Vol. 78 Thursday, No. 182 September 19, 2013

Part II

Department of the Treasury

Internal Revenue Service 26 CFR Parts 1 and 602 Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property; Final Rule

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DEPARTMENT OF THE TREASURY 11, 1.263(a)–1, 1.263(a)–2, 1.263(a)–3, Background and 1.263(a)–6, Merrill D. Feldstein or Section 263(a) provides that no Internal Revenue Service Alan S. Williams, Office of Associate deduction is allowed for (1) any amount Chief Counsel (Income Tax and paid out for new buildings or permanent 26 CFR Parts 1 and 602 Accounting), (202) 622–4950 (not a toll- improvements or betterments made to [TD 9636] free call); Concerning §§ 1.165–2, increase the value of any property or 1.167(a)–4, 1.167(a)–7, 1.167(a)–8, RIN 1545–BE18 estate, or (2) any amount expended in 1.168(i)–7, 1.263A–1, and 1.1016–3, restoring property or in making good the Kathleen Reed or Patrick Clinton, Office Guidance Regarding Deduction and exhaustion thereof for which an Associate Chief Counsel (Income Tax Capitalization of Expenditures Related allowance has been made. Final and Accounting), (202) 622–4930 (not a to Tangible Property regulations previously issued under toll-free call). section 263(a) provided that capital AGENCY: Internal Revenue Service (IRS), SUPPLEMENTARY INFORMATION: expenditures included amounts paid or Treasury. incurred to (1) add to the value, or Paperwork Reduction Act ACTION: Final regulations and removal of substantially prolong the useful life, of temporary regulations. The collection of information property owned by the taxpayer, or (2) contained in this final regulation has adapt the property to a new or different SUMMARY: This document contains final been reviewed and approved by the use. However, those regulations also regulations that provide guidance on the Office of Management and Budget in provided that amounts paid or incurred application of sections 162(a) and 263(a) accordance with the Paperwork for incidental repairs and maintenance of the Internal Revenue Code (Code) to Reduction Act of 1995 (44 U.S.C. of property within the meaning of amounts paid to acquire, produce, or 3507(d)) under control number 1545– section 162 and § 1.162–4 of the Income improve tangible property. The final 2248. An agency may not conduct or Tax Regulations are not capital regulations clarify and expand the sponsor, and a person is not required to expenditures under § 1.263(a)–1. standards in the current regulations respond to, a collection of information The determination of whether an under sections 162(a) and 263(a). These unless the collection of information expense may be deducted as a repair or final regulations replace and remove displays a valid control number must be capitalized generally requires temporary regulations under sections assigned by the Office of Management an examination of all of a taxpayer’s 162(a) and 263(a) and withdraw and Budget. particular facts and circumstances. proposed regulations that cross The collection of information in this Moreover, the subjective nature of the referenced the text of those temporary existing standards described above has regulations. This document also regulation is in §§ 1.263(a)–1(f)(5), 1.263(a)–3(h)(6), and 1.263(a)–3(n)(2). resulted in considerable controversy contains final regulations under section between taxpayers and the IRS over 167 regarding accounting for and This information is required in order for a taxpayer to elect to use the de minimis many years. retirement of depreciable property and In 2006, in an effort to reduce the final regulations under section 168 safe harbor, to elect to use the safe harbor for small taxpayers, and to elect controversy in this area, the IRS and the regarding accounting for property under Treasury Department published in the the Modified Accelerated Cost Recovery to capitalize repair and maintenance costs. This information will inform the Federal Register August 21, 2006 (71 FR System (MACRS) other than general 48590) proposed amendments to the asset accounts. The final regulations IRS that the taxpayer is electing to use these provisions, which allows regulations under section 263(a) relating will affect all taxpayers that acquire, to amounts paid to acquire, produce, or produce, or improve tangible property. taxpayers to obtain beneficial treatment for the amounts that qualify for these improve tangible property. The IRS and These final regulations do not finalize or the Treasury Department received remove the 2011 temporary regulations elections. The collection of information is voluntary to obtain a benefit under numerous written comments in under section 168 regarding general response to these proposed regulations. asset accounts and disposition of the final regulations. The likely respondents are business or other for- After considering these comments and property subject to section 168, which the statements at the public hearing, in are addressed in the notice of proposed profit institutions, and small businesses or organizations. 2008 the IRS and the Treasury rulemaking on this subject in the Department withdrew the 2006 Estimated total annual reporting Proposed Rules section in this issue of proposed regulations and proposed new burden: 1,100,000 hours. the Federal Register. regulations in the Federal Register DATES: Effective Date: These regulations Estimated annual burden hours per March 10, 2008 (73 FR 12838). The IRS are effective on September 19, 2013. respondent varies from .25 hours to .5 and the Treasury Department also Applicability Dates: In general, these hours, depending on individual received many written comments and final regulations apply to taxable years circumstances, with an estimated held a public hearing on the 2008 beginning on or after January 1, 2014. average of .275 hours. proposed regulations. On December 27, However, certain rules apply only to Estimated number of respondents: 2011, the IRS and the Treasury amounts paid or incurred in taxable 4,000,000. Department published temporary years beginning on or after January 1, Estimated frequency of responses: regulations in the Federal Register 2014. For dates of applicability of the Annually. regarding the deduction and final regulations, see §§ 1.162–3(j), Books or records relating to a capitalization of expenditures related to 1.162–4(c), 1.162–11(b)(2), 1.165–2(d), collection of information must be tangible property (TD 9564; 76 FR 1.167(a)–4(b), 1.167(a)–7(f), 1.167(a)– retained as long as their contents may 81060), withdrew the 2008 proposed 8(h), 1.168(i)–7(e), 1.263(a)–1(h), become material in the administration regulations, and published new 1.263(a)–2(j), 1.263(a)–3(r), 1.263(a)– of any internal revenue law. Generally, proposed regulations that cross 6(c), 1.263A–1(l), and 1.1016–3(j). tax returns and tax return information referenced the text of the 2011 FOR FURTHER INFORMATION CONTACT: are confidential, as required by section temporary regulations. The 2011 Concerning §§ 1.162–3, 1.162–4, 1.162– 6103. temporary regulations initially applied

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to taxable years beginning on or after Explanation of Provisions for property subject to section 168. January 1, 2012. The IRS and the I. Overview Instead, to address significant changes Treasury Department received in this area, revised regulations under numerous written comments in Section 263(a) generally requires the section 168 are being proposed response to the 2011 temporary and capitalization of amounts paid to concurrently with these final acquire, produce, or improve tangible proposed regulations and held a public regulations (and appear in the Proposed property. Section 162 allows a hearing on May 9, 2012. After Rules section of this issue of the Federal deduction for all the ordinary and Register). considering these comments and the necessary expenses paid or incurred statements at the public hearing, the IRS during the taxable year in carrying on II. Materials and Supplies Under and the Treasury Department published any trade or business, including the § 1.162–3 Notice 2012–73 (2012–51 IRB 713), on costs of certain supplies, repairs, and Responding to generally favorable November 20, 2012, announcing that, to maintenance. These final regulations comments on the treatment of materials assist taxpayers in their transitions to provide a general framework for and supplies in the 2011 temporary the 2011 temporary regulations and distinguishing capital expenditures regulations, the final regulations retain final regulations, the IRS and the from supplies, repairs, maintenance, the framework and many of the rules set Treasury Department would change the and other deductible business expenses. forth in the 2011 temporary regulations. applicability date of the 2011 temporary The final regulations retain many of the In response to comments, however, the regulations to taxable years beginning provisions of the 2011 temporary and final regulations expand the definition on or after January 1, 2014, while proposed regulations (2011 temporary of materials and supplies to include permitting taxpayers to choose to apply regulations), which in many instances property that has an acquisition or the 2011 temporary regulations to incorporated standards from case law production cost of $200 or less taxable years beginning on or after and other existing authorities under (increased from $100 or less), clarify January 1, 2012, and before the sections 162 and 263(a). The final application of the optional method of applicability date of the final regulations also modify several sections accounting for rotable and temporary of the 2011 temporary regulations in regulations. The Notice also alerted spare parts, and simplify the application response to comments received and to taxpayers that the IRS and the Treasury of the de minimis safe harbor of clarify and simplify the rules while § 1.263(a)–1(f) to materials and supplies. Department intended to publish final achieving results that are consistent The final regulations also define regulations in 2013 and expected the with the case law. The final regulations standby emergency spare parts and limit final regulations to apply to taxable adopt the same general format as the the application of the election to years beginning on or after January 1, 2011 temporary regulations, where capitalize materials and supplies to only 2014, but that the final regulations § 1.162–3 provides rules for materials rotable, temporary, and standby would permit taxpayers to apply its and supplies, § 1.162–4 addresses emergency spare parts. provisions to taxable years beginning on repairs and maintenance, § 1.263(a)–1 or after January 1, 2012. On December provides general rules for capital A. Definition of Materials and Supplies 17, 2012, the Treasury Department and expenditures, § 1.263(a)–2 provides Commenters requested that the dollar the IRS published technical rules for amounts paid for the threshold for characterizing a unit of amendments to TD 9564, which acquisition or production of tangible property as a material or supply be amended the applicability date of the property, and § 1.263(a)–3 provides increased from property with an 2011 temporary regulations to taxable rules for amounts paid for the acquisition cost of $100 or less to years beginning on or after January 1, improvement of tangible property. property with an acquisition cost of 2014, while permitting taxpayers to However, the final regulations refine $500 or $1,000. Specifically, choose to apply the 2011 temporary and simplify some of the rules commenters were concerned that the regulations to taxable years beginning contained in the 2011 temporary low $100 threshold would not capture on or after January 1, 2012, and before regulations and create a number of new many common supplies such as safe harbors. For example, the final calculators and coffee makers. Balancing the applicability date of the final regulations adopt a revised and concerns over distortions to income that regulations. See Federal Register (77 FR simplified de minimis safe harbor under could result from increasing the 74583). § 1.263(a)–1(f) and extend the safe acquisition cost to $500 (or more) with After considering all of the comments harbor for routine maintenance under the need to include the typical materials and the statements made at the public § 1.263(a)–3(i) to buildings. The final and supplies ordinarily used by many hearing on the 2011 temporary and regulations also add a safe harbor for taxpayers, the final regulations increase proposed regulations, the IRS and the small taxpayers to the rules governing the $100 threshold to $200. In addition, Treasury Department are removing the improvements to tangible property the final regulations retain the language 2011 temporary regulations under under § 1.263(a)–3. In addition, the final providing the IRS and the Treasury sections 162, 165, 167, 263(a), 263A, regulations refine several of the criteria Department with the authority to change 1016, and § 1.168(i)–7 and are issuing for defining betterments and the amount of this threshold through final regulations. The IRS and the restorations to tangible property. published guidance. Treasury Department are also removing In addition, these regulations finalize Commenters also continued to the 2011 proposed regulations and are certain temporary regulations under question the effect of the 2011 issuing new proposed regulations section 167 regarding accounting for temporary regulations on the treatment regarding the disposition of property and retirement of depreciable property of standby emergency spare parts under and section 168 regarding accounting Rev. Rul. 81–185 (1981–2 CB 59). To subject to section 168. The proposed for MACRS property, other than general resolve questions in this area, the final regulations are set forth in the notice of asset accounts. However, these regulations generally incorporate the proposed rulemaking on this subject in regulations do not finalize the rules definition of standby emergency spare the Proposed Rules section in this issue under § 1.168(i)–1T or § 1.168(i)–8T parts provided in Rev. Rul. 81–185 into of the Federal Register. addressing the definition of disposition the definition of materials and supplies

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and provide that these parts are eligible materials and supplies, the treatment is taxpayers may have pools of rotable or for the optional election to capitalize consistent with the holdings of the temporary parts that are treated certain materials and supplies provided revenue rulings, which permit taxpayers differently for financial statement in § 1.162–3(d). to treat rotable, temporary, or standby purposes, the final regulations modify emergency spare parts as assets subject B. Election To Capitalize Certain this rule. The final regulations provide to the allowance for depreciation. Materials and Supplies that a taxpayer that uses the optional The final regulations also clarify the method for rotable and temporary spare The 2011 temporary regulations procedure for a taxpayer that wants to parts for Federal tax purposes must use retained the rule from the 2008 revoke the election to capitalize and the optional method for all of the pools proposed regulations permitting a depreciate certain materials and of rotable and temporary spare parts taxpayer to elect to capitalize and supplies. The taxpayer may revoke this used in the same trade or business for depreciate amounts paid for certain election by filing a request for a letter which the optional method is used for materials and supplies. Several ruling and obtaining the consent of the the taxpayer’s books and records. Thus, comments noted that the requirement to Commissioner of Internal Revenue to a taxpayer generally is not required to elect to capitalize certain material and revoke this election. The Commissioner use the optional method for those pools supply costs continued to be may grant a request to revoke this of rotable or temporary spare parts for inconsistent with prior IRS election if the taxpayer acted reasonably which it does not use the optional pronouncements that distinguished and in good faith, and the revocation method in its books and records for the certain depreciable property from will not prejudice the interests of the trade or business. However, if a taxpayer materials and supplies. See, for Government. In deciding whether to chooses to use the optional method for example, Rev. Rul. 2003–37 (2003–1 CB grant such a request, the Commissioner any pool of rotable or temporary spare 717) (permitting taxpayers to treat anticipates applying standards similar parts for which the taxpayer does not certain rotable spare parts used in a to the standards under § 301.9100–3 of use the optional method in its books service business as depreciable assets); this chapter for granting extensions of and records for the trade or business, Rev. Rul. 81–185 (1981–2 CB 59) time for making regulatory elections. (concluding that major standby Finally, one commenter requested then the taxpayer must use the optional emergency spare parts are depreciable that the rules governing materials and method for all its pools of rotable and property); Rev. Rul. 69–201 (1969–1 CB supplies be modified to address the cost temporary spare parts in that trade or 60) (holding that standby replacement of acquiring or producing rotable spare business. parts used in pit mining business are parts that a taxpayer leases to customers Commenters also requested that the items for which depreciation is in the ordinary course of the taxpayer’s optional method for rotable and allowable); Rev. Rul. 69–200 (1969–1 CB leasing business. This commenter temporary spare parts be treated as the 60) (holding that flight equipment requested that the final regulations default method of accounting for rotable rotable spare parts and assemblies are clarify that these leased rotable spare and temporary spare parts, instead of tangible property for which depreciation parts are included in the definition of treating rotable and temporary spare is allowable while expendable flight rotable and temporary spare parts and parts as used and consumed in the equipment spare parts are materials and that a taxpayer may elect to capitalize taxable year when disposed. Many supplies); Rev. Proc. 2007–48 (2007–2 and depreciate these leased rotable taxpayers do not use the optional CB 110) (providing a safe harbor method spare parts under the materials and method of accounting for rotable and of accounting to treat certain rotable supplies rules. Under the 2011 temporary spare parts, and that method spare parts as depreciable assets). In temporary regulations, the definition of requires a degree of record keeping that addition, several comments noted that rotable and temporary spare parts would be overly burdensome for all the rule under the 2011 temporary includes only components acquired to taxpayers. Therefore, the final regulations could lead to problematic maintain, repair, or improve a unit of regulations do not adopt this suggestion results, such as permitting a component property owned, leased, or serviced by and continue to generally treat rotable acquired to improve a unit of tangible the taxpayer. This definition of rotable and temporary spare parts as materials property owned by the taxpayer to be and temporary spare parts does not and supplies that are used and treated as an asset and depreciated over include components that the taxpayer consumed in the taxable year when a recovery period different from the unit leases to its customers and that are disposed of by the taxpayer, unless the of tangible property intended to be unrelated to other property owned, taxpayer chooses a different treatment improved. leased to other parties, or serviced by under § 1.162–3. To address these concerns, the final the taxpayer. The final regulations do regulations retain the rule permitting a not expand the definition of rotable and D. Materials and Supplies Under the de taxpayer to elect to capitalize and temporary spare parts to include leased Minimis Safe Harbor depreciate amounts paid for certain rotable spare parts. The IRS and the materials and supplies but provide that Treasury Department believe that these There were numerous comments on this rule is only applicable to rotable, parts are outside the scope of the application of the de minimis rule temporary, or standby emergency spare regulations governing materials and provided in the 2011 temporary parts. By limiting the application of the supplies. regulations to materials and supplies rule to rotable, temporary, or standby under §§ 1.162–3T(f) (election to apply emergency spare parts, the final C. Optional Method for Rotable and de minimis rule to materials and regulations resolve the potentially Temporary Spare Parts supplies) and 1.263(a)–2T(g) (general de problematic results arising in the 2011 One commenter requested that the minimis rule) and the interaction temporary regulations. And while the final regulations remove the between the two sections. In response to final rule modifies Rev. Rul. 2003–37, requirement that the optional method these comments, the final regulations Rev. Rul. 81–185, Rev. Rul. 69–200, and for rotable and temporary spare parts, if more clearly coordinate the two Rev. Rul. 69–201 to the extent that the elected, be used for all of a taxpayer’s provisions as addressed below in the regulations characterize certain tangible rotable and temporary spare parts in the discussion of the de minimis safe properties addressed in these rulings as same trade or business. Recognizing that harbor.

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E. Property Treated as Materials and the greater of (1) 0.1 percent of the financial accounting books and records. Supplies in Published Guidance taxpayer’s gross receipts for the taxable A taxpayer with an applicable financial Several commenters questioned the year as determined for Federal income statement may rely on the de minimis effect of the 2011 temporary regulations tax purposes, or (2) 2 percent of the safe harbor under § 1.263(a)–1(f) of the on prior published guidance that taxpayer’s total depreciation and final regulations only if the amount paid permits taxpayers to treat certain amortization expense for the taxable for property does not exceed $5,000 per property as materials and supplies. For year as determined on the taxpayer’s invoice, or per item as substantiated by example, Rev. Proc. 2002–12 (2002–1 applicable financial statement. the invoice. The final regulations CB 374) allows a taxpayer to treat The IRS and the Treasury Department provide the IRS and the Treasury smallwares as materials and supplies received a significant number of Department with the authority to change that are not incidental under § 1.162–3. comments addressing the de minimis the safe harbor amount through Similarly, Rev. Proc. 2002–28 (2002–1 safe harbor provided in § 1.263(a)–2T(g). published guidance. CB 815) allows a qualifying small Nearly all comments raised concerns Commenters also asked that the de business taxpayer to treat certain about the administrative burden the minimis safe harbor be expanded to inventoriable items in the same manner ceiling would place on taxpayers, noting include not only amounts paid for as materials and supplies that are not that taxpayers would be required to property costing less than a certain incidental under § 1.162–3. The final keep detailed accounts of amounts that dollar amount but also amounts paid for regulations do not supersede, obsolete, they generally do not track because such property having a useful life less than a or replace these revenue procedures to amounts are expensed under their certain period of time. The final the extent they deem certain property to financial accounting capitalization regulations adopt this suggestion and constitute materials and supplies under policies. Thus, while the ceiling itself provide that the de minimis safe harbor § 1.162–3. This designated property could be calculated relatively simply, also applies to a financial accounting continues to qualify as materials and the financial accounting systems procedure that expenses amounts paid supplies under the final regulations, employed by most taxpayers would not for property with an economic useful because the definition of material and allow them to easily determine which life of 12 months or less as long as the supplies includes property that is costs the de minimis rule applied to amount per invoice (or item) does not and, therefore, whether or not exceed $5,000. Such amounts are identified as materials and supplies in applicable costs exceeded the ceiling. deductible under the de minims rule published guidance. Commenters also pointed out that the whether this financial accounting III. Repairs Under § 1.162–4 operation of the ceiling requirement did procedure applies in isolation or in The 2011 temporary regulations not allow taxpayers to anticipate when combination with a financial accounting provided that amounts paid for repairs they had reached the gross receipts or procedure for expensing amounts paid and maintenance to tangible property depreciation limitation or to identify for property that does not exceed a are deductible if the amounts paid are assets that would be excluded under the specified dollar amount. Under either not required to be capitalized under de minimis rule during a taxable year, procedure, if the cost exceeds $5,000 § 1.263(a)–3. The IRS and the Treasury because the ceiling amount could only per invoice (or item), then the amounts Department received no comments on be calculated after the end of a taxable paid for the property will not fall within this regulation. The final regulations year. Commenters also highlighted the the de minimis safe harbor. In addition, retain the rule from the 2011 temporary complexities inherent in the application an anti-abuse rule is provided to regulations. In addition, the final of the ceiling requirement for aggregate costs that are improperly split regulations add a cross reference to consolidated groups. In many cases, among multiple invoices. commenters suggested that the § 1.263(a)–3(n), the new election to B. Taxpayers Without an Applicable administrative burden imposed would capitalize amounts paid for repair and Financial Statement maintenance consistent with the outweigh any potential tax benefit. Many commenters suggested that this The 2011 temporary regulations did taxpayer’s books and records, discussed not provide a de minimis safe harbor for later in this preamble. problem be resolved by removing the ceiling altogether and permitting taxpayers without an applicable IV. De Minimis Safe Harbor Under taxpayers to deduct for Federal income financial statement, but the preamble §§ 1.263(a)–1(f) and 1.162–3(f) tax purposes amounts properly requested comments addressing alternatives that would provide the IRS A. De Minimis Safe Harbor Ceiling expensed under their financial accounting policies. and the Treasury Department with The 2011 temporary regulations The final regulations adopt assurance that a taxpayer is using a required a taxpayer to capitalize commenters’ suggestions that the ceiling reasonable, consistent methodology that amounts paid to acquire or produce a in the de minimis rule in the 2011 clearly reflects income. One commenter unit of real or personal property, temporary regulations be eliminated and suggested that the definition of including the related transaction costs. that amounts properly expensed under applicable financial statement be However, § 1.263(a)–2T(g) provided a de a taxpayer’s financial accounting expanded to include financial minimis exception permitting a policies be deductible for tax purposes. statements subject to a compliance taxpayer to deduct certain amounts paid To both address taxpayers’ concerns and review under the rules of the American for tangible property if the taxpayer had ensure that the de minimis safe harbor Institute of Certified Public an applicable financial statement, had in the final regulations requires Accountants’ (AICPA) Statement of written accounting procedures for taxpayers to use a reasonable, consistent Standards for Accounting and Review expensing amounts paid for such methodology that clearly reflects Services. Numerous comments also property under specified dollar income for Federal income tax requested that the de minimis rule be amounts, and treated such amounts as purposes, the ceiling in § 1.263(a)– generally expanded to taxpayers expenses on its applicable financial 2T(g)(1)(iv) has been replaced with a without an applicable financial statement. Under § 1.263(a)–2T(g)(1)(iv), new safe harbor determined at the statement. a taxpayer’s de minimis deduction for invoice or item level and based on the The final regulations include a de the taxable year was limited to a ceiling: policies that the taxpayer utilizes for its minimis rule for taxpayers without an

