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Examiners Stand Down on Audits of Capitalization Issues
Examiners “Stand Down” on Audits of Capitalization Issues
The IRS’s Large Business and International Division (LB&I) has issued a field directive to its examiners and managers that they should cease conducting examinations of the repair versus capitalization issue for costs related to tangible property. The directive, which follows the issuance of comprehensive temporary regulations in late 2011, applies to both current examinations and new examinations of certain issues for tax years beginning before January 1, 2012.
Comment: On the day that LB&I released the Directive, IRS Special Counsel Scott Dinwiddie told practitioners in Washington, DC, that the IRS is “standing down from prior-year exam activity.” Instead, LB&I is reserving examinations for issues arising under the most recent capitalization regulations, Dinwiddie said.
At the end of 2011, the IRS issued comprehensive temporary regulations on the capitalization of costs relating to tangible property. The temporary regulations are effective for tax years (or costs incurred in tax years) beginning on or after January 1, 2012.
The IRS recently issued two companion revenue procedures (Rev. Procs. 2012-19 and 2012-20) that provide automatic consent for taxpayers to change their accounting method(s) to a method permitted under the capitalization-repair temporary regulations. The revenue procedures waive certain limitations on obtaining automatic consent for taxpayers that change their accounting method for the first or second tax year beginning on or after January 1, 2012.
Comment: Under Rev. Proc. 2011-14, taxpayers that change their accounting method under the temporary regulations beginning in 2012 would get audit protection for years before 2012.
The LB&I directive applies to exam activity on a number of taxpayer issues:
- Whether costs incurred to maintain, replace, or improve tangible property must be capitalized under Code Sec. 263(a); and
- Any correlative issues involving the disposition of structural components of a building or dispositions of other tangible depreciable assets.
Comment: The directive does not apply to current examinations relating to costs for which the IRS has provided specific guidance (such as for the electric utility industry).
Tax years before January 1, 2012
For tax years beginning before January 1, 2012, the directive instructs examiners to discontinue current activity with regard to the Issues, and not to begin any new exam activity with regard to the issues. However, if a taxpayer applies for a change in accounting method (Form 3115) for a tax year not covered by the temporary regulations, examiners are instructed to “risk assess” the Form 3115 and determine whether to examine it.
When discontinuing current exams, LB&I will inform taxpayers that the IRS "neither accepts nor rejects the position taken in the tax return. The taxpayer will be allowed a two-year period to adopt the appropriate method of accounting provided in Rev. Proc. 2012-19 and 2012-20. If the taxpayer has not changed accounting methods in the first or second tax year beginning after December 31, 2011, the IRS may audit the repair expenses for tax years ending on or after January 1, 2012.
If examining a return for a tax year beginning on or after January 1, 2012, but before January 1, 2014, and the taxpayer applied for a method change, the examiner should perform a risk assessment regarding the method change. If the taxpayer has not applied for a method change, it should be allowed to do so. For tax years beginning on or after January 1, 2014, the directive instructs examiners to follow normal exam procedures.
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