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Understanding the New Tangible Property Regulations: Acquisition of Tangible Property


11/22/13

I. Introduction

On September 13, 2013, the U.S. Government issued final regulations and reissued proposed regulations providing guidance on the treatment of costs incurred to acquire, maintain and dispose of tangible property. In this series of alerts, CohnReznick will explain the new regulations as they apply to the lifecycle of tangible property, from defining the units of property, the acquisition of tangible property, the de minimis rules, repairs and improvements to tangible property, and the disposition of tangible property, including the use of general asset accounts. This alert, the third of six, will cover treatment of costs to acquire tangible property as provided in the regulations.

II. Acquisition of Tangible Property

The regulations provide separate and specific rules for the acquisition of materials and supplies, from the acquisition or production of personal property and real property. Each set of rules are discussed separately below:

a. Materials and Supplies

The regulations define materials and supplies as tangible property for use in the taxpayer’s operation that is not inventory.1 A material or supply must:

i.  be acquired to maintain, repair, or improve a unit of tangible property;
ii. consist of fuel, lubricants, water, and other similar items that are reasonably expected to be consumed in 12 months or less;
iii. be a UOP that has a useful economic life of 12 months or less;
iv. be a UOP whose acquisition cost is $200 or less;
v. is identified as such in the Federal Register or the Internal Revenue Bulletin;  
vi. Rotable and temporary spare parts; or
vii. Standby emergency spare parts

In general, amounts paid for non-incidental materials and supplies are deductible in the taxable year in which the materials and supplies are used or consumed in the taxpayer’s operations, while amounts paid for incidental materials and supplies generally are deductible in the tax year in which they are paid.2 Incidental materials and supplies are those materials and supplies carried on hand and for which no record of consumption is kept.3 Examples of these materials and supplies may be paper, pencils, or Post-It notes for which no physical inventory is made. Non-incidental materials and supplies are all other materials and supplies for which records of consumption are kept.4 The final regulations also allow an election for immediate expensing under the de minimis provisions and an election to capitalize and amortize materials and supplies.5

The 2008 proposed regulations defined the first category of materials and supplies (above) as tangible property that is neither a UOP nor acquired as a single UOP. The final regulations modified this definition to clarify that property treated as a single UOP in the year acquired may qualify as a material and supply if, in a subsequent year, it is treated as a component used to maintain, repair or improve another UOP. 

The final regulations greatly expand the options available to account for rotable and temporary spare parts to include:

  • Expense upon final disposition of the part;
  • The use of an option method of accounting, which allows a deduction for the cost of the installed part with a corresponding inclusion to income for the fair-market value of the replaced part (this method must be used for all rotable spare parts); and
  • Make an election to capitalize and amortize the cost of the part.6
     

b. Personal Property

The final regulations define tangible personal property as any tangible property except land and improvements to land.7 Therefore, tangible personal property may not be buildings or parking structures, but it can be property contained in or attached to a building. Tangible personal property may include office equipment, production machinery, cash registers, racks, and shelves. 

A taxpayer must capitalize any amounts paid to acquire or produce tangible personal property.8 “Amount”, however, is defined broadly. The taxpayer must capitalize not only the amount paid to acquire or produce the property itself, but must also capitalize the transaction costs related to the property, as well as costs for work performed before the property was placed in service.9

There are two types of transaction costs requiring capitalization:

  • Amounts paid to investigate or otherwise pursue the property. For example, costs paid to an interior designer to consider the aesthetics of a conference table qualify under this section. As such, that type of transaction cost must be capitalized.   
  • “Inherently facilitative amounts.” “Inherently facilitative amounts” are specific costs the regulations have designated. These costs include shipping fees, moving costs, application fees, and costs of reviewing sales documents.10 Even if the personal property is not acquired, the taxpayer must still capitalize these “inherently facilitative amounts.”   

Employee compensation and overhead costs do not qualify as transaction costs.11 Accordingly, taxpayers may currently deduct amounts paid for employee compensation and overhead costs. Nonetheless, a taxpayer may elect to treat either, or both, as capital expenditures. The taxpayer makes this election by capitalizing those costs in the taxpayer’s federal tax return.

Finally, the taxpayer must also capitalize costs for work performed prior to the date the property is placed in service. This term is also defined broadly, and includes testing and examining. However, after the property is placed in service, costs for quality control testing and repairs do not need to be capitalized.

c. Real Property

As with tangible personal property, the costs of acquiring or producing real property are capital expenditures. Real property includes land and improvements to land, such as buildings and other permanent structures.12 The taxpayer must capitalize not only the amount paid to acquire or produce the real property itself. The taxpayer must also capitalize the transaction costs related to the property, as well as costs for work performed before the property was placed in service. 

Rules similar to those related to the acquisition of personal property apply when determining transaction costs and costs for work performed for real property. However, there is an exception to the transaction costs rules. In real property acquisitions, a taxpayer does not have to capitalize two types of costs:

  • Costs relating to the decision whether to purchase real property, and
  • Costs relating to the decision as to which property the taxpayer should acquire.13

d. De Minimis Rule for Acquisitions

The regulations provide for a de minimis rule for acquisitions of both real and personal property. However, the de minimis rule cannot be used for acquisitions of either land or inventory property.14 If the cost of the taxpayer’s property meets a de minimis test, the taxpayer may deduct the cost of the property. Upon sale or disposition, property that met the de minimis test will not be treated as a capital asset. However, a taxpayer may elect not to apply the de minimis test and capitalize amounts paid to acquire or produce tangible property, even if the costs are de minimis. To do so, the taxpayer must only capitalize those costs on its federal income tax return. 

View our previous alert in the series:
Understanding the New Tangible Property Regulations: Final Regulations Issued
Understanding the New Tangible Property Regulations: Unit of Property

 


1 See Treas. Reg. § 1.162-3(c)(1).
2 See Treas. Reg. § 1.162-3(a) for additional requirements for the deductibility of incidental materials and supplies.
3 Treas. Reg. § 1.162-3(a)(2).

4 Treas. Reg. § 1.162-3(a)(1).
5 Treas. Reg. § 1.163-3(d).
6 Treas. Reg. § 1.162-3(d)-(e).
7 Treas. Reg. § 1.48-1(c).
8 Treas. Reg. § 1.263(a)-2(d)(1).
9 Treas. Reg. § 1.263(a)-2(f).
10 See Treas. Reg. § 1.263(a)-2(f)(2)(ii)
11 Treas. Reg. § 1.263(a)-2(f)(2)(iv).
12 Treas. Reg. § 1.263(a)-2(b)(3).
13 Treas. Reg. § 1.263(a)-2(f)(2)(iii).
14 Treas. Reg. § 1.263(a)-1(f)(2)(i)-(ii).


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 CohnReznick 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.

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