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applicable financial statement. While limitations provided in the final procedures prior to the beginning of the careful consideration was given to the regulation. Thus, if examining agents 2012 taxable year, the provisions of the suggestion of relying on reviewed and a taxpayer agree that certain 2011 temporary regulations are elective financial statements as defined in the amounts in excess of the de minimis for taxable years beginning prior to AICPA’s Statement of Standards for safe harbor limitations are not material January 1, 2014. In addition, the final Accounting and Review Services, the or otherwise should not be subject to regulations are not applicable until final regulations do not adopt this review, that agreement should be taxable years beginning on or after standard. While the AICPA standard for respected, notwithstanding the January 1, 2014. Therefore, taxpayers reviewed financial statements ensures requirements of the de minimis safe without written accounting procedures that the taxpayer’s policies comply with harbor. However, a taxpayer that seeks that choose to elect the de minimis safe the applicable financial accounting a deduction for amounts in excess of the harbor for their 2014 taxable years framework, the standard does not amount allowed by the safe harbor has should have sufficient time to consider contemplate a review of the taxpayer’s the burden of showing that such and draft appropriate procedures prior internal control, fraud risk, or treatment clearly reflects income. to the applicability date of the final regulations. Moreover, the de minimis accounting records. Thus, the standard C. Safe Harbor Election does not provide sufficient assurance to safe harbor is intended to provide the IRS that such policies are being Commenters asked whether the de recordkeeping simplicity to taxpayers followed and, accordingly, that the minimis rule in the 2011 temporary by allowing them to follow an taxpayer is using a reasonable, regulations was mandatory or elective established financial accounting policy consistent methodology that clearly and, if mandatory, requested a change to for federal tax purposes, and allowing reflects its income. However, the final make the safe harbor elective. The final retroactive application is inconsistent regulations do provide a de minimis regulations adopt these suggestions and with such purpose. safe harbor for taxpayers without an provide that the de minimis rule is a safe harbor, elected annually by E. Application to Consolidated Group applicable financial statement if Members accounting procedures are in place to including a statement on the taxpayer’s deduct amounts paid for property timely filed original Federal tax return Several comments noted that the rule costing less than a specified dollar for the year elected. The final for use of a consolidated group’s amount or amounts paid for property regulations provide that, if elected, the applicable financial statement failed to de minimis safe harbor must be applied consider situations in which taxpayers with an economic useful life of 12 to all amounts paid in the taxable year are included on a consolidated months or less. The de minimis safe for tangible property that meet the applicable financial statement but are harbor for taxpayers without an requirements of the de minimis safe not members in an underlying applicable financial statement provides harbor, including amounts paid for consolidated group for Federal income a reduced per invoice (or item) materials and supplies that meet the tax purposes. Comments requested that threshold because there is less requirements. In addition, the final taxpayers in this situation be permitted assurance that the accounting regulations provide that a taxpayer may to rely on the financial policies of the procedures clearly reflect income. A not revoke an election to use the de group that apply to them as well as the taxpayer without an applicable financial minimis safe harbor. An election to use group’s consolidated applicable statement may rely on the de minimis the de minimis safe harbor may not be financial statement to satisfy the safe harbor only if the amount paid for made through the filing of an requirements of the de minimis rule. property does not exceed $500 per application for change in accounting The final regulations adopt this invoice, or per item as substantiated by method. suggestion and provide that if a the invoice. If the cost exceeds $500 per taxpayer’s financial results are reported invoice (or item), then no portion of the D. Written Accounting Procedures on the applicable financial statement for cost of the property will fall within the The 2011 temporary regulations a group of entities, then the group’s de minimis safe harbor. Similar to the required that to utilize the de minimis applicable financial statement may be safe harbor for a taxpayer with an safe harbor, a taxpayer must have treated as the applicable financial applicable financial statement, this written accounting procedures in place statement of the taxpayer. Furthermore, provision provides the IRS and the at the beginning of the taxable year in this situation, the written accounting Treasury Department with the authority treating the amounts paid for property procedures provided for the group and to change the safe harbor amount costing less than a certain dollar amount utilized for the group’s applicable through published guidance. In as an expense for financial accounting financial statement may be treated as addition, an anti-abuse rule is provided purposes. Commenters suggested that the written accounting procedures of the to aggregate costs that are improperly transition guidance be issued for taxpayer. split among multiple invoices. taxpayers that did not have written Finally, for both taxpayers with accounting procedures in place at the F. Transaction and Other Additional applicable financial statements and beginning of 2012. Alternatively, one Costs taxpayers without applicable financial commenter suggested that taxpayers be The preamble to the 2011 temporary statements, the de minimis safe harbor allowed to make the drafting of a regulations provided that the de is not intended to prevent a taxpayer written accounting procedure minimis rule did not apply to amounts from reaching an agreement with its IRS retroactive to the beginning of 2012. paid for labor and overhead incurred in examining agents that, as an The final regulations do not adopt repairing or improving property. administrative matter, based on risk these suggestions for transition relief. Commenters pointed out that the analysis or materiality, the IRS Although the publication of the 2011 preamble did not provide any policy examining agents will not review temporary regulations late in the reason for excluding labor and overhead certain items. It is not intended that calendar year (December 27, 2011) costs from the de minimis rule and that examining agents must now revise their likely prevented taxpayers without the exclusion would require rules to materiality thresholds in accordance written accounting procedures at that allocate additional invoice costs, such with the de minimis safe harbor time from implementing such as freight and installation costs, between

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tangible property costs and labor and these materials and supplies satisfied all costs of other property produced by the overhead costs, requiring additional requirements of the de minimis rule, taxpayer or property acquired for resale. recordkeeping by taxpayers. including the ceiling. Many comments In general, under section 263A, if Additionally, one commenter pointed raised concerns about the administrative property is held for future production, out that the de minimis rule in the 2011 burdens associated with identifying and taxpayers must capitalize direct and temporary regulations did not expressly allocating materials and supplies indirect costs allocable to such property provide for an exclusion of labor and between the de minimis rule and the (for example, purchasing, storage, and overhead costs. Commenters requested general rules for materials and supplies handling costs), even though production that additional costs included on an in a manner that would not exceed the has not begun. If property is not held for invoice for tangible property be de minimis rule ceiling. In many cases, production, indirect costs incurred prior included within the scope of the de commenters suggested that the to the beginning of the production minimis rule. administrative burden imposed would period must be allocated to the property The final regulations adopt the outweigh any potential tax benefit. and capitalized if, at the time the costs commenters’ suggestions, in part, and Thus, commenters requested revisions are incurred, it is reasonably likely that clarify the treatment under the de to the de minimis rule to reduce production will occur at some future minimis safe harbor of transaction costs taxpayers’ administrative burden of date. Thus, for example, a manufacturer and other additional costs of acquiring complying with the 2011 temporary must capitalize the costs of storing and and producing property subject to the regulations. handling raw materials before the raw safe harbor. To simplify the application To simplify application of the de materials are committed to production. of the de minimis rule to tangible minimis safe harbor, the final In addition, § 1.263A–1T(e)(2)(i) property, the final regulations provide regulations require that the de minimis provides that indirect material costs that a taxpayer electing to apply the de safe harbor be applied to all eligible include the cost of materials that are not minimis safe harbor is not required to materials and supplies (other than an integral part of specific property include in the cost of the tangible rotable, temporary, and standby produced and the cost of materials that property the additional costs of emergency spare parts subject to the are consumed in the ordinary course of acquiring or producing such property if election to capitalize or rotable and performing production or resale these costs are not included in the same temporary spare parts subject to the activities that cannot be identified or invoice as the tangible property. optional method of accounting for such associated with particular units of However, the final regulations also parts) if the taxpayer elects the de property. provide that a taxpayer electing to apply minimis safe harbor under § 1.263(a)- Therefore, if tangible property is the de minimis safe harbor must include 1(f). Unlike the 2011 temporary acquired with the expectation of being in the cost of such property all regulations rule permitting taxpayers to used in the production of other additional costs (for example, delivery select materials and supplies for property, and it is reasonably likely that fees, installation services, or similar application of the de minimis safe production will occur at some future costs) of acquiring or producing such harbor, the requirement in the final date, section 263A may apply to property if these costs are included on regulations to apply the de minimis safe capitalize the cost of the property the same invoice with the tangible harbor, if elected, to all eligible acquired. Thus, for example, if a property. If an invoice includes amounts materials and supplies simplifies the taxpayer acquires a component part, the paid for multiple tangible properties application of the de minimis rule and cost of which is otherwise eligible for and the invoice includes additional reduces the administrative burden on the de minimis safe harbor, but the invoice costs related to the multiple the IRS. Taxpayers that do not elect the component part is installed, or expected properties, then the taxpayer must de minimis safe harbor provided in the to be installed in the future, in the allocate the additional invoice costs to final regulations for the taxable year taxpayer’s manufacturing equipment each property using a reasonable must treat their amounts paid for used to produce property for sale, under method. The final regulations specify materials and supplies in accordance section 263A, the cost of the component that a reasonable allocation method with the rules provided in § 1.162–3. part must be capitalized as an indirect includes, but is not limited to, specific cost of property produced by the H. Coordination With Section 263A identification, a pro rata allocation, or a taxpayer. On the other hand, if property weighted average method based on each Commenters asked for clarification on is acquired without the expectation of property’s relative cost. The final the interaction of the de minimis rule being used in the production of property regulations also clarify that additional with section 263A. Several comments and the taxpayer elects and properly costs consist of the transaction costs asked whether the application of the de applies the de minimis rule to the (that is, the facilitative costs under minimis rule resulted in property with amount paid for property in the taxable § 1.263(a)–2(f)) of acquiring or an unadjusted basis of zero, which year, if expectations change in a producing the property and the costs would then be subject to section 263A, subsequent taxable year and the under § 1.263(a)–2(d) for work or, alternatively, whether section 263A property is actually used in production, performed prior to the date that the unit required taxpayers to capitalize the cost then section 263A will not require of tangible property is placed in service. of property subject to section 263A, capitalization of the cost of the property regardless of whether the de minimis at the time the expectation changes or G. Materials and Supplies rule applied. when the property is used in The IRS and Treasury Department The final regulations clarify the production. received numerous comments on the interaction between the two provisions. application of the de minimis rule to The final regulations provide that I. Change in Accounting Procedures Not materials and supplies under § 1.162–3T amounts paid for tangible property Change in Method of Accounting of the 2011 temporary regulations. eligible for the de minimis safe harbor Several commenters questioned Under the 2011 temporary regulations, may, nonetheless, be subject to whether a change in a taxpayer’s taxpayers were permitted to select capitalization under section 263A if the financial accounting procedures (for materials and supplies to be expensed amounts paid for this tangible property example, its financial accounting under the de minimis rule provided that comprise the direct or allocable indirect capitalization policy) is a change in

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method of accounting for de minimis amounts. In addition, the 2011 establishing the timing of decisions. expenses to which the provisions of temporary regulations provided that Thus, such a rule could generate sections 446 and 481 and the costs relating to activities performed in significant controversy over unduly accompanying regulations apply. The the process of determining whether to small amounts. final regulations provide that the use of acquire real property and which real Moreover, the final regulations retain the de minimis safe harbor is a taxable property to acquire generally are the list of inherently facilitative costs year election and may not be made by deductible pre-decisional costs unless that generally must be capitalized as the filing of an application for a change they are described in the regulations as transaction costs. However, in response in method of accounting. Thus, if a inherently facilitative costs. The 2011 to comments, the final regulations taxpayer meets the requirements for the temporary regulations also provided clarify the meaning of finders’ fees and safe harbor, which requires, in part, that inherently facilitative amounts brokers’ commissions and provide a having written accounting procedures in allocable to real or personal property are definition of contingency fees. The final place at the beginning of the taxable capital expenditures related to such regulations provide that for purposes of year and treating amounts paid for property, even if such property is not § 1.263(a)–2, a contingency fee is an property as an expense in accordance eventually acquired or produced. amount paid that is contingent on the with those procedures, then a change in Commenters requested that the successful closing of the acquisition of the procedures, by itself, is not a change requirement to capitalize facilitative real or personal property. The final in accounting method. For example, if a costs be removed as overbroad. regulations also clarify that contingency taxpayer’s written financial accounting Commenters also stated that it was fees facilitate the acquisition of the capitalization policy at the beginning of inappropriate to provide a special rule property ultimately acquired and are not 2014 states that amounts paid for that depends on the nature of the allocable to real or personal property property costing less than $200 will be property acquired (real property or not acquired. Therefore, if a real estate treated as an expense, and the taxpayer personal property) and inappropriate to broker’s commission is contingent on changes its written policy as of the require capitalization of inherently the successful closing of the acquisition beginning of 2015 to treat amounts paid facilitative amounts allocable to of real property, the amount paid as the for property costing less that $500 as an property not acquired. Other broker’s commission inherently expense, the taxpayer is not required to commenters recommended that the list facilitates the acquisition of the property file an application for its 2015 taxable describing inherently facilitative acquired and, therefore, must be year to change its method of accounting amounts be revised to exclude activities capitalized as part of the basis of such for applying the de minimis safe harbor that are dependent on the type of property. However, no portion of the or determining amounts paid to acquire service provider (for example, a broker), broker’s contingency fee is allocable to or produce tangible property under rather than being based on a specific real property that the taxpayer did not § 1.263(a)–1(f). activity (for example, securing an acquire. In addition, the final appraisal). One commenter asked for V. Amounts Paid To Acquire or regulations retain the rule that clarification regarding the treatment of a inherently facilitative amounts allocable Produce Tangible Property Under broker’s commission if the commission § 1.263(a)–2 to real or personal property are capital was contingent on the buyer’s expenditures related to such property, Section 1.263(a)–2T of the 2011 successful acquisition of real property even if such property is not eventually temporary regulations provided rules for but a portion of the broker’s activities acquired or produced. As discussed in applying section 263(a) to amounts paid were performed in investigating the the preamble to the 2008 proposed to acquire or produce a unit of real or acquisition. regulations, the IRS and the Treasury personal property. In general, the final The final regulations generally retain Department believe that this rule is regulations retain the rules from the the 2011 temporary regulation rules consistent with established authorities. 2011 temporary regulations, including addressing facilitative amounts. As in See, for example, Sibley, Lindsay & Curr general requirements to capitalize the 2011 temporary regulations, the Co. v. Commissioner, 15 T.C. 106 (1950), amounts paid to acquire or produce a final regulations include the special rule acq., 1951–1 CB 3. The final regulations unit of real or personal property, for the acquisition of real property also clarify that, except for contingency requirements to capitalize amounts paid providing that, except for amounts fees as discussed above, inherently to defend or perfect title to real or specifically identified as inherently facilitative amounts allocable to personal property, and rules for facilitative, an amount paid by a determining the extent to which taxpayer in the process of investigating property not acquired may be allocated taxpayers must capitalize transaction or otherwise pursuing the acquisition of to those properties and recovered in costs related to the acquisition of real property does not facilitate the accordance with the applicable property. In the final regulations, the de acquisition if it relates to activities provisions of the Code, including minimis safe harbor has been moved to performed in the process of determining sections 165, 167, and 168. § 1.263(a)–1(f) to reflect its broader whether to acquire real property and VI. Amounts Paid To Improve Property application to amounts paid for tangible which real property to acquire. The final Under § 1.263(a)–3 property, including amounts paid for regulations do not expand the deduction improvements and materials and of such pre-decisional, investigatory A. Overview supplies, except as otherwise provided costs to personal property because, Comments received with respect to under section 263A. unlike real property acquisitions, the rules under the 2011 temporary The 2011 temporary regulations personal property acquisitions do not regulations for determining whether an provided that a taxpayer must, in typically raise issues of whether the amount improves, betters, or restores general, capitalize amounts paid to transaction costs should be property largely focused on the facilitate the acquisition or production characterized as deductible business application of the rules to building of real or personal property. To alleviate expansion costs rather than costs to property, the lack of a safe harbor for controversy between taxpayers and the acquire a specific property. In addition, routine maintenance for building IRS, the 2011 temporary regulations personal property acquisitions do not property, the standards to be applied in included a list of inherently facilitative typically provide clear evidence determining whether a betterment has

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occurred, the treatment of post-casualty regulations for non-building property regulations clarify that for purposes of expenditures under the restoration and applied by the courts and the IRS determining whether an amount paid by standards, and the standards to be for determining when components of a a lessee constitutes a leasehold applied in determining whether a single property are placed in service for improvement, the unit of property and replacement of a major component or cost recovery purposes, may be a more the improvement rules are applied in substantial structural part has occurred. consistent general standard for accordance with the rules for leased The final regulations generally retain identifying the relevant property upon buildings (or leased portions of the rules of the 2011 temporary which to apply the improvement building) under § 1.263(a)–3(e)(2)(v) or regulations for determining the unit of analysis. for leased property other than buildings property and for determining whether Like plant property, buildings are under § 1.263(a)–3(e)(3)(iv). Thus, for there is an improvement to a unit of complex properties composed of example, if a lessee pays an amount for property. The final regulations also numerous component parts that perform work on an addition that it previously retain the simplifying conventions set discrete and major functions or made to a leased building, the taxpayer out in the 2011 temporary regulations, operations. Unlike plant property, determines whether the work performed including the routine maintenance safe however, where the discrete and major constitutes an improvement to the entire harbor and the optional regulatory functions or operations are not leased building structure, not merely to accounting method. In addition, in consistent from plant to plant, the the addition. The final regulations also response to the comments, the final discrete and major functions or clarify that when a lessee or lessor regulations modify the 2011 temporary operations performed from building to improvement is comprised of a building regulations in several areas. The building are frequently similar. The erected on leased property, then the unit concerns raised by commenters and the building system definitions set forth in of property for the building and the relevant changes to the 2011 temporary the 2011 temporary regulations are application of the improvement rules regulations are discussed in this based on well understood costing are determined under the provisions for preamble. standards that have been routinely buildings, rather than under the applied to buildings for many years for B. Determining the Unit of Property provisions for leased buildings. valuations, cost accounting, and The 2011 temporary regulations financial reporting. To help ensure that D. Special Rules for Determining generally defined the unit of property as the improvement standards are applied Improvement Costs consisting of all the components of equitably and consistently across 1. Costs Incurred During an property that are functionally building property, the final regulations Improvement interdependent, but provided special continue to apply the improvement rules for determining the unit of rules to both the building structure and The 2011 temporary regulations did property for buildings, plant property, the defined building systems. To the not prescribe rules related to the ‘‘plan and network assets. The 2011 temporary extent the particular facts and of rehabilitation’’ doctrine as regulations also provided special rules circumstances of a subset of buildings traditionally described in the case law. for determining the units of property for used in one or more industries present The judicially-created plan of condominiums, cooperatives, and unique challenges to application of the rehabilitation doctrine provides that a leased property, and for the treatment of building structure or building system taxpayer must capitalize otherwise improvements (including leasehold definitions, taxpayers are encouraged to deductible repair or maintenance costs improvements). The final regulations request guidance under the Industry if they are incurred as part of a general retain the unit of property rules Issue Resolution (IIR) procedures. plan of rehabilitation, modernization, contained in the 2011 temporary and improvement to the property. See, regulations. C. Unit of Property for Leasehold for example, Moss v. Commissioner, 831 The 2011 temporary regulations Improvements F.2d 833 (9th Cir. 1987); United States generally defined a building as a unit of The 2011 temporary regulations v. Wehrli, 400 F.2d 686 (10th Cir. 1968); property, but required the application of provide rules for determining the unit of Norwest Corp. v. Commissioner, 108 the improvement standards to the property for leased property and for T.C. 265 (1997). The 2011 temporary building structure and the enumerated determining the unit of property for regulations did not restate the plan of building systems. A number of leasehold improvements. The IRS and rehabilitation doctrine but, rather, used comments objected to the requirement the Treasury Department received no the language of the section 263A rule that the taxpayer perform the written comments on these rules, and providing that a taxpayer must improvement analysis at the building the final regulations retain the rules capitalize both the direct costs of an structure and system level. The from the 2011 temporary regulations, improvement as well as the indirect comments stated that such treatment is with some clarifications. Under the rule costs that directly benefit or are inconsistent with the treatment of other in the 2011 temporary regulations, a incurred by reason of the improvement. complex property under the 2011 question could arise regarding the The 2011 temporary regulations also temporary regulations, is inconsistent property to be analyzed for determining included an exception to this provision with the treatment of building property whether an improvement to a lessee for an individual residence, which under depreciation rules, and fails to improvement constitutes an permitted an individual taxpayer to take into account the relative improvement to the lessee’s property. In capitalize repair and maintenance costs importance of the various building this context, the 2011 temporary incurred at the time of a substantial systems. Several comments requested regulations suggested that the taxpayer residential remodel. that the building, including its must determine whether there has been The final regulations retain the rules structural components, should be an improvement to the lessee from the 2011 temporary regulations treated as the unit of property for improvement by itself, rather than by and continue to provide that indirect applying the improvement rules to applying the improvement standards to costs, such as repair and maintenance buildings. Other commenters pointed the general unit of property rules for costs, that do not directly benefit and out that a functional interdependence leased buildings or for leased property that are not incurred by reason of an standard, used in the 2011 temporary other than buildings. The final improvement are not required to be

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capitalized under section 263(a), installation of a replacement asset. request, the final regulations include a regardless of whether they are incurred Commenters requested that the final safe harbor election for building at the same time as an improvement. In regulations include this explicit property held by taxpayers with gross addition, in response to comments conclusion. Commenters also asked receipts of $10,000,000 or less (‘‘a requesting examples of the application whether the principles of Rev. Rul. qualifying small taxpayer’’). The final of this standard, the final regulations 2000–7 would apply to allow the regulations permit a qualifying small add this analysis to several examples. deduction of removal costs when the taxpayer to elect to not apply the By providing a standard based on the taxpayer disposes of a component of a improvement rules to an eligible section 263A language, the final unit of property and the taxpayer takes building property if the total amount regulations set out a clear rule for into account the adjusted basis of the paid during the taxable year for repairs, determining when otherwise deductible component in realizing loss. maintenance, improvements, and indirect costs must be capitalized as Commenters also questioned whether a similar activities performed on the part of an improvement to property and taxpayer would be required to capitalize eligible building does not exceed the obsolete the plan of rehabilitation component removal costs if these costs lesser of $10,000 or 2 percent of the doctrine to the extent that the court- were an indirect cost of a restoration (for unadjusted basis of the building. created doctrine provides different example, the replacement of a Eligible building property includes a standards. component when the taxpayer has building unit of property that is owned properly deducted a loss for that or leased by the qualifying taxpayer, 2. Removal Costs component) rather than a betterment to provided the unadjusted basis of the The 2011 temporary regulations did the underlying unit of property. building unit of property is $1,000,000 not provide a separate rule for the The final regulations provide a or less. The final regulations provide the treatment of removal costs. Rather, the specific rule clarifying the treatment of IRS and the Treasury Department with 2011 temporary regulations addressed removal costs in these contexts. The the authority to adjust the amounts of component removal costs as an example final regulations state that if a taxpayer the safe harbor and gross receipts of a type of indirect cost that must be disposes of a depreciable asset limitations through published guidance. capitalized if the removal costs directly (including a partial disposition under The final regulations provide simple benefit or are incurred by reason of an Prop. Reg. § 1.168(i)–1(e)(2)(ix) rules for determining the unadjusted improvement. The preamble to the 2011 September 19, 2013, or Prop. Reg. basis of both owned and leased building temporary regulations stated that the § 1.168(i)–8(d) (September 19, 2013)) for units of property. In this situation, the costs of removing a component of a unit Federal tax purposes and has taken into final regulations also eliminate the need of property should be analyzed in the account the adjusted basis of the asset to separately analyze the building same manner as any other indirect cost or component of the asset in realizing structure and the building systems, as (such as a repair cost) incurred during gain or loss, the costs of removing the required elsewhere in the improvement a repair or an improvement to property. asset or component are not required to rules in the final regulations. Therefore, the preamble concluded, if be capitalized under section 263(a). The Under the safe harbor for small the cost of removing a component of a final regulations also provide that if a taxpayers, a taxpayer includes amounts unit of property directly benefitted or taxpayer disposes of a component of a not capitalized under the de minimis was incurred by reason of an unit of property and the disposal is not safe harbor election of § 1.263(a)–1(f) improvement to the unit of property, the a disposition for Federal tax purposes, and under the routine maintenance safe cost must be capitalized. The preamble then the taxpayer must deduct or harbor for buildings (discussed later in to the 2011 temporary regulations also capitalize the costs of removing the this preamble) to determine the annual noted that the 2011 temporary component based on whether the amount paid for repairs, maintenance, regulations were not intended to affect removal costs directly benefit or are improvements, and similar activities the holding of Rev. Rul. 2000–7 (2000– incurred by reason of a repair to the unit performed on the building. If the 1 CB 712) as it applied to the cost of of property or an improvement to the amount paid for repairs, maintenance, removing an entire unit of property. unit of property. In addition, the final improvements, and similar activities Under Rev. Rul. 2000–7, a taxpayer is regulations provide several examples performed on a building unit of not required to capitalize the cost of illustrating these principles. property exceeds the safe harbor removing a retired depreciable asset threshold for a taxable year, then the E. Safe Harbor for Small Taxpayers under section 263(a) or section 263A, safe harbor is not applicable to any even when the retirement and removal The 2011 temporary regulations did amounts spent during the taxable year. occur in connection with the not provide any special rules for small In that case, the taxpayer must apply the installation of a replacement asset. Rev. taxpayers to assist them in applying the general rules for determining Rul. 2000–7 reasoned that the costs of general rules for improvements to improvements, including the routine removing a depreciable asset generally buildings. One commenter stated that maintenance safe harbor for buildings. have been allocable to the removed asset small taxpayers generally do not have The taxpayer may also elect to apply the and, thus, generally have been the administrative means or sufficient de minimis safe harbor under deductible when the asset is retired. See documentation or information to apply § 1.263(a)–1(f) to amounts qualifying §§ 1.165–3(b); 1.167(a)–1(c); 1.167(a)– the improvement rules to their building under the de minimis safe harbor, 11(d)(3)(x); Rev. Rul. 74–455 (1974–2 structures and systems as required regardless of the application of the safe CB 63); Rev. Rul. 75–150 (1975–1 CB under the 2011 temporary regulations. harbor for small taxpayers. 73). Therefore, the commenter requested that The safe harbor for building property Commenters acknowledged the an annual dollar threshold, such as held small taxpayers may be elected preamble language but observed that the $10,000, be established for buildings annually on a building-by-building basis 2011 temporary regulations did not with an initial cost of $1,000,000 or less by including a statement on the explicitly state that the costs incurred to and that taxpayers be permitted to taxpayer’s timely filed original Federal remove an entire unit of property are deduct annual amounts spent on the tax return, including extensions, for the not required to be capitalized, even building if they did not exceed the year the costs are incurred for the when incurred in connection with the threshold amount. In response to this building. Amounts paid by the taxpayer

