Originally published on Forbes.com.
You may have read that we are in for a tough tax season what with delays because of Congress not getting around to the extenders and IRS budget cuts. Well. That’s not all. There are new regulations going into effect about the tax treatment of tangible property. Tangible property is of course stuff – like automobiles and computers and buildings – all sorts of stuff.
Outside of fairly specialized areas like equipment leasing , the biggest impact of the regulations is in the area of buildings both for landlords and tenants who have made improvements. There are some businesses that don’t involve being either a landlord or a tenant in a building but not a very high percentage. Buildings are what may be yielding the refunds of biblical proportions that I discussed with Michael Greenwald of Friedman LLP. Friedman LLP is located at 1700 Broadway in Manhattan surrounded by some of the big buildings that may be yielding big refunds thanks to the new regulations. But what about the hellish part, you may ask?
Remember The AT&T Breakup?
In 1984 the “Bell System”, which was something of a monopoly of telephone service was broken up by a divestiture of AT&T. When a company divests it distributes stock in companies that it owns. It can be a tax-free transaction which requires disclosure by shareholders and an allocation of basis among the various assets. Well, “everybody” owned stock in AT&T and typically they had acquired it over a period of years. So just about “everybody” had a complicated return that year. The phase-in of the passive activity loss rules after the Tax Reform Act of 1986 was a similar horror show. These regulations promise a similar flurry.
Have you ever heard of Form 3115? Go ahead and take a look at the eight page form, that’s why I gave you a link. Now take a look at the twenty pages of instructions. Scroll to the very end where there is an estimate of the burden that the form puts on the taxpayers as required by the Paperwork Reduction Act.
The total for just Form 3115, not including any of its five possible schedules, for recordkeeping, learning about the law or the form and preparing and sending the form to the IRS comes to slightly over 80 hours . I have to tell you the 20 hours for learning about the law or the form is on the low side, but presumably those of us who do that will be able to spread the learning over more than one form. The other 60 hours better be way on the high side, if the developing consensus among practitioners is correct.
Check out what Christian Wood wrote in the Journal of Accountancy.
With the new regulations effective for tax years beginning on or after Jan. 1, 2014, almost every federal tax return for businesses that own tangible property should have at least one Form 3115 or an election statement that the taxpayers will need to file to adopt the rules under the final regulations. For example, taxpayers will need to file a Form 3115 to adopt the materials-and-supplies provision or file an election statement to use the de minimis rules. Failure to include the Form 3115 or election statement may indicate either an unauthorized accounting method change (one that did not obtain the IRS’s required consent) or the taxpayer’s noncompliance with the final regulations.
Now I have read the repair regulations a few times without that dawning on me. That JOA article was back in February, but I have peculiar reading habits for a tax practitioner. I try to look at all the original source material to find interesting stories for my blog, so I got my wake-up call about just about everybody who is not a pure W-2 working stiff having to file Form 3115 at the Wolter Kluwer User Conference in Orlando.
The instructor indicated that if we did not join in with other practitioners in launching a tsunami of accounting method change forms on the IRS, dire consequences awaited us and out clients. Now any conference that includes a trip to Universal Studios for two haunted house experiences – one based on aliens and the other based on the movie Dracula and an inspirational speech by someone from a reality TV show deserves a bit of skepticism.
My big hope from the inspirational speech was that Daymond John looking at the overwhelmingly white audience was inspired to suggest to young African Americans that if they don’t have an idea to start a clothing line. they consider working on an accounting degree.
Regardless, having read the regs several times already, I thought I should ask around about the need for just about everybody to file Form 3115 for 2014.
Say It Ain’t So Joe
First I came for the bloggers. Both Joe Kristan and Tony Nitti. Joe offered a ray of hope
I have to admit that until the last week or so, I hadn’t really focused on the 3115 issue. Other than safe-harbors, I didn’t really think the changes would mean much to most businesses. Now I understand that there are speakers saying everyone has to do 3115s. I’m looking at it some more to see if I missed something.
I do think the IRS ought to clarify that no 3115 is needed if there is no 481(a) adjustment.
Tony on the other hand supports the 3115 for all view
Peter, having gone through the regs in great detail, I don’t see how every business won’t need a 3115.
I reached out to my old boss Bob Charron who heads tax operations for Friedman LLP, making him Michael Greenwald’s boss too I guess.
I agree with everyone and his brother. IRS is expecting 3115s from everyone with depreciable property. Perhaps not if they have written off their depreciable property already, but I believe there are other things that require 3115s, such as defining Unit of Property, materials and supplies. I have experts in my firm handling these things, but we expect to prepare 3115s for most of our clients, and in many cases more than one.I formed a committee of 10 people in the firm to become experts on the Repair Regs.
