The Unit of Property (UOP) concept is not new, but the rules are new to The Tangible Property Regulations under § 1.263(a).
In the past, the regulations did not define property for the purposes of determining whether an expenditure after an asset is placed into service adds value to the property, extends the useful life of the property, or adapts the property to a new or different use. If any of these facts are true, the expenditure generally must be capitalized.
In the early 2000s, the courts agreed that to determine whether there had been an improvement, it was first necessary to define the improved property.
FedEx Corp v. the United States, Smith v. Commissioner, and Ingram Industries, Inc. v. Commissioner were just a few of the many court cases that determined that a comparison must be made before a depreciation or expense decision can be made.
While the application of these court cases was primarily on personal property, the final Tangible Property Regulations define the UOP for most property types, including buildings.
Determining whether there is an improvement to a property is a two-step process.
First, the UOP is established.
Under The Tangible Property Regulations, the property’s size is unimportant. A building can be very small or very large. No matter the size, each building and its structural components are a single UOP.
Second, the facts and circumstances are considered to determine whether the work constitutes a betterment to that UOP.
Taxpayers have been applying rules to capitalize and then depreciate tangible property for years. Under the final regulations, the taxpayer must consider certain building systems separate from the building structure in determining whether an improvement has occurred to the building. These building systems are further broken down into components that serve a discreet and critical function.
As a side note, building systems do not define whether the expenditure must be capitalized or expensed. Therefore, if your cost segregation provider is telling you otherwise, they are incorrect and show a lack of basic tax knowledge at this firm.
Kevin Jerry is a nationally recognized expert in Tax Method Changes. He specializes in Cost Segregation, Tangible Property Regulations, and revenue recognition changes. Kevin graduated cum laude from the University of Cincinnati with a Master of Science in Real Estate Taxation. Over the last seven years, he has worked with Eric Wallace on the Tangible Property Regulations with some of the largest property owners in the country.