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to which the taxpayer properly applies improvement standards under the 2011 their applicable financial statements, and elects the safe harbor are not treated temporary regulations must now be and such treatment may not be as improvements to the building under applied to the building structure and indicative of whether the activities are § 1.263(a)–3 and may be deducted under each building system separately, these routine. Third, the final regulations § 1.162–1 or § 1.212–1, as applicable, in components are more analogous to clarify the applicability of the routine the taxable year that the amounts are section 1245 property, which qualifies maintenance safe harbor by adding three paid or incurred, provided the amounts for the routine maintenance safe harbor. items to the list of exceptions from the otherwise qualify for deduction under Commenters suggested that using a routine maintenance safe harbor: (1) those sections. A taxpayer may not period shorter than a building’s class Amounts paid for a betterment to a unit revoke an election to apply the safe life, such as 20 years, could alleviate the of property, (2) amounts paid to adapt harbor for small taxpayers. IRS and the Treasury Department’s a unit of property to a new or different concern that the cost of true use, and (3) amounts paid for repairs, F. Safe Harbor for Routine Maintenance improvements would not be properly maintenance, or improvement of 1. Buildings capitalized if the safe harbor were network assets. The first two exceptions The 2011 temporary regulations extended to buildings. Another were included in the general rule for the provided that the costs of performing commenter argued that the distinction safe harbor in the 2011 temporary certain routine maintenance activities between building property and non- regulations, but were not clearly stated building property for purposes of the as exceptions. The exception for for property other than a building or the safe harbor is arbitrary because, in many network assets was added because of the structural components of a building are respects, retail buildings are similar to difficulty in defining the unit of not required to be capitalized as an other complex property, such as aircraft, property for network assets and the improvement. Under the routine which are not excluded from the safe preference for resolving issues involving maintenance safe harbor, an amount harbor. network assets through the IIR program. paid was deemed not to improve a unit In response to these comments, the Finally, the exception relating to of property if it was for the recurring final regulations contain a safe harbor amounts paid for property for which a activities that a taxpayer (or a lessor) for routine maintenance for buildings. taxpayer has taken a basis adjustment expected to perform as a result of the The inclusion of a routine maintenance resulting from a casualty loss is slightly taxpayer’s (or the lessee’s) use of the safe harbor for buildings is expected to modified to be consistent with the unit of property to keep the unit of alleviate some of the difficulties that revised casualty loss restoration rule, property in its ordinarily efficient could arise in applying the which is discussed in this preamble. operating condition. The 2011 improvement standards for certain temporary regulations provided that the restorations to building structures and 3. Reasonable Expectation That activities are routine only if, at the time building systems. To balance Activities Will Be Performed More Than the unit of property was placed in commenters’ suggestions of using a Once service, the taxpayer reasonably shorter period, such as 20 years, with A taxpayer’s reasonable expectation of expected to perform the activities more the concerns expressed in the preamble whether it will perform qualifying than once during the period prescribed to the 2011 temporary regulations, the maintenance activities more than once under sections 168(g)(2) and 168(g)(3) final regulations use 10 years as the during the relevant period will be (the Alternative Depreciation System period of time in which a taxpayer must determined at the time the unit of class life), regardless of whether the reasonably expect to perform the property (or building structure or property was depreciated under the relevant activities more than once. system, as applicable) is placed in Alternative Depreciation System. The While periods longer than 10 years were service. The final regulations modify the preamble to the 2011 temporary considered, the use of a period much safe harbor for routine maintenance by regulations explained that the routine longer than 10 years would, contrary to adding that a taxpayer’s expectation will maintenance safe harbor did not apply current authority, permit the costs of not be deemed unreasonable merely to building property, because the long many major remodeling and restoration because the taxpayer does not actually class life for such property (40 years projects to be deducted under the safe perform the maintenance a second time under section 168(g)(2)) arguably could harbor, regardless of the nature or extent during the relevant period, provided allow major remodeling or restoration of the work involved. that the taxpayer can otherwise projects to be deducted under the safe substantiate that its expectation was harbor, regardless of the nature or extent 2. Other Changes reasonable at the time the property was of the work involved, and that The final regulations make several placed in service. Thus, for a unit of deducting such costs would be additional changes and clarifications to property previously placed in service, inconsistent with case law. The 2011 the safe harbor for routine maintenance, whether the maintenance is actually temporary regulations provided several which are applicable to both buildings performed more than once during the factors for taxpayers to consider in and other property. First, the regulations relevant period is not controlling for determining whether a taxpayer is confirm that routine maintenance can be assessing the reasonableness of a performing routine maintenance, performed any time during the life of taxpayer’s original expectation. including the recurring nature of the the property provided that the activities However, if a similar or identical unit of activity, industry practice, qualify as routine under the regulation. property is placed in service in a future manufacturers’ recommendations, the Second, for purposes of determining tax year, the taxpayer’s experience with taxpayer’s experience, and the whether a taxpayer is performing the original property may be taken into taxpayer’s treatment of the activity on routine maintenance, the final account as a factor in assessing whether its applicable financial statement. regulations remove the taxpayer’s the taxpayer reasonably expects to Comments on the routine treatment of the activity on its perform the activities more than once maintenance safe harbor generally applicable financial statement from the during the relevant period for the requested that the safe harbor be factors to be considered. Taxpayers may similar or identical unit of property. The extended to building property. One have several different reasons for taxpayer’s actual experience, therefore, commenter stated that because the capitalizing maintenance activities on may be used in assessing the

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reasonableness of the taxpayer’s 2. Amelioration of Material Condition or type of property. Whether any single expectation of the frequency of Defect factor applies to a particular unit of restoration or replacement at the time a Commenters requested that certain property depends on the nature of the new unit of property is placed in examples be clarified to distinguish property. For example, while amounts service, but hindsight should not be more clearly between circumstances paid for work performed on an office used to invalidate a taxpayer’s that require capitalization of amounts building or a retail building may clearly reasonable expectation as established at paid to ameliorate a material condition comprise a physical enlargement or increase the capacity, efficiency, the time the unit of property was first or defect and circumstances that do not strength, or quality of such building placed in service when subsequent require capitalization. One commenter under certain facts, it is unclear how to events do not conform to the taxpayer’s requested that the final regulations measure whether work performed on an reasonable expectation. include a rule that would provide for an office building or retail building allocation of expenditures between pre- 4. Amounts Not Qualifying for the increases the productivity or output of and post-acquisition periods based on Routine Maintenance Safe Harbor such buildings, as those terms are facts and circumstances if an The final regulations clarify that generally understood. Thus, the expenditure both ameliorates a pre- amounts incurred for activities falling productivity and output factors would existing condition and ameliorates outside the routine maintenance safe not generally apply to buildings. On the normal wear and tear that results from harbor are not necessarily expenditures other hand, it is appropriate to evaluate the taxpayer’s use of the property. With required to be capitalized under many items of manufacturing respect to whether amounts paid to § 1.263(a)–3. Amounts incurred for equipment in terms of output or ameliorate conditions are betterments, activities that do not meet the routine productivity as well as size, capacity, other comments reiterated suggestions maintenance safe harbor are subject to efficiency, strength, and quality. provided in response to the 2008 analysis under the general rules for Accordingly, the final regulations clarify proposed regulations, as described in improvements. that the applicability of each the preamble to the 2011 temporary quantitative and qualitative factor G. Betterments regulations. depends on the nature of the unit of The final regulations do not adopt the 1. Overview property, and if an addition or increase comments with respect to expenditures in a particular factor cannot be The 2011 temporary regulations to ameliorate pre-existing conditions or measured in the context of a specific provided that an amount paid results in defects. The facts and circumstances type of property, then the factor is not a betterment, and accordingly, an rule provided in the final regulations is relevant in determining whether there improvement, if it (1) ameliorates a consistent with established case law and has been a betterment to the property. material condition or defect that existed represents an administrable standard for prior to the acquisition of the property determining whether an improvement 4. Application of Betterment Rule or arose during the production of the has occurred. Several commenters questioned the property; (2) results in a material 3. Material Addition or Increase in betterment rule in the 2011 temporary addition to the unit of property regulations that requires consideration (including a physical enlargement, Productivity, Efficiency, Strength, Quality, or Output of all facts and circumstances, including expansion, or extension); or (3) results the treatment of the expenditures on a in a material increase in the capacity, Many commenters requested that the taxpayer’s applicable financial productivity, efficiency, strength, or final regulations provide explanations statement. One commenter questioned quality of the unit of property or its and quantitative bright lines for whether the treatment of an expenditure output. As applied to buildings, an determining the materiality of an on a taxpayer’s applicable financial amount results in a betterment to the addition to a unit of property or an statement should be relevant in building if it results in a betterment to increase in capacity, productivity, determining whether an amount paid the building structure or any of the efficiency, strength, quality, or output of results in a betterment and suggested building systems. a unit of property. Additionally, removal of this factor from the facts and The final regulations retain the commenters requested more explanation circumstances test provided in the 2011 provisions of the 2011 temporary of terms such as productivity, quality, temporary regulations. The IRS and the regulations related to betterments with and output, and how such standards Treasury Department recognize that several refinements. Specifically, the should be applied across a variety of taxpayers may apply different standards final regulations reorganize and clarify different types of tangible property. for capitalizing amounts on their the types of activities that constitute These suggestions were extensively applicable financial statements and betterments to property. Also, the final considered, but the final regulations do such standards may not be controlling regulations no longer phrase the not adopt the suggestions to establish for whether the activities are betterment test in terms of amounts that quantitative bright lines. Quantitative betterments for Federal tax purposes. result in a betterment. Rather, the final bright lines, although objective, would Thus, the final regulations remove the regulations provide that a taxpayer must produce inconsistent results given the taxpayer’s treatment of the expenditure capitalize amounts that are reasonably broad array of factual settings where the on its financial statement as a factor to expected to materially increase the betterment rules apply. Instead, the final be considered in performing a productivity, efficiency, strength, regulations continue to rely on betterment analysis under the final quality, or output of a unit of property qualitative factors to provide fair and regulations. In addition, the final or that are for a material addition to a equitable treatment for all taxpayers in regulations omit the reference to the unit of property. Elimination of the determining whether a particular cost taxpayer’s facts and circumstances in ‘‘results in’’ standard should reduce constitutes a betterment. determining whether amounts are paid controversy for expenditures that span The final regulations clarify, however, for a betterment to the taxpayer’s more than one tax year or when the that not every single quantitative or property. The IRS and the Treasury outcome of the expenditure is uncertain qualitative factor listed in the Department believe that an analysis of a when the expenditure is made. betterment standard applies to every taxpayer’s particular facts and

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circumstances is implicit in the H. Restorations provided in the 2011 temporary application of all the final regulations regulations were too subjective, and 1. Overview governing improvements and need not numerous commenters requested that be specifically provided in the The 2011 temporary regulations the final regulations reintroduce a application of the betterment rules. provided that an amount is paid to bright-line definition of what constitutes The 2011 temporary regulations restore, and therefore improve, a unit of a major component or substantial provided that, when an expenditure is property if it meets one of six tests: (1) structural part for purposes of applying necessitated by a particular event, the it is for the replacement of a component the restoration standards, particularly determination of whether an of a unit of property and the taxpayer with regard to buildings. Several expenditure is for the betterment of a has properly deducted a loss for that commenters suggested that a fixed unit of property is made by comparing component (other than a casualty loss percentage of a building should be the condition of the property under § 1.165–7); (2) it is for the defined as the major component. In immediately after the expenditure with replacement of a component of a unit of addition, commenters asked for the condition of the property property and the taxpayer has properly clarifying guidance or more examples, immediately prior to the event taken into account the adjusted basis of arguing that the major component test of necessitating the expenditure. The IRS the component in realizing gain or loss the 2011 temporary regulations uses and the Treasury Department received resulting from the sale or exchange of broad, undefined, and subjective terms. comments requesting that the final the component; (3) it is for the repair of The final regulations retain the regulations clarify the application of the damage to a unit of property for which substantive rules of the 2011 temporary appropriate comparison rule for the taxpayer has properly taken a basis regulations, but clarify the definition of determining whether an expenditure is adjustment as a result of a casualty loss major component, and, more for a betterment of a unit of property. under section 165, or relating to a significantly, add a new definition for The final regulations retain this general casualty event described in section 165 major components and substantial rule but clarify that the rule applies (‘‘casualty loss rule’’); (4) it returns the structural parts of buildings. Although when the event necessitating the unit of property to its ordinarily the IRS and the Treasury Department expenditure is either normal wear and efficient operating condition if the considered several bright-line tests, tear or damage to the unit of property property has deteriorated to a state of none were found to fairly, equitably, during the taxpayer’s use of the disrepair and is no longer functional for and in a readily implementable manner distinguish between expenditures that property. Thus, the final regulations its intended use; (5) it results in the constitute restorations and expenditures clarify that the appropriate comparison rebuilding of the unit of property to a that constitute deductible repairs or rule focuses on events affecting the like-new condition after the end of its maintenance consistent with the case condition of the property and not on class life; or (6) it is for the replacement law and administrative rulings in the business decisions made by taxpayers. of a major component or a substantial area. In addition, the final regulations structural part of the unit of property (‘‘major component rule’’). In many cases, particularly with confirm that the rule does not apply to regard to buildings, establishing a clear wear, tear, or damage that occurs prior The IRS and the Treasury Department received a number of comments threshold, such as 30 percent of a to the taxpayer’s acquisition or use of defined amount, would be unworkable. the property. In these situations, the regarding the 2011 temporary regulations restoration rules. The final Largely due to the complex nature of the amelioration of a material condition or property involved and the fact that units defect rule may apply. regulations generally retain the restoration standards set forth in the of property include assets placed in service in multiple taxable years, 5. Retail Store Refresh or Remodels 2011 temporary regulations but revise applying a fixed percentage to a both the major component rule and the A substantial number of comments building structure or a building system casualty loss rule in response to were received with respect to the in a way that creates a consistent and comments. betterment examples in the 2011 equitable result proved exceedingly temporary regulations that address retail 2. Replacement of a Major Component intricate and complex, thereby failing to store refresh or remodel projects, or Substantial Structural Part achieve the simplifying objective of a requesting the addition of quantitative bright line test. The final regulations, bright lines and the inclusion of a. Definition of Major Component and Substantial Structural Part therefore, do not adopt any of the bright- additional detail in the examples. line tests suggested. As discussed previously in this The 2011 temporary regulations preamble, the final regulations do not provided that an amount paid for the b. General Rule for Major Component adopt the suggestions to provide replacement of a major component or and Substantial Structural Part quantitative bright lines in applying the substantial structural part of a unit of To provide additional guidance for betterment rules. However, the final property is an amount paid to restore determining what constitutes a major regulations include additional detail in (and, therefore, improve) the unit of component or substantial structural a number of the examples, including the property. The determination of whether part, the final regulations clarify the examples related to building refresh or a component or part was ‘‘major’’ or distinction between a major component remodels, illustrating distinctions ‘‘substantial’’ depended on the facts and and a substantial structural part. between betterments and maintenance circumstances, including both Specifically, the final regulations activities when a taxpayer undertakes qualitative and quantitative factors. separate ‘‘major component,’’ which multiple simultaneous activities on a Commenters expressed concern that focuses on the function of the building. To the extent the rules in the the lack of a bright-line test or component in the unit of property, from final regulations present situations that additional definitions would result in ‘‘substantial structural part,’’ which might be addressed through the IIR uncertainty and disputes in applying focuses on the size of the replacement program, taxpayers may pursue the restoration rules contained in the component in relation to the unit of additional guidance through the IIR 2011 temporary regulations. Several property. The final regulations define a process. commenters stated that the standards major component as a part or

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combination of parts that performs a to the section 168 disposition eliminating the casualty loss rule, discrete and critical function in the regulations, the safe harbor for small commenters requested that the final operation of the unit of property. The taxpayers, and the addition and revision regulations allow a taxpayer to elect to final regulations define a substantial of many examples, the revised forego recognizing the casualty loss and structural part as a part or combination definition of major component for making a corresponding adjustment to of parts that comprises a large portion buildings should relieve much of the basis to avoid application of the of the physical structure of the unit of controversy in determining whether the casualty loss rule. property. replacement of a major component or a The casualty loss rule in 2011 In response to comments, the final substantial structural part of a unit of temporary regulations was based on the regulations retain, but also clarify, the property is an amount paid to restore a capitalization rule provided in section exception to the major component rule. building. 263(a)(2), which states that no The 2011 temporary regulations deduction shall be allowed for any provided that the replacement of a 3. Casualty Loss Rule amount expended in restoring property minor component, even though such The 2011 temporary regulations or in making good the exhaustion component might affect the function of provided that an amount is paid to thereof for which an allowance is or has the unit of property, generally would restore a unit of property if it is for the been made. When property has been not, by itself, constitute a major repair of damage to the unit of property damaged in a casualty and a loss for component. The exception was meant to for which the taxpayer has properly such property has been claimed, apply to relatively minor components, taken a basis adjustment as a result of amounts paid to replace the damaged such as a switch, which generally a casualty loss under section 165, or property are incurred to restore property performs a discrete function (turning relating to a casualty event described in for which an allowance has been made. property on and off) and is critical to the section 165 (‘‘casualty loss rule’’). Thus, under section 263(a)(2), when the operation of a unit of property (that is, Capitalization of restoration costs is basis in replaced property has been property will not run without it). To required under the casualty loss rule, recovered by the taxpayer, capitalization provide additional clarification even when the amounts paid for the of the replacement property is regarding this exception, the final repair exceed the adjusted basis appropriate. regulations clarify that an incidental remaining in the property and Recognizing that such a rule can component of a unit of property, even regardless of whether the amounts may provide harsh results for a taxpayer with though such component performs a otherwise qualify as repair costs. The valuable property with low adjusted discrete and critical function in the 2011 temporary regulations recognized a basis that is destroyed in a casualty operation of the unit of property, taxpayer’s ability to deduct a casualty event, considerable consideration was generally will not, by itself, constitute a loss under section 165 or, to the extent given to the suggestion that the major component. eligible, to deduct the repair expense regulations provide an election to forgo associated with the casualty damage. a casualty loss deduction. Ultimately, c. Major Component and Substantial But the 2011 temporary regulations did however, it was concluded that the IRS Structural Part of Buildings not permit a taxpayer to deduct both and the Treasury Department do not The final regulations address the amounts arising from the same event in have the authority to permit taxpayers request for additional clarity regarding the same taxable year. to electively avoid the basis adjustment the definition of major component for Commenters requested that the final requirement imposed by section buildings by adding a new definition for regulations eliminate the casualty loss 1016(a). Section 1016(a) states that ‘‘a major components and substantial rule. Commenters argued that proper adjustment in respect of the structural parts of buildings. In the case recognition of a casualty loss under property shall in all cases be made for of buildings, the final regulations section 165 is irrelevant in determining . . . losses, or other items, properly provide that an amount is for the whether the costs to restore the damage chargeable to capital account. . .’’ replacement of a major component or resulting from a casualty should be Therefore, even if a taxpayer could substantial structural part if the capitalized, and the 2011 temporary choose to forgo claiming a loss for replacement includes a part or regulations should not deny one tax property damage under section 165, combination of parts that (1) comprises benefit (the ability to deduct repair section 1016 requires an adjustment to a major component or a significant costs) based on a taxpayer’s realization the basis of the property because a loss portion of a major component of the of another tax benefit (the ability to properly could be claimed. building structure or any building deduct a casualty loss). Similarly, In response to commenters’ system, or (2) comprises a large portion commenters argued that the Code allows suggestions, the final regulations revise of the physical structure of the building both a casualty loss and a repair the casualty loss rule to permit a structure or any building system. deduction, and the IRS and the Treasury deduction, where otherwise While the definition of major Department had not offered any permissible, for amounts spent in excess component for buildings introduces an justification for denying a deduction for of the adjusted basis of the property additional level of analysis (a significant the cost to repair damaged property only damaged in a casualty event. Thus, a portion of a major component) that must because the taxpayer has taken a taxpayer is still required to capitalize be applied in determining whether an casualty loss deduction. Commenters amounts paid to restore damage to amount spent on a building constitutes argued that the 2011 temporary property for which the taxpayer has a restoration, the rule provides an regulations penalize taxpayers that have properly recorded a basis adjustment, analytical framework and reaches suffered a casualty as a result of but the costs required to be capitalized conclusions that are generally consistent property damage. Commenters under the casualty loss rule are limited with the case law. Therefore, in practice suggested that the casualty loss rule in to the excess of (1) the taxpayer’s basis this framework should be readily the 2011 temporary regulations results adjustments resulting from the casualty applicable for amounts spent on in similarly situated taxpayers being event, over (2) the amount paid for buildings. In combination with the treated differently, based on whether an restoration of damage to the unit of addition of a routine maintenance safe asset has adjusted basis at the time of a property that also constitutes a harbor for buildings, the modifications casualty event. As an alternative to restoration under the other criteria of

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§ 1.263(a)–3(k)(1) (excluding the maintenance programs, conducted regulatory accounting rules of the casualty loss rule). Casualty-related according to manufacturer’s original Federal Energy Regulatory Commission expenditures in excess of this limitation specifications, constitute rebuilding a (FERC), the Federal Communications are not treated as restoration costs under unit of property to like-new condition. Commission (FCC), or the Surface § 1.263(a)–3(k)(1)(iii) and may be The final regulations adopt the standard Transportation Board (STB). A taxpayer properly deducted if they otherwise provided in the 2011 temporary that uses the regulatory accounting constitute ordinary and necessary regulations but clarify that generally a method does not apply the rules under business expenses (for example, repair comprehensive maintenance program, sections 162, 212, or 263(a) in and maintenance expenses) under even though substantial, does not return determining whether amounts paid to section 162. The final regulations a unit of property to like-new condition. repair, maintain, or improve property contain several examples illustrating the are capital expenditures or deductible I. Adaptation to a New or Different Use casualty loss rule, including one expenses. Section 263A continues to example that demonstrates the The 2011 temporary regulations apply to costs required to be capitalized operation of the new limitation on required a taxpayer to capitalize to property produced by the taxpayer or amounts required to be capitalized. amounts paid to adapt a unit of property to property acquired for resale. to a new or different use (that is, a use The IRS and the Treasury Department 4. Salvage Value Exception inconsistent with the taxpayer’s received no comments on this Under the 2011 temporary intended ordinary use at the time the methodology, and the final regulations regulations, a restoration includes property was originally placed in retain the rule from the 2011 temporary amounts paid for the replacement of a service by the taxpayer). As applied to regulations, with one modification. The component of a unit of property when buildings, the new or different use final regulations modify the description the taxpayer has properly deducted a standard is applied separately to the of the regulatory accounting method to loss for that component (other than a building structure and its building clarify that, for purposes of determining casualty loss under § 1.165–7) and for systems. Commenters requested whether an amount is for a capital the replacement of a component of a clarification of the adaptation rules and expenditure, an eligible taxpayer must unit of property when the taxpayer has additional examples. Commenters also apply the method of accounting that it properly taken into account the adjusted asked that, for specific industries, the is required to follow by FERC, FCC, or basis of the component in realizing gain regulations provide that changes to STB (whichever is applicable). or loss resulting from the sale or facilities in response to a change in exchange of the component. In response product mix, a reallocation of floor VIII. Election To Capitalize Repair and to comments, the final regulations retain space, the need to rebrand, or the Maintenance Costs these rules but provide an exception for introduction of a new product line do The 2011 temporary regulations did property that cannot be depreciated to not constitute a new or different use. not contain an election for taxpayers to an adjusted basis of zero due to the The final regulations retain the capitalize expenditures made with application of salvage value (for substantive rules of the 2011 temporary respect to tangible property that would example, property placed in service regulations but add additional examples otherwise be deductible under these before 1981, and post-1980 assets that to illustrate the rules. The final regulations. Commenters requested that, do not qualify for the Accelerated Cost regulations provide that if an amount to reduce uncertainty in applying Recovery System of former section 168 adapts the unit of property in a manner subjective standards and to reduce (ACRS) or MACRS). When a loss is inconsistent with the taxpayer’s administrative burden, the final properly deducted or the adjusted basis intended ordinary use of the property regulations include an election to of the component is realized from a sale when placed in service, the amount capitalize repair and maintenance or exchange, and the amount of loss or must be capitalized as an adaptation of expenditures as improvements if the basis adjustment is attributable only to the unit of property to a new or different taxpayer treats such costs as capital the remaining salvage value (the amount use. In response to comments, two new expenditures for financial accounting a taxpayer is expected to receive in cash examples address circumstances in purposes. In response to these or trade-in allowance upon disposition which part of a retail building unit of comments as well as in recognition of of an asset at the end of its useful life) property is converted to provide new the significant administrative burden as computed for Federal income tax services or products. However, reduction achieved by permitting a purposes, a taxpayer is not required to providing tailored guidance for specific taxpayer to follow for Federal income treat amounts paid for the replacement industries or specific types of property tax purposes the capitalization policies of the component as a restoration under (for example, retail sales facilities) is not used for its books and records, the final § 1.263(a)–3(k)(1)(i) or (k)(1)(ii). appropriate for broadly applicable regulations permit a taxpayer to elect to Amounts subject to this exception must guidance. Specific industry guidance is treat amounts paid during the taxable be evaluated under other provisions of better addressed through the IIR year for repair and maintenance to the regulations to determine if the program. tangible property as amounts paid to amounts are paid to improve tangible improve that property and as an asset VII. Optional Regulatory Accounting property. subject to the allowance for Method depreciation, as long as the taxpayer 5. Rebuild to Like-New Condition The 2011 temporary regulations incurs the amounts in carrying on a The 2011 temporary regulations provided an optional regulatory method, trade or business and the taxpayer treats provided that a unit of property is which permitted certain regulated the amounts as capital expenditures on rebuilt to a like-new condition if it is taxpayers to follow the method of its books and records used for regularly brought to the status of new, rebuilt, accounting they used for regulatory computing income. Under the final remanufactured, or similar status under accounting purposes in determining regulations, a taxpayer that elects this the terms of any federal regulatory whether an amount paid improves treatment must apply the election to all guideline or the manufacturer’s original property. For purposes of the optional amounts paid for repair and specifications. Commenters asked for method, a taxpayer in a regulated maintenance to tangible property that it clarification on whether comprehensive industry is a taxpayer subject to the treats as capital expenditures on its