Then I reached out to Lucien Gauthier who heads the Boston Tax Institute.
I do not have an informed opinion, but Peter Birkholz who presents our 1-day seminar on the subject disagrees.
At A Boston Tax Institute Seminar
When you go to a BTI seminar, you don’t get a trip to an amusement park thrown in or any inspirational speakers. The seminars are in Holiday Inn type venues convenient to highways. There is an undistinguished selection of danish, so so coffee and some orange juice. You’re own your own for lunch.
On the other hand you end up out of pocket less than a couple of hundred, if you don’t go crazy on lunch, rather than the thousands required by the junket style training that WK offers. So I signed up for Peter Birkholz’s “Repairs versus Improvements”. The other Peter, whose demeanor has more than a hint of Rick on Pawn Stars
insists that the need for many, many Forms 3115 is greatly exaggerated. The way Peter explains it, the more general view comes from discussions with IRS personnel further down the food chain than the one that he is talking to. The principle is that if you reached the same conclusion as the regulations would dictate by other reasoning then filing an accounting method change with no income adjustment is not necessary.
So the result of all this inquiry is to have my partners just a little frustrated with me, since I am still hanging fire on whether we need to do Form 3115 when there is no adjustment required. My defense is that I will start looking to see where we want to be filing the Form 3115, because of the advantage that it can bring to some clients.
The Refunds Of Biblical Proportions
The potential large refunds are something that I got into with Michael Greenwald. The differing perspectives on the prospect of accounting method changes may well reflect differences in client base. According to Accounting Today , Friedman LLP ranks 43 in a nation with over 80,000 accounting firms. Some of its clients are the top players in Metro New York real estate.
Commercial real estate is where the real positive excitement about the regulations exists. When you spend money on a commercial building, there is a stark choice for tax purposes. You either expense it as a repair or write it off over 39 years. Although, there is case law to the contrary the general tendency is to figure that if something is a big bill, there is a good chance that it should be capitalized.
The new regulations force accountants to lift up their eyes from the invoices and look at the actual building. Much of the teaching in the regulations is done by example. Besides the basic structure there are eight separate units to consider as part of a building. One of them is heating, ventilation and cooling. Consider two buildings. One has 10 roof-mounted HVAC units. The other has a single chiller unit. If you replaced four of the 10 roof units or the single chiller unit, you will get a whopping big bill, which you would either expense or capitalize depending on how aggressive you are. What the regs say is that you can probably expense the four roof mounted units, but definitely have to capitalize the single chiller.
Here is where accounting method changes come in for some big money. Suppose that four years ago you spent, to make the math easy, $390,000 on items which you capitalize (and of course to make the math easy placed in service on January 1). It is too late to amend that return, but with an accounting method change you get to write off the $350,000 that remains undepreciated in 2014. That’s what people are excited about. Of course, it is more likely to be a help to the owners of large buildings who might have capitalized the replacement of 10 out of 100 elevators six years ago. Small time landlords who own buildings with just one of everything are not going to have even proportional adjustments.
And it is the tax preparers for the small time or even medium time landlords that Peter Birkholz is talking to at a BTI seminar. For them these regulations are not an opportunity to do studies that they can charge big bucks for while still looking like heroes. It’s one more complication that they probably won’t be able to charge anything for.
Wait And See?
If you are involved in real estate or advising people who are, you should be studying these regulations and looking back over what has or has not been capitalized. The things that were capitalized are easy and fun. Easy because they are on the depreciation schedule. Fun because they might yield big write-offs. When it comes to things that were not capitalized particularly going back more than five years or so, there might be a temptation to take a “Who’s gonna know?” approach. Of course, I am ethically proscribed from giving advice based on the audit lottery, but purely out of intellectual interest, we discussed how something that was done seven years ago could be detected now. Peter Birkholz pointed out that if permits were pulled there might be something of a permanent trail and if you catch the Agent From Hell on your next audit, AFH might follow that.
As far as preparing Form 3115 where there will be no adjustment, I’m hoping that there will be some clarification between now and February, but I’m not real optimistic.
Note
There is an awful lot to the repair regulations and this post is not meant to be a thorough discussion by any means. It is more of a wake-up call. If you own significant real estate and your tax adviser has not been discussing this with you, it is amazing that somebody has not come along and poached that slow poke’s business. I like that kind of loyalty. When your accountant dies, be sure to give me a call. On the other hand, if you have been told you are going to have to spend a king’s ransom on this exercise, but will not be getting an emperor’s ransom in benefits, you may want to adopt a wait and see approach. If you have a strong aversion to going on extension, get over it. . You don’t want the first Form 3115 that your preparer does to be yours .