Repair Regs Impact on Businesses

by Billy Litz

In September 2013, the IRS issued new regulations (repair regs) that govern when taxpayers must capitalize and when they can deduct certain expenditures for acquiring, producing or improving tangible property. These new rules have caused taxpayers and their accountants to change their methods of determining which items are capital assets.

While the repair regs have brought confusion to most, they also offer great tax savings opportunities. To adopt the new rules, a taxpayer would request a change in accounting method from the IRS by filing Form 3115. This would require the taxpayer to “scrub” their books to ensure they conform with the new regulations by removing items previously capitalized that should have been expensed under the new repair regs and allows the taxpayer to reduce their 2014 income by the undepreciated basis of these items.

The implementation of the repair regs has been very time consuming for both taxpayers and their accountants as they work towards conforming to a new method. It is very important that taxpayers make the adjustment on their 2014 tax returns, as the IRS will not allow taxpayers to apply the regulations retrospectively and scrub their books after 2014.

In February 2015, the IRS offered small businesses relief from filing Form 3115 and the requirement to go back through prior years to conform to the new regulations. Instead, small businesses can now automatically elect to conform prospectively, with the tax year beginning January 1, 2014. A small business is defined, for these purposes, as a business with less than $10 million in assets OR less than an average of $10 million in gross receipts over the last three years.

This was a welcome relief for many taxpayers who bore the burden of filing Form 3115 to apply for a change in accounting method even if there were no adjustments to be made. However, electing to forego filing the Form 3115 could come at a high cost for businesses that would otherwise benefit from scrubbing their books and recognizing expenses in 2014, for the undepreciated basis of items previously capitalized.

If you would like to discuss the effect that the IRS’ new repair regulations have on your business, please give us a call.