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books and records in that taxable year. filing an amended Federal tax return publication of the 2008 proposed A taxpayer making the election must (including any applicable statements) regulations and after the publication of begin to depreciate the cost of such for the applicable taxable year on or the 2011 temporary regulations. In improvements when the improvements before 180 days from the due date addition, taxpayers and the IRS are placed in service by the taxpayer including extensions of the taxpayer’s routinely reach agreements on under the applicable provisions of the Federal tax return for the applicable calculation methodologies and amounts. Code and regulations. The election is taxable year, notwithstanding that the Separate procedures will be provided made by attaching a statement to the taxpayer may not have extended the due under which taxpayers may obtain taxpayer’s timely filed original Federal date. automatic consent for a taxable year tax return (including extensions) for the Finally, a taxpayer may also choose to beginning on or after January 1, 2012, to taxable year in which the improvement apply the 2011 temporary regulations to change to a method of accounting is placed in service. Once made, the taxable years beginning on or after provided in the final regulations. election may not be revoked. January 1, 2012, and before January 1, Although a taxpayer seeking a change in A taxpayer that capitalizes repair and 2014. For taxpayers choosing to apply method of accounting to comply with maintenance costs under the election is the temporary regulations to these these regulations generally must take still eligible to apply the de minimis taxable years, certain provisions of the into account a full adjustment under safe harbor, the safe harbor for small temporary regulations only apply to section 481(a), it is anticipated that for taxpayers, and the routine maintenance amounts paid or incurred in taxable the specific situation where a taxpayer safe harbor to repair and maintenance years beginning on or after January 1, seeks to change to a method of costs that are not treated as capital 2012, and before January 1, 2014. accounting that is applicable only to expenditures on its books and records. amounts paid or incurred in taxable X. Change in Method of Accounting years beginning on or after January 1, IX. Applicability Dates The IRS and the Treasury Department 2014, a limited section 481(a) The final regulations generally apply received several comments regarding adjustment will apply, taking into to taxable years beginning on or after the procedures that a taxpayer should account only amounts paid or incurred January 1, 2014. However, certain utilize to change its method of in taxable years beginning on or after provisions of the final regulations only accounting to comply with the January 1, 2014, or at a taxpayer’s apply to amounts paid or incurred in regulations. Several commenters favored option, amounts paid or incurred in taxable years beginning on or after the use of a cut-off method, primarily taxable years beginning on or after January 1, 2014. For example, the de for reasons of administrative January 1, 2012. minimis safe harbor election under convenience. However, other § 1.263(a)–1(f) only applies to amounts commenters asserted that any change in Special Analyses paid or incurred for tangible property method of accounting must include a It has been determined that this after January 1, 2014, for taxable years section 481(a) adjustment. Treasury decision is not a significant beginning on or after January 1, 2014. The final regulations provide that, regulatory action as defined in Alternatively, a taxpayer may except as otherwise stated, a change to Executive Order 12866, as generally choose to apply the final comply with the final regulations is a supplemented by Executive Order regulations to taxable years beginning change in method of accounting to 13563. Therefore, a regulatory on or after January 1, 2012. For which the provisions of sections 446 assessment is not required. It also has taxpayers choosing this early and 481 and the accompanying been determined that section 553(b) of application, certain provisions of the regulations apply. A taxpayer seeking to the Administrative Procedure Act (5 final regulations only apply to amounts change to a method of accounting U.S.C. chapter 5) does not apply to these paid or incurred in taxable years permitted in the final regulations must regulations. beginning on or after January 1, 2012. secure the consent of the Commissioner Pursuant to the Regulatory Flexibility For example, for these taxpayers, the de in accordance with § 1.446–1(e) and Act (5 U.S.C. chapter 6), it is hereby minimis safe harbor election only follow the administrative procedures certified that these final regulations will applies to amounts paid or incurred for issued under § 1.446–1(e)(3)(ii) for not have a significant economic impact tangible property after January 1, 2012, obtaining the Commissioner’s consent to on a substantial number of small for taxable years beginning on or after change its accounting method. In entities. This regulation affects all small January 1, 2012. general, a taxpayer seeking a change in business taxpayers. While a collection For taxpayers choosing to apply the method of accounting to comply with of information is required by this final regulations to taxable years these regulations must take into account regulation in §§ 1.263(a)–1(f)(5), beginning on or after January 1, 2012, or a full adjustment under section 481(a). 1.263(a)–2(h)(6), and 1.263(a)–3(n), this where applicable, to amounts paid or The imposition of a section 481(a) collection will not have a significant incurred in taxable years beginning on adjustment for a change in method of economic impact on small entities. This or after January 1, 2012, the final accounting to conform to the final information is required for a taxpayer to regulations provide transition relief for regulations provides for a uniform and elect to use the de minimis safe harbor, taxpayers that did not make the certain consistent rule for all taxpayers and to elect a safe harbor for determining the elections (for example, the election to ultimately reduces the administrative treatment of amounts related to apply the de minimis safe harbor or the burdens on taxpayers and the IRS in buildings owned or leased by small election to apply the safe harbor for enforcing the requirements of section taxpayers, and to elect to capitalize small taxpayers) on their timely filed 263(a). Although the IRS and the certain repair and maintenance costs. original Federal tax return for their 2012 Treasury Department recognize that These elections were provided in the or 2013 taxable year (the applicable requiring a section 481(a) adjustment regulations in response to comment taxable year). Specifically, for taxable may place a burden on taxpayers to letters submitted on behalf of small years beginning on or after January 1, calculate reasonable adjustments, business taxpayers requesting that these 2012, and ending on or before taxpayers have shown a willingness and types of provisions be added to the September 19, 2013, a taxpayer is ability to make these calculations in regulations to assist small businesses. permitted to make these elections by requesting method changes after the All of these elections are voluntary,

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beneficial, and were designed to or produce materials and supplies (as beginning when used in the taxpayer’s simplify the application of sections 162 defined in paragraph (c) of this section) operations; and 263(a) to small taxpayers. The are deductible in the taxable year in (iii) Is a unit of property as provisions require a taxpayer to file a which the materials and supplies are determined under § 1.263(a)–3(e) that statement with the taxpayer’s timely first used in the taxpayer’s operations or has an economic useful life of 12 filed original tax return to inform the are consumed in the taxpayer’s months or less, beginning when the IRS that the taxpayer is electing to use operations. property is used or consumed in the these provisions. The estimated time to (2) Incidental materials and supplies. taxpayer’s operations; prepare a statement should not exceed Amounts paid to acquire or produce (iv) Is a unit of property as 15 minutes, and the filing of the incidental materials and supplies (as determined under § 1.263(a)–3(e) that statement allows the taxpayer to receive defined in paragraph (c) of this section) has an acquisition cost or production the beneficial treatment for the amounts that are carried on hand and for which cost (as determined under section 263A) that qualify for the statement. Based on no record of consumption is kept or of of $200 or less (or other amount as these facts, a regulatory flexibility which physical inventories at the identified in published guidance in the analysis under Regulatory Flexibility beginning and end of the taxable year Federal Register or in the Internal Act (5 U.S.C. chapter 6) is not required. are not taken, are deductible in the Revenue Bulletin (see Pursuant to section 7805(f) of the Code, taxable year in which these amounts are § 601.601(d)(2)(ii)(b) of this chapter); or this regulation was submitted to the paid, provided taxable income is clearly (v) Is identified in published guidance Chief Counsel for Advocacy of the Small reflected. in the Federal Register or in the Internal Business Administration for comment (3) Use or consumption of rotable and Revenue Bulletin (see on its impact on small business. temporary spare parts. Except as § 601.601(d)(2)(ii)(b) of this chapter) as Statement of Availability for IRS provided in paragraphs (d), (e), and (f) materials and supplies for which Documents of this section, for purposes of treatment is permitted under this paragraph (a)(1) of this section, rotable section. For copies of recently issued revenue and temporary spare parts (defined (2) Rotable and temporary spare procedures, revenue rulings, notices, under paragraph (c)(2) of this section) parts. For purposes of this section, and other guidance published in the are first used in the taxpayer’s rotable spare parts are materials and Internal Revenue Bulletin or Cumulative operations or are consumed in the supplies under paragraph (c)(1)(i) of this Bulletin, please visit the IRS Web site at taxpayer’s operations in the taxable year section that are acquired for installation http://www.irs.gov. in which the taxpayer disposes of the on a unit of property, removable from Drafting Information parts. that unit of property, generally repaired (b) Coordination with other provisions or improved, and either reinstalled on The principal authors of these of the Internal Revenue Code. Nothing the same or other property or stored for regulations are Merrill D. Feldstein and in this section changes the treatment of later installation. Temporary spare parts Kathleen Reed, Office of the Associate any amount that is specifically provided are materials and supplies under Chief Counsel (Income Tax and for under any provision of the Internal paragraph (c)(1)(i) of this section that Accounting). Other personnel from the Revenue Code (Code) or regulations are used temporarily until a new or IRS and the Treasury Department have other than section 162(a) or section 212 repaired part can be installed and then participated in their development. and the regulations under those are removed and stored for later List of Subjects sections. For example, see § 1.263(a)–3, installation. which requires taxpayers to capitalize (3) Standby emergency spare parts. 26 CFR Part 1 amounts paid to improve tangible Standby emergency spare parts are Income taxes, Reporting and property and section 263A and the materials and supplies under paragraph recordkeeping requirements. regulations under section 263A, which (c)(1)(i) of this section that are— require taxpayers to capitalize the direct (i) Acquired when particular 26 CFR Part 602 and allocable indirect costs, including machinery or equipment is acquired (or Record and recordkeeping the cost of materials and supplies, of later acquired and set aside for use in requirements. property produced by the taxpayer and particular machinery or equipment); Adoption of Amendments to the property acquired for resale. See also (ii) Set aside for use as replacements Regulations § 1.471–1, which requires taxpayers to to avoid substantial operational time include in inventory certain materials loss caused by emergencies due to Accordingly, 26 CFR parts 1 and 602 and supplies. particular machinery or equipment are amended as follows: (c) Definitions—(1) Materials and failure; supplies. For purposes of this section, (iii) Located at or near the site of the PART 1—INCOME TAXES materials and supplies means tangible installed related machinery or ■ Paragraph 1. The authority citation property that is used or consumed in the equipment so as to be readily available for part 1 continues to read in part as taxpayer’s operations that is not when needed; follows: inventory and that— (iv) Directly related to the particular (i) Is a component acquired to machinery or piece of equipment they Authority: 26 U.S.C. 7805 * * * maintain, repair, or improve a unit of serve; ■ Par. 2. Section 1.162–3 is revised to tangible property (as determined under (v) Normally expensive; read as follows: § 1.263(a)–3(e)) owned, leased, or (vi) Only available on special order serviced by the taxpayer and that is not and not readily available from a vendor § 1.162–3 Materials and supplies. acquired as part of any single unit of or manufacturer; (a) In general—(1) Non-incidental tangible property; (vii) Not subject to normal periodic materials and supplies. Except as (ii) Consists of fuel, lubricants, water, replacement; provided in paragraphs (d), (e), and (f) and similar items, reasonably expected (viii) Not interchangeable in other of this section, amounts paid to acquire to be consumed in 12 months or less, machines or equipment;

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(x) Not acquired in quantity (generally (A) A financial statement required to temporary, or standby emergency spare only one is on hand for each piece of be filed with the Securities and part defined in paragraph (c)(3) or (c)(4) machinery or equipment); and Exchange Commission (SEC) (the 10–K of this section if— (xi) Not repaired and reused. or the Annual Statement to (i) The rotable, temporary, or standby (4) Economic useful life—(i) General Shareholders); emergency spare part is intended to be rule. The economic useful life of a unit (B) A certified audited financial used as a component of a unit of of property is not necessarily the useful statement that is accompanied by the property under paragraph (c)(1)(iii), (iv), life inherent in the property but is the report of an independent certified or (v) of this section; period over which the property may public accountant (or in the case of a (ii) The rotable, temporary, or standby reasonably be expected to be useful to foreign entity, by the report of a emergency spare part is intended to be the taxpayer or, if the taxpayer is similarly qualified independent used as a component of a property engaged in a trade or business or an professional), that is used for— described in paragraph (c)(1)(i) and the activity for the production of income, (1) Credit purposes; taxpayer cannot or has not elected to the period over which the property may (2) Reporting to shareholders, capitalize and depreciate that property reasonably be expected to be useful to partners, or similar persons; or under this paragraph (d); or (3) Any other substantial non-tax (iii) The amount is paid to acquire or the taxpayer in its trade or business or purpose; or produce a rotable or temporary spare for the production of income, as (C) A financial statement (other than part and the taxpayer uses the optional applicable. See § 1.167(a)-1(b) for the a tax return) required to be provided to method of accounting for rotable and factors to be considered in determining the federal or a state government or any temporary spare parts under paragraph this period. federal or state agency (other than the (e) to of this section. (ii) Taxpayers with an applicable SEC or the Internal Revenue Service). (3) Manner of electing. A taxpayer financial statement. For taxpayers with (5) Amount paid. For purposes of this makes the election under paragraph (d) an applicable financial statement (as section, in the case of a taxpayer using of this section by capitalizing the defined in paragraph (c)(4)(iii) of this an accrual method of accounting, the amounts paid to acquire or produce a section), the economic useful life of a terms amount paid and payment mean rotable, temporary, or standby unit of property, solely for the purposes a liability incurred (within the meaning emergency spare part in the taxable year of applying the provisions of paragraph of § 1.446–1(c)(1)(ii)). A liability may the amounts are paid and by beginning (c)(4)(iii) of this section, is the useful not be taken into account under this to recover the costs when the asset is life initially used by the taxpayer for section prior to the taxable year during placed in service by the taxpayer for the purposes of determining depreciation in which the liability is incurred. purposes of determining depreciation its applicable financial statement, (6) Produce. For purposes of this under the applicable provisions of the regardless of any salvage value of the section, produce means construct, build, Internal Revenue Code and the Treasury property. If a taxpayer does not have an install, manufacture, develop, create, Regulations. See § 1.263(a)–2 for the applicable financial statement for the raise, or grow. This definition is treatment of amounts paid to acquire or taxable year in which a unit of property intended to have the same meaning as produce real or personal tangible was originally acquired or produced, the the definition used for purposes of property. A taxpayer must make this economic useful life of the unit of section 263A(g)(1) and § 1.263A– election in its timely filed original property must be determined under 2(a)(1)(i), except that improvements are Federal tax return (including paragraph (c)(4)(i) of this section. excluded from the definition in this extensions) for the taxable year the asset Further, if a taxpayer treats amounts paragraph (c)(6) and are separately is placed in service by the taxpayer for paid for a unit of property as an expense defined and addressed in § 1.263(a)–3. purposes of determining depreciation. in its applicable financial statement on Amounts paid to produce materials and See §§ 301.9100–1 through 301.9100–3 a basis other than the useful life of the supplies are subject to section 263A. of this chapter for the provisions property or if a taxpayer does not (d) Election to capitalize and governing extensions of time to make depreciate the unit of property on its depreciate certain materials and regulatory elections. In the case of an S applicable financial statement, the supplies—(1) In general. A taxpayer corporation or a partnership, the economic useful life of the unit of may elect to treat as a capital election is made by the S corporation or property must be determined under expenditure and to treat as an asset partnership, and not by the shareholders paragraph (c)(4)(i) of this section. For subject to the allowance for depreciation or partners. A taxpayer may make an example, if a taxpayer has a policy of the cost of any rotable spare part, election for each rotable, temporary, or treating as an expense on its applicable temporary spare part, or standby standby emergency spare part that financial statement amounts paid for a emergency spare part as defined in qualifies for the election under this unit of property costing less than a paragraph (c)(3) or (c)(4) of this section. paragraph (d). A taxpayer may revoke an certain dollar amount, notwithstanding Except as specified in paragraph (d)(2) election made under this paragraph (d) that the unit of property has a useful life of this section, an election made under with respect to a rotable, temporary, or of more than one year, the economic this paragraph (d) applies to amounts standby emergency spare part only by useful life of the unit of property must paid during the taxable year to acquire filing a request for a private letter ruling be determined under paragraph (c)(4)(i) or produce any rotable, temporary, or and obtaining the Commissioner’s of this section. standby emergency spare part to which consent to revoke the election. The (iii) Definition of applicable financial paragraph (a) of this section would Commissioner may grant a request to statement. The taxpayer’s applicable apply (but for the election under this revoke this election if the taxpayer acted financial statement is the taxpayer’s paragraph (d)). Any property for which reasonably and in good faith and the financial statement listed in paragraphs this election is made shall not be treated revocation will not prejudice the (c)(4)(iii)(A) through (C) of this section as a material or a supply. interests of the Government. See that has the highest priority (including (2) Exceptions. A taxpayer may not generally § 301.9100–3 of this chapter. within paragraph (c)(4)(iii)(B) of this elect to capitalize and depreciate under The manner of electing and revoking the section). The financial statements are, in paragraph (d) of this section any amount election to capitalize under this descending priority— paid to acquire or produce a rotable, paragraph (d) may be modified through

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guidance of general applicability (see paid to maintain, repair, or improve the supply, that the taxpayer computes its §§ 601.601(d)(2) and 601.602 of this part in the taxable year these amounts income on a calendar year basis, that the chapter). An election may not be made are paid. taxpayer does not make the election to or revoked through the filing of an (iv) Reinstallation of part. The apply paragraph (d) of this section, or application for change in accounting taxpayer must deduct the amounts paid use the method of accounting described method or, before obtaining the to reinstall the part and those amounts in paragraph (e) of this section, and that Commissioner’s consent to make the included in the basis of the part under the taxpayer has not elected to apply the late election or to revoke the election, by paragraphs (e)(2)(ii)(B) and (e)(2)(iii) of de minimis safe harbor under filing an amended Federal tax return. this section, to the extent that those § 1.263(a)–1(f). The following examples (e) Optional method of accounting for amounts have not been previously illustrate only the application of this rotable and temporary spare parts—(1) deducted under this paragraph (e)(2)(iv), section and, unless otherwise stated, do In general. This paragraph (e) provides in the taxable year that the part is not address the treatment under other an optional method of accounting for reinstalled on a unit of property. provisions of the Code (for example, rotable and temporary spare parts (the (v) Disposal of the part. The taxpayer section 263A). optional method for rotable parts). A must deduct the amounts included in Example 1. Non-rotable components. A taxpayer may use the optional method the basis of the part under paragraphs owns a fleet of aircraft that it operates in its for rotable parts, instead of the general (e)(2)(ii)(B) and (e)(2)(iii) of this section, business. In Year 1, A purchases a stock of rule under paragraph (a)(3) of this to the extent that those amounts have spare parts, which it uses to maintain and section, to account for its rotable and not been previously deducted under repair its aircraft. A keeps a record of paragraph (e)(2)(iv) of this section, in consumption of these spare parts. In Year 2, temporary spare parts as defined in A uses the spare parts for the repair and paragraph (c)(2) of this section. A the taxable year in which the part is maintenance of one of its aircraft. Assume taxpayer that uses the optional method disposed of by the taxpayer. each aircraft is a unit of property under for rotable parts must use this method (f) Application of de minimis safe § 1.263(a)–3(e) and that spare parts are not for all of its pools of rotable and harbor. If a taxpayer elects to apply the rotable or temporary spare parts under temporary spare parts used in the same de minimis safe harbor under paragraph (c)(2) of this section. Assume these trade or business and for which it uses § 1.263(a)–1(f) to amounts paid for the repair and maintenance activities do not this method for its books and records. If production or acquisition of tangible improve the aircraft under § 1.263(a)–3. a taxpayer uses the optional method for property, then the taxpayer must apply These parts are materials and supplies under paragraph (c)(1)(i) of this section because rotable and temporary spare parts for the de minimis safe harbor to amounts paid for all materials and supplies that they are components acquired and used to pools of rotable or temporary spare parts maintain and repair A’s aircraft. Under for which the taxpayer does not use the meet the requirements of § 1.263(a)–1(f), paragraph (a)(1) of this section, the amounts optional method for its book and except for those materials and supplies that A paid for the spare parts in Year 1 are records, then the taxpayer must use the that the taxpayer elects to capitalize and deductible in Year 2, the taxable year in optional method for all its pools of depreciate under paragraph (d) of this which the spare parts are first used to repair rotable spare parts in the same trade or section or for which the taxpayer and maintain the aircraft. business. The optional method for properly uses the optional method of Example 2. Rotable spare parts; disposal rotable parts is a method of accounting accounting for rotable and temporary method. B operates a fleet of specialized spare parts under paragraph (e) of this vehicles that it uses in its service business. under section 446(a). Under the optional Assume that each vehicle is a unit of method for rotable parts, the taxpayer section. If the taxpayer properly applies property under § 1.263(a)–3(e). At the time must apply the rules in this paragraph the de minimis safe harbor under that it acquires a new type of vehicle, B also (e) to each rotable or temporary spare § 1.263(a)–1(f) to amounts paid for acquires a substantial number of rotable part (part) upon the taxpayer’s initial materials and supplies, then these spare parts that it will keep on hand to installation, removal, repair, amounts are not treated as amounts paid quickly replace similar parts in B’s vehicles maintenance or improvement, for materials and supplies under this as those parts break down or wear out. These reinstallation, and disposal of each part. section. See § 1.263(a)–1(f)(5) for the rotable parts are removable from the vehicles (2) Description of optional method for time and manner of electing the de and are repaired so that they can be minimis safe harbor and § 1.263(a)– reinstalled on the same or similar vehicles. rotable parts—(i) Initial installation. In Year 1, B acquires several vehicles and a The taxpayer must deduct the amount 1(f)(3)(iv) for the treatment of safe number of rotable spare parts to be used as paid to acquire or produce the part in harbor amounts. replacement parts in these vehicles. In Year the taxable year that the part is first (g) Sale or disposition of materials 2, B repairs several vehicles by using these installed on a unit of property for use and supplies. Upon sale or other rotable spare parts to replace worn or in the taxpayer’s operations. disposition, materials and supplies as damaged parts. In Year 3, B removes these (ii) Removal from unit of property. In defined in this section are not treated as rotable spare parts from its vehicles, repairs each taxable year in which the part is a capital asset under section 1221 or as the parts, and reinstalls them on other similar vehicles. In Year 5, B can no longer use the removed from a unit of property to property used in the trade or business under section 1231. Any asset for which rotable parts it acquired in Year 1 and which it was initially or subsequently disposes of them as scrap. Assume that B installed, the taxpayer must— the taxpayer makes the election to does not improve any of the rotable spare (A) Include in gross income the fair capitalize and depreciate under parts under § 1.263(a)–3. Under paragraph market value of the part; and paragraph (d) of this section shall not be (c)(1)(i) of this section, the rotable spare parts (B) Include in the basis of the part the treated as a material or supply, and the acquired in Year 1 are materials and fair market value of the part included in recognition and character of the gain or supplies. Under paragraph (a)(3) of this income under paragraph (e)(2)(ii)(A) of loss for such depreciable asset are section, rotable spare parts are generally used this section and the amount paid to determined under other applicable or consumed in the taxable year in which the remove the part from the unit of provisions of the Code. taxpayer disposes of the parts. Therefore, (h) Examples. The rules of this section under paragraph (a)(1) of this section, the property. amounts that B paid for the rotable spare (iii) Repair, maintenance, or are illustrated by the following parts in Year 1 are deductible in Year 5, the improvement of part. The taxpayer may examples, in which it is assumed, taxable year in which B disposes of the parts. not currently deduct and must include unless otherwise stated, that the Example 3. Rotable spare parts; in the basis of the part any amounts property is not an incidental material or application of optional method of

