3 Effective DatesTemporary Regulations are generally effective for taxable years beginning on or after January 1, 2012Special rules apply for amounts paid or incurred in taxable years beginning on or after January 1, 2012 for:Materials and suppliesDe minimis ruleCosts to facilitateTransition guidance issued March 7, 2012 (Rev. Proc and )Effective for taxable years starting after January 1, 201219 possible method changes under the guidanceAll automatic changes!Must file with 2012 or 2013 returnPossibly discuss: when the method changes must be filed.
5 Temporary Regulations Discussion AreasMaterials and suppliesDe Minimus ruleAmounts paid to improve propertyBuildingsRetirements, dispositions and general asset account election
6 Materials and Supplies – General Rules Material and supplies are tangible property used or consumed in the taxpayer’s operations that is not inventory and is:a component acquired to maintain, repair, or improve a unit of tangible property;fuel, lubricants, water, or similar items that are reasonably expected to be consumed in 12 months or less;a unit of property that has an economic useful life of 12-months or less;a unit of property with an acquisition or production cost less than $100; orproperty identified in future published guidanceIf the criteria above met, the item is deemed to be a “material or supply”, and therefore, not subject to capitalization.Optional election to capitalize and depreciate the materials and suppliesSpecial rules for rotable and temporary spare parts
7 Materials and Supplies – Issues and Considerations What you need to consider:What has changed?Materials and supplies definition has been providedSpecial methods for rotable spare partsCurrent treatment of materials and supplies?Timing of deductions - Incidental vs. Non-incidental (e.g. are supplies tracked?)Existence of rotables and current treatmentOpportunities within the Temporary RegulationsExpanded definition of materials and supplies (e.g. $100 items)Review balance sheet for material and supplies inventories and consider if these items are tracked for their usageElection to capitalize (e.g. NOL preservation)
8 Deduction limited to greater of: De minimis RuleApplicable Financial Statement (“AFS”)Written capitalization policyExpense in AFS according to written policyRequirements.1% of tax gross receipts, or2% of depreciation on AFSDeduction limited to greater of:
9 De Minimis Rule - Example To be eligible for the de minimis rule, the total aggregate amounts paid and not capitalized by the taxpayer must be less than or equal to the greater of $125,000 (0.1 % of its total gross receipts of $125M) or $140,000 (2 % of its total book depreciation/amortization $7M). Because the taxpayer pays $160,000 for the computers and this amount exceeds $140,000, it may not apply the de minimis rule to the total amounts paid for the 400 computers.However, if it makes an election to capitalize $20,000, the amounts paid to acquire 50 of the 400 computers purchased in Year 1, it would not be required to capitalize the amounts paid to acquire the 350 computers in Year 1.
10 De Minimis Rule – Issues and Considerations What you need to consider:What has changed?Previously no rules or guidance on capitalization thresholds; the temporary regulations now provide that guidanceIdentification of expenses to consider for the de minimis thresholdIdentify trial balance account containing tangible propertyItems qualifying as materials and supplies or repairs and maintenance (e.g. reduction of expenses for de minimis calculation)Items not related to tangible property (e.g. deductible repairs and services)Policy, system updates, and documentationIs the policy being followed (e.g. expenditures outside of policy limit currently deducted)?System updates for expenditure tracking on a go-forward basis (e.g. quantity fields, account mapping, description field assignments, etc.)Document accounts and create calculation templates for compliance workpapers
11 Amounts Paid to Improve Property Determine the unit of propertyApply the improvement standardsConsider the routine maintenance safe harbor
12 Unit of Property Buildings Each building and its structural components is a UoPImprovement standards are applied at the building & building system levelPlant PropertyFunctional interdependence is relevantDiscrete and major function standard must be appliedNetwork AssetsBased on facts and circumstances or as provided in published guidanceFunctional interdependence test not determinativeLeased PropertyEach building and its structural components (lessor) or the portion of each building subject to the lease and the structural components associated with the leased portion (lessee)Improvement standards are applied to the portion of the building & building systems subject to the lease (lessee)Other PropertyFunctional InterdependenceFacts & circumstances
13 Amounts Paid to Improve Property Determine the unit of propertyApply the improvement standardsConsider the routine maintenance safe harbor
14 Capitalize amounts to: Amounts Paid to Acquire or Produce Tangible Property - Temp. Reg. § 1.263(a)-2TCapitalize amounts to:Acquire or produce a unit of real or personal property,Defend or protect title to a unit or real or personal property, orFacilitate the acquisition or production of real or personal propertyDoes not apply to:Amounts treated as materials and supplies under Temp. Reg. § TAmounts subject to de minimis rule
