SECTION 263 TANGIBLE PROPERTY REGULATIONS (TPR) AND THE FORM

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1 SECTION 263 TANGIBLE PROPERTY REGULATIONS (TPR) AND THE FORM 3115 Every effort has been made to ensure the accuracy of the materials, neither he author nor the NSTP assumes any responsibility for any individual s reliance on the information provided. Each participant should verify independently the information provided before relying on them and asses the tax and other consequences of using the particular strategy, technique or suggestion before recommending the same to a client or implementing the same on a client s behalf. This document covers the issues most likely to be encountered by the small business/rental client. There are many other consideration for the large entity that should be researched further to determine the tax treatment for those entities. HISTORY OF THE REGULATIONS: The new regulations were introduced in 2011 to much discussion and discontent. The IRS reviewed the new regulations ad issued final regulations in September of 2013 which were effective with the filing of the 2014 business tax returns. So what are these new regulations and what do they mean? The regulations were issued to standardize the treatment of expenditures for repairs, improvements, betterments, and restoration. Several issues must be addressed with your client to correctly assess the treatment of these expenditures: Do you have a capitalization policy? How do you determine when an expenditure is a repair? Do you keep inventory on any of your materials and supplies? Do you have rotable spare parts? The IRS has determined that any repair or maintenance expenditure which is considered betterment, restoration or an adaption of an asset or property to like new condition must be capitalized. If it is part of a building then it adopts the life of that building, in other words 39 years for commercial property and 27 ½ years for residential rental property. The IRS has set several safe harbors that small business can use. Namely that the entity has been consistent in expensing repairs and maintenance; that the item purchased is less than $500 or will last less than a year; and, the entity has established a formal accounting policy. Any routine maintenance costs can still be expenses known as the Routine Maintenance Safe Harbor. These would be costs that are needed to maintain the property in a reasonable, efficient manner. Changing the oil in a delivery truck every 6,000 miles or so is routine maintenance. However repairing the air conditioning unit or replacing the tires is not considered routing maintenance and those costs would be capitalized. And finally, there is a Small Taxpayer Safe Harbor which stats that if you have spent less than the lesser of $10,000 or 2% of the original cost than those expenditures can be expensed.

2 NEW REGULATIONS : (ii) The determination of the amount properly allowable for exhaustion, wear and tear, obsolescence, amortization, and depletion must be made on the basis of facts reasonably known to exist at the end of the taxable year. A taxpayer is not permitted to take advantage in a later year of the taxpayer s prior failure to take any such allowance or the taxpayer s taking an allowance plainly inadequate under the known facts in prior years. In the case of depreciation, if in prior years the taxpayer has consistently taken proper deductions under one method, the amount allowable for such prior years may not be increased, even though a greater amount would have been allowable under another proper method. For rules governing losses on retirement or disposition of depreciable property, including rules for determining basis, see 1.167(a)-8, 1.168(i)-1T (e), 1.168(i)-8T, Prop. Reg (i)-1(e) (September 19, 2013), or Prop. Reg (i)-8 (September 19, 2013), as applicable. The application of this paragraph is illustrated by the following examples (for purposes of this example, assume section 167(f)(1) as in effect on September 19, 2013, applies to taxable years beginning on or after January 1, 2014): Example On July 1, 2014, A, a calendar-year taxpayer, purchased and placed in service off-the-shelf computer software at a cost of $36,000. This computer software is not an amortizable section 197 intangible. Pursuant to section 167(f)(1), the useful life of the computer software is 36 months. It has no salvage value. Computer software placed in service in 2014 is not eligible for the additional first year depreciation deduction provided by section 168(k). A did not deduct any depreciation for the computer software for 2014 and deducted depreciation of $12,000 for the computer software for As a result, the total amount of depreciation allowed for the computer software as of December 31, 2015, was $12,000. However, the total amount of depreciation allowable for the computer software as of December 31, 2015, is $18,000 ($6,000 for 2014 $12,000 for 2015). As a result, the unrecovered cost of the computer software as of December 31, 2015, is $18,000 (cost of $36,000 less the depreciation allowable of $18,000 as of December 31, 2015). Accordingly, depreciation for 2016 for the computer software is $12,000 (unrecovered cost of $18,000 divided by the remaining useful life of 18 months as of January 1, 2016 multiplied by 12 full months in 2016). THE BASICS: Supplies any purchases under $200 or with a useful life of 12 months or less are supplies. If a business has a policy for expensing vs. capitalizing then can use the de minimis safe harbor that allows expensing up to $500 (the safe harbor amount for business with a GAAP statement is $5,000). And then a distinction needs to be made as to whether they are incidental, nonincidental or rotable and temporary spare parts. Improvements to Buildings the new example of improvements is if it better the property, restores it, or adapts it to a new or different use. The new rules define building improvements and buildings systems and that any improvements to a building system is an improvements to the building as a whole. For purpose of capitalizing and the improvement the building is considered to be a single unit of property.

