New Audit Techniques Guide for Capitalization of Tangible Property

By Debbie Shi, CPA, Chicago, and Tracy Watkins, J.D., LL.M., Washington

Editor: Greg A. Fairbanks, J.D., LL.M.

The IRS's Large Business and International (LB&I) division released its latest Audit Techniques Guide (ATG) for examining the capitalization and disposition of tangible property on Sept. 14, 2016. The ATG, Capitalization of Tangible Property, serves as a tool for IRS examiners to aid in the identification of potential tax issues and risk areas to ensure compliance with the final tangible property regulations and disposition regulations.

The Final Regulations

After a turbulent proposal and comment process, the IRS issued the final tangible property regulations in 2013, providing guidance on when costs incurred to acquire, produce, or improve tangible property must be capitalized or may be deducted (T.D. 9636). In 2014, the IRS addressed dispositions of tangible depreciable property and general asset accounts with the release of the final disposition regulations (T.D. 9689). The final regulations generally require taxpayer compliance for tax years beginning on or after Jan. 1, 2014. Taxpayers may elect to apply the final regulations to tax years beginning on or after Jan. 1, 2012.

Exam Activity

As the issuance of the final regulations drew closer, LB&I directed examiners on March 15, 2012, to "stand down" or cease all examination activity for tax positions taken on original returns for costs incurred to maintain, replace, or improve tangible property and any related issues involving dispositions (LB&I Directive 04-0312-004). The directive aimed to conserve exam resources and allow time for taxpayers to comply with the final regulations. The stand-down period ended when:

1. A taxpayer filed a method change for an item covered by the directive for a tax year beginning on or after Jan. 1, 2012, but before Jan. 1, 2014; or

2. The taxpayer filed its tax return for the first tax year beginning on or after Jan. 1, 2014.

The ATG provides guidance to IRS examiners for audits initiated following the stand-down period.

The Audit Techniques Guide

The ATG contains 18 chapters and covers topics outlined in the final regulations. Before diving into the details of the final regulations and related method change issues, the ATG provides an introductory chapter with a brief history of the capitalization of tangible property, including relevant case law and the evolution of the regulations, spanning the proposed, temporary, and final stages. This section also contains a helpful chart of general terminology used throughout the ATG with citations to the final regulations.

The next chapter in the ATG discusses compliance considerations related to the implementation of the final regulations. Specific areas of focus include but are not limited to capitalization-to-repair studies for prior years, industry-specific guidance, basis adjustment considerations, and coordination with other Code sections (Secs. 199 and 263A).

The remaining chapters in the ATG examine the following topics related to the final regulations:

  • Unit of property (chapter 3);
  • Amounts paid to acquire or produce property (chapter 4);
  • De minimis safe harbor (chapter 5);
  • Improvement rules—betterments, restorations, new or different use (chapters 6-8);
  • Safe harbors—special rules—other provisions (chapter 9);
  • Materials and supplies (chapter 10);
  • Leased property (chapter 11);
  • Dispositions (chapters 12-14);
  • General asset accounts (chapter 15); and
  • Accounting method changes (chapters 16-18).

The main body of the ATG outlines the general rules and definitions related to each chapter's topic, followed by audit procedures to assist examiners with identifying potential audit issues, assessing audit risk, and evaluating other examination considerations. Audit procedures common to the ATG's various chapters include the following, among others:

  • Review Form(s) 3115, Application for Change in Accounting Method, for compliance with the final regulations;
  • Examine the taxpayer's present and proposed method(s) of accounting;
  • Consider whether the taxpayer made the appropriate election(s) for applicable entities;
  • Review Sec. 481(a) adjustment computations;
  • Review sampling methodologies for reasonableness;
  • Review policies and procedures regarding asset capitalization and dispositions;
  • Review applicable financial statements, SEC filings (i.e., Form 10-K), annual reports, and tax returns;
  • Review public sources of information related to the taxpayer (i.e., news releases, legal proceedings related to tangible property);
  • Review Schedules M; and
  • Conduct interviews with relevant personnel.
Conclusion

The ATG summarizes the final tangible property regulations and disposition regulations. While the ATG is intended to serve as a guideline, it provides taxpayers with valuable insights into specific issues that the IRS may scrutinize upon exam. Taxpayers should review the ATG to ensure that proper documentation exists to support compliance with the final regulations. Taxpayers familiar with the regulations should not expect major surprises, as the ATG primarily recaps topics covered in the final regulations and raises relevant questions to evaluate compliance.

EditorNotes

Greg Fairbanks is a tax managing director with Grant Thornton LLP in Washington.

For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or greg.fairbanks@us.gt.com.

Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.

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