15 Amounts Paid to Improve Property ImprovementCapitalizableBetterment?Restoration?Adaptation?
16 Amounts Paid to Improve Property BettermentCorrects a material defect existing prior to the taxpayer’s acquisition of the UoP or one that arose during the production of the UoP;Results in a material addition (e.g., physical enlargement, expansion or extension) to the UoP; orResults in a material increase in capacity, strength, productivity, efficiency, quality, or output of the UoPRestorationRepair or replacement of a component of a unit of property and the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss (including casualty loss)Returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of nonfunctional disrepairRebuilding of the unit of property to a like-new condition after the end of its class lifeReplacement of a part or a combination of parts that comprise a major component or a substantial structural part of a unit of propertyAdaptationModification of a unit of property that is not consistent with the taxpayer’s intended ordinary use of the unit of property at the time the property was placed in service
17 Amounts Paid to Improve Property What you need to consider:What has changed?More clearly defined criteria to determine deductible repairsReview prior repairs studies for impact of changes pursuant to the Tangible Property RegulationsReview previously claimed repairs and maintenance expenditures (e.g. line 14) deducted for both book and tax purposesReview fixed asset ledgers for additional repair and maintenance reclassification opportunities pursuant to the Temporary RegulationsSystem Updates, Documentation, and Policy Changes:Updates to capital request forms for tax “unit of property” and tax repairs requirements (e.g. checklists)Provide training sessions to facility managers and engineers to assist in the identification of tax improvements and repairsSystem updates for units of property, tax only repairs, and documentation of positions
18 Amounts Paid to Improve Property Determine the unit of propertyApply the improvement standardsConsider the routine maintenance safe harbor
19 Routine Maintenance Safe Harbor – Temp. Reg. § 1.263(a)-3T(f) Amount paid is deemed to not improve the unit of property if it is for the recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of the UoP to keep the unit of property in its ordinarily efficient operating conditionSafe harbor does not apply to buildings or structural components of buildings (or building systems)Routine maintenance is activities that the taxpayer reasonably expects (at the time the property is placed in service) to perform more than once during the ADS class life of the UoPConsider recurring nature of activity, taxpayer’s experience, manufacturer recommendations, industry practice, treatment on AFSDoes not apply to amounts capitalized as betterments, adaptations, and certain restorations
20 Improvement standards applied to BuildingsUnit of PropertyEach building and its structural components are a unit of propertyImprovement standards applied toBuilding systems:heating, ventilation, and air conditioning systems (HVAC)plumbing systemselectrical systemsall escalators;all elevatorsfire protection and alarm systemssecurity systemsgas distribution systemsother structural components identified in published guidanceBuilding structure, which is defined as the building and its structural components (other than the sub-systems above)
21 Buildings – Issues and Considerations What you need to consider:What has changed?Unit of property for building repairs and retirements re-definedBuilding systems definedApplication to leased propertyIdentification and basis determination:Cost segregation studies, Building construction information (e.g. AIA documents), Other reasonable methods, etc. for basis determinationConsider effect of reclassification or cost segregation studies on unit of propertyPolicy, System Updates, and DocumentationIdentify building systems during construction and segregate in fixed asset systemsUpdate capital request forms for building system specific questions for future projectsDocument and create calculation templates for compliance workpapers to show break out of building systems and basis information
22 Dispositions, Retirements & General Asset Accounts (Temp. Reg. §§ 1 Dispositions, Retirements & General Asset Accounts (Temp. Reg. §§ T and (i)-1T)Retirement of a structural component of a building is a disposition under IRC § 168Provide rules for accounting for assets to which IRC § 168 applies, and the rules for determining gain or loss on the disposition of such propertyRules are critical to operation of the restoration improvement standardGeneral asset accounting and associated elections require affirmative action and must be considered during the placed in service year of an asset to ensure flexibility when evaluating the deductibility of future expenditures
23 Dispositions and Retirements Gain/loss recognized on retirement of a structural component of a building (now defined as a disposition)Loss (but not gain) recognized on the physical abandonment or transfer to supplies or scrap account (applies to components of buildings as well)Taxpayer may elect to treat a component of a UoP in a general asset account as a specific asset and deduct undepreciated basis at dispositionA taxpayer is not precluded from claiming a repair deduction under the casualty loss restoration test for a UoP included in general asset
24 General Asset Accounts (GAA) ElectiveAssets may be grouped into a single GAA if—Same depreciation method (cannot combine bonus and non-bonus)Same recovery periodSame convention (must be placed in service in same month, quarter, etc.); andPlaced in service in same taxable yearA single asset can be placed into a GAAIf GAA elected, no loss on disposition recognized until all assets in GAA disposed ofCan elect to treat a component of an asset as a single asset for disposition purposesStructural components of buildings generally defined under section 48 regulationsDefinition of component must be consistently used for all assets in a single GAAElection provides flexibility in determining whether to take a loss on a disposition or possibility a deduction for repairs costs (assuming such costs are not a capitalizable improvement)
