Press Room: Tax Release

March 09, 2012

New Tangible Property Regs Create Opportunities and Pitfalls

The new temporary regulations, effective for taxable years beginning in 2012, expand the definition of materials and supplies, provide a number of potentially favorable alternative or electable methods and present a few traps for the unwary. Planning before year-end may be necessary to take full advantage of the opportunities in the regulations and to avoid pitfalls. The regulations are extensive; however, the focus here is just the materials and supplies section of the regulations.

The rules have a much broader application than might be expected: Taxpayers may need to update capitalization policies and procedures accordingly.

The regulations define materials and supplies as tangible assets acquired or produced with an economic life of less than a year that are used in a trade or business and are not inventory. The definition also includes longer lived units of property with an acquisition or production cost of $100 or less.

The scope of the rules is much broader than the label materials and supplies would suggest. Examples of such items in the regulations include a landfill with a life of less than a year, low cost assets held for rental and the bulk purchase of fax machines that individually cost less than $100. In addition, the regulations provide that the cost of materials and supplies includes both direct and indirect costs for produced property and transaction costs for acquired property. Because of the breadth of this definition, it may be difficult for taxpayers to identify the assets and costs subject to these rules without system modifications.

Default, alternative and electable methods are available: Taxpayers should consider which elections they should make so that they can plan accordingly and account properly throughout the year.

The default methods of accounting for materials and supplies include deducting incidental materials and supplies when paid or incurred and deducting nonincidental materials and supplies when used or consumed. Rotable or temporary spare parts (which are included in the definition of materials and supplies) may be deducted either when disposed of or when placed in service (subject to recapitalization under special rules when rotable or temporary spare parts are removed from service for repair). Materials and supplies costing less than $100 each are deductible under a de minimis rule but may still be subject to capitalization under the Sec. 263A uniform capitalization rules. Finally, taxpayers may elect to deduct materials and supplies under the book capitalization threshold (subject to certain conditions and dollar limitations), or to treat materials and supplies as depreciable assets. The most beneficial feasible method for materials and supplies will vary from taxpayer to taxpayer. As a consequence, taxpayers will need to analyze and assess their own facts and circumstances as well as other factors such as available bonus depreciation to determine which of these methods is most appropriate.

Pitfalls: Delays in addressing these regulations could lead to unnecessary taxes and additional work later.

If taxpayers are unable to identify all items that qualify as materials and supplies, they risk being deemed to have made inadvertent binding elections in situations where the book method is a proper electable method. For example, if the material or supply is a part used for maintenance or repair on HVAC equipment that is capitalized and depreciated under the book capitalization policy, a taxpayer may be deemed to have elected (as a result of the book treatment) to capitalize and depreciate that item for tax purposes even though it would have been otherwise deductible for tax purposes. Taxpayers should identify qualifying materials and supplies and available methods before the original return is filed to avoid inadvertent elections.

Further, taxpayers must be able to demonstrate that the conditions for using certain favorable methods are satisfied. The availability of the method of deducting materials and supplies using the book capitalization method is conditioned on the ability to demonstrate that the total dollar amount of materials and supplies deducted does not exceed a computed threshold. If insufficient information exists to demonstrate that the conditions to deduct are met, then materials and supplies may be deducted only when used or consumed. 

To avoid these pitfalls, many taxpayers will need to make some modifications to their accounting systems to provide the information necessary to take advantage of the electable methods or to follow the book capitalization policy. Taxpayers may lose the opportunity to use the most beneficial methods for materials and supplies if they delay consideration of these implementation issues until the return is being prepared.

Next steps

Taxpayers should identify expenditures that are treated as materials and supplies for book purposes and determine whether the book method is appropriate and beneficial for tax purposes. If the book method is not appropriate, the taxpayer should consider available elections and alternative methods. If the book method is appropriate, taxpayers should ensure that they can demonstrate that deductions do not exceed specified limitations. Finally, taxpayers should evaluate whether Form 3115 filings are necessary to implement desirable methods.

Conclusion

Many taxpayers engaged in a trade or business will be affected in some way by the new materials and supplies regulations. Taking no action could result in tax exposure or missed opportunities. Taxpayers will need to evaluate the impacts of these regulations early enough to take advantage of them not only on the original return for the 2012 tax year but, for some taxpayers, prior to the end of the first quarter ending in 2012, if the new regulations impact the financial reporting of tax positions taken prior to 2012 or estimated tax payment calculations for 2012.

For more information, click here to view the regulations or contact your WTAS advisor.