Repairs and Maintenance Costs Method Change Designated Tier I Issue

By John Salza, J.D., Milwaukee, WI, and Kathleen Meade, CPA, MST, New York, NY

Procedure & Administration

The IRS Large and Mid-Size Business (LMSB) Division has issued two industry director directives (IDDs) relating to situations in which a taxpayer changes its method of accounting to recharacterize costs previously capitalized under Sec. 263(a) as deductible repairs and maintenance expenses under Sec. 162. The first directive, IDD No. 1 (LMSB-4-0110-001), elevates repairs method changes to a Tier I issue for IRS examination purposes, a step that practitioners have long anticipated. The second directive, IDD No. 2 (LMSB-4-0110-002), issued concurrently with IDD No. 1, provides guidance to the field to effectively utilize resources in the examination of a taxpayer that changes its method of accounting to recharacterize previously capitalized costs as deductible repairs and maintenance expenses under Sec. 162.


Introduced in 2006 as an element of LMSB issue management strategy, issue tiering is intended to strengthen the LMSB’s ability to identify and prioritize certain issues in a coordinated manner, thereby providing consistent treatment among taxpayers. Tier I issues are of high strategic importance to the LMSB, have a significant impact on one or more industries, and generally involve a large number of taxpayers, a significant dollar amount, a substantial compliance risk, or high visibility. The IRS places issues in this category if it has an established legal position or LMSB directive published on the issue. In May 2008, the IRS issued a memorandum (LMSB-4-0509-019) notifying LMSB executives of an emerging issue relating to the recharacterization of costs previously capitalized under Sec. 263(a) as currently deductible repairs under Sec. 162. Citing a significant increase in Form 3115, Application for Change in Accounting Method, filings since mid-December 2008, many involving substantial Sec. 481(a) adjustments, the memorandum was widely viewed by practitioners as the first step toward elevating repairs method changes as a tier issue for IRS examination purposes. (For more on LMSB-4-0509-019, see Kay, “LMSB Identifies New Repairs Issue,” 41 The Tax Adviser 15 (January 2010).)

In August 2009, this view was further reinforced when the IRS unexpectedly added the repairs method change to the list of automatic changes outlined in the appendix of Rev. Proc. 2008-52 (see Rev. Proc. 2009-39), but only under the added conditions that a third copy of the application be filed with the Ogden service center (presumably to enable better tracking by the IRS) and a mandatory statement containing various representations and additional disclosures be included with the method change application on Form 3115.

Consistent with rulings issued under the advance consent procedures, the terms and conditions governing automatic consents for repairs method changes explicitly state that no ruling is made regarding the appropriateness of the unit of property (UOP) used to determine the deductibility of repair costs and that the director (i.e., exam division) will ascertain whether the taxpayer’s determination of the UOP is correct. On January 22, 2010, the IRS issued the long-awaited guidance designating the repairs method change as a Tier I issue and providing direction to field agents on the examination of taxpayers that change their method of accounting to recharacterize previously capitalized costs under Sec. 263(a) as deductible repairs and maintenance under Sec. 162, the key points of which are discussed below.

IDD No. 1

The IRS issued the first IDD on January 22, 2010, designating as a Tier I issue situations in which a taxpayer changes its method of accounting to recharacterize previously capitalized costs under Sec. 263(a) as deductible repairs and maintenance under Sec. 162. As a consequence of the Tier I designation, examiners who encounter the issue are now required to address it during the risk analysis process to determine whether it will be examined and must use designated tracking codes when examining the issue.

If it is determined that the issue will be examined, the appropriate industry and/or capitalization technical adviser must be contacted for assistance in developing the issue. In addition, the involvement of an engineer and computer audit specialists may be required in certain cases to address specific technical and statistical sampling issues. The directive reminds field agents that neither the granting of automatic consent under Rev. Proc. 2008-52 nor the granting of advance consent under Rev. Proc. 97-27 precludes examiners from auditing the issue of whether certain expenses are deductible repair costs or costs that the taxpayer should capitalize.

With respect to the risk assessment and examination approach required under the IRS tiering process, the directive instructs examiners to first review the taxpayer’s determination of the UOP because that determination can affect whether a project should be accounted for as a repair (deductible) or as an improvement (capitalizable). In addition to the UOP determination, examining agents are advised to apply Secs. 263(a), 263A, and 162 as well as other legal authorities to the specific projects and underlying expenditures incurred in each year. However, in applying Sec. 263(a), examiners are cautioned that the current version of the proposed regulations on treatment of amounts paid to acquire, produce, or improve tangible property (REG-168745-03, issued in March 2008 and currently in the process of being rewritten) may not be cited or relied on until issued in final format, at which point they will be applied on a prospective basis only.

Noting that the UOP determination varies based on the type of property and that certain issues are industry specific, the directive suggests grouping industries with similar issues, such as the following:

  • UOP issues present in all industries;
  • Regulated industries with network assets (e.g., utilities, telecommunications, and railroad industries); and
  • Remodeling and renovation issues common to the gaming, retail, restaurant, and hospitality industries.

Finally, the directive refers exam teams to the concurrently issued IDD No. 2 (discussed below) for more information and examination guidance on this issue.

IDD No. 2

The second directive provides guidance to IRS field agents when examining taxpayers that have the newly designated Tier I issue pertaining to an accounting method change to recharacterize previously capitalized costs as deductible repairs and maintenance under Sec. 162. Specifically, the second directive reiterates the point made in IDD No. 1 that examiners are not precluded from auditing an issue simply because the IRS National Office has granted advance or automatic consent for the change. In particular, the directive notes that the terms and conditions governing accounting method changes for this issue explicitly state that no determination is made by the IRS National Office as to whether the taxpayer is using the appropriate UOP in assessing the deductibility of repair and maintenance costs and that the director (i.e., exam division) will ascertain whether the taxpayer’s determination of its UOP, and the application of that UOP to specific expenditures, is correct. Accordingly, examiners are directed that they may challenge any factual representations made by a taxpayer in auditing this issue, including (but not limited to) a taxpayer’s determination of a UOP and the determination that specific costs qualify for deduction or capitalization under current law.


As noted, the elevation of the repairs method change to Tier I status has been widely anticipated by tax professionals, and the new directives reiterate the key points outlined in the previously released LMSB emerging issue memorandum (LMSB-04-0509-019). Therefore, the new directives primarily provide a uniform format and approach for examiners to evaluate potential compliance risk related to the issue, outline the established issue management and oversight process, and provide audit guidelines.

Accordingly, taxpayers that have made method changes for this issue and taken positions inconsistent with authoritative guidance, or that have not sufficiently documented the legal authority for positions taken (e.g., the determination of the UOP and the mandatory statement disclosures and representations enumerated in the appendix, Section 3.06 of Rev. Proc. 2008-52), should review the new directives and take any necessary corrective action (e.g., compile missing documentation and legal authority, apply for a voluntary method change to adopt compliant accounting methods) in order to be prepared to respond to information requests and defend their positions on exam.

Editor: Kevin D. Anderson, CPA, J.D.


Kevin Anderson is a partner, National Tax Services, with BDO Seidman, LLP, in Bethesda, MD.

For additional information about these items, contact Mr. Anderson at (301) 634-0222 or

Unless otherwise noted, contributors are members of or associated with BDO Seidman, LLP.

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.