3 Unit of Property if a building owner pays for betterment, restoration or adapts any of the building systems, they have also affected the building as a whole and therefore the cost must be capitalized and not expensed. For example an argument may have been made in the past that renovating an air conditioning system did not necessarily improve the building as a whole and the repairs would be expensed. However, under the new rules the building is now a unit of property as a whole and any work performed on any of the building is now a unit of property as a whole and work performed on any of the building systems also improves the building structure and therefore needs to be capitalized. Building structure includes o The building o Building structural components not include in the list of building systems Building systems includes o HVAV systems o Plumbing systems o Electrical systems o Escalators o Elevators o Fire-protection and alarm systems o Security systems for the protection of the building and its occupants o Gas distribution systems o Other structural components as designated in the Internal Revenue Bulletin Unit of Property as it related to Personal Property the new regulations include the concept of functional interdependence when applying the unit of property to property other than buildings. For example if you own the cab to pull a tractor trailer you cannot separate the engine from the tires from the overall cab structure. They are all functionally interdependent and cannot be separated for purposes of avoiding the new regulations. In the case of plant property, a unit of property is comprised of each component (or group of components) within the unit of property that performs a discrete and major function or operation within the functionally inter-dependent machinery or equipment. Components of property are functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayer.

4 This follows the anti-abuse rule: If you need all the parts of a machine together for the machine to work, then it s one machine (and thus one unit of property ). So no playing games with breaking apart the different pieces of the machine into different assets. Examples: 1. Able owns an office building that contains a HVAC system. The HVAC system incorporates ten roof-mounted units that service different parts of the building. The roofmounted units are not connected and have separate controls and duct work that distribute the heated or cooled air to different spaced in the building s interior. Able pays an amount for labor and materials for work performed on the roof-mounted units. Under paragraph (e)(2)(i) of this section, Able must treat the building and its structural components as a single unit of property. As provided under paragraph (e)(2)(ii) of this section, an amount is paid to improve a building if it is for an improvement to the building structure or any designated building system. Under paragraph (e)(2)(ii)(b)(1) of this section, the entire HVAC system, including all of the roof-mounted units and their components, comprise a building system. Therefore, under paragraph (e)(2)(ii) of this section, if an amount paid by Able for work on the roof-mounted units is an improvement (for example, a betterment) to the HVAC system, Able must treat this amount as an improvement to the building. 2. Bob owns a building that it uses in its retail business. The building contains two elevator banks in different locations in its building. Each elevator bank contains three elevators. Bob pays an amount for labor and materials for work performed on the elevators. Under paragraph (e)(2)(i) of this section, Bob must treat the building and its structural components as a single unit of property. As provided under paragraph (e)(2)(ii) of this section, an amount is paid to improve a building if it is for an improvement to the building structure or any designated building system. Under paragraph (e)(2)(ii)(b)(5) of this section, all six elevators, including all their components, comprise a building system. Therefore, under paragraph (e)(2)(ii) of this section, if an amount paid by Bob for work on the elevators is an improvement (for example, a betterment) to the elevator system, Bob must treat this amount as an improvement to the building.

5 3. Carl has a laundering line comprising a sorter, boiler, washer, dryer, ironer, and folder. Because the laundering line is deemed to be an industrial process, it is defined as plant property. Each component that performs a discreet and major function is to be treated as a separate unit of property. Effectively, each sorter, boiler, washer, dryer, ironer, folder is a separate unit-of-property. The final repair regulations stat the unit of property for plant property used to perform an industrial process generally is comprised of each component (or grouping of components) within the plant that performs a discrete and major function or operation within functionally interdependent machinery and equipment. 4. David operated a restaurant with an assembly line system that prepares and cooks tortillas. The unit of property is the entire tortilla cooking line because the various components of the cooking line are functionally interdependent. Although the equipment is used to perform a manufacturing process, the equipment is not being used in an industrial process, as it performs a small-scale function as a part of David s retail restaurant operations. Therefore, it is not considered plant property. Safe Harbor Guidelines: Safe Harbor for small taxpayers: if the total amount during the year for repairs, maintenance, and improvements on an eligible business does not exceed the lesser of $10,000 or 2% of the unadjusted basis of the building then the amount paid do not need to be capitalized. A small taxpayer is defined as having average gross income (based on the last three years) that falls under $10 million. Safe Harbor for routine maintenance: this includes any recurring activity to keep the building or property other than building in good operating condition and may include o The inspection, cleaning, and testing of the building structure or any of its systems o The replacement of damaged or worn parts with comparable and commercially available replacement parts o The inspection, cleaning and testing of the unit of property o The replacement of damaged or worn parts of the unit of property with comparable and commercially available replacement parts Facilitative Cost Rules: All amounts paid to facilitate the acquisition of tangible property must also be capitalized. Taxpayers do not have to capitalize the amounts paid for non-facilitative

