The implementation of the repair/capitalization regulations is still generating a lot of commentary. Unfortunately, much of the commentary is confusing to practitioners and even misleading due to its incompleteness. We posted several technical articles to TaxPlace in November and December, with the December article focusing on the (limited) situations in which a Form 3115 (change of accounting method) would have to be filed. We encourage you to refer to those articles for guidance. Here, we address some of the recent questions that have come in from practitioners worried about how to implement the regulations based on some of the articles they have been reading by tax commentators. As we pointed out in our TaxPlace article, it looks like numerous large tax firms and some commentators are pushing the idea that Forms 3115 will have to be filed for nearly all clients, and others have followed along out of fear. The bottom line, however, is that Forms 3115 will not be required for the vast majority of farm clients (and other small businesses).
Here are the major points to keep in mind with respect to the repair/capitalization regulations:
- The IRS has provided three possible ways to handle de-minimis amounts:
- Do nothing (pegging the de minimis amount at zero) and examine every repair, supply and asset purchase to determine if the amount must be capitalized (based on the regulations and caselaw). It’s easy to predict that many self-prepared returns will end up adopting (probably inadvertently) this approach. Fortunately, the Congress recently extended through 2014 the ability to make or revoke an I.R.C. §179 election on an amended return which allows a taxpayer to “fix” this issue on audit if necessary. For future years, a Form 3115 will have to be filed.
- For taxpayers that have an “applicable financial statement” (AFS), a $5,000 safe harbor for expensing applies. The regulations require that these taxpayers (again, practically no farmers, ranchers or small businesses) adopt a repair/capitalization policy and change their method of accounting (triggering the preparation and filing of Form 3115 in accordance with Rev. Proc. 2014-16 and Rev. Proc. 2015-13). These taxpayers have already adopted a repair/capitalization policy, and they are changing a method of accounting because their AFS, reviewed financial statements or the system under which they have adopted that repair/capitalization policy will need to come into compliance with the regulations.
- For taxpayers with no AFS that have never adopted a capitalization policy for their books (virtually all farming and ranching operations and all small businesses), the $500 de minimis safe harbor should be adopted. But, this does not require the filing of Form 3115. It’s merely the adoption of a capitalization policy. It’s not a change in accounting method.
Most taxpayers (and virtually all ag taxpayers) have not adopted a method of accounting for the handling of repairs, supplies or small tools. They have never been required to do so. The same can be said for the vast majority of small corporations, partnerships, LLCs and other similar entities – they have not adopted a method of accounting for the treatment of repairs, supplies or small tools. They don’t have a repair/capitalization policy for their books. Thus, the implementation of the repair/capitalization regulations does not involve a change in accounting method for these taxpayers and no Form 3115 would have to be filed. They are simply adopting a method and Form 3115 is not required for that.
While it is true that a “qualified taxpayer” (a taxpayer with average gross receipts over the three preceding tax years of $10 million or less) can file a less-complete Form 3115, that does not mean that such a taxpayer has a Form 3115 filing requirement. As noted above, a Form 3115 only need be filed if a change of accounting method is involved. The adoption of a capitalization policy does not constitute a change in accounting method that would trigger a Form 3115 filing requirement. So, while the vast majority of farming and ranching operations will qualify as a “qualified taxpayer” that does not mean that they have a Form 3115 filing requirement. They still aren’t changing a method of accounting, merely adopting one.
Hopefully, this helps clear-up some of the confusion created by the misleading information out there concerning the repairs/capitalization regulations. Stay tuned.