IRS issues method change rules for tangible asset regulations

On Wednesday, March 7, 2012, the IRS released two highly-anticipated revenue procedures, Rev. Proc. 2012-19 and Rev. Proc. 2012-20, which explain the procedures for obtaining automatic consent to change to the accounting methods provided in the recently-published tangible asset regulations for taxable years beginning on or after Jan. 1, 2012 (see TD 9564, REG-168745-03 and REG-168745-03 (update) (the "tangible asset regulations") and Repairs regulations finally issued on capitalization of tangible asset costs.

Discussion

Rev. Proc. 2012-19 and Rev. Proc. 2012-20 (the revenue procedures) provide the automatic consent procedures for taxpayers to change to methods of accounting to comply with the tangible asset regulations. Specifically, Rev. Proc. 2012-19 provides 13 new automatic method changes to comply with the rules for:

• Materials and supplies
• Repairs
• Capital expenditures
• Costs to acquire or produce tangible property
  
• Costs to improve tangible property

Rev. Proc. 2012-20 provides six new automatic method changes to comply with the rules for:

• Depreciating leasehold improvements
• Single asset accounts (SAA), mass asset accounts (MAA) and general asset accounts (GAA)
  
• Dispositions

Both revenue procedures are effective for taxable years beginning on or after Jan. 1, 2012 and, thus, do not provide any procedures for early adoption. The revenue procedures also waive the scope limitations normally applicable to automatic method changes for taxpayers' first or second taxable years beginning after Dec. 31, 2011. While the tangible asset regulations are generally effective for taxable years beginning on or after Jan. 1, 2012, a method change with a full section 481(a) adjustment¹ is generally required to implement changes resulting from the regulations. The revenue procedures specify which method changes permit the use of statistical sampling² in calculating the section 481(a) adjustment, which ones require modified section 481(a) adjustments³, and which ones require modified cut-off methods.⁴ In addition, the duplicate copy of any Form 3115, Application for Change in Accounting Method, filed pursuant to either revenue procedure is required to be sent to an Ogden, UT address instead of the IRS National Office address in Washington, DC.

The table below presents a high-level summary of the method changes provided by the revenue procedures, as well as the related required adjustments.

Insights

Since the revenue procedures do not provide provisions for early adoption, it will be up to the IRS's Large Business and International division (LB&I) and/or Small Business/Self-Employed division (SBSE) to determine how they want IRS agents to examine prior years and whether they will challenge early adoption of any of the provisions in the tangible asset regulations. Now that the method change rules have been released, it is anticipated that LB&I and/or SBSE will issue a directive to examiners addressing how to examine repairs vs. capital expenditure issues in years beginning prior to Jan. 1, 2012. With the two-year waiver of the scope limitations normally applicable to automatic method changes, many taxpayers should be eligible to automatically change their methods to comply with the tangible asset regulations during 2012 or 2013 despite, for example, being under exam or in the last year of their trade or business.

Although Forms 3115 filed pursuant to the revenue procedures cannot be filed for taxable years beginning prior to Jan. 1, 2012, taxpayers should take time now to determine the impact of complying with the tangible asset regulations and the method changes that will need to be made in order to be in a position to make appropriate estimated tax payments and financial accounting adjustments. In addition, taxpayers will obtain audit protection for each item included in a Form 3115 prepared pursuant to either revenue procedure upon the proper filing of the duplicate copy with the Ogden, UT address. Finally, with the tangible asset regulations' expansion of the definition of dispositions to include the retirement of a structural component of a building, many taxpayers that own or lease buildings should consider making late GAA elections for buildings placed in service prior to Jan. 1, 2012, while they still can.

Natalie Tucker, director, Washington National Tax
Tom Windram, partner, Washington National Tax
Kevin Johnson, director, Minneapolis, Minn.

¹ A section 481(a) adjustment prevents the duplication or omission of amounts upon the change from the taxpayer's old method to the new method and is computed notwithstanding the statute of limitations. A positive or unfavorable section 481(a) adjustment is generally spread over four taxable years, while a negative or favorable section 481(a) adjustment is recognized in full in the year of change.

²Statistical sampling permitted if the taxpayer uses the methodology provided by Rev. Proc. 2011-42.

³Modified section 481(a) adjustment only includes amounts paid or incurred in taxable years beginning on or after Jan. 1, 2012.

⁴Type of prospective application varies depending on the specific type of method change (e.g., in the case of a taxpayer changing from a single asset account to a multiple asset account for the same assets or vice versa, the unadjusted depreciable basis and the depreciation reserve of the assets as of the beginning of the year of change are accounted for using the new method of accounting).

⁵ Method change only available for taxpayer's first or second taxable year beginning after Dec. 31, 2011.