6 costs connected to real property. These may include the costs incurred to research whether or not to acquire the property and which real property to acquire. Following is the list provided by Treasury that are considered inherently facilitative amounts: Transporting the property (for example, shipping fees and moving costs) Securing an appraisal or determining the value or price of property Negotiating the terms or structure of the acquisition and obtaining tax advice on the acquisition Application fees, bidding costs, or similar expenses Preparing and reviewing the documents that effectuate the acquisition of the property (for example, preparing the bid, offer, sales, contract, or purchase agreement) Examining and evaluating the title of property Obtaining regulatory approval of the acquisition or securing permits related to the acquisition, including application fees Conveying property between the parties, including sales and transfer taxes and title registration costs Finders fees or brokers commissions, including contingency fees Architectural, geological, survey, engineering, environmental, or inspection services pertaining to particular properties Services provided by a qualified intermediary or other facilitator for an exchange Partial Dispositions of Assets the building owner is now able to accelerate the depreciation of partial dispositions rather than waiting for when the full asset is disposed. SECTION 481 ADJUSTMENTS: The new regulations may also require a catch-up adjustment so that income and/or expenses are not double-counted or an item is omitted in the accounting change. This is generally not necessary for those small businesses that have been using a combination of Section 179 and bonus depreciation to fully write off assets. If the change in accounting period results in a positive 481(a) adjustment that is less than $50,000 than the taxpayer may make a 481(a) de minimis election. The election is made by completing the Form 3115 and take the entire 481(a) adjustment into account in the year of the change when the entity implements the change in method of accounting. Note that a 41(a) adjustment for either repairs or maintenance that should not have been capitalized or for partial or prior dispositions may also result in AMT or state adjustments as well. For a business return the 481(a) would be reported for the applicable asset. On the Form 1040 report the adjustment on the Other Income line on the applicable Schedule C, Schedule E or Schedule F.

7 481 (a) General rule In computing the taxpayer s taxable income for any taxable year (referred to in this section as the year of the change ) (1) if such computation is under a method of accounting different form the method under which the taxpayer s taxable income for the preceding taxable year was computed, then (2) there shall be taken into account those adjustments which are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or omitted, except there shall not be taken into account any adjustment in respect of any taxable year to which this section does not apply unless the adjustment is attributable to a change in the method of accounting initiated by the taxpayer. (b) Limitation on tax where adjustments are substantial If (1) Three year allocation (A) the method of accounting from which the change is made was used by the taxpayer in computing his taxable income for the 2 taxable years preceding the year of the change, and (B) the increase in taxable income for the year of the change which results solely by reason of the adjustments required by subsection (a)(2) exceeds $3,000, then the tax under this chapter attributable to such increase in taxable income shall not be greater than the aggregate increase in the taxes under this chapter (or under the corresponding provisions of prior revenue laws) which would result if one-third of such increase were included for each of the 2 preceding taxable years. If (2) Allocation under new method of accounting (A) the increase in taxable income for the year of the change which results solely by reason of the adjustments required by subsection (a)(2) exceeds $3,000, and (B) the taxpayer establishes his taxable income (under the new method of accounting) for one or more taxable years consecutively preceding the taxable year of the change for which the taxpayer in computing taxable income used the method of accounting from which the change is made, then the tax under this chapter (or under the corresponding provisions of prior revenue laws) which would result if the adjustments required by subsection (a)(2) were allocated to the taxable year or years specified in subparagraph (B) to which they are properly allocable under the new method of accounting and the balance of the adjustment required by subsection (a)(2) was allocated to the taxable year of the change. (3) Special rules for computations under paragraph (1) and (2) For purposes of this subsection (A) There shall be taken into account the increase and decrease in tax for any taxable year preceding the year of the change to which no adjustment is allocated under paragraph (1) or (2) but which is affected by a net operating loss (as defined in section 172) or by a capital

