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UPDATED LB&I DIRECTIVE for Taxpayers Who Adopted a Method of Accounting Relating to the Conversion of Capitalized Assets to Repair Expense under I.R.C. Section 263(a)

LB&I Control No: LB&I-04-0313-001
Impacted IRM 4.51.2

March 22, 2013

 

MEMORANDUM FOR ALL LB&I EMPLOYEES
FROM: Heather C. Maloy
Commissioner, Large Business & International Division
SUBJECT: UPDATED LB&I DIRECTIVE for Taxpayers Who Adopted a Method of Accounting Relating to the Conversion of Capitalized Assets to Repair Expense under I.R.C. Section 263(a)

This memorandum replaces LB&I Directive No. LB&I-4-0312-004, dated March 15, 2012, and provides direction to the field in examinations of the repair versus capitalization issue. The effective date of the tangible property temporary regulations, in amendments published December 17, 2012, in T.D. 9564, has been extended to taxable years beginning on or after January 1, 2014. Accordingly, this memorandum provides modified examination instructions for taxable years beginning on or after January 1, 2012, and before January 1, 2014, and restates prior examination instructions for taxable years beginning before January 1, 2012, and on or after January 1, 2014.   

Background

On December 27, 2011, the Service published temporary regulations (T.D. 9564) to clarify and expand the standards in the current regulations under sections 162(a) and 263(a), and provide some bright-line tests (for example, a de minimis rule for certain acquisitions) for applying these standards. The temporary regulations also amend the general asset account regulations and provide guidance regarding the accounting for, and dispositions of, property subject to section 168. The temporary regulations affect all taxpayers that acquire, produce, or improve tangible property, and are applicable to taxable years (or costs incurred in taxable years, as appropriate) beginning on or after January 1, 2014 (per amendments effective December 17, 2012). For taxable years beginning on or after January 1, 2012, and before the applicability dates provided in forthcoming final regulations (hereinafter, the “Option Period”), taxpayers may choose to apply the temporary regulations (as contained in 26 CFR part 1 edition revised as of April 1, 2012).

As provided in Notice 2012-73, I.R.B. 2012-51, 713, the IRS and the Treasury Department expect to publish final tangible property regulations in 2013 that may include changes to the rules provided in the temporary regulations.  The IRS and the Treasury Department expect the final regulations to apply to taxable years beginning on or after January 1, 2014, and to permit taxpayers to apply the provisions of the final regulations for taxable years beginning during the Option Period.

Taxpayers choosing to apply the provisions of the temporary regulations to taxable years beginning on or after January 1, 2012, may continue to rely on the procedures by which a taxpayer may obtain the automatic consent of the Commissioner of Internal Revenue to change its methods of accounting provided in Revenue Procedures 2012-19, 2012-14 I.R.B. 689, and 2012-20, 2012-14 I.R.B. 700. For taxpayers choosing to apply the provisions of the final regulations to taxable years beginning on or after January 1, 2012, the IRS and the Treasury Department expect to publish procedures for obtaining automatic consent to change a method of accounting when the final regulations are published. (Hereinafter in total, “Applicable Procedures”).

Revenue Procedure 2012-19 provides the procedures for requesting a change for the following methods of accounting addressed in the temporary regulations:

  • Materials and supplies (§§ 1.162-3T & 4T);
  • Capital expenditures in general (§ 1.263(a)-1T);
  • Transaction costs (§ 1.263(a)-2T); and
  • Improvements (§ 1.263(a)-3T).

Revenue Procedure 2012-20 provides the procedures for requesting a change for the following methods of accounting addressed in the temporary regulations:

  • Leased property (§ 1.167(a)-4T);
  • General asset accounts (§ 1.168(i)-1T);
  • MACRS property (§ 1.168(i)-7T); and
  • Dispositions of MACRS property (§ 1.168(i)-8T).

Scope of this Directive

This directive applies to the exam activity relating to positions taken on original returns relating to the following issues (hereinafter, “Issues”).[1]

  1. Whether costs incurred to maintain, replace, or improve tangible property must be capitalized under section 263(a) (see, e.g., Rev. Proc. 2011-14, Appendix section 3.06, Repair and maintenance costs (designated change number 144)); and,
  2. Any correlative Issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets (other than a building or its structural components) (see, e.g., Rev. Proc. 2011-14, Appendix sections 6.24 and 6.25 (designated change numbers 146 and 147, respectively)).

