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Q&A on The Tangible Property Regulations

Questions from the Webinar on August 2, 2022

  • Why are the Regulations being ignored?
    The Tangible Property Regulations are extremely difficult to understand and even more challenging to implement. Our best guess is that the Regulations take at least 800 hours to learn. As a result, most Tax Professionals defer to the old and seemingly conservative method of depreciating any expenditure above the dollar threshold set up for each client. For example, an expenditure over $5,000 is depreciated, and any expenditure under $5,000 is capitalized. Unfortunately, not only does this cause the taxpayer to overpay taxes, but it also is not compliant with US Tax Code. 
  • How is the Service Enforcing the Tangible Property Regulations?
    Right now, they seem to be focusing on the largest corporations in the country. However, several court cases, like the Churchill case, give the Service plenty of time to get to the smaller taxpayers. The Churchill case allows the Service to audit an incorrectly depreciated asset over the asset’s entire class life. That means the IRS has twenty-seven or thirty-nine years to conduct an audit. 
  • What happens if the Service audits a depreciation schedule and finds a depreciated asset which should have been expensed?
    This question is crucial. Under §1016-3, the IRS has the legal right to DISALLOW ALL FUTURE DEPRECIATION ON THAT ASSET. That is draconian, to be sure, but a taxpayer MUST take what is allowed or allowable. 
  • My CPA says that the IRS does not audit depreciation schedules.
    According to reliable sources, the IRS is now auditing the schedules of the largest corporations. Also, now that the IRS has a reason to audit schedules and impose penalties and interest on incorrectly depreciated assets, we can all be confident that IRS will eventually look at smaller taxpayers’ schedules.
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  • I replaced a large roof membrane on a retail center in 2019. Can I take the PAD you spoke about?
    No. You can only take a PAD in the tax year you replaced the membrane. Unfortunately, you are now continuing to depreciate the old membrane AND the new membrane. The old membrane is called a ghost asset. You could have expensed the remaining basis of the old membrane in 2019. However, if the membrane was the only portion of the roof replaced, there is a good chance we can go back and expense it.
  • Do the Tangible Property Regulations apply to single-family residential rentals?
    Absolutely. Many short-term rental owners (Airbnb types of arrangements) are now educated on the Regulations and applying them whenever a repair needs to be made. 
  • How do the Tangible Property Regulations determine if my new HVAC system is a betterment?
    Excellent question. Remember, the Regulations have four major tests (this is an over-simplification, there are actually twelve additional sub-tests). The examples in the Regulations state that if the expenditure materially increases the efficiency, strength, size, or output, it must be depreciated. However, the examples do not have bright lines. The word “material” can be subjective. One example states that an efficiency increase of fifty percent must be capitalized. Another example states that an efficiency increase of ten percent must be expensed. The gray area in between is why you need TPTM to help you make that determination.
  • Does your firm work with my CPA?
    Yes! We are not in the business of doing tax returns, nor are we interested in stealing your CPA’s hard-earned clients. Instead, we want to partner with your CPA and help them with all of their clients who own real estate.

You can learn more about the Tangible Property Regulations here.