8 loss carryback or carryover (as defined in section 1212), determined with reference to taxable years with respect to which adjustments under paragraph (1) or (2) are allocated. (B) The increase or decrease in the tax for any taxable year for which an assessment of any deficiency, or a credit or refund of any overpayment, is prevented by any law or rule of law, shall be determined by reference to the tax previously determined (within the meaning of section 1314(a)) for such year. (C) In applying section 7807(b)(1), the provisions of chapter 1 (other than subchapter E, relating to self-employment income) and chapter 2 of the Internal Revenue Code of 1939 shall be treated as the corresponding provisions of the Internal Revenue Code of (c) Adjustment under regulations In the case of any change described in subsection (a), the taxpayer may, in such manner and subject to such conditions as the Secretary may be regulations prescribe, take the adjustments required by subsection (a)(2) into account in computing the tax imposed by this chapter for the taxable year or years permitted under such regulations. WHAT ABOUT FULLY DEPRECIATED ITEMS: Fully depreciated 1245 property with the proper class lives is not affected Fully depreciated 1250 property that should not have been capitalized will need an adjustment Fully depreciated prior year capitalized items that should have been expensed can by removed from the depreciation schedule and are not subject to the recapture rules. Correcting the class life would trigger a method 7 filing requirement. For example: the entity capitalized the replacement of all furnaces in the building as 7 years property. They were installed 10 years ago and have no remaining depreciation according to the tax schedule. The furnaces are part of the building structure and should be a 39 year asset, not a 7 year class property. If the entity has a 5 year asset that was incorrectly classified as a 7 year asset but took Section 179 on the full amount this would not trigger a 3115 filing. The asset is fully depreciated anyway and with Rev. Proc method 7 is no longer prohibited after an IRS audit. Verify that all bonus deprecation elections are correct. If the entity elects out of bonus depreciation it must do so for the entire class of assets. Section 179 is an asset by asset election. WHEN AND WHY A FORM 3115 WOULD BE NEEDED: The automatic accounting method described in Rev. Proc says that the accounting method changes to comply with the new tangible property regulations (TPR) will be automatic in 2014 but will require additional paperwork in future years. It is recommended that the Form 3115, which is a one-time only submission, be submitted with the filing of the 2014 returns. The Form 3115 is actually sent in twice once as a separate filing with the IRS before the tax return is submitted. This filing is sent to 1973 Rulon White Boulevard, MS 4917, Ogden, Utah The second filing is submitted with the income tax return.

9 The assumption being made with the reading of the new regulations is that the IRS is expecting the Form 3115 with every 2014 income tax return that is filed. The general sentiment form the accounting community is that it will increase the audit risk to the accountant and the business if the Form 3115 is not included. Even if you are filing the Form 3115 to notify the IRS that there is no change to the accounting period as you have been doing everything right, this will protect you in the future years. Think cover letter that is included with every compiled financial statement that is submitted to a bank or financial institution. Is the letter truly necessary? Not really, as in essence it is saying that as the accountant you are not responsible for the contents of the financial statements only that you are presenting it in a manner familiar to the financial institution. If you are uncertain extend the return! An automatic extension of 6 months from the due date of the (excluding any extension) of the federal income tax return for the year of change requested of the Form 3115 is granted to file a Form 3115 under the automatic change procedures provided by the taxpayer by either a timely filed return (including any extension) of its original federal income tax return for the year of the change or files an amended return within the 6-month extension period implementing the requested change in method of accounting for the year of the change. The original Form 3115 must be submitted with the amended federal tax return. Reporting of the new regulations on the Form 3115 may be divided into four different situations: 1. Taxpayer must file the 3115 and apply the new regulations to assets as of January 1, 2014 that are either on the depreciation schedule or should be on the depreciation as well as to all future expenditures. These filings would use the 184, 186 and 192 filings and methods. 2. Taxpayer must file the 3115 and apply the new regulations to new expenditures after January 1, These filings would generally apply to materials and supplies and use the 186 and/or 187 filings and methods. Or they may utilize the inherently facilitative rules of method The taxpayer has the option of filing the 3115 but must file if they want to take advantage of the retroactive benefits of the new regulations. 4. The taxpayer has the option of filing the 3115 for all transactions from January 1, 2014 and after. **Code 184 filing is due with the 2014 return and enables the taxpayer to adopt the repairs and maintenance threshold and take a 481(a) adjustment for all items that was capitalized but should have been expensed. **Code 186 filing allows the taxpayer to adopt the safe-harbor amount of $200 for material and supplies and for transactions after January 1, **Code 187 filing is the incidental material and supplies rule. **Code 192 is the method that allows for the proper capitalization of assets purchased and includes the definition for inherently facilitative costs.

