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Transitional Guidance Released for Temporary Repair Regulations

On March 7, the Internal Revenue Service ("IRS") released Revenue Procedures 2012-19 and 2012-20, which provide transition rules relating to the temporary regulations regarding deduction and capitalization of expenditures related to tangible property issued on December 23, 2011 that were discussed in our previous tax alert. The temporary regulations are effective for tax years beginning on or after January 1, 2012, and affect all taxpayers that acquire, produce, or improve tangible property. The transition rules address repair and maintenance, materials and supplies, depreciation, disposition, and related tax accounting method changes. The guidance also provides the procedures by which taxpayers may obtain the automatic consent of the Commissioner of Internal Revenue to change to the methods of accounting for tax years beginning on or after January 1, 2012.

Our View of the News

The Internal Revenue Service has revised procedures on the deduction and capitalization of expenditures related to tangible property. As detailed in J.H. Cohn's tax alerts on this topic, the revised procedures shift the frame of reference for determining whether a repair is expensed or capitalized from the entire building to structural components of the building. Given the magnitude of tangible property held by companies in the real estate sector, these revised procedures may create significant tax implications for owners renovating properties and retrofitting tenant space. It is now likely that certain repairs that were previously treated as expenses will now be required to be capitalized. On the other hand, owners now have the opportunity to write-off the underappreciated portion of the building components replaced or the tenant improvements removed during the retrofitting.

The potential tax impact to real estate owners can best be seen by example. Consider the case of a landlord that replaces the entire roof on a building it has owned for 10 years at a cost of $300,000. Under the new regulations the landlord must capitalize the cost of the new roof. The landlord performs a Building Component Study and determines that the old roof had a cost of $200,000. Under the new regulations, the landlord can write off the undepreciated basis of the old roof (approximately $150,000, using a 39-year tax life) in the year the new roof is installed. At a 40 percent tax rate, this generates $60,000 in tax savings.

J.H. Cohn's Real Estate Industry Practice strongly encourages real estate financial executives to discuss the impact of these revised procedures with their accountants and assess the potential tax implications.

Rev. Proc. 2012-19 addresses repair and maintenance, materials, and supplies, and related method changes. Rev. Proc. 2012-20 addresses depreciation, disposition, and related method changes.

Rev. Proc. 2012-19 separates the accounting method changes into the following categories:

  • Deducting repair and maintenance costs and changing the definition of units of property for purposes of determining whether amounts paid or incurred improve a unit of property
  • Change to the regulatory accounting method
  • Deducting non-incidental materials and supplies when used or consumed
  • Deducting incidental materials and supplies when paid or incurred
  • Deducting non-incidental rotable and temporary spare parts when disposed of
  • Change to the optional method for rotable and temporary spare parts
  • Deducting dealer expenses that facilitate the sale of property
  • Deducting de minimis amounts
  • Deducting certain costs for investigating and pursuing the acquisition of real property
  • Change to the safe harbor for routine maintenance on property other than buildings
  • Non-dealer expense to facilitate the sale of property
  • Capitalizing acquisition or production costs
  • Capitalizing improvements to tangible property

Rev. Proc. 2012-20 establishes new automatic accounting method changes for:

  • Depreciation of leasehold improvements
  • Changing from a permissible to another permissible method of accounting for depreciation of MACRS property
  • Disposition of a building or structural component
  • Dispositions of tangible depreciable assets (other than a building or its structural components)
  • Dispositions of tangible depreciable assets in a general asset account
  • General asset account elections

Each of the above accounting method changes has separate detailed rules for implementing it. If your method of accounting for deducting and capitalizing expenditures relating to tangible property differs from the temporary regulations, you will likely be required to file Form 3115 and request an automatic change in accounting method.

Download the full PDF.

Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and J.H. Cohn LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

Published date: 3/23/2012

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