The IRS has released the latest volley in the ongoing attempt to establish an understandable and reasoanble set of rules guiding taxpayers on capitalization requirements--a set of temporary regulations in T.D. 9564 effective January 1, 2012 (available on BNA) and a corresponding set of proposed regulations, REG-168745-03. Here's the background statement from TD 9564:
The United States Supreme Court has recognized the highly factual nature of determining whether expenditures are for capital improvements or for ordinary repairs. See Welch v. Helvering, 290 U.S. 111, 114 (1933) (“decisive distinctions [between capital and ordinary expenditures] are those of degree and not of kind”); Deputy v. du Pont, 308 U.S. 488, 496 (1940) (each case “turns on its special facts”). Because of the factual nature of the issue, the courts have articulated a number of ways to distinguish between deductible repairs and non-deductible capital improvements. For example, in Illinois Merchants Trust Co. v. Commissioner, 4 B.T.A. 103, 106 (1926), acq. (V-2 CB 2), the court explained that repair and maintenance expenses are incurred for the purpose of keeping property in an ordinarily efficient operating condition over its probable useful life for the uses for which the property was acquired. Capital expenditures, in contrast, are for replacements, alterations, improvements, or additions that appreciably prolong the life of the property, materially increase its value, or make it adaptable to a different use. In Estate of Walling v. Commissioner, 373 F.2d 190, 192-193 (3rd Cir. 1966), the court explained that the relevant distinction between capital improvements and repairs is whether the expenditures were made to “put” or “keep” property in efficient operating condition. In Plainfield-Union Water Co. v. Commissioner, 39 T.C. 333, 338 (1962), nonacq. on other grounds (1964-2 CB 8), the court stated that if the expenditure merely restores the property to the state it was in before the situation prompting the expenditure arose and does not make the property more valuable, more useful, or longer-lived, then such an expenditure is usually considered a deductible repair. In contrast, a capital expenditure is generally considered to be a more permanent increment in the longevity, utility, or worth of the property.The standards for applying section 263(a), as set forth in the regulations, case law, and administrative guidance, are difficult to discern and apply in practice and have led to considerable uncertainty and controversy for taxpayers. On January 20, 2004, the IRS and the Treasury Department published Notice 2004-6 (2004-3 IRB 308) announcing an intention to propose regulations providing guidance in this area. The notice identified issues under consideration by the IRS and the Treasury Department and invited public comment on whether these or other issues should be addressed in the regulations and, if so, what specific rules and principles should be provided.On August 21, 2006, the IRS and the Treasury Department published in the Federal Register (71 FR 48590-01) proposed amendments to the regulations under section 263(a) (2006 proposed regulations) relating to amounts paid to acquire, produce, or improve tangible property. The IRS and the Treasury Department received numerous written comments on the 2006 proposed regulations and held a public hearing on December 19, 2006. On March 10, 2008, after consideration of the comment letters and the statements at the public hearing, the IRS and the Treasury Department withdrew the 2006 proposed regulations and proposed new regulations (2008 proposed regulations) in the Federal Register (73 FR 47 12838-01) under sections 162(a) (relating to the deduction for ordinary and necessary trade or business expenses) and section 263(a) (relating to the capitalization requirement). The IRS and the Treasury Department received several comment letters on the 2008 proposed regulations and held a public hearing on the 2008 proposed regulations on June 24, 2008. After considering the comment letters and the statements at the public hearing, the IRS and the Treasury Department are issuing temporary regulations amending 26 CFR part 1. The IRS and the Treasury Department are also withdrawing the 2008 proposed regulations and are proposing new regulations that incorporate the text of these temporary regulations.
Many of the changes made appear to be done to accommodate commenters who complained that the rules would amount to a change in the "way we've always done things." The treatment of rotable parts is an example.
The 2008 proposed regulations proposed to allow a deduction for amounts paid for rotable or temporary spare parts when the parts were discarded from the taxpayer's operations. Alternatively, a taxpayer could elect to capitalize and depreciate rotable spare parts over the parts' applicable recovery period.The IRS and the Treasury Department received comments stating that the requirement to defer the deduction of rotable spare parts until the year of disposition is inconsistent with the method that many taxpayers currently use for rotable spare parts and would result in an administrative burden for those taxpayers. One commentator explained that, under this method, a taxpayer deducts an amount paid for a new rotable spare part in the taxable year in which it installs the rotable part in its equipment. The taxpayer includes in income and assigns a cost basis equal to the fair market value of the used, non-functioning part, and capitalizes the costs of repairing the part. If the repaired part is later used as a replacement part in the taxpayer's equipment, the taxpayer deducts the basis of the part in the taxable year it is re-installed. This cycle continues until disposition of the part.The temporary regulations generally adopt the recommendations of the commentator and include the proposed method of accounting for rotable parts as an optional method. This optional method may be used as an alternative to treating the parts as used or consumed in the year of disposition or electing to treat the parts as depreciable assets. If a taxpayer chooses to use the optional method, the method must be used for all of the taxpayer's rotable and temporary spare parts in the same trade or business.
There were similar changes to the "materials and supplies" parts of the regulations.
This is a long set of rules, but apparently not involving sea changes compared to the prior proposed regulations. The more extensive set of examples should be helpful to taxpayers.
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