10 **Method 7 is for any impermissible to permissible depreciation changes such as class life is not correct, bonus was handled correctly, and assets that were depreciated and should not have been or vice versa. Some of the consequences of not filing the Form 3115 may include: 1. If there are expenditures that should have been expensed but were capitalized the taxpayer would not have the option to correct the difference and would have a permanent reduction. 2. If the event of an IRS audit, the taxpayer may have permanent differences due to denied depreciation deductions. 3. The taxpayer may be unable to deduct repair and maintenance costs unless the 3115 is filed. 4. Without adopting a Accounting Policy for the entity it may limit or eliminate the ability to use the safe harbor provisions. 5. The changes for the 2014 are generally automatic and incur no filing fee PREPARING THE FORM 3115: If you are preparing a form to report a Code 184, 186, or 192 change, you would answer the questions in Parts I, II, III and V on pages 1 through 3 of the form and leave the rest of the form blank. (see samples starting on page 00) REFERENCES: If you want even more detail, refer to Treas. Reg (a)-3(j), Treas. Reg (a)-3(k) and Treas. Reg (a)-3(1). You may also want to ready TD 9636 and TD And if you really want to dig into the nitty gritty details, check out Rev. Proc , Rev. Proc and Rev. Proc For the newest change see Rev. Proc

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12 Appendix A Sample Small Business Accounting Policy for Tangible Property 12

13 Accounting Policy for Capitalizing vs. Expensing Tangible Property (Not including Inventory) POLICY IS FOR: (hereinafter referred to as the business ) Date of Adoption: Definitions Tangible property Property that can be physically touched. Tangible property include both tangible personal property and tangible real property. Tangible property does not include intangible property such as logos, copyrights, trademarks, patents, etc. Tangible personal property Any tangible property except land and improvements thereto, such as buildings or other inherently permanent structure (including items which are structural components of such buildings or structures). See Treas. Reg (c). Tangible real property Land and improvements thereto, such as buildings or other inherently permanent structures (including items that are structural components of the buildings or structures) that are not personal property. See Treas. Reg (a)-2(b)(3) and (d). When to Treat Amounts Paid for Tangible Property as Materials and Supplies Amounts paid for materials and supplies will be treated as materials and supplies expense in the business books if the amounts qualify for treatment as materials and supplies for federal income tax purposes under either Treas. Reg or its future equivalent (default materials and supplies rules) or Treas. Reg (a)-1(f)(1)(ii) or its future equivalent (de minimis safe harbor election for taxpayers without applicable financial statements). In general, this means that any amounts paid to acquire or produce tangible property will be expensed as materials and supplies in the business books if it is not inventory and if it meets at least one of the following tests: The cost of acquiring or producing the property is $500 or less The property has an economic useful life of 12 months or less, beginning when the property is used or consumed in the business operations The property is a component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or services by the business 13

14 The property consist of fuel, lubricants, water, and similar items, reasonably expected to be consumed in 12 months or less, beginning when used in the business operations There is published guidance from the Treasury or the IRS which permits taxpayers to treat the property as materials and supplies (for example, Rev. Proc on smallwares and Rev. Proc on certain inventoriable items) When to Treat Amounts Paid for Tangible Property as Repairs Amounts paid for repairs and maintenance to tangible property will be treated as repairs expense in the business books if they qualify for treatment as repairs for federal income tax purposes under Treas. Reg or its future equivalent. This means that any amounts paid to acquire or produce tangible property will be expensed as repairs in the business books if the amount is not required to be capitalized for federal income tax purposes. See the section below on improvements for guidance on when to capitalize. When to Treat Amounts Paid for Tangible Property as Routine Maintenance Amounts paid to maintain tangible property will be treated as maintenance expense in the business books if the amounts fall under the safe harbor for routine maintenance, per Treas. Reg (a)-3(i) or its future equivalent. Buildings For buildings, routine maintenance means the recurring activities that the business expects to perform as a result of the business use of the building to keep the building structure or its building systems in its ordinarily efficient operating conditions. It will not include any improvements which increase the value of the building or the building s asset life. Examples of routine maintenance for buildings include: The inspection, cleaning, and testing of the building structure or each building system The replacement of damaged or worn parts with comparable and commercially available replacement parts Routine maintenance may be performed at any time during the useful life of the building structure or building systems. However, activities are routine only if the business reasonably expects to perform the activities more than once during the 10-year period beginning at the time the building structure or the building system upon which the routine maintenance is performed is placed in service by the business. Property other than buildings For property other than buildings, routine maintenance means the recurring activities that the business expects to perform as a result of the business; use of the unit of property to keep the unit of property in its ordinarily efficient operating conditions. It will not include any improvements which increase the value of the property or the property s asset life. 14