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accounting. C operates a fleet of specialized property under § 1.263(a)–3(e). Because the Example 8. Materials and supplies that vehicles that it uses in its service business. engines were acquired as part of the aircraft, cost less than $200; de minimis safe harbor. Assume that each vehicle is a unit of a single unit of property, the engines are not Assume the same facts as in Example 7 property under § 1.263(a)–3(e). At the time materials or supplies under paragraph except that G’s scanners qualify for the de that it acquires a new type of vehicle, C also (c)(1)(i) of this section nor rotable or minimis safe harbor under § 1.263(a)–1(f), acquires a substantial number of rotable temporary spare parts under paragraph (c)(2) and G properly elects to apply the de spare parts that it will keep on hand to of this section. Accordingly, D may not apply minimis safe harbor under § 1.263(a)–1(f) to replace similar parts in C’s vehicles as those the rules of this section to the aircraft engines amounts paid in Year 1. G must apply the de parts break down or wear out. These rotable upon the original acquisition of the aircraft minimis safe harbor under § 1.263(a)–1(f) to parts are removable from the vehicles and are nor after the removal of the engines from the amounts paid for the scanners, rather than repaired so that they can be reinstalled on the aircraft for use in the same or similar aircraft. treat these amounts as costs of materials and same or similar vehicles. C uses the optional Rather, D must apply the rules under supplies under this section. In accordance method of accounting for all its rotable and §§ 1.263(a)–2 and 1.263(a)–3 to the aircraft, with § 1.263(a)–1(f)(3)(iv), G may deduct the temporary spare parts under paragraph (e) of including its engines, to determine the amounts paid for all 50 scanners under this section. In Year 1, C acquires several treatment of amounts paid to acquire, § 1.162–1 in the taxable year the amounts are vehicles and a number of rotable spare parts produce, or improve the unit of property. paid. (the ‘‘Year 1 rotable parts’’) to be used as Example 5. Consumable property. E Example 9. Unit of property that costs $200 replacement parts in these vehicles. In Year operates a fleet of aircraft that carries freight or less; bulk purchase. H provides consulting 2, C repairs several vehicles and uses the for its customers. E has several storage tanks services to its customers. In Year 1, H pays Year 1 rotable parts to replace worn or on its premises, which hold jet fuel for its $500 to purchase one box of 10 toner damaged parts. In Year 3, C pays amounts to aircraft. Assume that once the jet fuel is cartridges to use as needed for H’s printers. remove these Year 1 rotable parts from its placed in E’s aircraft, the jet fuel is Assume each toner cartridge is a unit of vehicles. In Year 4, C pays amounts to reasonably expected to be consumed within property under § 1.263(a)–3(e). In Year 1, H’s maintain, repair, or improve the Year 1 12 months or less. On December 31, Year 1, employees place 8 of the toner cartridges in rotable parts. In Year 5, C pays amounts to E purchases a two-year supply of jet fuel. In printers in H’s office, and store the remaining reinstall the Year 1 rotable parts on other Year 2, E uses a portion of the jet fuel 2 cartridges for use in a later taxable year. similar vehicles. In Year 8, C removes the purchased on December 31, Year 1, to fuel The toner cartridges are materials and Year 1 rotable parts from these vehicles and the aircraft used in its business. The jet fuel supplies under paragraph (c)(1)(iv) of this stores these parts for possible later use. In that E purchased in Year 1 is a material or section because even though purchased in Year 9, C disposes of the Year 1 rotable parts. supply under paragraph (c)(1)(ii) of this one box costing more than $200, the allocable Under paragraph (e) of this section, C must section because it is reasonably expected to cost of each unit of property equals $50. be consumed within 12 months or less from deduct the amounts paid to acquire and Therefore, under paragraph (a)(1) of this the time it is placed in E’s aircraft. Under install the Year 1 rotable parts in Year 2, the section, the $400 paid by H for 8 of the paragraph (a)(1) of this section, E may deduct taxable year in which the rotable parts are cartridges is deductible in Year 1, the taxable in Year 2 the amounts paid for the portion first installed by C in C’s vehicles. In Year year in which H first uses each of those of jet fuel used in the operation of E’s aircraft cartridges. The amounts paid by H for each 3, when C removes the Year 1 rotable parts in Year 2. of the remaining 2 cartridges ($50 each) are from its vehicles, C must include in its gross Example 6. Unit of property that costs $200 deductible in the taxable year in which each income the fair market value of each part. or less. F operates a business that rents out Also, in Year 3, C must include in the basis a variety of small individual items to cartridge is first used in H’s business. of each Year 1 rotable part the fair market customers (rental items). F maintains a Example 10. Materials and supplies used value of the rotable part and the amount paid supply of rental items on hand. In Year 1, F in improvements; coordination with to remove the rotable part from the vehicle. purchases a large quantity of rental items to § 1.263(a)–3. J owns various machines that In Year 4, C must include in the basis of each use in its rental business. Assume that each are used in its business. Assume that each Year 1 rotable part the amounts paid to rental item is a unit of property under machine is a unit of property under maintain, repair, or improve each rotable § 1.263(a)–3(e) and costs $200 or less. In Year § 1.263(a)–3(e). In Year 1, J purchases a part. In Year 5, the year that C reinstalls the 2, F begins using all the rental items supply of spare parts for its machines. J Year 1 rotable parts (as repaired or improved) purchased in Year 1 by providing them to acquired the parts to use in the repair or in other vehicles, C must deduct the customers of its rental business. F does not maintenance of the machines under § 1.162– reinstallation costs and the amounts sell or exchange these items on established 4 or in the improvement of the machines previously included in the basis of each part. retail markets at any time after the items are under § 1.263(a)–3. The spare parts are not In Year 8, the year that C removes the Year used in the rental business. The rental items rotable or temporary spare parts under 1 rotable parts from the vehicles, C must are materials and supplies under paragraph paragraph (c)(2) of this section. In Year 2, J include in income the fair market value of (c)(1)(iv) of this section. Under paragraph uses all of these spare parts in an activity that each rotable part removed. In addition, in (a)(1) of this section, the amounts that F paid improves a machine under § 1.263(a)–3. Year 8, C must include in the basis of each for the rental items in Year 1 are deductible Under paragraph (c)(1)(i) of this section, the part the fair market value of that part and the in Year 2, the taxable year in which the rental spare parts purchased by J in Year 1 are amount paid to remove each rotable part items are first used in F’s business. materials and supplies. Under paragraph from the vehicle. In Year 9, the year that C Example 7. Unit of property that costs $200 (a)(1) of this section, the amounts paid for the disposes of the Year 1 rotable parts, C may or less. G provides billing services to its spare parts are otherwise deductible as deduct the amounts remaining in the basis of customers. In Year 1, G pays amounts to materials and supplies in Year 2, the taxable each rotable part. purchase 50 scanners to be used by its year in which J uses those parts. However, Example 4. Rotable part acquired as part employees. Assume each scanner is a unit of because these materials and supplies are of a single unit of property; not material or property under § 1.263(a)–3(e) and costs less used to improve J’s machine, J is required to supply. D operates a fleet of aircraft. In Year than $200. In Year 1, G’s employees begin capitalize the amounts paid for those spare 1, D acquires a new aircraft, which includes using 35 of the scanners, and F stores the parts under § 1.263(a)–3. two new aircraft engines. The aircraft costs remaining 15 scanners for use in a later Example 11. Cost of producing materials $500,000 and has an economic useful life of taxable year. The scanners are materials and and supplies; coordination with section more than 12 months, beginning when it is supplies under paragraph (c)(1)(iv) of this 263A. K is a manufacturer that produces placed in service. In Year 5, after the aircraft section. Under paragraph (a)(1) of this liquid waste as part of its operations. K is operated for several years in D’s business, section, the amounts G paid for 35 of the determines that its current liquid waste D removes the engines from the aircraft, scanners are deductible in Year 1, the taxable disposal process is inadequate. To remedy repairs or improves the engines, and either year in which G first uses each of those the problem, in Year 1, K constructs a reinstalls the engines on a similar aircraft or scanners. The amounts that G paid for each leaching pit to provide a draining area for the stores the engines for later reinstallation. of the remaining 15 scanners are deductible liquid waste. Assume the leaching pit is a Assume the aircraft purchased in Year 1, in the taxable year in which each machine is unit of property under § 1.263(a)–3(e) and including its two engines, is a unit of first used in G’s business. has an economic useful life of 12 months or

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less, starting on the date that K begins to use costs of each part on its timely filed Federal 2014. However, a taxpayer may apply the leaching pit as a draining area. At the end tax return for the taxable year in which the paragraph (e) of this section (the of this period, K’s factory will be connected part is placed in service for purposes of optional method of accounting for to the local sewer system. In Year 2, K starts determining depreciation under the rotable and temporary spare parts) to using the leaching pit in its operations. The applicable provisions of the Internal Revenue amounts paid to construct the leaching pit Code and the Treasury Regulations. See taxable years beginning on or after (including the direct and allocable indirect § 1.263(a)–2(g) for the treatment of capital January 1, 2014. Except as provided in costs of property produced under section expenditures. paragraphs (j)(2) and (j)(3) of this 263A) are amounts paid for a material or Example 14. Election to apply de minimis section, § 1.162–3 as contained in 26 supply under paragraph (c)(1)(iii) of this safe harbor. (i) N provides consulting CFR part 1 edition revised as of April 1, section. However, the amounts paid to services to its customers. In Year 1, N pays 2011, applies to taxable years beginning construct the leaching pit may be subject to amounts to purchase 50 laptop computers. before January 1, 2014. capitalization under section 263A if these Each laptop computer is a unit of property (2) Early application of this section— amounts comprise the direct or allocable under § 1.263(a)–3(e), costs $400, and has an (i) In general. Except for paragraph (e) economic useful life of more than 12 months. indirect costs of property produced by K. of this section, a taxpayer may choose Example 12. Costs of acquiring materials Also in Year 1, N purchases 50 office chairs and supplies for production of property; to be used by its employees. Each office chair to apply this section to amounts paid or coordination with section 263A. In Year 1, L is a unit of property that costs $100. N has incurred in taxable years beginning on purchases jigs, dies, molds, and patterns for an applicable financial statement (as defined or after January 1, 2012. A taxpayer may use in the manufacture of L’s products. in § 1.263(a)–1(f)(4)) and N has a written choose to apply paragraph (e) of this Assume each jig, die, mold, and pattern is a accounting policy at the beginning Year 1 to section (the optional method of unit of property under § 1.263(a)–3(e). The expense amounts paid for units of property accounting for rotable and temporary economic useful life of each jig, die, mold, costing $500 or less. N treats amounts paid spare parts) to taxable years beginning and pattern is 12 months or less, beginning for property costing $500 or less as an on or after January 1, 2012. when each item is used in the manufacturing expense on its applicable financial statement in Year 1. (ii) Transition rule for election to process. The jigs, dies, molds, and patterns capitalize materials and supplies on are not components acquired to maintain, (ii) The laptop computers are not materials repair, or improve any of L’s equipment or supplies under paragraph (c) of this 2012 and 2013 returns. If under under paragraph (c)(1)(i) of this section. L section. Therefore, the amounts N pays for paragraph (j)(2)(i) of this section, a begins using the jigs, dies, molds and the computers must generally be capitalized taxpayer chooses to make the election to patterns in Year 2 to manufacture its under § 1.263(a)–2(d) as amounts paid for the capitalize and depreciate certain products. These items are materials and acquisition of tangible property. The office materials and supplies under paragraph supplies under paragraph (c)(1)(iii) of this chairs are materials and supplies under (d) of this section for its taxable year section. Under paragraph (a)(1) of this paragraph (c)(1)(iv) of this section. Thus, beginning on or after January 1, 2012, under paragraph (a)(1) of this section, the section, the amounts paid for the items are and ending on or before September 19, otherwise deductible in Year 2, the taxable amounts paid for the office chairs are deductible in the taxable year in which they 2013 (applicable taxable year), and the year in which L first uses those items. taxpayer did not make the election However, the amounts paid for these are first used in N’s business. However, materials and supplies may be subject to under paragraph (f) of this section, if N specified in paragraph (d)(3) of this capitalization under section 263A if these properly elects to apply the de minimis safe section on its timely filed original amounts comprise the direct or allocable harbor under § 1.263(a)–1(f) to amounts paid Federal tax return for the applicable indirect costs of property produced by L. in Year 1, then N must apply the de minimis taxable year, the taxpayer must make Example 13. Election to capitalize and safe harbor under § 1.263(a)–1(f) to amounts the election specified in paragraph depreciate. M is in the mining business. M paid for the computers and the office chairs, (d)(3) of this section for the applicable rather than treat the office chairs as the costs acquires certain temporary spare parts, which taxable year by filing an amended it keeps on hand to avoid operational time of materials and supplies under § 1.162–3. Under the de minimis safe harbor, N may not Federal tax return for the applicable loss in the event it must make temporary taxable year on or before 180 days from repairs to a unit of property that is subject capitalize the amounts paid for the computers under § 1.263(a)–2 nor treat the the due date including extensions of the to depreciation. These parts are not used to office chairs as materials and supplies under improve property under § 1.263(a)–3(d). taxpayer’s Federal tax return for the § 1.162–3. Instead, in accordance with These temporary spare parts are used until a applicable taxable year, notwithstanding § 1.263(a)–1(f)(3)(iv), under § 1.162–1, N may new or repaired part can be installed and that the taxpayer may not have extended deduct the amounts paid for the computers then are removed and stored for later the due date. and the office chairs in the taxable year paid. temporary installation. M does not use the (3) Optional application of TD 9564. optional method of accounting for rotable (i) Accounting method changes. Except for section 1.162–3T(e), a and temporary spare parts in paragraph (e) of Except as otherwise provided in this taxpayer may choose to apply § 1.162– this section for any of its rotable or temporary section, a change to comply with this 3T as contained in TD 9564 (76 FR spare parts. The temporary spare parts are section is a change in method of 81060) December 27, 2011, to amounts materials and supplies under paragraph accounting to which the provisions of paid or incurred (to acquire or produce (c)(1)(i) of this section. Under paragraphs property) in taxable years beginning on (a)(1) and (a)(3) of this section, the amounts sections 446 and 481 and the paid for the temporary spare parts are accompanying regulations apply. A or after January 1, 2012, and before deductible in the taxable year in which they taxpayer seeking to change to a method January 1, 2014. A taxpayer may choose are disposed of by M. However, because it is of accounting permitted in this section to apply section 1.162–3T(e) (the unlikely that the temporary spare parts will must secure the consent of the optional method of accounting for be disposed of in the near future, M would Commissioner in accordance with rotable and temporary spare parts) as prefer to treat the amounts paid for the spare § 1.446–1(e) and follow the contained in TD 9564 (76 FR 81060) parts as capital expenditures subject to administrative procedures issued under December 27, 2011, to taxable years depreciation. M may elect under paragraph § 1.446–1(e)(3)(ii) for obtaining the beginning on or after January 1, 2012, (d) of this section to treat the cost of each and before January 1, 2014. temporary spare part as a capital expenditure Commissioner’s consent to change its accounting method. and as an asset subject to an allowance for § 1.162–3T [Removed] depreciation. M makes this election by (j) Effective/applicability date—(1) In ■ capitalizing the amounts paid for each spare general. This section generally applies Par. 3. Section 1.162–3T is removed. part in the taxable year that M acquires the to amounts paid or incurred in taxable ■ Par. 4. Section 1.162–4 is revised to spare parts and by beginning to recover the years beginning on or after January 1, read as follows:

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§ 1.162–4 Repairs. taxable years beginning on or after (3) Optional application of TD 9564. (a) In general. A taxpayer may deduct January 1, 2014. Except as provided in A taxpayer may choose to apply amounts paid for repairs and paragraphs (b)(2)(ii) and (b)(2)(iii) of this § 1.165–2T as contained in TD 9564 (76 maintenance to tangible property if the section, § 1.162–11(b) as contained in 26 FR 81060) December 27, 2011, to taxable amounts paid are not otherwise required CFR part 1 edition revised as of April 1, years beginning on or after January 1, to be capitalized. For the election to 2011, applies to taxable years beginning 2012, and before January 1, 2014. capitalize amounts paid for repair and before January 1, 2014. maintenance consistent with the (ii) Early application of this § 1.165–2T [Removed] taxpayer’s books and records, see paragraph. A taxpayer may choose to ■ Par. 9. Section 1.165–2T is removed. § 1.263(a)–3(n). apply this paragraph (b) to taxable years ■ Par. 10. Section 1.167(a)–4 is revised (b) Accounting method changes. A beginning on or after January 1, 2012. to read as follows: change to comply with this section is a (iii) Optional application of TD 9564. change in method of accounting to A taxpayer may choose to apply § 1.167(a)–4 Leased property. which the provisions of sections 446 § 1.162–11T(b) as contained in TD 9564 (a) In general. Capital expenditures and 481 and the accompanying (76 FR 81060) December 27, 2011, to made by either a lessee or lessor for the regulations apply. A taxpayer seeking to taxable years beginning on or after erection of a building or for other change to a method of accounting January 1, 2012, and before January 1, permanent improvements on leased permitted in this section must secure 2014. property are recovered by the lessee or the consent of the Commissioner in lessor under the provisions of the accordance with § 1.446–1(e) and follow § 1.162–11T [Removed] Internal Revenue Code (Code) the administrative procedures issued ■ Par. 7. Section 1.162–11T is removed. applicable to the cost recovery of the under § 1.446–1(e)(3)(ii) for obtaining ■ Par. 8. Section 1.165–2 is amended building or improvements, if subject to the Commissioner’s consent to change by: depreciation or amortization, without its accounting method. ■ 1. Revising paragraphs (c) and (d). regard to the period of the lease. For (c) Effective/applicability date—(1) In ■ 2. Removing paragraph (e). example, if the building or improvement general. This section applies to taxable The revisions read as follows: is property to which section 168 years beginning on or after January 1, applies, the lessee or lessor determines 2014. Except as provided in paragraphs § 1.165–2 Obsolescence of nondepreciable the depreciation deduction for the (c)(2) and (c)(3) of this section, § 1.162– property. building or improvement under section 4 as contained in 26 CFR part 1 edition * * * * * 168. See section 168(i)(8)(A). If the revised as of April 1, 2011, applies to (c) Cross references. For the allowance improvement is property to which taxable years beginning before January under section 165(a) of losses arising section 167 or section 197 applies, the 1, 2014. from the permanent withdrawal of lessee or lessor determines the (2) Early application of this section. A depreciable property from use in the depreciation or amortization deduction taxpayer may choose to apply this trade or business or in the production of for the improvement under section 167 section to taxable years beginning on or income, see § 1.167(a)–8, § 1.168(i)–1, or section 197, as applicable. after January 1, 2012. § 1.168(i)–1T, § 1.168(i)–8T, Prop. Reg. (b) Effective/applicability date—(1) In (3) Optional application of TD 9564. § 1.168(i)–1 (September 19, 2013), or general. Except as provided in A taxpayer may choose to apply Prop. Reg. § 1.168(i)–8 (September 19, paragraph (b)(2) or (b)(3) of this section, § 1.162–4T as contained in TD 9564 (76 2013), as applicable. For provisions this section applies to taxable years FR 81060), December 27, 2011, to respecting the obsolescence of beginning on or after January 1, 2014. taxable years beginning on or after depreciable property for which (2) Application of this section to January 1, 2012, and before January 1, depreciation is determined under leasehold improvements placed in 2014. section 167 (but not under section 168, service after December 31, 1986, in § 1.162–4T [Removed] section 1400I, section 1400L(c), section taxable years beginning before January 168 prior to its amendment by the Tax 1, 2014. For leasehold improvements ■ Par. 5. Section 1.162–4T is removed. Reform Act of 1986, Public Law 99–514 placed in service after December 31, ■ Par. 6. Section 1.162–11 is amended (100 Stat. 2121 (1986)), or under an 1986, in taxable years beginning before by: additional first year depreciation January 1, 2014, a taxpayer may— ■ 1. Revising paragraph (b). deduction provision of the Internal (i) Apply the provisions of this ■ 2. Removing paragraphs (c) and (d). The revision reads as follows: Revenue Code (for example, section section; or 168(k) through (n), 1400L(b), or (ii) Depreciate any leasehold § 1.162–11 Rentals. 1400N(d))), see § 1.167(a)–9. For the improvement to which section 168 * * * * * allowance of casualty losses, see applies under the provisions of section (b) Improvements by lessee on lessor’s § 1.165–7. 168 and depreciate or amortize any property—(1) In general. The cost to a (d) Effective/applicability date—(1) In leasehold improvement to which taxpayer of erecting buildings or making general. This section applies to taxable section 168 does not apply under the permanent improvements on property of years beginning on or after January 1, provisions of the Code that are which the taxpayer is a lessee is a 2014. Except as provided in paragraphs applicable to the cost recovery of that capital expenditure. For the rules (d)(2) and (d)(3) of this section, § 1.165– leasehold improvement, without regard regarding improvements to leased 2 as contained in 26 CFR part 1 edition to the period of the lease. property when the improvements are revised as of April 1, 2011, applies to (3) Application of this section to tangible property, see § 1.263(a)–3(f). taxable years beginning before January leasehold improvements placed in For the rules regarding depreciation or 1, 2014. service before January 1, 1987. Section amortization deductions for leasehold (2) Early application of § 1.165–2(c). A 1.167(a)–4 as contained in 26 CFR part improvements, see § 1.167(a)–4. taxpayer may choose to apply paragraph 1 edition revised as of April 1, 2011, (2) Effective/applicability date—(i) In (c) of this section to taxable years applies to leasehold improvements general. This paragraph (b) applies to beginning on or after January 1, 2012. placed in service before January 1, 1987.

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(4) Change in method of accounting. § 1.167(a)–7T [Removed] (b) Required use of single asset Except as provided in § 1.446– ■ Par. 13. Section 1.167(a)–7T is accounts. A taxpayer must account for 1(e)(2)(ii)(d)(3)(i), a change to comply removed. an asset in a single asset account if the with this section for depreciable assets ■ Par. 14. Section 1.167(a)–8 is taxpayer uses the asset both in a trade placed in service in a taxable year amended by: or business (or for the production of ending on or after December 30, 2003, ■ 1. Revising paragraphs (g) and (h). income) and in a personal activity, or if is a change in method of accounting to ■ 2. Removing paragraph (i). the taxpayer places in service and which the provisions of section 446(e) The revisions read as follows: disposes of the asset during the same and the regulations under section 446(e) taxable year. Also, if general asset § 1.167(a)–8 Retirements. apply. Except as provided in § 1.446– account treatment for an asset 1(e)(2)(ii)(d)(3)(i), a taxpayer also may * * * * * terminates under § 1.168(i)– treat a change to comply with this (g) Applicability. This section applies 1T(c)(1)(ii)(A), (e)(3)(iii), (e)(3)(vii), (g), section for depreciable assets placed in to property for which depreciation is or (h)(2) or Prop. Reg. § 1.168(i)– service in a taxable year ending before determined under section 167 (but not 1(c)(1)(ii)(A), (e)(3)(iii), (e)(3)(vii), (g), or December 30, 2003, as a change in under section 168, section 1400I, (h)(2) (September 19, 2013), as method of accounting to which the section 1400L(c), section 168 prior to its applicable, the taxpayer must account provisions of section 446(e) and the amendment by the Tax Reform Act of for the asset in a single asset account regulations under section 446(e) apply. 1986, Public Law 99–514 (100 Stat. beginning in the taxable year in which 2121(1986)), or under an additional first the general asset account treatment for § 1.167(a)–4T [Removed] year depreciation deduction provision the asset terminates. If a taxpayer ■ Par. 11. Section 1.167(a)–4T is of the Internal Revenue Code (for accounts for an asset in a multiple asset removed. example, section 168(k) through (n), account or a pool and the taxpayer ■ Par. 12. Section 1.167(a)–7 is 1400L(b), or 1400N(d))). disposes of the asset, the taxpayer must amended by: (h) Effective/applicability date—(1) In account for the asset in a single asset ■ 1. Revising paragraphs (e) and (f). general. This section applies to taxable account beginning in the taxable year in ■ 2. Removing paragraph (g). years beginning on or after January 1, which the disposition occurs. See The revisions read as follows: 2014. Except as provided in paragraphs § 1.168(i)–8T(g)(2)(i) or Prop. Reg. (h)(2) and (h)(3) of this section, § 1.168(i)–8(h)(2)(i) (September 19, § 1.167(a)–7 Accounting for depreciable § 1.167(a)–8 as contained in 26 CFR part property. 2013), as applicable. If a taxpayer 1 edition revised as of April 1, 2011, disposes of a component of a larger asset * * * * * applies to taxable years beginning before (e) Applicability. Paragraphs (a), (b), and the unadjusted depreciable basis of January 1, 2014. the disposed of component is included and (d) of this section apply to property (2) Early application of § 1.167(a)– in the unadjusted depreciable basis of for which depreciation is determined 8(g). A taxpayer may choose to apply the larger asset, the taxpayer must under section 167 (but not under section paragraph (g) of this section to taxable account for the component in a single 168, section 1400I, section 1400L(c), years beginning on or after January 1, asset account beginning in the taxable section 168 prior to its amendment by 2012. year in which the disposition occurs. the Tax Reform Act of 1986, Public Law (3) Optional application of TD 9564. See Prop. Reg. § 1.168(i)–8(g)(3)(i) 99–514 (100 Stat. 2121 (1986)), or under A taxpayer may choose to apply (September 19, 2013). an additional first year depreciation § 1.167(a)–8T as contained in TD 9564 (c) Establishment of multiple asset deduction provision of the Internal (76 FR 81060) December 27, 2011, to accounts or pools—(1) Assets eligible for Revenue Code (for example, section taxable years beginning on or after multiple asset accounts or pools. Except 168(k) through (n), 1400L(b), or January 1, 2012, and before January 1, as provided in paragraph (b) of this 1400N(d))). Paragraph (c) of this section 2014. does not apply to general asset accounts section, assets that are subject to either as provided by section 168(i)(4), § 1.167(a)–8T [Removed] the general depreciation system of § 1.168(i)–1, § 1.168(i)–1T and Prop. ■ Par. 15. Section 1.167(a)–8T is section 168(a) or the alternative Reg. § 1.168(i)–1 (September 19, 2013). removed. depreciation system of section 168(g) may be accounted for in one or more (f) Effective/applicability date—(1) In ■ Par. 16. Section 1.168(i)–7 is added to multiple asset accounts or pools. general. This section applies to taxable read as follows: years beginning on or after January 1, (2) Grouping assets in multiple asset 2014. Except as provided in paragraphs § 1.168(i)–7 Accounting for MACRS accounts or pools—(i) General rules. (f)(2) and (f)(3) of this section, property. Assets that are eligible to be grouped § 1.167(a)–7 as contained in 26 CFR part (a) In general. A taxpayer may into a single multiple asset account or 1 edition revised as of April 1, 2011, account for MACRS property (as defined pool may be divided into more than one applies to taxable years beginning before in § 1.168(b)–1(a)(2)) by treating each multiple asset account or pool. Each January 1, 2014. individual asset as an account (a ‘‘single multiple asset account or pool must (2) Early application of § 1.167(a)– asset account’’ or an ‘‘item account’’) or include only assets that— 7(e). A taxpayer may choose to apply by combining two or more assets in a (A) Have the same applicable paragraph (e) of this section to taxable single account (a ‘‘multiple asset depreciation method; years beginning on or after January 1, account’’ or a ‘‘pool’’). A taxpayer may (B) Have the same applicable recovery 2012. establish as many accounts for MACRS period; (3) Optional application of TD 9564. property as the taxpayer wants. This (C) Have the same applicable A taxpayer may choose to apply section does not apply to assets convention; and § 1.167(a)–7T as contained in TD 9564 included in general asset accounts. For (D) Are placed in service by the (76 FR 81060) December 27, 2011, to rules applicable to general asset taxpayer in the same taxable year. taxable years beginning on or after accounts, see § 1.168(i)–1, § 1.168(i)–1T, (ii) Special rules. In addition to the January 1, 2012, and before January 1, or Prop. Reg. § 1.168(i)–1 (September 19, general rules in paragraph (c)(2)(i) of 2014. 2013), as applicable. this section, the following rules apply

