjustment (e.g., § 481);
  3. Estimate the additional time necessary to calculate, prepare and file the accounting method changes and advise their client of the estimated additional cost; and
  4. Be prepared to disengage from any clients who decline to prepare required filings.

CAMICO strongly encourages tax practitioners to consider each tax client’s tangible property regulations implications as soon as possible so that the client and you have ample time to comply and make informed tax decisions. CAMICO’s prior experience suggests that actions or recommendations alleged to be late are frequently preludes to tax claims. Don’t let this happen to you.

Additional Information

For a detailed list of potential consequences for not filing required Form 3115, see “Consequences of Not Filing the Required Tangible Property Regulation 3115s by Tax Year 2014” by Eric P. Wallace, CPA. The author also provides a tangible property regulation subscription service which is available at www.tprtoolsandtemplates.com.

KPMG provides a comprehensive Tangible Property Regulations website, available at www.kpmg.com/us/repairregs.

See “Implementing the new tangible property regulations,” Journal of Accountancy (February 1, 2014) at: www.journalofaccountancy.com/issues/2014/feb/20137725.html.

The final tangible property regulations generally refer to the following:

  • Treas. Reg. § 1.162-3 provides rules for materials and supplies
  • Treas. Reg. § 1.162-4 addresses repairs and maintenance
  • Treas. Reg. § 1.263(a)-1 provides general rules for capital expenditures
  • Treas. Reg. § 1.263(a)-2 provides rules for amounts paid for the acquisition or production of tangible property, and
  • Treas. Reg. § 1.263(a)-3 provides rules for amounts paid for the improvement of tangible property
  • Treas. Reg. § 1.1016-3 addresses the “use it or lose it” provisions (generally applicable to depreciation (class lives or bonus impermissibly applied) and/or repairs (prior, current, or future repairs capitalized that should have been written off))

The final MACRS disposition of tangible property regulations generally refer to the following:

  • Treas. Reg. § 1.168-1(i) provides rules for general asset accounts
  • Treas. Reg. § 1.168-8(i) provides rules for partial or prior asset MACRS asset dispositions

The following items may need to be referenced in order to complete Form(s) 3115:

  • Instructions to Form 3115
  • Revenue Procedure 2014-16 involves method changes for amount paid to acquire, produce or improve tangible property
  • Revenue Procedure 2014-17 involves method changes for depreciation
  • Revenue Procedure 2014-54 involves method changes for depreciation and dispositions
  • Revenue Procedure 2011-14 involves procedures to obtain an automatic consent change in method of accounting
  • Revenue Procedure 2011-14 involves procedures to obtain an automatic consent change in method of accounting (and 2014-16 and 2014-54 are updates to this document)
  • Revenue Procedures 2012-1 and 2015-1 involves additional procedures for accounting method changes
  • Revenue Procedure 87-56 on the proper class lives of assets for various business activities
  • IRS Cost Segregation Audit Technique Guide, September 23, 2010

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