15 Examples of routine maintenance for property other than buildings include: The inspection, cleaning, and testing of the unit of property The replacement of damaged or worn parts of the unit of property with comparable and commercially available replacement parts Routine maintenance may be performed at any time during the useful life of the unit or property. However, activities are routine only if, at the time the unit of property is placed in service by the business reasonably expects to perform the activities more than once during the class life of the unit property. In this context, class life means the life of the property under the alternative depreciation system, or ADS, rules. Here s a table of the most commonly encountered asset classes and their ADS class lives: Description of assets included ADS Recovery Period (in years) Office Furniture, Fixtures, and Equipment Includes furniture and fixtures that are not a structural component of a building. Includes such assets as desks, files, safes, and communications equipment. Does not include communications equipment that is in other classes. Information Systems Includes computers and their peripheral equipment used in administering normal business transactions and the maintenance of business records, their retrieval and analysis. Data Handling Equipment; except Computers Includes only typewriters, calculators, adding and accounting machines, copiers, and duplicating equipment Automobile, Taxis Light General Purpose Trucks Includes trucks for use over the road (actual weight less than 13,000 pounds) Heavy General Purpose Trucks Includes heavy general purpose trucks, concrete ready mix-trucks, and or trucks, for use over the road (actual unloaded weight 13,000 pounds or more) Trailers and Trailer-Mounted Containers Tables describing a complete list of ADS class lives, including special class lives for assets in specific industries (especially various manufacturing industries), can be found at IRS.gov. When to Capitalize Amounts Paid to Acquire or Produce Tangible Property The business will capitalize all amounts paid to acquire or produce tangible property, not including materials and supplies, in its books. This includes leasehold improvements, land and land improvements, buildings, machinery and equipment, and furniture and fixtures

16 Amounts paid to acquire or produce a unit of real or personal property include the invoice price, transaction costs, and costs for work performed prior to the date that the unit of property is placed in service by the business. The business accounting policies for tangible property held as inventory are not covered in this document. When to Capitalize Amounts Paid to Facilitate Acquisition of Tangible Property The business will capitalize all amounts paid to facilitate the acquisition of tangible property, not including materials and supplies, in its books. This will include, but not necessarily be limited to, the Treasury s list of what is considers inherently facilitative amounts [see Treas. Reg (a)-2(f)(2)(ii)]. Inherently facilitative amounts Transporting the property (for example, shipping fees and moving costs) Securing and appraisal or determining the value or price of property Negotiating the terms or structure of the acquisition and obtaining tax advice on the acquisition Application fees, bidding costs, or similar expenses Preparing and reviewing the documents that effectuate the acquisition of the property (for example, preparing the bid, offer, sales contract, or purchase agreement) Examining and evaluating the title of property Obtaining regulatory approval of the acquisition or securing permits related to the acquisition, including the application fees Conveying property between the parties, including sales and transfer taxes, and title registration costs Finders fees or brokers commissions, including contingency fees Architectural, geological, survey, engineering, environmental, or inspection services pertaining to particular properties Services provided by a qualified intermediary or other facilitator of an exchange under section 1031 Amounts that are not facilitative The business will not capitalize in its books any amounts that are not considered facilitative amounts for federal income tax purposes per Treas. Reg (a)-2(f)(2)(iii). These are amounts paid that relate to activities performed in the process of determining whether to acquire real property and which real property to acquire. Note this is different from facilitative costs because facilitative costs occur after you ve decided which property to acquire. Note also that this rule only applies to real property. 16

17 When to Capitalize Amounts Paid to Improve Tangible Property The business will capitalize all amounts paid to improve tangible property, not including repairs and maintenance, in its books. The nosiness will treat all betterments, restorations, and adaptations to a new or different use as improvements to tangible property. Betterments The company will treat all betterments, as a defined in Treas. Reg (a)-3(j) or its future equivalent, as improvements in its books. This means that any amount paid will be treated as a betterment to a unit of property if it meets at least one of three tests: It ameliorates a material condition or defect that either existed prior to the business acquisition of the unit of property or arose during the production of the unit property, whether or not the business was aware of the condition or defect at the time of acquisition or production It s for a material addition, including a physical enlargement, expansion, extension, or addition of a major component to the unit of property or a material increase in the capacity, including additional cubic or linear space, of the unit of property It s reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of the unit of property Restorations The business will treat all restorations, as defined in Treas. Reg (a)-3(k) or its future equivalent, as improvements in its books. This means that any amount paid will be treated as a restoration if it meets at least one of six tests: It s for the replacement of a component of a unit of property for which the business has properly deducted a loss for that component, other than a casualty loss It s for the replacement of a component of a unit of property for which the nosiness has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component It s for the restoration of damage to a unit of property for which the business is required to take a basis adjustment as a result of a casualty loss or relating to a casualty event, subject to certain limits [see Treas.Reg.1.263(a)-3(k)(4) on these limit It returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use It results in the rebuilding of the unit of property to a like-new condition after the end of its class life (see the section on routine maintenance for an explanation of using class lives) 17

