Treasury Department And IRS Issue Proposed Regulations Relating To The Deduction And Capitalization Of Expenditures Relating To Tangible Property

The Treasury Department and IRS have issued proposed regulations governing the deduction and capitalization of expenditures connected with the acquisition, production or improvement of tangible property. The proposed regulations clarify and expand upon rules contained in the existing final regulations under Section 263(a).

The proposed regulations create new simplifying conventions and bright-line tests to add clarity regarding whether certain costs should be capitalized or deducted. When finalized, these regulations should present opportunities to change or adopt methods of accounting to accelerate the deduction of expenses connected with the acquisition, production or improvement of tangible property.

The regulations are proposed to apply to taxable years beginning on or after the date final regulations are published. The preamble specifically states that a taxpayer may not seek a change in method of accounting in reliance upon the proposed regulations. The preamble predicts that method changes under the final regulations will be made under automatic consent procedures.

The following summary highlights areas of particular interest. It is not intended to be a comprehensive discussion of every item covered in the over 120 pages of proposed regulations or to address rules that are unchanged from previous guidance.

The proposed regulations adopt a 12-month rule that provides that an amount paid for the acquisition or production of a unit of property with a useful life of 12 months or less is not a capital expenditure.

De minimis ruleAlthough not specifically contained in the proposed regulations, the IRS is considering adopting a de minimis rule that would allow taxpayers to deduct expenses below a certain amount that would otherwise have been required to be capitalized. The preamble to the proposed regulations describes the de minimis rule that was considered by Treasury and the IRS and asks for comments regarding the future adoption of a de minimis rule.

Improvements to propertyThe proposed regulations contain rules relating to the improvement of property including general rules for improvements; rules to determine the proper “unit of property”; rules for determining whether there is a material increase in value; and whether an amount paid “restores” the property. These rules provide specific tests to be applied to determine whether certain amounts should be capitalized.

Repair allowance methodThe proposed regulations adopt a rule that provides an optional repair allowance safe-harbor method. The rule is modeled after the former Class Life Asset Depreciation Range (“CLADR”) repair allowance system. Under this rule, a repair allowance amount is determined separately for each Modified Accelerated Cost Recovery System (“MACRS”) asset class. A taxpayer compares amounts paid for materials and labor during the taxable year to repair, maintain or improve repair allowance property to the repair allowance amount. Amounts paid up to the repair allowance amount are deducted. Amounts in excess of the repair allowance amount are capitalized.

Acquisition and selling expensesThe proposed regulations provide that (except for dealers in property) commissions and other transaction costs paid to facilitate the sale of property generally must be capitalized (and reduce the amount of gain on the sale of property). This rule applies only to transaction costs and not to other repair or improvement costs in anticipation of selling a particular piece of property.

Next stepsTaxpayers should familiarize themselves with the rules under the proposed regulations and assess the possible impact that the rules will have upon them when finalized. Taxpayers may want to consider providing comments regarding whether certain rules be changed or new rules be adopted, such as a de minimis rule. Comments on the proposed rules should be submitted to the IRS by .