COLUMNS
Revisiting the Final Tangible Property Regulations Regarding Buildings On July 4, President Trump signed the One Big Beautiful Bill Act (OBBBA) into law. The act includes changes to section 179 depreciation, increasing the immediate deduction to $2.5 million and making 100% bonus depreciation permanent. Both changes will have a major impact on how property is depreciated. This is a good time for a refresher on tangible property regulations, as they also impact a property’s depreciable basis.
Stephen Gilman Managing Director Cbiz Boston, MA
In 2013, the IRS issued T.D. 9636, which provides the Final Tangible Property Regulations, commonly called the repair regulations. These regulations attempt to streamline and assist taxpayers and practitioners in determining when property additions must be capitalized and when they can be expensed. The final regulations provide rules covering five different areas: materials and supplies, capitalized costs (including the de minimis safe harbor election), cost to acquire or produce tangible property, costs to improve tangible property and dispositions of property. This article will focus on capitalized costs, including the de minimis safe harbor election and expenses to improve tangible property. Treasury Regulation Section 1.263(a)-1(f) governs the de minimis safe-harbor election that can be made, which allows taxpayers to expense items that fall under a certain dollar threshold. Whether the taxpayer has an “applicable financial statement” or not impacts the dollar threshold. An “applicable financial statement” is defined as any of the following: • • •
A financial statement required to be filed with the SEC. A financial statement required to be provided to the federal or state governmental agency. A certified, audited financial statement.
A taxpayer with an “applicable financial statement” can deduct amounts paid for property and improvements under $5,000 provided they have a written accounting policy in place at the beginning of the year that states the $5,000 threshold and consistently treats such items as an expense for financial statement purposes. The $5,000 threshold is on a per-item basis, not a per-invoice basis. Taxpayers without an “applicable financial statement” can also make the de minimis safe-harbor election; however, the expensing threshold is reduced to $2,500 per invoice item. Although in this situation, no written policy is necessary in this situation, it is a best practice to have one in place. Also, taxpayers must also be consistent with the treatment of these items as expenses for internal financial statements. In both above cases, the taxpayer is required to attach a statement with their annual tax return each year
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indicating that the de minimis safe-harbor election is being made. To determine whether an expenditure should be capitalized, it is important to understand the definition of a unit of property. The regulations define a unit of property as all functionally interdependent components. Special rules determine the unit of property for buildings, condominiums and cooperatives, leased property, network assets (such as railroad tracks) and plant property. This article focuses on the application of these rules as they relate to buildings. The regulations stipulate that when applying the improvement standards, buildings are divided into nine different property units or “building systems.” Those units of property are as follows: • • • • • • • • •
All heating, ventilation and air conditioning (HVAC) systems. All plumbing systems, including pipes and drains. All electrical systems, including wiring and outlets. All escalators and elevators in the building are considered a single unit of property. All fire-protection and alarm systems. All security systems for the protection of the building and its occupants, including window and door locks and security cameras. Gas distribution systems. Other structural components that are not part of the building structure. The building structure itself, which comprises the roof, windows and foundation doors.
When making improvements to a building, the taxpayer must consider each of the above systems and determine whether the expenditure is a betterment, a restoration or an adaptation to a different use. For example, a building’s HVAC system comprises 10 rooftop HVAC units, and the taxpayer replaces three of them. Is this a betterment, restoration or an adaptation to a different use that would require the cost of the HVAC units to be capitalized? Although the final regulations do not provide specific, bright-line tests to determine whether a replacement to a building system would constitute a betterment or a restoration, they include examples that suggest that if 30% or less of the building system (unit of property) is replaced, it would not be considered a betterment or restoration. Therefore, in the above example, the HVAC units could be expensed. The tangible property regulations provide significant benefits for taxpayers. However, the regulations are quite complex, which makes it imperative to consult a tax advisor.
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