18 Is for the replacement of a part of combination of parts that comprise a major component or a substantial structural part of a unit of property A casualty loss in this context is, generally speaking, any loss arising from a casualty event such as a fire, storm, shipwreck, or other casualty. This definition doesn t include losses from theft. See Treas. Reg Like-new condition in this context means a unit of property is brought to the status of new, rebuilt, remanufactured, or a similar status under the terms of any federal regulatory guideline or the manufacturer s original specifications. Generally, a comprehensive maintenance program, even though substantial, does not return a unit of property to a like-new condition. See Treas. Reg (a)-3(k)(5). A major component in this context is a part of combination of parts that performs a discrete and critical function in the operation of the unit of property (does not include incidental components of the property). A substantial structural part in this context is a part or combination of parts that comprises a large portion of the physical structure of the unit of property. See Treas. Reg (a)-3(k)(6). Adaptations to a new or different use The business will treat all adaptations to a new or different use, as defined in Treas. Reg (a)-3(l) or its future equivalent, as improvements in its books. A new or different use is a use inconsistent with the business ordinary ise of the unit of property at the time originally placed in service by the business. Conflicts Between This Document and Treasury Regulations If any explanation of tax accounting rules in this document is in conflict with the applicable treasury regulations, the business books will follow the accounting rules as described in the treasury regulations. For example, if Treas. Reg is changed such that this document s explanation of its provisions regarding materials and supplies is no longer up to date, the business will follow the provisions of the treasury regulation for its bookkeeping, not this document. 18

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20 Exhibit B IRS Tables of Automatic Accounting Method Changes for the New TPRs 20

21 Changes under the final tangible property regulations: Description of Change DCN Citation A change to deducting amounts paid or incurred for repair and maintenance or a change to capitalizing amounts paid or incurred for improvements to tangible property and, if depreciable, to depreciating such property under section 167 or section 168. Includes a change, if any, in the method of identifying the unit of property, or in the case of a building, identifying the buildings structure or building system for the purpose of making the change. Change to the regulatory accounting method , 1.263(a) (a)-3(m) Change to deducting non-incidental materials and supplies when used or consumed (a)(1), (c)(1) Change to deducting incidental materials and supplies when paid or incurred (a)(2), (c)(1) Change to deducting non-incidental rotable and temporary spare parts when disposed of (a)(3), (c)(2) Change to the optional method for rotable and temporary spare parts (e) Change by a dealer in property to deduct commissions and other transaction costs that facilitate the sale of property Change by a non-dealer in property to capitalizing commissions and other costs that facilitate the sale of property (a)-1(e)(2) (a)-1(e)(1) Change to capitalizing acquisition or production costs and, if depreciable, to depreciating such property under section 167 or section (a)-2 Change to deducting certain costs for investigating or pursuing the acquisition of real property (whether and which) (a)-2(f)(2)(iii) 21

22 Exhibit C: Example of Form 3115 with DCN

23 Form 3115 (Rev. December 2009) Department of the Treasury Internal Revenue Service Name of filer (name of parent corporation if a consolidated group) (see instructions) Application for Change in Accounting Method OMB No Identification number (see instructions) Principal business activity code number (see instructions) Number, street, and room or suite no. If a P.O. box, see the instructions. City or town, state, and ZIP code Tax year of change begins (MM/DD/YYYY) Tax year of change ends (MM/DD/YYYY) Name of contact person (see instructions) Name of applicant(s) (if different than filer) and identification number(s) (see instructions) Contact person s telephone number If the applicant is a member of a consolidated group, check this box If Form 2848, Power of Attorney and Declaration of Representative, is attached (see instructions for when Form 2848 is required), check this box Check the box to indicate the type of applicant. Individual Cooperative (Sec. 1381) Corporation Partnership Controlled foreign corporation S corporation (Sec. 957) Insurance co. (Sec. 816(a)) 10/50 corporation (Sec. 904(d)(2)(E)) Insurance co. (Sec. 831) Qualified personal service Other (specify) corporation (Sec. 448(d)(2)) Exempt organization. Enter Code section Check the appropriate box to indicate the type of accounting method change being requested. (see instructions) Depreciation or Amortization Financial Products and/or Financial Activities of Financial Institutions Other (specify) Caution. To be eligible for approval of the requested change in method of accounting, the taxpayer must provide all information that is relevant to the taxpayer or to the taxpayer's requested change in method of accounting. This includes all information requested on this Form 3115 (including its instructions), as well as any other information that is not specifically requested. The taxpayer must attach all applicable supplemental statements requested throughout this form. Part I Information For Automatic Change Request 1 Enter the applicable designated automatic accounting method change number for the requested automatic change. Enter only one designated automatic accounting method change number, except as provided for in guidance published by the IRS. If the requested change has no designated automatic accounting method change number, check "Other," and provide both a description of the change and citation of the IRS guidance providing the automatic change. See instructions. Yes 184 (a) Change No. (b) Other Description 2 Do any of the scope limitations described in section 4.02 of Rev. Proc cause automatic consent to be unavailable for the applicant's requested change? If "Yes," attach an explanation Note. Complete Part II below and then Part IV, and also Schedules A through E of this form (if applicable). Part II Information For All Requests Yes No 3 Did or will the applicant cease to engage in the trade or business to which the requested change relates, or terminate its existence, in the tax year of change (see instructions)? X If Yes, the applicant is not eligible to make the change under automatic change request procedures. 4 a Does the applicant (or any present or former consolidated group in which the applicant was a member during the applicable tax year(s)) have any Federal income tax return(s) under examination (see instructions)?..... X If No, go to line 5. b Is the method of accounting the applicant is requesting to change an issue (with respect to either the applicant or any present or former consolidated group in which the applicant was a member during the applicable tax year(s)) either (i) under consideration or (ii) placed in suspense (see instructions)? Signature (see instructions) Under penalties of perjury, I declare that I have examined this application, including accompanying schedules and statements, and to the best of my knowledge and belief, the application contains all the relevant facts relating to the application, and it is true, correct, and complete. Declaration of preparer (other than applicant) is based on all information of which preparer has any knowledge. Filer Preparer (other than filer/applicant) No Signature and date Signature of individual preparing the application and date Name and title (print or type) Name of individual preparing the application (print or type) Name of firm preparing the application For Privacy Act and Paperwork Reduction Act Notice, see the instructions. Cat. No E Form 3115 (Rev )

