Tax Relief Blog

New proposed regs address complex issue – capitalization of tangible assets – Part III

Mike Habib, EA
myIRSTaxRelief.com IRS has issued new comprehensive proposed regs on when amounts are treated as paid to acquire, produce, or improve tangible property. They replace controversial proposed regs that were issued on the same subject in 2006 and that IRS has now withdrawn. The new proposed regs would be effective for tax years beginning on or after the date that they are finalized.

Since the beginning of the week, we have included a series of articles on the topic. This article, the third in the series, explains how the proposed regs would differentiate between currently deductible repairs and improvement or betterments to property that have to be capitalized. For how the proposes regs would define materials and supplies that are deductible under Code Sec. 162, and prescribe new rules for when the deduction for these items may be claimed, see Part I . For how the proposed regs would treat amounts related to the acquisition or production of real or personal property, see Part II.

Observation: The regs would make several significant liberalizations by doing away with the so-called “restoration principle” and putting in place a new routine maintenance safe harbor. They also attempt to reflect the large body of case law on repairs vs. improvements and adopt all-encompassing guidelines where none existed before. However, the regs if adopted nonetheless may be difficult to apply to a particular taxpayer’s facts and circumstances, as evidenced by the plethora of examples, many on them complex, that attempt to illustrate how the regs would affect “typical” capital and non-capital expenditures.

Out with the plan of rehabilitation doctrine. Under the judicially developed plan of rehabilitation doctrine, a taxpayer must capitalize otherwise deductible repair costs if they are incurred as part of a general plan of renovation or rehabilitation. The new proposed regs would specifically provide that repairs made at the same time as an improvement, but that do not directly benefit or are not incurred by reason of the improvement, don’t have to be capitalized under Code Sec. 263(a) . However, a taxpayer would have to capitalize under Code Sec. 263A otherwise deductible repair costs if the taxpayer improves a unit of property and the otherwise deductible repair costs directly benefit or are incurred by reason of the improvement to the property. (Prop Reg § 1.263(a)-3(d)(4)) The preamble adds that when the proposed regs are finalized, the judicially-created plan of rehabilitation doctrine will be obsolete, particularly with regard to the assertion that the doctrine transforms otherwise deductible repair costs into capital improvement costs solely because the repairs are performed at the same time as an improvement, or are pursuant to a maintenance plan, even though the repairs do not improve the property. (Preamble to Prop Reg 03/07/2008)

New proposed regs address complex issue–capitalization of tangible assets

Mike Habib, EA
myIRSTaxRelief.com

IRS has issued new comprehensive proposed regs on when amounts are treated as paid to acquire, produce, or improve tangible property. They replace controversial proposed regs that were issued on the same subject in 2006 and that IRS has now withdrawn. The new proposed regs would be effective for tax years beginning on or after the date that they are finalized.

This article explains how the proposed regs would define materials and supplies that are deductible under Code Sec. 162, and prescribe new rules for when the deduction for these items may be claimed. Future articles will explain other key aspects of the new proposed regs, such as how to treat amounts paid to sell property, transaction costs related to acquisitions, and what constitutes a repair versus an improvement or betterment to property.