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when establishing multiple asset years beginning on or after January 1, (i) Taxpayer with applicable financial accounts or pools— 2014. statement. (A) Assets subject to the mid-quarter (2) Early application of this section. A (ii) Taxpayer without applicable convention may only be grouped into a taxpayer may choose to apply the financial statement. multiple asset account or pool with provisions of this section to taxable (iii) Taxpayer with both an applicable assets that are placed in service in the years beginning on or after January 1, financial statement and a non-qualifying same quarter of the taxable year; 2012. financial statement. (B) Assets subject to the mid-month (3) Optional application of TD 9564. (2) Exceptions to de minimis safe convention may only be grouped into a A taxpayer may choose to apply harbor. multiple asset account or pool with § 1.168(i)–7T as contained in TD 9564 (3) Additional rules. assets that are placed in service in the (76 FR 81060) December 27, 2011, to (i) Transaction and other additional same month of the taxable year; taxable years beginning on or after costs. (C) Passenger automobiles for which January 1, 2012, and before January 1, (ii) Materials and supplies. the depreciation allowance is limited 2014. (iii) Sale or disposition. under section 280F(a) must be grouped (4) Change in method of accounting. (iv) Treatment of de minimis into a separate multiple asset account or A change to comply with this section for amounts. pool; depreciable assets placed in service in a (v) Coordination with section 263A. (D) Assets not eligible for any taxable year ending on or after (vi) Written accounting procedures for additional first year depreciation December 30, 2003, is a change in groups of entities. deduction (including assets for which method of accounting to which the (vii) Combined expensing accounting the taxpayer elected not to deduct the provisions of section 446(e) and the procedures. additional first year depreciation) regulations under section 446(e) apply. (4) Definition of applicable financial provided by, for example, section 168(k) A taxpayer also may treat a change to statement. through (n), 1400L(b), or 1400N(d), must comply with this section for depreciable (5) Time and manner of making be grouped into a separate multiple assets placed in service in a taxable year election. asset account or pool; ending before December 30, 2003, as a (6) Anti-abuse rule. (E) Assets eligible for the additional change in method of accounting to (7) Examples. first year depreciation deduction may which the provisions of section 446(e) (g) Accounting method changes. only be grouped into a multiple asset and the regulations under section 446(e) (h) Effective/applicability date. account or pool with assets for which apply. (1) In general. (2) Early application of this section. the taxpayer claimed the same § 1.168(i)–7T [Removed] percentage of the additional first year (i) In general. depreciation (for example, 30 percent, ■ Par. 17. Section 1.168(i)–7T is (ii) Transition rule for de minimis safe 50 percent, or 100 percent); removed. harbor election on 2012 or 2013 returns. (F) Except for passenger automobiles ■ Par. 18. Section 1.263(a)–0 is (3) Optional application of TD 9564. described in paragraph (c)(2)(ii)(C) of amended by: § 1.263(a)–2 Amounts paid to acquire this section, listed property (as defined ■ 1. The table of contents introductory or produce tangible property. in section 280F(d)(4)) must be grouped text is revised. (a) Overview. into a separate multiple asset account or ■ 2. Revising the section heading and (b) Definitions. pool; entries to the table of contents for (1) Amount paid. (G) Assets for which the depreciation §§ 1.263(a)–1, 1.263(a)–2 and 1.263(a)– (2) Personal property. allowance for the placed-in-service year 3. (3) Real property. is not determined by using an optional ■ 3. Adding § 1.263(a)–6 to the table of (4) Produce. depreciation table (for further guidance, contents. The revisions and additions (c) Coordination with other provisions see section 8 of Rev. Proc. 87–57, 1987– read as follows: of the Internal Revenue Code. 2 CB 687, 693 (see § 601.601(d)(2) of this § 1.263(a)–0 Outline of regulations under (1) In general. chapter)) must be grouped into a section 263(a). (2) Materials and supplies. separate multiple asset account or pool; This section lists the paragraphs in (d) Acquired or produced tangible and §§ 1.263(a)–1 through 1.263(a)–3 and property. (H) Mass assets (as defined in § 1.263(a)–6. (1) Requirement to capitalize. § 1.168(i)–8T(b)(2) or Prop. Reg. (2) Examples. § 1.168(i)–8(b)(3) (September 19, 2013), § 1.263(a)–1 Capital expenditures; in (e) Defense or perfection of title to as applicable) that are or will be subject general. property. to § 1.168(i)–8T(f)(2)(iii) or Prop. Reg. (a) General rule for capital (1) In general. § 1.168(i)–8(g)(2)(iii) (September 19, expenditures. (2) Examples. 2013), as applicable,(disposed of or (b) Coordination with other (f) Transaction costs. converted mass asset is identified by a provisions of the Internal Revenue (1) In general. mortality dispersion table) must be Code. (2) Scope of facilitate. grouped into a separate multiple asset (c) Definitions. (i) In general. account or pool. (1) Amount paid. (ii) Inherently facilitative amounts. (d) Cross references. See § 1.167(a)– (2) Produce. (iii) Special rule for acquisitions of 7(c) for the records to be maintained by (d) Examples of capital expenditures. real property. a taxpayer for each account. In addition, (e) Amounts paid to sell property. (A) In general. see § 1.168(i)–1(l)(3) for the records to (1) In general. (B) Acquisitions of real and personal be maintained by a taxpayer for each (2) Dealer in property. property in a single transaction. general asset account. (3) Examples. (iv) Employee compensation and (e) Effective/applicability date—(1) In (f) De minimis safe harbor election. overhead costs. general. This section applies to taxable (1) In general. (A) In general.

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(B) Election to capitalize. (4) Improvements to property. (iv) Appropriate comparison. (3) Treatment of transaction costs. (5) Additional rules. (A) In general. (i) In general. (i) Year placed in service. (B) Normal wear and tear. (ii) Treatment of inherently (ii) Change in subsequent taxable (C) Damage to property. facilitative amounts. year. (4) Examples. (iii) Contingency fees. (6) Examples. (k) Capitalization of restorations. (4) Examples. (f) Improvements to leased property. (1) In general. (g) Treatment of capital expenditures. (1) In general. (2) Application of restorations to (h) Recovery of capitalized amounts. (2) Lessee improvements. buildings. (1) In general. (i) Requirement to capitalize. (3) Exception for losses based on (2) Examples. (ii) Unit of property for lessee salvage value. (i) Accounting method changes. improvements. (4) Restoration of damage from (j) Effective/applicability date. (3) Lessor improvements. casualty. (1) In general. (i) Requirement to capitalize. (i) Limitation. (2) Early application of this section. (ii) Unit of property for lessor (ii) Amounts in excess of limitation. (i) In general. improvements. (5) Rebuild to like-new condition. (ii) Transition rule for election to (4) Examples. (6) Replacement of a major capitalize employee compensation and (g) Special rules for determining component or substantial structural overhead costs on 2012 or 2013 returns. improvement costs. part. (1) Certain costs incurred during an (3) Optional application of TD 9564. (i) In general. improvement. § 1.263(a)–3 Amounts paid to improve (A) Major component. (i) In general. tangible property. (B) Substantial structural part. (ii) Exception for individuals’ (ii) Major components and substantial (a) Overview. residences. (b) Definitions. (2) Removal costs. structural parts of buildings. (1) Amount paid. (i) In general. (7) Examples. (2) Personal property. (ii) Examples. (l) Capitalization of amounts to adapt (3) Real property. (3) Related amounts. property to a new or different use. (4) Owner. (4) Compliance with regulatory (1) In general. (c) Coordination with other provisions requirements. (2) Application of adaptation rule to of the Internal Revenue Code. (h) Safe harbor for small taxpayers. buildings. (1) In general. (1) In general. (3) Examples. (2) Materials and supplies. (2) Application with other safe harbor (m) Optional regulatory accounting (3) Example. provisions. method. (d) Requirement to capitalize amounts (3) Qualifying taxpayer. (1) In general. paid for improvements. (i) In general. (2) Eligibility for regulatory (e) Determining the unit of property. (ii) Application to new taxpayers. accounting method. (1) In general. (iii) Treatment of short taxable year. (3) Description of regulatory (2) Building. (iv) Definition of gross receipts. accounting method. (i) In general. (4) Eligible building property. (4) Examples. (ii) Application of improvement rules (5) Unadjusted basis. (n) Election to capitalize repair and to a building. (i) Eligible building property owned maintenance costs. (A) Building structure. by the taxpayer. (1) In general. (B) Building system. (ii) Eligible building property leased (2) Time and manner of election. (iii) Condominium. to the taxpayer. (3) Exception. (A) In general. (6) Time and manner of election. (4) Examples. (B) Application of improvement rules (7) Treatment of safe harbor amounts. (o) Treatment of capital expenditures. to a condominium. (8) Safe harbor exceeded. (p) Recovery of capitalized amounts. (iv) Cooperative. (9) Modification of safe harbor (q) Accounting method changes. (A) In general. amounts. (r) Effective/applicability date. (B) Application of improvement rules (10) Examples. (1) In general. to a cooperative. (i) Safe harbor for routine (2) Early application of this section. (v) Leased building. maintenance. (i) In general. (A) In general. (1) In general. (ii) Transition rule for elections on (B) Application of improvement rules (i) Routine maintenance for buildings. 2012 and 2013 returns. to a leased building. (ii) Routine maintenance for property (3) Optional application of TD 9564. (1) Entire building. other than buildings. * * * * * (2) Portion of building. (2) Rotable and temporary spare parts. § 1.263(a)–6 Election to deduct or (3) Property other than a building. (3) Exceptions. (i) In general. (4) Class life. capitalize certain expenditures. (ii) Plant property. (5) Coordination with section 263A. (a) In general. (A) Definition. (6) Examples. (b) Election provisions. (B) Unit of property for plant (j) Capitalization of betterments. (c) Effective/applicability date. property. (1) In general. (1) In general. (iii) Network assets. (2) Application of betterment rules. (2) Early application of this section. (A) Definition. (i) In general. (3) Optional application of TD 9564. (B) Unit of property for network (ii) Application of betterment rules to § 1.263(a)–0T [Removed] assets. buildings. (iv) Leased property other than (iii) Unavailability of replacement ■ Par. 19. Section 1.263(a)–0T is buildings. parts. removed.

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Par. 20. Section 1.263(a)–1 is revised a business entity, and certain other sell the truck on November 15, Year 1. B pays to read as follows: transactions. See § 1.263(a)–5. for an appraisal to determine a reasonable (5) An amount paid to acquire or asking price. On February 15, Year 2, B sells § 1.263(a)–1 Capital expenditures; in create interests in land, such as the truck to C. In Year 1, B must capitalize the amount paid to appraise the truck, and general. easements, life estates, mineral interests, (a) General rule for capital in Year 2, must reduce the amount realized timber rights, zoning variances, or other from the sale of the truck by the amount paid expenditures. Except as provided in interests in land. for the appraisal. chapter 1 of the Internal Revenue Code, (6) An amount assessed and paid Example 4. Costs of abandoned sale of no deduction is allowed for— under an agreement between personal property used in a trade or business. (1) Any amount paid for new bondholders or shareholders of a Assume the same facts as in Example 3, buildings or for permanent corporation to be used in a except that, instead of selling the truck on improvements or betterments made to reorganization of the corporation or February 15, Year 2, B decides on that date not to sell the truck and takes the truck off increase the value of any property or voluntary contributions by shareholders estate; or the market. In Year 1, B must capitalize the to the capital of the corporation for any amount paid to appraise the truck. However, (2) Any amount paid in restoring corporate purpose. See section 118 and B may recognize the amount paid to appraise property or in making good the § 1.118–1. the truck as a loss under section 165 in Year exhaustion thereof for which an (7) An amount paid by a holding 2, the taxable year when the sale is allowance is or has been made. company to carry out a guaranty of abandoned. (b) Coordination with other provisions dividends at a specified rate on the Example 5. Sales costs of personal property of the Internal Revenue Code. Nothing stock of a subsidiary corporation for the not used in a trade or business. Assume the same facts as in Example 3, except that B in this section changes the treatment of purpose of securing new capital for the any amount that is specifically provided does not use the truck in B’s trade or subsidiary and increasing the value of business but instead uses it for personal for under any provision of the Internal its stockholdings in the subsidiary. This purposes. In Year 1, B must capitalize the Revenue Code or the Treasury amount must be added to the cost of the amount paid to appraise the truck, and in Regulations other than section 162(a) or stock in the subsidiary. Year 2, must reduce the amount realized section 212 and the regulations under (e) Amounts paid to sell property—(1) from the sale of the truck by the amount paid those sections. For example, see section In general. Commissions and other for the appraisal. 263A, which requires taxpayers to transaction costs paid to facilitate the Example 6. Costs of abandoned sale of capitalize the direct and allocable sale of property are not currently personal property not used in a trade or business. Assume the same facts as in indirect costs to property produced by deductible under section 162 or 212. the taxpayer and property acquired for Example 5, except that, instead of selling the Instead, the amounts are capitalized truck on February 15, Year 2, B decides on resale. See also section 195 requiring costs that reduce the amount realized in that date not to sell the truck and takes the taxpayers to capitalize certain costs as the taxable year in which the sale occurs truck off the market. In Year 1, B must start-up expenditures. or are taken into account in the taxable capitalize the amount paid to appraise the (c) Definitions. For purposes of this year in which the sale is abandoned if truck. Although B abandons the sale in Year section, the following definitions apply: a deduction is permissible. These 2, B may not treat the amount paid to (1) Amount paid. In the case of a amounts are not added to the basis of appraise the truck as a loss under section 165 because the truck was not used in B’s trade taxpayer using an accrual method of the property sold or treated as an accounting, the terms amount paid and or business or in a transaction entered into intangible asset under § 1.263(a)–4. See for profit. payment mean a liability incurred § 1.263(a)–5(g) for the treatment of (within the meaning of § 1.446– amounts paid to facilitate the (f) De minimis safe harbor election— 1(c)(1)(ii)). A liability may not be taken disposition of assets that constitute a (1) In general. Except as otherwise into account under this section prior to trade or business. provided in paragraph (f)(2) of this the taxable year during which the (2) Dealer in property. In the case of section, a taxpayer electing to apply the liability is incurred. a dealer in property, amounts paid to de minimis safe harbor under this (2) Produce means construct, build, facilitate the sale of such property are paragraph (f) may not capitalize under install, manufacture, develop, create, treated as ordinary and necessary § 1.263(a)–2(d)(1) or § 1.263(a)–3(d) any raise, or grow. This definition is business expenses. amount paid in the taxable year for the intended to have the same meaning as (3) Examples. The following acquisition or production of a unit of the definition used for purposes of examples, which assume the sale is not tangible property nor treat as a material section 263A(g)(1) and § 1.263A– an installment sale under section 453, or supply under § 1.162–3(a) any 2(a)(1)(i), except that improvements are illustrate the rules of this paragraph (e): amount paid in the taxable year for excluded from the definition in this tangible property if the amount Example 1. Sales costs of real property. A specified under this paragraph (f)(1) paragraph (c)(2) and are separately owns a parcel of real estate. A sells the real defined and addressed in § 1.263(a)–3. estate and pays legal fees, recording fees, and meets the requirements of paragraph (d) Examples of capital expenditures. sales commissions to facilitate the sale. A (f)(1)(i) or (f)(1)(ii) of this section. But The following amounts paid are must capitalize the fees and commissions see section 263A and the regulations examples of capital expenditures: and, in the taxable year of the sale, must under section 263A, which require (1) An amount paid to acquire or reduce the amount realized from the sale of taxpayers to capitalize the direct and produce a unit of real or personal the real estate by the fees and commissions. allocable indirect costs of property tangible property. See § 1.263(a)–2. Example 2. Sales costs of dealers. Assume produced by the taxpayer (for example, (2) An amount paid to improve a unit the same facts as in Example 1, except that property improved by the taxpayer) and of real or personal tangible property. See A is a dealer in real estate. The commissions property acquired for resale. and fees paid to facilitate the sale of the real (i) Taxpayer with applicable financial § 1.263(a)–3. estate may be deducted as ordinary and (3) An amount paid to acquire or necessary business expenses under section statement. A taxpayer electing to apply create intangibles. See § 1.263(a)–4. 162. the de minimis safe harbor may not (4) An amount paid or incurred to Example 3. Sales costs of personal property capitalize under § 1.263(a)–2(d)(1) or facilitate an acquisition of a trade or used in a trade or business. B owns a truck § 1.263(a)–3(d) nor treat as a material or business, a change in capital structure of for use in B’s trade or business. B decides to supply under § 1.162–3(a) any amount

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paid in the taxable year for property requirements of paragraph (f)(4) of this safe harbor provided under this described in paragraph (f)(1) of this section, the taxpayer must meet the paragraph (f), then the taxpayer must section if— requirements of paragraph (f)(1)(i) of also apply the de minimis safe harbor to (A) The taxpayer has an applicable this section to qualify to elect the de amounts paid for all materials and financial statement (as defined in minimis safe harbor under this supplies (as defined under § 1.162–3) paragraph (f)(4) of this section); paragraph (f). that meet the requirements of (B) The taxpayer has at the beginning (2) Exceptions to de minimis safe § 1.263(a)–1(f). See paragraph (f)(3)(iv) of the taxable year written accounting harbor. The de minimis safe harbor in of this section for treatment of materials procedures treating as an expense for paragraph (f)(1) of this section does not and supplies under the de minimis safe non-tax purposes— apply to the following: harbor. (1) Amounts paid for property costing (i) Amounts paid for property that is (iii) Sale or disposition. Property to less than a specified dollar amount; or or is intended to be included in which a taxpayer applies the de (2) Amounts paid for property with an inventory property; minimis safe harbor contained in this economic useful life (as defined in (ii) Amounts paid for land; paragraph (f) is not treated upon sale or § 1.162–3(c)(3)) of 12 months or less; (iii) Amounts paid for rotable, other disposition as a capital asset (C) The taxpayer treats the amount temporary, and standby emergency under section 1221 or as property used paid for the property as an expense on spare parts that the taxpayer elects to in the trade or business under section its applicable financial statement in capitalize and depreciate under § 1.162– 1231. accordance with its written accounting 3(d); and (iv) Treatment of de minimis procedures; and (iv) Amounts paid for rotable and amounts. An amount paid for property (D) The amount paid for the property temporary spare parts that the taxpayer to which a taxpayer properly applies the does not exceed $5,000 per invoice (or accounts for under the optional method de minimis safe harbor contained in this per item as substantiated by the invoice) of accounting for rotable parts pursuant paragraph (f) is not treated as a capital or other amount as identified in to § 1.162–3(e). expenditure under § 1.263(a)–2(d)(1) or published guidance in the Federal (3) Additional rules—(i) Transaction § 1.263(a)–3(d) or as a material and Register or in the Internal Revenue and other additional costs. A taxpayer supply under § 1.162–3, and may be Bulletin (see § 601.601(d)(2)(ii)(b) of this electing to apply the de minimis safe deducted under § 1.162–1 in the taxable chapter). harbor under paragraph (f)(1) of this year the amount is paid provided the (ii) Taxpayer without applicable section is not required to include in the amount otherwise constitutes an financial statement. A taxpayer electing cost of the tangible property the ordinary and necessary expenses to apply the de minimis safe harbor may additional costs of acquiring or incurred in carrying on a trade or not capitalize under § 1.263(a)–2(d)(1) producing such property if these costs business. or § 1.263(a)–3(d) nor treat as a material are not included in the same invoice as (v) Coordination with section 263A. or supply under § 1.162–3(a) any the tangible property. However, the Amounts paid for tangible property amount paid in the taxable year for taxpayer electing to apply the de described in paragraph (f)(1) of this property described in paragraph (f)(1) of minimis safe harbor under paragraph section may be subject to capitalization this section if— (f)(1) of this section must include in the under section 263A if the amounts paid (A) The taxpayer does not have an cost of such property all additional costs for tangible property comprise the direct applicable financial statement (as (for example, delivery fees, installation or allocable indirect costs of other defined in paragraph (f)(4) of this services, or similar costs) if these property produced by the taxpayer or section); additional costs are included on the property acquired for resale. See, for (B) The taxpayer has at the beginning same invoice with the tangible property. example, § 1.263A–1(e)(3)(ii)(R) of the taxable year accounting For purposes of this paragraph, if the requiring taxpayers to capitalize the cost procedures treating as an expense for invoice includes amounts paid for of tools and equipment allocable to non-tax purposes— multiple tangible properties and such property produced or property acquired (1) Amounts paid for property costing invoice includes additional invoice for resale. less than a specified dollar amount; or costs related to these multiple (vi) Written accounting procedures for (2) Amounts paid for property with an properties, then the taxpayer must groups of entities. If the taxpayer’s economic useful life (as defined in allocate the additional invoice costs to financial results are reported on the § 1.162–3(c)(3)) of 12 months or less; each property using a reasonable applicable financial statement (as (C) The taxpayer treats the amount method, and each property, including defined in paragraph (f)(4) of this paid for the property as an expense on allocable labor and overhead, must meet section) for a group of entities then, for its books and records in accordance the requirements of paragraph (f)(1)(i) or purposes of paragraph (f)(1)(i)(A) of this with these accounting procedures; and paragraph (f)(1)(ii) of this section, section, the group’s applicable financial (D) The amount paid for the property whichever is applicable. Reasonable statement may be treated as the does not exceed $500 per invoice (or per allocation methods include, but are not applicable financial statement of the item as substantiated by the invoice) or limited to specific identification, a pro taxpayer, and for purposes of other amount as identified in published rata allocation, or a weighted average paragraphs (f)(1)(i)(B) and (f)(1)(i)(C) of guidance in the Federal Register or in method based on the property’s relative this section, the written accounting the Internal Revenue Bulletin (see cost. For purposes of this paragraph procedures provided for the group and § 601.601(d)(2)(ii)(b) of this chapter). (f)(3)(i), additional costs consist of the utilized for the group’s applicable (iii) Taxpayer with both an applicable costs of facilitating the acquisition or financial statement may be treated as financial statement and a non- production of such tangible property the written accounting procedures of the qualifying financial statement. For under § 1.263(a)–2(f) and the costs for taxpayer. purposes of this paragraph (f)(1), if a work performed prior to the date that (vii) Combined expensing accounting taxpayer has an applicable financial the tangible property is placed in procedures. For purposes of paragraphs statement defined in paragraph (f)(4) of service under § 1.263(a)–2(d). (f)(1)(i) and (f)(1)(ii) of this section, if this section in addition to a financial (ii) Materials and supplies. If a the taxpayer has, at the beginning of the statement that does not meet taxpayer elects to apply the de minimis taxable year accounting procedures