This directive does not apply to current examination activity relating to (1) costs for which the IRS provides specific guidance, separate from the temporary regulations, for determining whether expenditures incurred to maintain, replace or improve tangible property must be capitalized under section 263(a), or (2) issues that do not pertain to whether costs incurred to maintain, replace, or improve tangible property must be capitalized under section 263(a). See, for example:

  • Rev. Proc. 2001-46 and Rev. Proc. 2002-65, Track maintenance allowance for certain railroads;
  • Rev. Proc. 2011-14, Appendix section 3.07, Wireline network asset maintenance allowance and units of property methods of accounting under Rev. Proc. 2011-27 (designated change number 158);
  • Rev. Proc. 2011-14, Appendix section 3.08, Wireless network asset maintenance allowance and units of property methods of accounting under Rev. Proc. 2011-28 (designated change number 159); 
  • Rev. Proc. 2011-14, Appendix section 3.09, Method of accounting under Rev. Proc. 2011-43 for taxpayers in the business of transporting, delivering, or selling electricity (designated change number 160); or,
  • Rev. Proc. 2011-14, Appendix section 6.01, A change from an impermissible to a permissible method of accounting for depreciation or amortization (depreciation) (designated change number 7); or,
  • Rev. Proc. 2011-14, Appendix section 3.05, Materials and Supplies (designated change number 143).

Examination of Tax Years Beginning before January 1, 2012

  1. You should discontinue current exam activity with regard to the Issues;
  2. You should not begin any new exam activity with regard to the Issues;
  3. If, however, a taxpayer files a Form 3115 with regard to the Issues on or after December 27, 2011 (the date the temporary regulations were published) for a tax year not included in the Option Period, you should risk assess the Form 3115 and determine, in consultation with the Methods of Accounting and Timing or the Deductible and Capital Expenditures Issue Practice Groups, whether to examine the Form 3115;
  4. You should take the following steps to discontinue the exam activity with regard to the Issues:

     
    (a) Withdraw Forms 4564, Information Document Request, or portions thereof, relating to the development of this issue for amounts paid to maintain, replace, or improve tangible property, and any correlative Issues involving the disposition of associated assets.

     
    (b) Withdraw all Forms 5701, Notice of Proposed Adjustment, which propose an adjustment to repair expenses related to whether costs incurred to maintain, replace, or improve tangible property must be capitalized under section 263(a), and any correlative adjustments involving the disposition of associated assets.

     
    (c) Develop and issue a Form 5701 with a Form 886-A, Explanation of Adjustments, containing the following language:

       
    (i) The Service neither accepts nor rejects the position taken in the tax return related to the method to determine the proper treatment of amounts incurred to repair tangible property. [Insert taxpayer name] will be allowed a two-year period to adopt the appropriate methods of accounting provided in Rev. Procs. 2012-19 and 2012-20 and any other Applicable Procedures issued in the future. If an appropriate method is adopted, a change in method of accounting can be made in accordance with Section 4 or 5 of the Applicable Procedure for all assets. If [insert taxpayer name] has not changed its accounting method consistent with the Applicable Procedures, then the repair expense will be subject to risk assessment and possible examination for tax years beginning on or after January 1, 2014.

     
    (d) After the taxpayer has signed the Form 5701 with the 886A, Explanation of Adjustments, upload the documents into the Information Management System (IMS) to substantiate for the subsequent examination team that the taxpayer was notified that Service has discontinued examination of the issue. Input into IMS as follows: UIL 263.14-01, and Issue Tracking Attribute Code 1400.

     
    (e) Retain copies of pertinent workpapers in the IMS file or other central location permitted by IRM 4.46.7.2.3(3)(c)&(d).

     
    (f) Complete the Form 5346, Examination Information Report, in accordance with the specific instructions provided for this issue located on the Deductible and Capital Expenditures Issue Practice Group website.

Examination of Tax Years Beginning on or after January 1, 2012 but before January 1, 2014

When you begin examining a return for a taxable year beginning on or after January 1, 2012, but before January 1, 2014, you should determine:

  1. If the taxpayer has changed its method of accounting with respect to the Issues, with or without filing a Form 3115, Application for Change in Accounting Method;
  2. If yes, perform a risk assessment regarding the method change;
  3. If no, the Option Period is still open. Do not examine the issue.

Examination of Tax Years Beginning on or after January 1, 2014

You should apply the regulations in effect and follow normal exam procedures.

Section 481(a) Adjustment

When performing a risk assessment of the section 481(a) adjustment for the Issues, you should:

  1. Consider if the adjustment properly accounts for amounts paid to acquire, produce, or improve tangible property that were computed under the taxpayer's prior method and previously deducted under section 162;
  2. Determine if the section 481(a) adjustment(s) resulting from any prior year change was taken into account; and
  3. Consider the accuracy of the section 481(a) adjustment.

Contacts

For further guidance regarding this directive, please contact a member of the LB&I Issue Practice Groups for Deductible and Capital Expenditures or Methods of Accounting and Timing.

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

cc:  Division Counsel, LB&I
      Chief, Appeals



 [1] For guidance on claims or amended returns, you should consult with the Deductible and Capital Expenditures Issue Practice Group. 

 

Page Last Reviewed or Updated: 14-Feb-2014