24 Form 3115 (Rev ) Page 2 Part II Information For All Requests (continued) Yes No 4 c Is the method of accounting the applicant is requesting to change an issue pending (with respect to either the applicant or any present or former consolidated group in which the applicant was a member during the applicable tax year(s)) for any tax year under examination (see instructions)? d Is the request to change the method of accounting being filed under the procedures requiring that the operating division director consent to the filing of the request (see instructions)? If Yes, attach the consent statement from the director. e Is the request to change the method of accounting being filed under the 90-day or 120-day window period?.. If Yes, check the box for the applicable window period and attach the required statement (see instructions). 90 day 120 day: Date examination ended f If you answered Yes to line 4a, enter the name and telephone number of the examining agent and the tax year(s) under examination. Name Telephone number Tax year(s) g Has a copy of this Form 3115 been provided to the examining agent identified on line 4f? a Does the applicant (or any present or former consolidated group in which the applicant was a member during the applicable tax year(s)) have any Federal income tax return(s) before Appeals and/or a Federal court?.... If Yes, enter the name of the (check the box) Appeals officer and/or counsel for the government, telephone number, and the tax year(s) before Appeals and/or a Federal court. Name Telephone number Tax year(s) b Has a copy of this Form 3115 been provided to the Appeals officer and/or counsel for the government identified on line 5a? c Is the method of accounting the applicant is requesting to change an issue under consideration by Appeals and/or a Federal court (for either the applicant or any present or former consolidated group in which the applicant was a member for the tax year(s) the applicant was a member) (see instructions)? If Yes, attach an explanation. 6 If the applicant answered Yes to line 4a and/or 5a with respect to any present or former consolidated group, attach a statement that provides each parent corporation s (a) name, (b) identification number, (c) address, and (d) tax year(s) during which the applicant was a member that is under examination, before an Appeals office, and/or before a Federal court. 7 If, for federal income tax purposes, the applicant is either an entity (including a limited liability company) treated as a partnership or an S corporation, is it requesting a change from a method of accounting that is an issue under consideration in an examination, before Appeals, or before a Federal court, with respect to a Federal income tax return of a partner, member, or shareholder of that entity? If Yes, the applicant is not eligible to make the change. 8a Does the applicable revenue procedure (advance consent or automatic consent) state that the applicant does not receive audit protection for the requested change (see instructions)? b If Yes, attach an explanation. 9a Has the applicant, its predecessor, or a related party requested or made (under either an automatic change procedure or a procedure requiring advance consent) a change in method of accounting within the past 5 years (including the year of the requested change)? b If "Yes," for each trade or business, attach a description of each requested change in method of accounting (including the tax year of change) and state whether the applicant received consent. c If any application was withdrawn, not perfected, or denied, or if a Consent Agreement granting a change was not signed and returned to the IRS, or the change was not made or not made in the requested year of change, attach an explanation. 10 a Does the applicant, its predecessor, or a related party currently have pending any request (including any concurrently filed request) for a private letter ruling, change in method of accounting, or technical advice?... b If Yes, for each request attach a statement providing the name(s) of the taxpayer, identification number(s), the type of request (private letter ruling, change in method of accounting, or technical advice), and the specific issue(s) in the request(s). 11 Is the applicant requesting to change its overall method of accounting? If Yes, check the appropriate boxes below to indicate the applicant s present and proposed methods of accounting. Also, complete Schedule A on page 4 of this form. X X X X Present method: Cash Accrual Hybrid (attach description) Proposed method: Cash Accrual Hybrid (attach description) Form 3115 (Rev )