Last year the IRS finalized regulations that are commonly referred to as the “repair regulations” (Treasury Decision 9636). Broadly speaking, these regulations provide comprehensive standards for determining whether a particular expenditure may be deducted on your tax return as a repair expense or must be capitalized and depreciated.
The IRS requires taxpayers to “adopt” the final regulations, effective for their 2014 tax year. Unfortunately, the adoption of the final regulations required virtually every business taxpayer that owns tangible property to file a Form 3115. This complex 8-page form is used to change a taxpayer’s accounting methods.
In order to file the Form and adopt the repair regulations it is necessary to review all of a taxpayer’s expenditures in tax years that began before 2014 and determine whether those expenditures were properly accounted for as repairs or capital expenditures on earlier tax returns by applying the principles of the repair regulations. As you might imagine, a complete review of this type is potentially a lengthy and expensive process.
The IRS received much criticism for requiring all taxpayers to undergo this type of comprehensive review in order to adopt the regulations. Gratefully, the agency recently responded with some significant relief for “small business taxpayers” (Revenue Procedure 2015-20). This relief allows a small business taxpayer to adopt all or most parts of the repair regulations without filing a Form 3115.
You are a small business taxpayer if your trade or business either has less than $10 million in assets on the first day of the 2014 tax year or the business has average annual gross receipts of less than $10 million over the three preceding tax years. If either test is satisfied, you may choose to adopt the repair regulations without filing the Form 3115.
If you are a qualifying taxpayer you may not necessarily want to exercise the option not to file Form 3115. First, if you take advantage of the filing relief you may not make a “late partial disposition election.” This election is a one-time opportunity available only in 2014 to treat prior-year retirements of structural components of buildings (such as a replaced roof) as a disposition that generates a retirement loss deduction. If you previously retired a structural component, you are likely still depreciating the cost allocable to the component. The partial disposition election allows you to claim a loss for the remaining undepreciated cost in 2014.
Secondly, if you choose to adopt the repair regulations without filing Form 3115, no deduction may be claimed in 2014 for amounts that you capitalized prior to 2014 but which are deductible under the final repair regulations. You must continue to capitalize and depreciate those amounts.
It should also be pointed that if you are selected for audit in some future year, the IRS has the authority to change the treatment of your prior expenditures to follow the treatment required by the final repair regulations even though you chose the relief.
The decision to opt out of filing Form 3115 needs to be made on a case-by-case basis by weighing the cost and inconvenience of the filing requirement against the value of any potential benefits.
If you do not qualify for filing relief or choose not to exercise it, a review of your prior year expenditures will be necessary to properly comply with the repair regulations. Generally speaking, this review may result in a deduction on your 2014 return if the amounts of prior capitalized expenditures that may be expensed under the repair regulations plus any retirement loss deductions for structural components under the partial disposition election exceed the amount of previously deducted expenditures that should be capitalized under the repair regulations. If the reverse is true, then the difference must be included in income over a four-year period.
Our firm stands ready and able to help you comply with the repair regulations on your 2014 return. Please contact us so that we can help you address these rules.