Revisiting the Tangible Property Regulations…Eight Years Later

The Tangible Property Regulations (TPR’s) were issued by the IRS in 2013 and apply to anyone who pays or incurs amounts to acquire, produce, or improve tangible real or personal property. Under Internal Revenue Code (IRC) Section 162, taxpayers are permitted to deduct amounts paid for repairs and maintenance to tangible real or personal property, assuming that the amounts would not otherwise be required to be capitalized under IRC Section 263(A). Prior to the issuance of these TPR’s, inconsistent administrative rulings and case law (with a pinch of anyone’s best guess) were relied upon for capitalization / expense analysis.

Under the TPR’s, the first step is to determine the unit of property (UoP). For buildings, the UoP is the building structure and each of its eight building systems, which are:

• Electrical systems, which include wiring, outlets, junction boxes, fixtures and associated connectors, and site utility equipment used to distribute electricity.
• Plumbing systems, which are comprised of pipes, valves, sinks, bathtubs, toilets, drains, water and sanitary sewer collection equipment, and site utility equipment used to distribute water and waste.
• HVAC system, which includes boilers, furnaces, chillers, radiators, pipes, ducting, motors and compressors.
• Gas distribution systems
• Elevators
• Escalators
• Fire protection and alarm systems, which consist of heat and smoke detection devices, alarm control panels, sprinkler heads, associated piping or plumbing, pumps, visual and audible alarms, and fire-fighting equipment.
• Security systems, which include security cameras, monitors, motion detectors, security lighting, alarm systems, entry and access systems.

For non-buildings, the UoP is based upon the functionality of the interdependent components. To say it differently, would you be able to place one component of property into service without placing another component of the property into service along with it? As a general rule, the smaller the UoP, the more likely that an expenditure would materially improve the UoP, which would lead to the conclusion that capitalization would be required.

After identifying the UoP, the next step is to apply the improvement standards: Has a betterment, restoration, or adaptation occurred? If so, capitalization is necessary.

• Amounts paid to fix a material condition or material defect, amounts paid for a material addition (i.e. a physical enlargement or expansion), or amounts paid to materially increase productivity, efficiency, quality, etc., are considered betterments.
• Amounts incurred to replace a major component, amounts paid to return a UoP to its original operating condition, or amounts paid to restore a UoP to like-new condition, qualify as restorations.
• Amounts expended to adapt a UoP to a new or different use are considered adaptations.

The TPR’s also contain several provisions that are elective and were prospective in their application. The Safe Harbor Election for Small Taxpayers, Safe Harbor for Routine Maintenance and Election to Capitalize Repair and Maintenance Costs should all be carefully evaluated and implemented where deemed appropriate.

And lastly, while the TPR’s do not specify recordkeeping requirements, it is encouraged that a capitalization policy be established (and followed). Any capitalization/expense analysis that is performed should be documented and retained for future reference.

Sources: IRS.gov, Bloomberg Tax