With the last major piece of guidance related to the final tangible property regulations now issued, many of the for-profit organizations and individuals impacted have already put plans in motion to file a change in their accounting methods. However, tax-exempt organizations are also subject to the regulations, and since the final regulations are effective for tax years beginning in 2014, tax-exempt filers too—particularly those with fiscal year-ends approaching—will need to determine how the final rules affect their business and implement any changes necessary to comply before filing their 2014 tax returns.
The tangible property regulations have been nearly a decade in the making, a product of the controversy regarding what is deductible and what must be capitalized and recovered over time through depreciation. The tangible property regulations attempt to provide formal guidance on this issue as well as iron out differences in interpretation of case law, which up to this point has been all taxpayers could rely upon in making the distinction.
The final regulations provide rules for expensing and capitalizing costs in five general areas:
- Materials and supplies
- Capital expenditures in general (including the de minimis safe harbor)
- Costs to acquire or produce tangible property
- Costs to improve tangible property
- Dispositions of modified accelerated cost recovery system property (including components thereof) and general asset accounts
Impact on Tax-Exempt Organizations
The tangible property regulations are applicable to tax-exempt organizations; however, the impact will differ from that of for-profit and individual taxpayers.
Capitalization Policies and the De Minimis Safe Harbor
In the final regulations, taxpayers may choose to make the de minimis safe harbor election, which means they aren’t required to capitalize amounts they expense (for financial accounting purposes) if those amounts are paid to acquire or produce a unit of property and the invoice or item cost is below a specified threshold. As a result, tax-exempt organizations should at the very least have a written capitalization policy that addresses the de minimis safe harbor rules. The policy should outline the threshold for capitalizing versus expensing and note any exceptions to that rule. For taxpayers with an applicable financial statement (AFS), the accepted threshold is $5,000 (per invoice or item). For those without an AFS, the accepted threshold is $500 (per invoice or item). If an organization’s expensing policy for financial accounting purposes exceeds these thresholds, the organization may still deduct such items when purchased if the deduction clearly reflects income.
Taxpayers may also deduct costs under this safe harbor for items with an economic useful life of less than 12 months as long as their book capitalization policy specifically expenses those items, regardless of whether they have an AFS. Aligning your capitalization policy with the tangible property regulations will allow your organization to take advantage of protective measures should your tax-exempt status be revoked (voluntarily or involuntarily) or if your organization generates unrelated business taxable income (UBTI).
Unrelated Business Taxable Income
If your organization generates UBTI and files Form 990-T annually, the effect of the tangible property regulations may be similar to the effect on for-profit entities. If you maintain separate tax depreciation lives and methods for fixed assets, you’ll likely need to at least file a change in accounting method to comply with the regulations. If you utilize straight-line depreciation or follow the depreciation lives and methods set out in generally accepted accounting principles, a change may not be needed.
Accounting Method Changes
While certain safe harbors and elections are implemented through the filing of statements or the treatment of an item on a timely filed federal tax return, the remaining provisions in the tangible property regulations are considered part of an organization’s accounting methods. Taxpayers seeking to change to a method of accounting permitted in the final regulations must secure the IRS’s consent before implementing that new method by filing Form 3115, Application for Change in Accounting Method. This form must be submitted with your timely filed tax return in the year of change.
Your organization can also make an election to allow for partial dispositions of property. The partial disposition rule allows you to recognize a loss on the disposition of a component—structural or otherwise—of an asset without having identified the component as an asset before the disposition. The rule reduces the number of cases where an original part and any subsequent replacements of that part must be capitalized and depreciated simultaneously, such as in the case of a roof or HVAC system.
This election may be particularly beneficial for exempt organizations reporting UBTI from rental income on debt-financed property, which is also called unrelated debt-financed income. Private foundations, including operating foundations, with depreciable assets should also consider the impact of the tangible property regulations in general and the partial disposition election in particular, since it can be beneficial when applied to depreciable assets used in determining net investment income subject to the 1 percent to 2 percent excise tax (such as property used in a rental activity).
The election is made in the year of a partial disposition. However, for the 2014 year only, your organization can make a retroactive partial disposition election for disposals that occurred before 2014. This retroactive election is made though an accounting method change, and it allows you to look back and compute a retroactive adjustment to claim any losses on partially disposed assets in prior years.
Tax-exempt entities with for-profit subsidiaries should review the tangible property regulations even if there is minimal impact at the exempt level. Most for-profit entities will be filing elections or changes in accounting methods to comply with the new rules, and exempt organizations should be sure their related entities are aware of the rules, their impact, and next steps for 2014 and beyond.
Qualified Small Taxpayer Relief
Revenue Procedure 2015-20 now provides simpler procedures for qualifying small taxpayers to comply with the tangible property regulations. Taxpayers don’t have to file Form 3115 to comply with the new rules if they’re a qualified small taxpayer, which is defined as a taxpayer with average annual gross receipts of $10 million or less for the prior three years or total assets of less than $10 million as of the first day of the tax year of change, which is 2014 in this case. However, there are drawbacks to this approach, which include no audit protection and no look-back adjustment.
Organizations filing Form 990-T and maintaining tax depreciation will likely need to file an accounting method change, Form 3115, and attach elections to their 2014 tax returns to be in compliance. Exempt entities with related organizations should be aware of the rules and ensure their affiliated entities are taking steps to implement the new regulations as well.
To discuss implications and next steps related to the tangible property regulations and how they may impact your organization, contact your Moss Adams professional.