In 2014, the IRS issued guidance, which over the last several years has made a significant impact on how hotel, restaurant, and food distribution owners capitalize and depreciate assets placed into service. Effective for tax years beginning January 1, 2014, the tangible property regulations regulate the treatment of normal repairs and maintenance versus an improvement to an asset. The regulations also clarify whether fixed asset additions must be capitalized or expensed immediately.
Wondering how this applies to your business, and if you need to make changes to take advantage of potential savings? Find out below.
What must be implemented?
All taxpayers that have depreciable fixed assets must have a capitalization policy that determines the threshold under which a fixed asset or an improvement to a unit of property is to be capitalized and depreciated. Under the new regulations, the IRS will allow a business without audited financial statements to have a “safe harbor” threshold of $2,500 per unit of property and $5,000 per unit of property for business owners with audited financial statements. While taxpayers are allowed to use higher capitalization thresholds, the taxpayer must be able to justify using a threshold above the allowed safe harbor amount in the event of an audit.
What is considered an “improvement to a unit of property”?
Business owners must make the distinction between routine maintenance and an improvement to a specific asset or unit of property. Improvements to a unit of property that must be capitalized and depreciated over its useful life are defined as betterments, a restoration to an original state, or an adaptation to a new use. Examples of a unit of property can include the building, HVAC system, and electrical system. Common improvements for hotel and restaurant owners could include expanding the hotel building or a restaurant conducting renovations to the inside of the building space used for restaurant operations.
What is considered routine maintenance?
Routine maintenance may be written off if the action will be completed more than once over a ten-year period. This could include hotel owners putting down new asphalt in the hotel’s parking lot every five years or restaurant owners replacing the floor titles of their restaurant every few years.
Can you deduct materials and supplies?
Under the regulations, there is a set de minimis of $200 or a useful life of 12 months or less that can be expensed immediately upon purchase. This allows hotel, restaurant, and food distribution owners to immediately expense items such as bed linens, glassware, tablecloth linens, utensils, and manufacturing supplies.
What are the opportunities under the regulations?
The regulations require great diligence in both year-end tax planning and tax return preparation, but do allow for substantial tax savings techniques for hotel, restaurant, and food distribution owners. Accelerated deductions of asset additions could be obtained under the tangible property regulations. If a unit of property such as a HVAC system or electrical system is placed in service and it replaces an old system, the business owner may be able to write off the old HVAC or electrical system that was replaced.
Each year, business owners should review their fixed asset purchases to determine if there are any additions that can be directly expensed or if there are any prior fixed assets additions that can be disposed of. Please reach out to us if you have any questions or would like more information on the tangible property regulations and the impact it can have for a restaurant, hotel, food distributor, or company that services the hospitality industry.
In issuing the Final Tangible Property Regulations, the IRS has adopted the most dramatic change affecting for-profit taxpayers since the overhaul of the Internal Revenue Code in 1986. The new regulations address, among other things:
Most of these changes must be adopted as a change in accounting method. This requires that, in addition to applying the new rules going forward, taxpayers must determine the impact of these rules on prior years and recognize the tax impact of any changes at the time of adoption.
Taxpayers will be required to file one or more Forms 3115 for each separate entity, trade or business activity. For example, an individual filing a Form 1040 that owns three rental properties reported as separate activities will be required to file three or more separate 3115s. The new regulations can be adopted for tax years as early as 2012, but must be adopted no later than tax year 2014.
Risk: If a taxpayer fails to implement the new rules and properly file the necessary 3115s, they will lose current and future tax depreciation deductions or potential write-offs on previously capitalized assets.
Reward: Implementation of these rules may present significant tax-saving opportunities for many taxpayers. There are now safe harbors for deducting certain de minimis expenditures. Taxpayers may also be able to expense greater amounts for certain repairs, materials and supplies. For many taxpayers there will be opportunities to write-off the undepreciated cost of certain previously capitalized assets. Examples of typical write-off opportunities:
The process of complying with the new regulations is complicated and may require a company to change the way it conducts business and the system it uses to capture information related to expenditures. Likewise, the process of evaluating the impact of changes in accounting method will likely require the collection of facts and documentation related to expenditures stretching years into the past. As such, waiting until the last minute to begin the process is ill-advised.
Aronson’s experts have the expertise and the resources to assist your business in dealing with the new Tangible Property Regulations. If you have questions about how these rules impact your business or what potential tax-saving opportunities may be available to you, please contact Blair Williams at 240.364.2687.