BGBC Partners, LLP Tax Update: Tangible Property Regulations – Reminders on a Few Key Provisions
As a store owner, you are well-aware that capital improvements and repairs and maintenance are a necessary cost to keep your store and its assets in peak shape. But what are the tax rules associated with these and similar costs? That is the focus of this week’s Tax Update.
The authority for what to capitalize, what to expense and various elections available are included in the so-called “Tangible Property Regulations” (“TPR”). Since we covered these rules in past Tax Updates, here are some reminders of key provisions in the TPR:
Capitalization or deduction. The TPR set forth the general rule that amounts paid to improve a unit of property must be capitalized. An improvement is defined as an expenditure that betters a unit of property, restores it, or adapts it to a new and different use. On the other hand, the regulations allow a current deduction for repairs and maintenance to property. Deductible repair and maintenance expenses are defined in a negative way-they are deductible if not otherwise required to be capitalized.
Unit of property. One key concept in the TPR is the "unit of property" (UOP) that is being improved or repaired. The smaller the UOP, the more likely it is that costs incurred in connection with it will have to be capitalized. The process for identifying a UOP necessitates involving a tax advisor or cost segregation specialist.
Property other than buildings. In general, for property other than buildings, a single UOP consists of all components that are functionally interdependent, such that one component can't be placed in service without the other components. Say that a business buys a battery-powered golf cart for its foreman to use in getting around a large warehouse. It buys the chassis from one vendor and the battery from another, and then assembles the two components. Here, the cart is the UOP, since the chassis can't be placed in service without the battery.
Buildings. When it comes to buildings, the TPR generally treat each building and its structural components as one UOP-the "building." The TPR also list nine specific building systems that are treated as separate from the building structure. An improvement to the building is defined by its effect on those systems, rather than on the building as a whole. If a taxpayer restores a building structure, such as by replacing the entire roof, the expense is treated as an improvement to the single UOP consisting of the building. If the taxpayer makes an improvement to a building system, such as the heating, ventilation, and air conditioning (HVAC) system, that expense is also an improvement to the building UOP.
De minimis safe harbor. The TPR contain a number of elections which may provide tax savings. One of the key elections is the “De minimis Safe Harbor” election. In general, this election allows business owners to deduct certain limited amounts paid for tangible property that are expensed for financial accounting purposes. The safe harbor amount depends on whether the taxpayer has an applicable financial statement (AFS). An AFS can be a certified audited financial statement that is used for credit purposes, for reporting to partners, or for other non-tax purposes.
A taxpayer with an AFS may rely on the de minimis safe harbor if no more than $5,000 per invoice, or per item as substantiated by the invoice, was paid for the property. For businesses without an AFS, the maximum figure is $2,500 rather than $5,000.
As you can see, these regulations are very involved, but must be considered for tax planning and compliance purposes. Consult your CPA to help you sort through which provisions affect your store. After all, you should get as much tax benefit as you can from your necessary capital outlays, while also avoiding tax compliance errors.
