We are going to review and discuss the new IRS Final Regulations for Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property (TD 9636). Let’s start with some history and definitions.

Prior to 2006, the IRS Regulations surrounding the treatment of business expenses for tangible property as either Repairs/Materials/Supplies to be expensed in the year of purchase or as capital items that fall under the UNICAP rules were brief, vague and often contradictory. (§263(a) and §162(a)) In 2006, new proposed regulations were issued for comments and concerns. (Prop. Reg. §1.168(i)-1 thru 8) In 2008, new proposed regulations were issued after taking these concerns into account and in 2011, after another round of fine-tuning, the temporary regulations were issued. Finally, in September of 2013, the final regulations were released, all 289 pages of them. (TD 9636)

The new regulations had several goals from the IRS side of things. They were meant to clarify the rules, establish consistency, and bring taxpayers into compliance. The IRS based their rulings on numerous tax court cases and refused to give concrete examples, leaving much to interpretation by taxpayers and tax professionals. Nothing new there for the seasoned tax professional.

Moving on to definitions on the items we will be discussing.

Unit of Property (UOP): Is a functional unit of tangible property that is functional interdependent of other units. It must not be something used to maintain, repair or improve the UOP. (Section 1.263A-10)

Materials and Supplies:

Incidental materials are deductible when they are paid for by a cash basis taxpayer. There is no strict record of consumption kept and they must be small in both an operational and financial sense. (ie. office supplies)

Non-Incidental materials and supplies are deductible when consumed. The cost is not usually minimal and record of their consumption is kept. (ie. Portable cash registers)

Rotable and Temporary Parts are not deductible until disposed of, as they usually have longer life spans but not necessarily a determinable life span. (ie. a spare tire on a business use vehicle)

Standby Emergency parts are usually expensive, purchased to prevent down time in the business, may be special order pieces, and would probably fall under the non-incidental consumption rules.

Certain smallwares, UOPs with a useful life of less then 12 months, and qualifying cash basis small business inventories may also fall under the Materials and Supplies definition.

Consumables including items such as oil, lubricants, water, and other items that have an expected economic useful life of less then 12 months (which can, and often is, different from the depreciable life) and cost of $200 or less. (Rev. Proc 2002-12 and 2002-28)

Uniform Capitalization (UNICAP or §263A) rules pertain to the capitalization of UOPs with a useful life of more then 12 months. These are items that would, under normal circumstances, be placed in depreciation or amortization when placed in service.

Economic Useful Life is defined as the period the UOP may be reasonably expected to be useful to the taxpayer. This may be, and often is, different from the depreciable life inherent to the property. (Reg. §1.162-3(c)(4)(i)) These definitions are sometimes supplanted by other code provisions, such as the UNICAP rules.

Repairs are usually maintenance type items that keep a UOP in serviceable condition or bring a damaged or worn UOP back to the condition it must be in to be considered serviceable.

Improvements are upgrades to existing UOPs to improve the life span, increase the FMV, or bring it to a higher standard then before the work was completed. A great short definition of this, which we will discuss in detail later, is B.A.R. (Betterment, Adaptation, or Restoration) (NATP 2014 The Nitty Gritty of the Final Repair Regulations, Genaro S Cardaropoli, MPA, CPA )

Next up, the “new rules”!

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