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treating as an expense for non-tax consolidated group filing a consolidated requirements for the de minimis safe harbor purposes (1) amounts paid for property income tax return, the election is made under paragraph (f)(1)(ii) of this section. If A costing less than a specified dollar for each member of the consolidated elects to apply the de minimis safe harbor amount; and (2) amounts paid for group by the common parent, and the under this paragraph (f) in Year 1, A may not capitalize the amounts paid for the 10 property with an economic useful life statement must also include the names printers or any other amounts meeting the (as defined in § 1.162–3(c)(3)) of 12 and taxpayer identification numbers of criteria for the de minimis safe harbor under months or less, then a taxpayer electing each member for which the election is paragraph (f)(1). Instead, in accordance with to apply the de minimis safe harbor made. In the case of an S corporation or paragraph (f)(3)(iv) of this section, A may under this paragraph (f) must apply the a partnership, the election is made by deduct these amounts under § 1.162–1 in the provisions of this paragraph (f) to the S corporation or the partnership and taxable year the amounts are paid provided amounts qualifying under either not by the shareholders or partners. An the amounts otherwise constitute deductible accounting procedure. election may not be made through the ordinary and necessary expenses incurred in carrying on a trade or business. (4) Definition of applicable financial filing of an application for change in statement. For purposes of this Example 2. De minimis safe harbor; accounting method or, before obtaining taxpayer without AFS. In Year 1, B purchases paragraph (f), the taxpayer’s applicable the Commissioner’s consent to make a 10 computers at $600 each for a total cost of financial statement (AFS) is the late election, by filing an amended $6,000 as indicated by the invoice. Assume taxpayer’s financial statement listed in Federal tax return. A taxpayer may not that each computer is a unit of property paragraphs (f)(4)(i) through (iii) of this revoke an election made under this under § 1.263(a)–3(e). B does not have an section that has the highest priority paragraph (f). The manner of electing AFS. B has accounting procedures in place (including within paragraph (f)(4)(ii) of the de minimis safe harbor under this at the beginning of Year 1 to expense this section). The financial statements amounts paid for property costing less than paragraph (f) may be modified through $1,000 and B treats the amounts paid for the are, in descending priority— guidance of general applicability (see (i) A financial statement required to computers as an expense on its books and §§ 601.601(d)(2) and 601.602 of this records. The amounts paid for the printers do be filed with the Securities and chapter). not meet the requirements for the de minimis Exchange Commission (SEC) (the 10–K (6) Anti-abuse rule. If a taxpayer acts safe harbor under paragraph (f)(1)(ii) of this or the Annual Statement to to manipulate transactions with the section because the amount paid for the Shareholders); intent to achieve a tax benefit or to property exceeds $500 per invoice (or per (ii) A certified audited financial avoid the application of the limitations item as substantiated by the invoice). B may statement that is accompanied by the provided under paragraphs not apply the de minimis safe harbor election to the amounts paid for the 10 computers report of an independent certified (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), public accountant (or in the case of a under paragraph (f)(1) of this section. and (f)(1)(ii)(D) of this section, Example 3. De minimis safe harbor; foreign entity, by the report of a appropriate adjustments will be made to similarly qualified independent taxpayer with AFS. C is a member of a carry out the purposes of this section. consolidated group for Federal income tax professional) that is used for— For example, a taxpayer is deemed to purposes. C’s financial results are reported (A) Credit purposes; on the consolidated applicable financial (B) Reporting to shareholders, act to manipulate transactions with an intent to avoid the purposes and statements for the affiliated group. C’s partners, or similar persons; or affiliated group has a written accounting (C) Any other substantial non-tax requirements of this section if— (i) The taxpayer applies the de policy at the beginning of Year 1, which is purpose; or followed by C, to expense amounts paid for (iii) A financial statement (other than minimis safe harbor to amounts property costing $5,000 or less. In Year 1, C a tax return) required to be provided to substantiated with invoices created to pays $6,250,000 to purchase 1,250 computers the federal or a state government or any componentize property that is generally at $5,000 each. C receives an invoice from its federal or state agency (other than the acquired or produced by the taxpayer supplier indicating the total amount due SEC or the Internal Revenue Service). (or other taxpayers in the same or ($6,250,000) and the price per item ($5,000). (5) Time and manner of election. A similar trade or business) as a single Assume that each computer is a unit of taxpayer that makes the election under unit of tangible property; and property under § 1.263(a)–3(e). The amounts paid for the computers meet the requirements this paragraph (f) must make the (ii) This property, if treated as a single unit, would exceed any of the for the de minimis safe harbor under election for all amounts paid during the paragraph (f)(1)(i) of this section. If C elects taxable year for property described in limitations provided under paragraphs to apply the de minimis safe harbor under paragraph (f)(1) of this section and (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), this paragraph (f) for Year 1, C may not meeting the requirements of paragraph and (f)(1)(ii)(D) of this section, as capitalize the amounts paid for the 1,250 (f)(1)(i) or paragraph (f)(1)(ii) of this applicable. computers or any other amounts meeting the section, as applicable. A taxpayer makes (7) Examples. The following examples criteria for the de minimis safe harbor under the election by attaching a statement to illustrate the application of this paragraph (f)(1) of this section. Instead, in the taxpayer’s timely filed original paragraph (f). Unless otherwise accordance with paragraph (f)(3)(iv) of this section, C may deduct these amounts under Federal tax return (including provided, assume that section 263A does not apply to the amounts § 1.162–1 in the taxable year the amounts are extensions) for the taxable year in which paid provided the amounts otherwise these amounts are paid. See described. constitute deductible ordinary and necessary §§ 301.9100–1 through 301.9100–3 of Example 1. De minimis safe harbor; expenses incurred in carrying on a trade or this chapter for the provisions governing taxpayer without AFS. In Year 1, A purchases business. extensions of time to make regulatory 10 printers at $250 each for a total cost of Example 4. De minimis safe harbor; elections. The statement must be titled $2,500 as indicated by the invoice. Assume taxpayer with AFS. D is a member of a ‘‘Section 1.263(a)–1(f) de minimis safe that each printer is a unit of property under consolidated group for Federal income tax harbor election’’ and include the § 1.263(a)–3(e). A does not have an AFS. A purposes. D’s financial results are reported has accounting procedures in place at the on the consolidated applicable financial taxpayer’s name, address, taxpayer beginning of Year 1 to expense amounts paid statements for the affiliated group. D’s identification number, and a statement for property costing less than $500, and A affiliated group has a written accounting that the taxpayer is making the de treats the amounts paid for the printers as an policy at the beginning of Year 1, which is minimis safe harbor election under expense on its books and records. The followed by D, to expense amounts paid for § 1.263(a)–1(f). In the case of a amounts paid for the printers meet the property costing less than $15,000. In Year 1,

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D pays $4,800,000 to purchase 800 elliptical qualify under the safe harbor. The amount except G purchases the 3 tablet computers at machines at $6,000 each. D receives an paid to the interior designer is a cost of $600 each for a total cost of $1,800. The invoice from its supplier indicating the total facilitating the acquisition of the table and amounts paid for the tablet computers do not amount due ($4,800,000) and the price per chairs under § 1.263(a)–2(f). Under paragraph meet the de minimis rule safe harbor under item ($6,000). Assume that each elliptical (f)(3)(i) of this section, F is not required to paragraphs (f)(1)(ii) and (f)(3)(vii) of this machine is a unit of property under include in the cost of tangible property the section because the cost of each computer § 1.263(a)–3(e). D may not apply the de additional costs of acquiring such property if exceeds $500. Therefore, the amounts paid minimis safe harbor election to the amounts these costs are not included in the same for the tablet computers may not be deducted paid for the 800 elliptical machines under invoice as the tangible property. Thus, F is under the safe harbor. paragraph (f)(1) of this section because the not required to include a pro rata allocation Example 9. De minimis safe harbor; amount paid for the property exceeds $5,000 of the amount paid to the interior designer materials and supplies. H is a corporation per invoice (or per item as substantiated by to determine the application of the de that provides consulting services to its the invoice). minimis safe harbor to the table and the customers. H has an AFS and a written Example 5. De minimis safe harbor; chairs. Accordingly, the amounts paid by F accounting policy at the beginning of the additional invoice costs. E is a member of a for the table and each chair meet the taxable year to expense amounts paid for consolidated group for Federal income tax requirements for the de minimis safe harbor property costing $5,000 or less. In Year 1, H purposes. E’s financial results are reported on under paragraph (f)(1)(ii) of this section, and purchases 1,000 computers at $500 each for the consolidated applicable financial F may not capitalize the amounts paid for the a total cost of $500,000. Assume that each statements for the affiliated group. E’s table or each chair under paragraph (f)(1) of computer is a unit of property under affiliated group has a written accounting this section. In addition, F is not required to § 1.263(a)–3(e) and is not a material or supply policy at the beginning of Year 1, which is capitalize the amounts paid to the interior under § 1.162–3. In addition, H purchases followed by E, to expense amounts paid for designer as a cost that facilitates the 200 office chairs at $100 each for a total cost property costing less than $5,000. In Year 1, acquisition of tangible property under of $20,000 and 250 customized briefcases at E pays $45,000 for the purchase and § 1.263(a)–2(f)(3)(i). Instead, F may deduct $80 each for a total cost of $20,000. Assume installation of wireless routers in each of its the amounts paid for the table, chairs, and that each office chair and each briefcase is a 10 office locations. Assume that each interior designer under § 1.162–1 in the material or supply under § 1.162–3(c)(1). H wireless router is a unit of property under taxable year the amounts are paid provided treats the amounts paid for the computers, § 1.263(a)–3(e). E receives an invoice from its the amounts otherwise constitute deductible office chairs, and briefcases as expenses on supplier indicating the total amount due ordinary and necessary expenses incurred in its AFS. The amounts paid for computers, ($45,000), including the material price per carrying on a trade or business. office chairs, and briefcases meet the item ($2,500), and total delivery and Example 7. De minimis safe harbor; 12- requirements for the de minimis safe harbor installation ($20,000). E allocates the month economic useful life. G operates a under paragraph (f)(1)(i) of this section. If H additional invoice costs to the materials on restaurant. In Year 1, G purchases 10 hand- elects to apply the de minimis safe harbor a pro rata basis, bringing the cost of each held point-of-service devices at $300 each for under this paragraph (f) in Year 1, H may not router to $4,500 ($2,500 materials + $2,000 a total cost of $3,000 as indicated by invoice. capitalize the amounts paid for the 1,000 labor and overhead). The amounts paid for G also purchases 3 tablet computers at $500 computers, the 200 office chairs, and the 250 each router, including the allocable each for a total cost of $1,500 as indicated by briefcases under paragraph (f)(1) of this additional invoice costs, meet the invoice. Assume each point-of-service device section. H may deduct the amounts paid for requirements for the de minimis safe harbor and each tablet computer has an economic the computers, the office chairs, and the under paragraph (f)(1)(i) of this section. If E useful life of 12 months or less, beginning briefcases under § 1.162–1 in the taxable year elects to apply the de minimis safe harbor when they are used in G’s business. Assume the amounts are paid provided the amounts under this paragraph (f) for Year 1, E may not that each device and each tablet is a unit of otherwise constitute deductible ordinary and capitalize the amounts paid for the 10 routers property under § 1.263(a)–3(e). G does not necessary expenses incurred in carrying on a (including the additional invoice costs) or have an AFS, but G has accounting trade or business. any other amounts meeting the criteria for procedures in place at the beginning of Year Example 10. De minimis safe harbor; the de minimis safe harbor under paragraph 1 to expense amounts paid for property coordination with section 263A. J is a (f)(1) of this section. Instead, in accordance costing $300 or less and to expense amounts member of a consolidated group for Federal with paragraph (f)(3)(iv) of this section, E paid for property with an economic useful income tax purposes. J’s financial results are may deduct these amounts under § 1.162–1 life of 12 months or less. Thus, G expenses reported on the consolidated AFS for the in the taxable year the amounts are paid the amounts paid for the hand-held devices affiliated group. J’s affiliated group has a provided the amounts otherwise constitute on its books and records because each device written accounting policy at the beginning of deductible ordinary and necessary expenses costs $300. G also expenses the amounts paid Year 1, which is followed by J, to expense incurred in carrying on a trade or business. for the tablet computers on its books and amounts paid for property costing less than Example 6. De minims safe harbor; non- records because the computers have an $1,000 or that has an economic useful life of invoice additional costs. F is a corporation economic useful life of 12 months of less, 12 months or less. In Year 1, J acquires jigs, that provides consulting services to its beginning when they are used. The amounts dies, molds, and patterns for use in the customer. F does not have an AFS, but F has paid for the hand-held devices and the tablet manufacture of J’s products. Assume each jig, accounting procedures in place at the computers meet the requirements for the de die, mold, and pattern is a unit of property beginning of Year 1 to expense amounts paid minimis safe harbor under paragraph (f)(1)(ii) under § 1.263(a)–3(e) and costs less than for property costing less than $500. In Year of this section. If G elects to apply the de $1,000. In Year 1, J begins using the jigs, dies, 1, F pays $600 to an interior designer to shop minimis safe harbor under this paragraph (f) molds and patterns to manufacture its for, evaluate, and make recommendations in Year 1, G may not capitalize the amounts products. Assume these items are materials regarding purchasing new furniture for F’s paid for the hand-held devices, the tablet and supplies under § 1.162–3(c)(1)(iii), and J conference room. As a result of the interior computers, or any other amounts meeting the elects to apply the de minimis safe harbor designer’s recommendations, F acquires a criteria for the de minimis safe harbor under under paragraph (f)(1)(i) of this section to conference table for $500 and 10 chairs for paragraph (f)(1) of this section. Instead, in amounts qualifying under the safe harbor in $300 each. In Year 1, F receives an invoice accordance with paragraph (f)(3)(iv) of this Year 1. Under paragraph (f)(3)(v) of this from the interior designer for $600 for his section, G may deduct the amounts paid for section, the amounts paid for the jigs, dies, services, and F receives a separate invoice the hand-held devices and tablet computers molds, and patterns may be subject to from the furniture supplier indicating a total under § 1.162–1 in the taxable year the capitalization under section 263A if the amount due of $500 for the table and $300 amounts are paid provided the amounts amounts paid for these tangible properties for each chair. For Year 1, F treats the otherwise constitute deductible ordinary and comprise the direct or allocable indirect costs amount paid for the table and each chair as necessary business expenses incurred in of other property produced by the taxpayer an expense on its books and records, and F carrying on a trade or business. or property acquired for resale. elects to use the de minimis safe harbor for Example 8. De minimis safe harbor; Example 11. De minimis safe harbor; anti- amounts paid for tangible property that limitation. Assume the facts as in Example 7, abuse rule. K is a corporation that provides

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hauling services to its customers. In Year 1, taxable years beginning on or after comply with this section, and paragraph K decides to purchase a truck to use in its January 1, 2012. (j) of this section provides the effective business. K does not have an AFS. K has (ii) Transition rule for de minimis safe and applicability dates for the rules accounting procedures in place at the harbor election on 2012 or 2013 returns. under this section. beginning of Year 1 to expense amounts paid If under paragraph (h)(2)(i) of this (b) Definitions. For purposes of this for property costing less than $500. K arranges to purchase a used truck for a total section, a taxpayer chooses to make the section, the following definitions apply: of $1,500. Prior to the acquisition, K requests election to apply the de minimis safe (1) Amount paid. In the case of a the seller to provide multiple invoices for harbor under paragraph (f) of this taxpayer using an accrual method of different parts of the truck. Accordingly, the section for amounts paid in its taxable accounting, the terms amount paid and seller provides K with four invoices during year beginning on or after January 1, payment mean a liability incurred Year 1—one invoice of $500 for the cab, one 2012, and ending on or before (within the meaning of § 1.446– invoice of $500 for the engine, one invoice September 19, 2013 (applicable taxable 1(c)(1)(ii)). A liability may not be taken of $300 for the trailer, and a fourth invoice year), and the taxpayer did not make the into account under this section prior to of $200 for the tires. K treats the amounts election specified in paragraph (f)(5) of the taxable year during which the paid under each invoice as an expense on its this section on its timely filed original liability is incurred. books and records. K elects to apply the de Federal tax return for the applicable (2) Personal property means tangible minimis safe harbor under paragraph (f) of personal property as defined in § 1.48– this section in Year 1 and does not capitalize taxable year, the taxpayer must make the amounts paid for each invoice pursuant the election specified in paragraph (f)(5) 1(c). to the safe harbor. Under paragraph (f)(6) of of this section for the applicable taxable (3) Real property means land and this section, K has applied the de minimis year by filing an amended Federal tax improvements thereto, such as buildings rule to amounts substantiated with invoices return for the applicable taxable year on or other inherently permanent created to componentize property that is or before 180 days from the due date structures (including items that are generally acquired as a single unit of tangible including extensions of the taxpayer’s structural components of the buildings property in the taxpayer’s type of business, Federal tax return for the applicable or structures) that are not personal and this property, if treated as single unit, taxable year, notwithstanding that the property as defined in paragraph (b)(2) would exceed the limitations provided under taxpayer may not have extended the due of this section. Any property that the de minimis rule. Accordingly, K is constitutes other tangible property deemed to manipulate the transaction to date. acquire the truck with the intent to avoid the (3) Optional application of TD 9564. under § 1.48–1(d) is treated as real purposes of this paragraph (f). As a result, K A taxpayer may choose to apply property for purposes of this section. may not apply the de minimis rule to these § 1.263(a)–1T as contained in TD 9564 Local law is not controlling in amounts and is subject to appropriate (76 FR 81060) December 27, 2011, to determining whether property is real adjustments. taxable years beginning on or after property for purposes of this section. (4) Produce means construct, build, (g) Accounting method changes. January 1, 2012, and before January 1, 2014. install, manufacture, develop, create, Except for paragraph (f) of this section raise, or grow. This definition is (the de minimis safe harbor election), a § 1.263(a)–1T [Removed] intended to have the same meaning as change to comply with this section is a ■ Par. 21. Section 1.263(a)–1T is the definition used for purposes of change in method of accounting to removed. section 263A(g)(1) and § 1.263A– which the provisions of sections 446 ■ 2(a)(1)(i), except that improvements are and 481 and the accompanying Par. 22. Section 1.263(a)–2 is revised to read as follows: excluded from the definition in this regulations apply. A taxpayer seeking to paragraph (b)(4) and are separately change to a method of accounting § 1.263(a)–2 Amounts paid to acquire or defined and addressed in § 1.263(a)–3. permitted in this section must secure produce tangible property. (c) Coordination with other provisions the consent of the Commissioner in (a) Overview. This section provides of the Code—(1) In general. Nothing in accordance with § 1.446–1(e) and follow rules for applying section 263(a) to this section changes the treatment of the administrative procedures issued amounts paid to acquire or produce a any amount that is specifically provided under § 1.446–1(e)(3)(ii) for obtaining unit of real or personal property. for under any provision of the Code or the Commissioner’s consent to change Paragraph (b) of this section contains the Treasury Regulations other than its accounting method. definitions. Paragraph (c) of this section section 162(a) or section 212 and the (h) Effective/applicability date—(1) In contains the rules for coordinating this regulations under those sections. For general. Except for paragraph (f) of this section with other provisions of the example, see section 263A requiring section, this section generally applies to Internal Revenue Code (Code). taxpayers to capitalize the direct and taxable years beginning on or after Paragraph (d) of this section provides allocable indirect costs of property January 1, 2014. Paragraph (f) of this the general requirement to capitalize produced by the taxpayer and property section applies to amounts paid in amounts paid to acquire or produce a acquired for resale. See also section 195 taxable years beginning on or after unit of real or personal property. requiring taxpayers to capitalize certain January 1, 2014. Except as provided in Paragraph (e) of this section provides costs as start-up expenditures. paragraph (h)(1) and paragraph (h)(2) of the requirement to capitalize amounts (2) Materials and supplies. Nothing in this section, § 1.263(a)–1 as contained in paid to defend or perfect title to real or this section changes the treatment of 26 CFR part 1 edition revised as of April personal property. Paragraph (f) of this amounts paid to acquire or produce 1, 2011, applies to taxable years section provides the rules for property that is properly treated as beginning before January 1, 2014. determining the extent to which materials and supplies under § 1.162–3. (2) Early application of this section— taxpayers must capitalize transaction (d) Acquired or produced tangible (i) In general. Except for paragraph (f) of costs related to the acquisition of property—(1) Requirement to capitalize. this section, a taxpayer may choose to tangible property. Paragraphs (g) and (h) Except as provided in § 1.162–3 apply this section to taxable years of this section address the treatment and (relating to materials and supplies) and beginning on or after January 1, 2012. A recovery of capital expenditures. in § 1.263(a)–1(f) (providing a de taxpayer may choose to apply paragraph Paragraph (i) of this section provides for minimis safe harbor election), a (f) of this section to amounts paid in changes in methods of accounting to taxpayer must capitalize amounts paid

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to acquire or produce a unit of real or determine the treatment of the rental items building unit of property because they were personal property (as determined under that are materials and supplies under for work performed prior to M’s placing the § 1.263(a)–3(e)), including leasehold § 1.162–3(c)(1). building in service. improvements, land and land Example 4. Acquisition or production cost. Example 11. Work performed prior to D purchases and produces jigs, dies, molds, placing the property in service. In January improvements, buildings, machinery and patterns for use in the manufacture of D’s Year 1, N purchases a new machine for use and equipment, and furniture and products. Assume that each of these items is in an existing production line of its fixtures. See § 1.263(a)–3(f) for the rules a unit of property as determined under manufacturing business. Assume that the for determining whether amounts are for § 1.263(a)–3(e) and is not a material and machine is a unit of property under leasehold improvements. Amounts paid supply under § 1.162–3(c)(1). D is required to § 1.263(a)–3(e) and is not a material or supply to acquire or produce a unit of real or capitalize under paragraph (d)(1) of this under § 1.162–3. N pays amounts to install personal property include the invoice section the amounts paid to acquire and the machine, and after the machine is price, transaction costs as determined produce the jigs, dies, molds, and patterns. installed, N pays amounts to perform a Example 5. Acquisition of land. F critical test on the machine to ensure that it under paragraph (f) of this section, and purchases a parcel of undeveloped real costs for work performed prior to the will operate in accordance with quality estate. F must capitalize under paragraph standards. On November 1, Year 1, the date that the unit of property is placed (d)(1) of this section the amount paid to critical test is complete, and N places the in service by the taxpayer (without acquire the real estate. See paragraph (f) of machine in service on the production line. N regard to any applicable convention this section for the treatment of amounts paid pays amounts to perform periodic quality under section 168(d)). A taxpayer also to facilitate the acquisition of real property. control testing after the machine is placed in must capitalize amounts paid to acquire Example 6. Acquisition of building. G service. Under paragraph (d)(1) of this real or personal property for resale. purchases a building. G must capitalize section, the amounts paid for the installation (2) Examples. The following examples under paragraph (d)(1) of this section the and the critical test performed before the amount paid to acquire the building. See illustrate the rules of this paragraph (d). machine is placed in service must be paragraph (f) of this section for the treatment capitalized by N as amounts to acquire the Unless otherwise provided, assume that of amounts paid to facilitate the acquisition the taxpayer does not elect the de machine. However, amounts paid for of real property. periodic quality control testing after N placed minimis safe harbor under § 1.263(a)– Example 7. Acquisition of property for the machine in service are not required to be 1(f) and that the property is not acquired resale and production of property for sale; capitalized as amounts paid to acquire the for resale under section 263A. coordination with section 263A. H purchases machine. goods for resale and produces other goods for Example 1. Acquisition of personal sale. H must capitalize under paragraph (e) Defense or perfection of title to property. A purchases new cash registers for (d)(1) of this section the amounts paid to use in its retail store located in leased space property—(1) In general. Amounts paid acquire and produce the goods. See section in a shopping mall. Assume each cash 263A for the amounts required to be to defend or perfect title to real or register is a unit of property as determined capitalized to the property produced or to the personal property are amounts paid to under § 1.263(a)–3(e) and is not a material or property acquired for resale. acquire or produce property within the supply under § 1.162–3. A must capitalize Example 8. Production of building; meaning of this section and must be under paragraph (d)(1) of this section the amount paid to acquire each cash register. coordination with section 263A. J constructs capitalized. Example 2. Acquisition of personal a building. J must capitalize under paragraph (2) Examples. The following examples (d)(1) of this section the amount paid to property that is a material or supply; illustrate the rule of this paragraph (e): coordination with § 1.162–3. B operates a construct the building. See section 263A for fleet of aircraft. In Year 1, B acquires a stock the costs required to be capitalized to the real Example 1. Amounts paid to contest of component parts, which it intends to use property produced by J. condemnation. X owns real property located to maintain and repair its aircraft. Assume Example 9. Acquisition of assets in County. County files an eminent domain that each component part is a material or constituting a trade or business. K owns complaint condemning a portion of X’s supply under § 1.162–3(c)(1) and B does not tangible and intangible assets that constitute property to use as a roadway. X hires an make elections under § 1.162–3(d) to treat the a trade or business. L purchases all the assets attorney to contest the condemnation. The materials and supplies as capital of K in a taxable transaction. L must amounts that X paid to the attorney must be expenditures. In Year 2, B uses the capitalize under paragraph (d)(1) of this capitalized because they were to defend X’s component parts in the repair and section the amount paid for the tangible title to the property. maintenance of its aircraft. Because the parts assets of K. See § 1.263(a)–4 for the treatment Example 2. Amounts paid to invalidate are materials and supplies under § 1.162–3, of amounts paid to acquire or create ordinance. Y is in the business of quarrying B is not required to capitalize the amounts intangibles and § 1.263(a)–5 for the treatment and supplying for sale sand and stone in a paid for the parts under paragraph (d)(1) of of amounts paid to facilitate the acquisition certain municipality. Several years after Y this section. Rather, to determine the of assets that constitute a trade or business. establishes its business, the municipality in treatment of these amounts, B must apply the See section 1060 for special allocation rules which it is located passes an ordinance that rules under § 1.162–3, governing the for certain asset acquisitions. prohibits the operation of Y’s business. Y treatment of materials and supplies. Example 10. Work performed prior to incurs attorney’s fees in a successful Example 3. Acquisition of unit of personal placing the property in service. In Year 1, M prosecution of a suit to invalidate the property; coordination with § 1.162–3. C purchases a building for use as a business municipal ordinance. Y prosecutes the suit to operates a rental business that rents out a office. Prior to placing the building in preserve its business activities and not to variety of small individual items to service, M pays amounts to repair cement defend Y’s title in the property. Therefore, customers (rental items). C maintains a steps, refinish wood floors, patch holes in the attorney’s fees that Y paid are not supply of rental items on hand to replace walls, and paint the interiors and exteriors of required to be capitalized under paragraph worn or damaged items. C purchases a large the building. In Year 2, M places the building (e)(1) of this section. quantity of rental items to be used in its in service and begins using the building as Example 3. Amounts paid to challenge business. Assume that each of these rental its business office. Assume that the work that building line. The board of public works of items is a unit of property under § 1.263(a)– M performs does not constitute an a municipality establishes a building line 3(e). Also assume that a portion of the rental improvement to the building or its structural across Z’s business property, adversely items are materials and supplies under components under § 1.263(a)–3. Under affecting the value of the property. Z incurs § 1.162–3(c)(1). Under paragraph (d)(1) of this § 1.263–3(e)(2)(i), the building and its legal fees in unsuccessfully litigating the section, C must capitalize the amounts paid structural components is a single unit of establishment of the building line. The for the rental items that are not materials and property. Under paragraph (d)(1) of this amounts Z paid to the attorney must be supplies under § 1.162–3(c)(1). However, C section, the amounts paid must be capitalized because they were to defend Z’s must apply the rules in § 1.162–3 to capitalized as amounts to acquire the title to the property.