25 Retirements, Dispositions & General Asset Accounts – Issues and Considerations What you need to consider:What has changed?Treatment/timing of real property retirements/dispositionsTiming for recognition of gains and lossesCurrent retirements methodology (e.g. retiring structural components of buildings) and conformation to Tangible Property RegulationsAdditional retirement opportunities and impact on repair expenditures (e.g. reverse prior retirements to sustain repair position)Application of GAA elections:Elect GAA on building property (leased and owned) to minimize compliance and avoid lost deductions (e.g. allowed or allowable)Need for GAA elections for personal property (e.g. different book and tax units)
27 Transition GuidanceRev. Procs and issued March 7, 2012Automatic consent for method changes to comply with temporary regulations for taxable years beginning on or after January 1, 2012Form 3115s due by extended due date of the return for the tax year of changeTemporary regulations cannot be early adopted under this guidanceScope limitations waived for first and second tax years beginning after December 31, 2011Taxpayers receive back year audit protection upon filing national office copy of Form 3115National office copy sent to Ogden, UTTaxpayers file a single Form 3115 for all concurrent changes under §§ T, T, 1.263(a)-1T, 1.263(a)-2T, 1.263(a)-3TSpecial rules may apply for concurrent depreciation changesMust take into account § 263A
28 Transition Guidance – Common Method Changes Change to deduct repairs/maintenance and change unit of property for purposes of applying improvement standardsChange made with § 481(a) adjustmentCan use statistical sampling to compute § 481(a) adjustment and support amounts on post-change returnsStatistical sampling methods must comply with Rev. ProcChange to capitalize (and if applicable, to depreciate) improvements to units of propertyChange to apply de minimis ruleChange made with modified § 481(a) adjustment§ 481(a) adjustment takes into account only amounts paid or incurred in taxable years beginning on or after January 1, 2012
29 Transition Guidance – Common Method Changes Change to dispositions of buildings and structural componentsAffects determination of gain/loss on disposition and may affect determination of whether expenditure is a capitalizable restorationChange made with § 481(a) adjustmentCan use statistical sampling to compute § 481(a) adjustment and support amounts on post-change returnsStatistical sampling methods must comply with Rev. ProcChange to make a general asset account election for MACRS property placed in service in a taxable year beginning before January 1, 2012May affect determination of whether expenditure is a capitalizable restorationChange made with § 481(a) adjustment if asset is no longer owned by the taxpayer as of beginning of year of changeChange made on a modified cut-off basis if assets are owned by the taxpayer as of the beginning of the year of changeUnadjusted depreciable basis and depreciation reserve of asset as of beginning of year of change accounted for on new method
30 LB&I Directive (LB&I-4-0312-004 (3/15/12)) IRS to discontinue current exams with respect to positions taken on original returns relating to—Whether costs incurred to maintain, replace, or improve tangible property must be capitalized under IRC § 263(a)Correlative issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets (other than a building or its structural components)Does not apply to exam activity relating to costs for which the IRS has provided specific guidance separate from the temporary regulationsFor accounting method changes on or after 12/23/2011 for a tax year beginning before 1/1/2012, exam is to risk-assess the Form 3115For taxable years beginning on or after 1/1/2012 and before 1/1/2014, exam to determine if taxpayer filed method change pursuant to guidance during scope waiver period
32 Financial statement impact ASC 740 ConsiderationsFinancial statement impactThe temporary regulations are prospective.Generally no impact for a financial statement reporting period ending prior to March 7, 2012.Financial accounting treatment depends on taxpayer’s intent to make the accounting method changes under Rev. Procs andRev. Procs and are critical in evaluating unrecognized tax benefit liabilitiesRev. Procs and include automatic consent to change methods of accounting.Rev. Procs and include waiver of scope limitations and allow taxpayers to change their methods of accounting while under examination.Amounts incurred in taxable years beginning on or after January 1, 2012Taxpayers may generally begin to account for costs incurred after 12/31/2011 consistent with the temporary regulations if the taxpayers expect to change their method of accounting pursuant to the temporary regulations and the revenue procedures.
33 Determine how your company will accomplish the following… Understand how the definitions of materials and supplies, UoP improvement, betterment, and routine maintenance affect the way your business capitalizes or deducts assetsUnderstand how the de minimis rule might affect your capitalization thresholdConsider how the favorable rules relating to facilitative costs apply in your businessUnderstand whether and to what extent your business currently accounts for dispositions and what the appropriate method(s) might be under the temporary regulationsConsider completing an assessment in advance of adopting the Temporary Regulations to determine potential impact and possible system limitations
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