Tier I Industry Director’s Directive on the Planning and Examination of Repairs vs. Capitalization Change in Accounting Method (CAM) #1

LMSB Control No.: LMSB-4-0110-001
Impacted IRM 4.51.2

January 22, 2010  

Introduction:

The Repairs vs. Capitalization CAM Issue has been designated an LMSB Tier I Issue. This memorandum is intended to provide direction to the field in the examination of a taxpayer who changes their method of accounting to re-characterize previously capitalized costs under § 263(a) as deductible repairs and maintenance under § 162. 

This Directive is not an official pronouncement of the law or the position of the Service and cannot be used, cited or relied upon as such.

Background:

Taxpayers are filing Forms 3115 requesting a Change in Accounting Method (CAM) for tangible assets.  This is a cross industry issue affecting all industries.  Significant impact has been recognized in the Utilities, Telecommunications, Gaming, Retail, Restaurant and Hotel Industries.  

This issue was previously declared an Emerging Issue by PFTG on May 8, 2009.
 
The first step involves the determination of a Unit of Property (UOP) and the application of the UOP to specific expenditures.  The UOP determination can impact whether a project should be accounted for as a repair (and deducted) or as an improvement (and subject to capitalization).  Current case law and other guidance are considerable and each project needs to be evaluated before the law can be properly applied.  The UOP determination varies based on the type of property as well.  We can approach these issues best by grouping industries with similar issues.  They include:

1. UOP issues present in all industries,
2. Regulated Industries with Network Assets; present in the Utilities and Telecommunications and Railroad Industries, and
3. Remodel and Renovation Issues; present in the Gaming, Retail, Restaurant and Hotel Industries.

Examining agents need to apply §§ 263(a), 263A and 162 as well as other legal authorities to the specific expenditures incurred in each year.

Industry Issue Resolution Solicitation

The Issue Management Team is seeking to publish guidance through the Industry Issue Resolution (IIR) process.  The IMT is currently soliciting IIR requests for this issue for entities operating in the following industries:

1. Retail and/or Restaurants
2. Utility
3. Telecommunication

Information on the Industry Issue Resolution program can be found in Revenue Procedure 2003-36, Internal Revenue Manual Section 7.40.1, and on irs.gov.

Planning and Examination Guidance:

Examiners who currently encounter this issue must address the issue during the risk analysis process to determine whether the issue will be examined.  Examiners should review the capitalization website for additional information. 

Once it is determined that the issue will be examined, examiners must contact the appropriate industry technical advisor and/or one of the capitalization technical advisors for assistance in developing the issue.  Before contacting the technical advisor, the examiner should obtain as much information as possible in order to hold a meaningful conversation with the technical advisor. 

In most cases, this issue will involve the assistance of an Engineer.  Computer Audit Specialists may also be involved to review or run a statistical sample.  It is recommended that audit teams begin their examination of this issue early in the audit cycle to facilitate timely case closings. 

Examination teams will analyze the underlying detail for the substantive issue to determine whether the expenditures included in the taxpayer’s § 481(a) adjustment is deductible using current law.  The Tangible Regulations are in the process of being re-written.  These Regulations were published as Proposed Regulations in August 2006, withdrawn and re-issued as Proposed Regulations in March of 2008.  The Proposed Regulations are clear that when issued, the Final Regulations will be prospective only.  The Proposed Regulations are not to be cited nor relied on until issued in final format. 

As of August 27, 2009, this issue falls under the automatic consent procedures under Appendix Section 3.06 of Rev. Proc. 2008-52.  Neither the granting of the automatic consent under Rev. Proc. 2008-52 nor the granting of consent under Rev. Proc. 97-27 precludes examiners from auditing the issue of whether certain expenses are deductible repair costs or costs that should be capitalized.  IDD #2 provides more information regarding the automatic consent under Rev. Proc. 2008-52 and the advance consent under Rev. Proc. 97-27 for an accounting method change with respect to this issue.

Issue Tracking

Examiners must use the following tracking codes when examining this issue:  

• UIL 263.14-01, and
• Issue Tracking Attribute Code 1400

If you have technical questions, please contact one of the Capitalization Technical Advisors Laurie Schutter at 616-365-4597 or David Boschetto at 626-312-5046 ext. 1063, or the appropriate Industry Technical Advisor. 

If you have any questions on the IIR process, please contact PFTG Senior Program Analyst David Lindenbaum at 202-283-8407.

If you have any questions regarding this IDD or the Issue Management Team, please contact Cindy S. Kim, RFPH Senior Program Analyst at (630) 493-5934.

cc:
Commissioner, LMSB
Deputy Commissioner (Operations)
Deputy Commissioner (International)
Division Counsel, LMSB
Commissioner, SBSE
Chief, Appeals
Director, Planning, Quality, Analysis & Support
Director, Research & Workload Identification