2/17/2015 Update: Information about our e-book appears at the bottom of page—and that ebook has been updated to reflect Revenue Procedure 2015-20. You can get more information on the new revenue procedure here.
Probably every accountant in our firm is nervous about me doing this.
But due to a number of requests from fellow CPAs, I’m going to share our approach for complying with the IRS’s requirement that taxpayers request permission to change their accounting method to comply with the new Sec. 263 and Sec. 162 Tangible Property Regs.
Some Quick Background Info
Let me quickly give you some background so you understand why taxpayers and their accountants need to deal with this mess. (Some readers are presumably new to the discussion.)
A while back, the Internal Revenue Service issued new regulations that require people to account for repairs and maintenance expenditures differently. The rules of the game changed, in other words. (For more information about how the rules changed, refer here and here.)
The rub in all this is you can’t simply change the way you do your accounting. You do need to do that. But you need to request permission to make the change. (I know… crazy.)
How a 3115 Request Works
To request permission to change your accounting for repairs and maintenance expenditures, you fill out a 10-page 3115 form. You then print two copies, filing one with your tax return and one with the Internal Revenue Service Center in Ogden Utah.
I know what you’re thinking. Why do they need two copies? Good question.
But now that we’re into this, I may as well mention that you probably won’t file one 3115 form. You’ll probably need to file more than one.
We’re finding most of our clients need to file at least a “code 184” 3115 to request permission to change the way that repair and maintenance expenditures are handled and also to change the capitalization procedures for tangible property improvements, for example.
And then we’re also finding that most clients also need to also file a “code 192” 3115 to request permission to change the way that asset acquisition and production costs are capitalized.
You or your clients may have other Form 3115s to file, too.
Why You Should Jump Through this Hoop
Okay, first, let me say this. Most tax accountants think this process you’re supposed to step through is crazy to force on small businesses and mom and pop real estate investors. (Read about the letter the AICPA wrote to the IRS, for example.)
And some tax accountants think the requirement to request an accounting method change is so absurd as to not merit any response (other than maybe a letter to one’s elected representatives).
I get all that. Emotionally, I am right there with those people.
But I think you have two strong reasons to prepare and file 3115s with your 2014 tax return.
First reason: The IRS expects 3115s, and as a result, many CPAs think that returns without a 3115 or two, since they’re obviously incomplete, should bear more audit risk.
A second reason: This year, you automatically get permission to change your accounting method. In other words, for 2014, a quick and easy automatic consent should occur. If you dilly dally and want to deal with this stuff later on, things may not go so smoothly.
In worst case scenarios, you could lose deductions because you botched the accounting method change. And you could face expensive fees for making the change late.
Tips for Learning the New Regs
If you’re a CPA or enrolled agent preparing the 3115 form, you should read the roughly 100-pp of regulations (see here for the Sec. 1.263 regs for example). That’s really the obvious first step.
If you’ve got a tax practitioner’s guide such as the popular QuickFinder series, I would also recommend reading through the very synoptic treatment provided in the Small Business edition of the QuickFinder. (The QuickFinder folks did an excellent job.)
Beyond that—and now we get down to brass tacks—I would suggest you prepare a few 3115s to see that the process doesn’t have to take that long.
Completing the 3115 Form(s) For the New Regs
For most small businesses, to prepare a 3115 for a “code 184” change, for example, you answer the questions asked in Part I, II, III and V on pages 1 through 3 of the form and then leave empty the questions and blanks on pages 4 through 9. (Note: the revenue procedures linked to above have the complete explanation of which taxpayers need to answer which questions on the form.)
Pretty straight forward, right? I think so.
Note that within Part II you answer questions that require additional statements. For example, you’ll need to describe what item you’ll be handling differently—for example, “repairs and maintenance expenses.” And you need to describe your old method and your new method.
In many cases with our clients, we believe a client’s “old” accounting method was the “proper” old regulation’s method and so use this description in our statement:
-REPAIRS AND MAINTENANCE EXPENSE ACCOUNT-
Cost of incidental repairs which neither materially add to the value of a property nor appreciably prolong its life, but keep a property in an ordinarily efficient operating condition, are deducted per former Treas. Reg. § 1.162-4.
Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of a property, are capitalized per former Treas. Reg. § 1.162-4.
And then our statement indicates that we want to use the “new” accounting method required by the new regulations, as shown here:
-REPAIRS AND MAINTENANCE EXPENSE ACCOUNT-
Deducting repairs costs in accordance with Treas. Reg. § 1.162-4.
Deducting routine maintenance costs which fall under the new safe harbor rules for routine maintenance described in Treas. Reg. § 1.263(a)-3(i).
Deducting costs for repairs, maintenance, improvements, and similar activities performed on eligible buildings when such treatment is permissible under the new safe harbor rules for small taxpayers described in Treas. Reg. § 1.263(a)-3(h).
Adopting the new capitalization rules for improving tangible property described in Treas. Reg. § 1.263(a)–3, except in such circumstances where the costs may be treated under the rules described in Treas. Reg. § 1.263(a)-3(h) (safe harbor for small taxpayers).
- Change to capitalizing costs for betterments, improvements, and restoration costs when such costs do not fall under the safe harbor for small taxpayers [§ 1.263(a)–3].
- Change to deducting certain costs for building property when such treatment is permissible under the safe harbor for small taxpayers [§ 1.263(a)-3(h)].
Again, this is all sort of irritating to have to do. But the work is mostly repetitive and copy and paste. And if there’s anything “good” about this 3115 stuff for the CPAs, it’s this: You should be able to have a staff accountant do most of the work.
Thinking about the Sec. 481 Adjustments
One final point to make is this: While often an accounting method change requires a “catchup” adjustment to make sure that income and expenses are not double-counted or and to make sure that no income or deduction item is omitted, we think in many cases, small businesses won’t have to calculate one of these adjustments.
Here’s why: For years now, many small businesses have been using a combination of bonus depreciation and Sec. 179 elections to expense assets. This combination means that stuff doesn’t get capitalized.
Which all brings us back to the question , “Why did the IRS decide to make small businesses do this?”
But you know what? Probably best to get up to speed on this tax law change and try to comply as best you can.
Would You Like More Information and Example 3115s?
With the issuance of Revenue Procedure 2015-20 (which appeared on February 13, 2015) many small businesses may decide not to worry about preparing and filing 3115 forms for the new TRPs. (See here for our post about the revenue procedure.)
However if you have taxpayers that need to file 3115s in response to the TPRs–perhaps to deal with late partial dispositions for example–you may interested in our ebook on the subject.
After originally writing this blog post, our CPA firm offices received requests from dozens of CPAs, EAs and small tax accounting firms to provide more detailed information about the preparation of Form 3115 for small businesses and real estate investors.
Accordingly, we’ve prepared a short, 60pp e-book. This downloadable e-book explains how the new regulations change the way small taxpayers need to do their accounting for tangible property deductions and then outlines an approach to complying with new regulations with a minimum amount of fuss and handwringing.
The e-book also provides three sample, completed 3115 forms for the most common (and perhaps the only) accounting method change requests small taxpayers will need to make… and also a sample accounting policy which should help a small taxpayer stay in compliance in the future. For $100, you can purchase and immediately download this e-book. Click the button here to make your purchase:View Cart
And an important note: We’re providing a money-back guarantee… if you don’t find our e-book saves you several hours of time and lets you easily prepare 3115s (for which you should be able to charge some multiple of the price you pay for the book) just email us and ask for a refund.