CFOs and their finance staff have had since March to digest guidance from the Internal Revenue Service and the U.S. Department of Treasury on how to apply new tax regulations regarding a corporation’s tangible property, including equipment and such things as elevators or desks. But the rules are so complicated they have many still scratching their head months later.
“It’s intimidating for many companies. And the level of effort needed to analyze what is the best strategic approach to implement, to quantify the effects of changing, and to actually implement the changes is more than many companies can spend or are willing to spend,” says Thomas Yeates, national director of cost segregation at Ernst & Young.
The new tangible-property rules are an attempt to provide more specific tax requirements for taxpayers. But they now require many corporations to reclassify property improvements formally deemed tax deductions or capital expenditures. In many cases, this will involve a significant change in the way a firm used to account for expenditures in its income statement and on its balance sheet.
Generally, the new regulations mandate that costs to enhance or improve tangible property have to be capitalized, and those costs incurred to simply repair and keep tangible property in working order would be allowed to be deducted. Previously, determining which category improvements to a property would fall into was fuzzy. The new rules include three tests to determine whether an expense is deemed a “betterment,” a “restoration,” or an “adaptation” of the property to a new and different use.
But nothing is as simple as it sounds when it comes to tax codes. The new tangible-property guidance, for instance, includes no fewer than 19 accounting-method changes that exist within the tangible-property rules’ section 481(a) tax adjustments.
The 481(a) adjustments must be applied, for instance, when a corporation changes its accounting method from deducting to capitalizing an expense, when a firm acquires new tangible property, or when it disposes of property. Since there are myriad ways to account for such an expense, this is an area that has typically perplexed corporation for years.
Speaking at a New York State Society of CPAs tax conference this week, Yeates quoted what IRS officials have said in the past about “dispositions” in the tangible-property regulations — that it “will be the battlefield that will remain after the final regs.” That’s because, as he puts it, “there is not a lot of guidance.”
In IRS terminology, anything deemed a sale, exchange, retirement, physical abandonment, or destruction of an asset falls into the “disposition” area. Under the new tangible-property rules, the retirement of the structural components of a building is also now included, where it was not in the past.