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.
But, according to Yeates, the language — and not just the structural change in the new guidance for dispositions — is what’s confusing. Under the new tangible-property regulations, taxpayers must use a reasonable valuation method for dispositions that is “consistently applied.” Determining what that means may be easier said than done, he said.
Some IRS officials interpret the “consistently applied” language to mean that once an asset has a disposition (as in the case of a roof repair being claimed as a full replacement) applied to it once, that is the way it is defined for every disposition thereafter, said Yeates.
The guidelines do improve some things for corporate taxpayers, however. Previously a taxpayer could not actually claim a “partial” disposition on the replacement of a roof, for example, hindering the taxpayer’s ability to claim another disposition on that same asset in the future. The new regulations now permit corporations to write off structural components of an asset that have been replaced, for example.
But the complex language of that beneficial provision of the guidance is in itself puzzling to corporations, according to Yeates. “This is a troubling issue . . . and will continue to cause confusion until more guidance is out,” he said.
The IRS has, however, been listening to some of the criticism thrown at all sections of the property regulations. It has since delayed the effective date of the tangible-property rules from originally applying to tax years beginning on or after January 1, 2012, to January 1, 2014. But it has not yet simplified those rules enough to corporate executives’ or accountants’ liking.
The section of the tangible-property rules that pertains to just repairs, for example, will require lots more collaboration and discussions between business units just to get to an acceptable level of adherence to the rules, said Yeates: “You need to basically tell your client to tell their tax people to take a field trip and talk to the accounting people.”
All of the talk is necessary, Yeates noted, since a company’s tax department needs to understand what the company’s accounting policy may be for a particular asset to assess whether the policy complies with the new regulations or if a change in accounting method for the firm may be needed. He also recommended having accounting and tax people speak with the company’s real estate property division.
This kind of communication will also come in handy if firms choose to adopt some tax changes early. The IRS is allowing companies to adopt those changes that may be favorable to the companies as early as their 2012 tax filing, and those changes that may be unfavorable to the companies by the later 2014 deadline.