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(f) Transaction costs—(1) In general. fees (defined in paragraph (f)(3)(iii) of facilitate the acquisition in the Except as provided in § 1.263(a)– this section); taxpayer’s timely filed original Federal 1(f)(3)(i) (for purposes of the de minimis (J) Architectural, geological, survey, tax return (including extensions) for the safe harbor), a taxpayer must capitalize engineering, environmental, or taxable year during which the amounts amounts paid to facilitate the inspection services pertaining to are paid. See §§ 301.9100–1 through acquisition of real or personal property. particular properties; or 301.9100–3 of this chapter for the See § 1.263(a)–5 for the treatment of (K) Services provided by a qualified provisions governing extensions of time amounts paid to facilitate the intermediary or other facilitator of an to make regulatory elections. In the case acquisition of assets that constitute a exchange under section 1031. of an S corporation or a partnership, the trade or business. See § 1.167(a)–5 for (iii) Special rule for acquisitions of election is made by the S corporation or allocations of facilitative costs between real property—(A) In general. Except as by the partnership, and not by the depreciable and non-depreciable provided in paragraph (f)(2)(ii) of this shareholders or partners. A taxpayer property. section (relating to inherently may revoke an election made under this (2) Scope of facilitate—(i) In general. facilitative amounts), an amount paid by paragraph (f)(2)(iv)(B) with respect to Except as otherwise provided in this the taxpayer in the process of each acquisition only by filing a request section, an amount is paid to facilitate investigating or otherwise pursuing the for a private letter ruling and obtaining the acquisition of real or personal acquisition of real property does not the Commissioner’s consent to revoke property if the amount is paid in the facilitate the acquisition if it relates to the election. The Commissioner may process of investigating or otherwise activities performed in the process of grant a request to revoke this election if pursuing the acquisition. Whether an determining whether to acquire real the taxpayer acted reasonably and in amount is paid in the process of property and which real property to good faith and the revocation will not investigating or otherwise pursuing the acquire. prejudice the interests of Government. (B) Acquisitions of real and personal acquisition is determined based on all of See generally § 301.9100–3 of this property in a single transaction. An the facts and circumstances. In chapter. The manner of electing and amount paid by the taxpayer in the determining whether an amount is paid revoking the election to capitalize under process of investigating or otherwise this paragraph (f)(2)(iv)(B) may be to facilitate an acquisition, the fact that pursuing the acquisition of personal the amount would (or would not) have modified through guidance of general property facilitates the acquisition of applicability (see §§ 606.601(d)(2) and been paid but for the acquisition is such personal property, even if such relevant but is not determinative. 601.602 of this section). An election property is acquired in a single may not be made or revoked through the Amounts paid to facilitate an transaction that also includes the acquisition include, but are not limited filing of an application for change in acquisition of real property subject to accounting method or, before obtaining to, inherently facilitative amounts the special rule set out in paragraph specified in paragraph (f)(2)(ii) of this the Commissioner’s consent to make the (f)(2)(iii)(A) of this section. A taxpayer late election or to revoke the election, by section. may use a reasonable allocation method (ii) Inherently facilitative amounts. filing an amended Federal tax return. to determine which costs facilitate the (3) Treatment of transaction costs—(i) An amount is paid in the process of acquisition of personal property and In general. Except as provided under investigating or otherwise pursuing the which costs relate to the acquisition of § 1.263(a)–1(f)(3)(i) (for purposes of the acquisition of real or personal property real property and are subject to the de minimis safe harbor), all amounts if the amount is inherently facilitative. special rule of paragraph (f)(2)(iii)(A) of paid to facilitate the acquisition of real An amount is inherently facilitative if this section. or personal property are capital the amount is paid for— (iv) Employee compensation and expenditures. Facilitative amounts (A) Transporting the property (for overhead costs—(A) In general. For allocable to real or personal property example, shipping fees and moving purposes of paragraph (f) of this section, must be included in the basis of the costs); amounts paid for employee property acquired. (B) Securing an appraisal or compensation (within the meaning of (ii) Treatment of inherently determining the value or price of § 1.263(a)–4(e)(4)(ii)) and overhead are facilitative amounts. Inherently property; treated as amounts that do not facilitate facilitative amounts allocable to real or (C) Negotiating the terms or structure the acquisition of real or personal personal property are capital of the acquisition and obtaining tax property. See section 263A, however, expenditures related to such property, advice on the acquisition; for the treatment of employee even if the property is not eventually (D) Application fees, bidding costs, or compensation and overhead costs acquired. Except for contingency fees as similar expenses; required to be capitalized to property defined in paragraph (f)(3)(iii) of this (E) Preparing and reviewing the produced by the taxpayer or to property section, inherently facilitative amounts documents that effectuate the acquired for resale. allocable to real or personal property acquisition of the property (for example, (B) Election to capitalize. A taxpayer not acquired may be allocated to those preparing the bid, offer, sales contract, may elect to treat amounts paid for properties and recovered as appropriate or purchase agreement); employee compensation or overhead as in accordance with the applicable (F) Examining and evaluating the title amounts that facilitate the acquisition of provisions of the Code and the Treasury of property; property. The election is made Regulations (for example, sections 165, (G) Obtaining regulatory approval of separately for each acquisition and 167, or 168). See paragraph (h) of this the acquisition or securing permits applies to employee compensation or section for the recovery of capitalized related to the acquisition, including overhead, or both. For example, a amounts. application fees; taxpayer may elect to treat overhead, but (iii) Contingency Fees. For purposes (H) Conveying property between the not employee compensation, as amounts of this section, a contingency fee is an parties, including sales and transfer that facilitate the acquisition of amount paid that is contingent on the taxes, and title registration costs; property. A taxpayer makes the election successful closing of the acquisition of (I) Finders’ fees or brokers’ by treating the amounts to which the real or personal property. Contingency commissions, including contingency election applies as amounts that fees must be included in the basis of the

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property acquired and may not be Example 6. Transaction costs allocable to open a new restaurant in City X. In October, allocated to the property not acquired. multiple properties. G, a retailer, wants to Year 1, K hires a real estate consultant to (4) Examples. The following examples acquire land for the purpose of building a identify potential property upon which K illustrate the rules of paragraph (f) of new distribution facility for its products. G may locate its restaurant, and is obligated to considers various properties on Highway X this section. For purposes of these compensate the consultant upon the in State Y. G incurs fees for the services of acquisition of property. The real estate examples, assume that the taxpayer does an architect to advise and evaluate the consultant identifies three properties, and K not elect the de minimis safe harbor suitability of the sites for the type of facility decides to acquire one of those properties. under § 1.263(a)–1(f): that G intends to construct on the selected Upon closing of the acquisition of that Example 1. Broker’s fees to facilitate an site. G must capitalize the architect fees as property, K pays the consultant its fee. The acquisition. A decides to purchase a building amounts paid to acquire land because these amount paid to the consultant constitutes a in which to relocate its offices and hires a amounts are inherently facilitative to the contingency fee under paragraph (f)(3)(iii) of real estate broker to find a suitable building. acquisition of land under paragraph this section because the payment is A pays fees to the broker to find property for (f)(2)(ii)(J) of this section. contingent on the successful closing of the A to acquire. Under paragraph (f)(2)(ii)(I) of Example 7. Transaction costs; coordination acquisition of property. Accordingly, under this section, A must capitalize the amounts with section 263A. H, a retailer, wants to paragraph (f)(3)(iii) of this section, K must paid to the broker because these costs are acquire land for the purpose of building a include the amount paid to the consultant in inherently facilitative of the acquisition of new distribution facility for its products. H the basis of the property acquired. K is not real property. considers various properties on Highway X permitted to allocate the amount paid Example 2. Inspection and survey costs to in State Y. H incurs fees for the services of between the properties acquired and not facilitate an acquisition. B decides to an architect to prepare preliminary floor acquired. plans for a building that H could construct purchase Building X and pays amounts to Example 10. Employee compensation and at any of the sites. Under these facts, the third-party contractors for a termite overhead. L, a freight carrier, maintains an architect’s fees are not facilitative to the inspection and an environmental survey of acquisition department whose sole function acquisition of land under paragraph (f) of this Building X. Under paragraph (f)(2)(ii)(J) of is to arrange for the purchase of vehicles and section. Therefore, H is not required to this section, B must capitalize the amounts aircraft from manufacturers or other parties paid for the inspection and the survey of the capitalize the architect fees as amounts paid to acquire land. However, the amounts paid to be used in its freight carrying business. As building because these costs are inherently provided in paragraph (f)(2)(iv)(A) of this facilitative of the acquisition of real property. for the architect’s fees may be subject to capitalization under section 263A if these section, L is not required to capitalize any Example 3. Moving costs to facilitate an portion of the compensation paid to acquisition. C purchases all the assets of D amounts comprise the direct or allocable indirect cost of property produced by H, such employees in its acquisition department or and, in connection with the purchase, hires any portion of its overhead allocable to its a transportation company to move storage as the building. Example 8. Special rule for acquisitions of acquisition department. However, under tanks from D’s plant to C’s plant. Under paragraph (f)(2)(iv)(B) of this section, L may paragraph (f)(2)(ii)(A) of this section, C must real property. J owns several retail stores. J decides to examine the feasibility of opening elect to capitalize the compensation and/or capitalize the amount paid to move the overhead costs allocable to the acquisition of storage tanks from D’s plant to C’s plant a new store in City X. In October, Year 1, J hires and incurs costs for a development a vehicle or aircraft by treating these amounts because this cost is inherently facilitative to as costs that facilitate the acquisition of that the acquisition of personal property. consulting firm to study City X and perform market surveys, evaluate zoning and property in its timely filed original Federal Example 4. Geological and geophysical tax return for the year the amounts are paid. costs; coordination with other provisions. E is environmental requirements, and make in the business of exploring, purchasing, and preliminary reports and recommendations as (g) Treatment of capital expenditures. developing properties in the United States for to areas that J should consider for purposes Amounts required to be capitalized the production of oil and gas. E considers of locating a new store. In December, Year 1, J continues to consider whether to purchase under this section are capital acquiring a particular property but first expenditures and must be taken into incurs costs for the services of an engineering real property in City X and which property firm to perform geological and geophysical to acquire. J hires, and incurs fees for, an account through a charge to capital studies to determine if the property is appraiser to perform appraisals on two account or basis, or in the case of suitable for oil or gas production. Assume different sites to determine a fair offering property that is inventory in the hands that the amounts that E paid to the price for each site. In March, Year 2, J of a taxpayer, through inclusion in engineering firm constitute geological and decides to acquire one of these two sites for inventory costs. geophysical expenditures under section the location of its new store. At the same (h) Recovery of capitalized amounts— 167(h). Although the amounts that E paid for time, J determines not to acquire the other site. Under paragraph (f)(2)(iii) of this (1) In general. Amounts that are the geological and geophysical services are capitalized under this section are inherently facilitative to the acquisition of section, J is not required to capitalize real property under paragraph (f)(2)(ii)(J) of amounts paid to the development consultant recovered through depreciation, cost of this section, E is not required to include in Year 1 because the amounts relate to goods sold, or by an adjustment to basis those amounts in the basis of the real activities performed in the process of at the time the property is placed in property acquired. Rather, under paragraph determining whether to acquire real property service, sold, used, or otherwise (c) of this section, E must capitalize these and which real property to acquire, and the disposed of by the taxpayer. Cost costs separately and amortize such costs as amounts are not inherently facilitative costs recovery is determined by the under paragraph (f)(2)(ii) of this section. required under section 167(h) (addressing the applicable provisions of the Code and amortization of geological and geophysical However, J must capitalize amounts paid to expenditures). the appraiser in Year 1 because the appraisal regulations relating to the use, sale, or Example 5. Scope of facilitate. F is in the costs are inherently facilitative costs under disposition of property. business of providing legal services to paragraph (f)(2)(ii)(B) of this section. In Year (2) Examples. The following examples clients. F is interested in acquiring a new 2, J must include the appraisal costs allocable illustrate the rule of paragraph (h)(1) of conference table for its office. F hires and to property acquired in the basis of the this section. For purposes of these incurs fees for an interior designer to shop property acquired. In addition, J may recover examples, assume that the taxpayer does for, evaluate, and make recommendations to the appraisal costs allocable to the property not elect the de minimis safe harbor F regarding which new table to acquire. not acquired in accordance with paragraphs under section § 1.263(a)–1(f). Under paragraphs (f)(1) and (2) of this (f)(3)(ii) and (h) of this section. See, for section, F must capitalize the amounts paid example, § 1.165–2 for losses on the Example 1. Recovery when property placed to the interior designer to provide these permanent withdrawal of non-depreciable in service. X owns a 10-unit apartment services because they are paid in the process property. building. The refrigerator in one of the of investigating or otherwise pursuing the Example 9. Contingency fee. K owns apartments stops functioning, and X acquisition of personal property. several restaurant properties. K decides to purchases a new refrigerator to replace the

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old one. X pays for the acquisition, delivery, paragraphs (f)(2)(iii), (f)(2)(iv), and this section provides the rules for and installation of the new refrigerator. (f)(3)(ii) of this section to amounts paid determining the appropriate unit of Assume that the refrigerator is the unit of in taxable years beginning on or after property. Paragraph (f) of this section property, as determined under § 1.263(a)– January 1, 2012. provides rules for leasehold 3(e), and is not a material or supply under § 1.162–3. Under paragraph (d)(1) of this (ii) Transition rule for election to improvements. Paragraph (g) of this section, X is required to capitalize the capitalize employee compensation and section provides special rules for amounts paid for the acquisition, delivery, overhead costs on 2012 or 2013 returns. determining improvement costs in and installation of the refrigerator. Under this If under paragraph (j)(2)(i) of this particular contexts, including indirect paragraph (h), the capitalized amounts are section, a taxpayer chooses to make the costs incurred during an improvement, recovered through depreciation, which election to capitalize employee removal costs, aggregation of related begins when the refrigerator is placed in compensation and overhead costs under costs, and regulatory compliance costs. service by X. paragraph (f)(2)(iv)(B) of this section for Paragraph (h) of this section provides a Example 2. Recovery when property used amounts paid in its taxable year in the production of property. Y operates a safe harbor for small taxpayers. plant where it manufactures widgets. Y beginning on or after January 1, 2012, Paragraph (i) provides a safe harbor for purchases a tractor loader to move raw and ending on or before September 19, routine maintenance costs. Paragraph (j) materials into and around the plant for use 2013 (applicable taxable year), and the of this section provides rules for in the manufacturing process. Assume that taxpayer did not make the election determining whether amounts are paid the tractor loader is a unit of property, as specified in paragraph (f)(2)(iv)(B) of for betterments to the unit of property. determined under § 1.263(a)–3(e), and is not this section on its timely filed original Paragraph (k) of this section provides a material or supply under § 1.162–3. Under Federal tax return for the applicable rules for determining whether amounts paragraph (d)(1) of this section, Y is required taxable year, the taxpayer must make are paid to restore the unit of property. to capitalize the amounts paid to acquire the tractor loader. Under this paragraph (h), the the election specified in paragraph Paragraph (l) of this section provides capitalized amounts are recovered through (f)(2)(iv)(B) of this section for the rules for amounts paid to adapt the unit depreciation, which begins when Y places applicable taxable year by filing an of property to a new or different use. the tractor loader in service. However, amended Federal tax return for the Paragraph (m) of this section provides because the tractor loader is used in the applicable taxable year on or before 180 an optional regulatory accounting production of property, under section 263A days from the due date including method. Paragraph (n) of this section the cost recovery (that is, the depreciation) extensions of the taxpayer’s Federal tax provides an election to capitalize repair may also be capitalized to Y’s property return for the applicable taxable year, and maintenance costs consistent with produced, and, consequently, recovered notwithstanding that the taxpayer may books and records. Paragraphs (o) and through cost of goods sold. See § 1.263A– 1(e)(3)(ii)(I). not have extended the due date. (p) of this section provide for the (3) Optional application of TD 9564. treatment and recovery of amounts (i) Accounting method changes. Except for § 1.263(a)–2T(f)(2)(iii), capitalized under this section. Unless otherwise provided under this (f)(2)(iv), (f)(3)(ii), and (g), a taxpayer Paragraphs (q) and (r) of this section section, a change to comply with this may choose to apply § 1.263(a)–2T as provide for accounting method changes section is a change in method of contained in TD 9564 (76 FR 81060) and state the effective/applicability date accounting to which the provisions of December 27, 2011, to taxable years for the rules in this section. sections 446 and 481 and the beginning on or after January 1, 2012, (b) Definitions. For purposes of this accompanying regulations apply. A and before January 1, 2014. A taxpayer section, the following definitions apply: taxpayer seeking to change to a method may choose to apply § 1.263(a)– (1) Amount paid. In the case of a of accounting permitted in this section 2T(f)(2)(iii), (f)(2)(iv), (f)(3)(ii) and (g) as taxpayer using an accrual method of must secure the consent of the contained in TD 9564 (76 FR 81060) accounting, the terms amounts paid and Commissioner in accordance with December 27, 2011, to amounts paid in payment mean a liability incurred § 1.446–1(e) and follow the taxable years beginning on or after (within the meaning of § 1.446– administrative procedures issued under January 1, 2012, and before January 1, 1(c)(1)(ii)). A liability may not be taken § 1.446–1(e)(3)(ii) for obtaining the 2014. into account under this section prior to Commissioner’s consent to change its the taxable year during which the accounting method. § 1.263(a)–2T [Removed] liability is incurred. (j) Effective/applicability date—(1) In ■ Par. 23. Section 1.263(a)–2T is (2) Personal property means tangible general. Except for paragraphs (f)(2)(iii), removed. personal property as defined in § 1.48– (f)(2)(iv), and (f)(3)(ii) of this section, ■ Par. 24. Section 1.263(a)–3 is revised 1(c). this section generally applies to taxable to read as follows: (3) Real property means land and years beginning on or after January 1, improvements thereto, such as buildings 2014. Paragraphs (f)(2)(iii), (f)(2)(iv), and § 1.263(a)–3 Amounts paid to improve or other inherently permanent (f)(3)(ii) of this section apply to amounts tangible property. structures (including items that are paid in taxable years beginning on or (a) Overview. This section provides structural components of the buildings after January 1, 2014. Except as rules for applying section 263(a) to or structures) that are not personal provided in paragraphs (j)(1) and (j)(2) amounts paid to improve tangible property as defined in paragraph (b)(2) of this section, § 1.263(a)–2 as contained property. Paragraph (b) of this section of this section. Any property that in 26 CFR part 1 edition revised as of provides definitions. Paragraph (c) of constitutes other tangible property April 1, 2011, applies to taxable years this section provides rules for under § 1.48–1(d) is also treated as real beginning before January 1, 2014. coordinating this section with other property for purposes of this section. (2) Early application of this section– provisions of the Internal Revenue Code Local law is not controlling in (i) In general. Except for paragraphs (Code). Paragraph (d) of this section determining whether property is real (f)(2)(iii), (f)(2)(iv), and (f)(3)(ii) of this provides the requirement to capitalize property for purposes of this section. section of this section, a taxpayer may amounts paid to improve tangible (4) Owner means the taxpayer that has choose to apply this section to taxable property and provides the general rules the benefits and burdens of ownership years beginning on or after January 1, for determining whether a unit of of the unit of property for Federal 2012. A taxpayer may choose to apply property is improved. Paragraph (e) of income tax purposes.

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(c) Coordination with other provisions provided in paragraph (e)(3)(i) of this waste to and from the property line and of the Code—(1) In general. Nothing in section. However, special rules are between buildings and other permanent this section changes the treatment of provided for buildings (see paragraph structures); any amount that is specifically provided (e)(2) of this section), plant property (see (3) Electrical systems (including for under any provision of the Code or paragraph (e)(3)(ii) of this section), wiring, outlets, junction boxes, lighting the regulations other than section 162(a) network assets (see paragraph (e)(3)(iii) fixtures and associated connectors, and or section 212 and the regulations under of this section), leased property (see site utility equipment used to distribute those sections. For example, see section paragraph (e)(2)(v) of this section for electricity from the property line to and 263A requiring taxpayers to capitalize leased buildings and paragraph (e)(3)(iv) between buildings and other permanent the direct and allocable indirect costs of of this section for leased property other structures); property produced and property than buildings), and improvements to (4) All escalators; acquired for resale. property (see paragraph (e)(4) of this (5) All elevators; (2) Materials and supplies. A material section). Additional rules are provided (6) Fire-protection and alarm systems or supply as defined in § 1.162–3(c)(1) if a taxpayer has assigned different (including sensing devices, computer that is acquired and used to improve a MACRS classes or depreciation methods controls, sprinkler heads, sprinkler unit of tangible property is subject to to components of property or mains, associated piping or plumbing, this section and is not treated as a subsequently changes the class or pumps, visual and audible alarms, material or supply under § 1.162–3. depreciation method of a component or alarm control panels, heat and smoke (3) Example. The following example other item of property (see paragraph detection devices, fire escapes, fire illustrates the rules of this paragraph (c): (e)(5) of this section). Property that is doors, emergency exit lighting and signage, and fire fighting equipment, Example. Railroad rolling stock. X is a aggregated or subject to a general asset railroad that properly treats amounts paid for account election or accounted for in a such as extinguishers, and hoses); the rehabilitation of railroad rolling stock as multiple asset account (that is, pooled) (7) Security systems for the protection deductible expenses under section 263(d). X may not be treated as a single unit of of the building and its occupants is not required to capitalize the amounts paid property. (including window and door locks, because nothing in this section changes the (2) Building—(i) In general. Except as security cameras, recorders, monitors, treatment of amounts specifically provided otherwise provided in paragraphs (e)(4), motion detectors, security lighting, for under section 263(d). and (e)(5)(ii) of this section, in the case alarm systems, entry and access (d) Requirement to capitalize amounts of a building (as defined in § 1.48– systems, related junction boxes, paid for improvements. Except as 1(e)(1)), each building and its structural associated wiring and conduit); provided in paragraph (h) or paragraph components (as defined in § 1.48– (8) Gas distribution system (including (n) of this section or under § 1.263(a)– 1(e)(2)) is a single unit of property associated pipes and equipment used to 1(f), a taxpayer generally must capitalize (‘‘building’’). See paragraph (e)(2)(iii) of distribute gas to and from the property the related amounts (as defined in this section for condominiums, line and between buildings or paragraph (g)(3) of this section) paid to paragraph (e)(2)(iv) of this section for permanent structures); and improve a unit of property owned by the cooperatives, and paragraph (e)(2)(v) of (9) Other structural components taxpayer. However, see paragraph (f) of this section for leased buildings. identified in published guidance in the this section for the treatment of amounts (ii) Application of improvement rules Federal Register or in the Internal paid to improve leased property. See to a building. An amount is paid to Revenue Bulletin (see section 263A for the requirement to improve a building under paragraph (d) § 601.601(d)(2)(ii)(b) of this chapter) that capitalize the direct and allocable of this section if the amount is paid for are excepted from the building structure indirect costs of property produced by an improvement under paragraphs (j), under paragraph (e)(2)(ii)(A) of this the taxpayer and property acquired for (k), or paragraph (l) of this section to section and are specifically designated resale; section 1016 for adding any of the following: as building systems under this section. capitalized amounts to the basis of the (A) Building structure. A building (iii) Condominium—(A) In general. In unit of property; and section 168 for the structure consists of the building (as the case of a taxpayer that is the owner treatment of additions or improvements defined in § 1.48–1(e)(1)), and its of an individual unit in a building with for depreciation purposes. For purposes structural components (as defined in multiple units (such as a of this section, a unit of property is § 1.48–1(e)(2)), other than the structural condominium), the unit of property improved if the amounts paid for components designated as buildings (‘‘condominium’’) is the individual unit activities performed after the property is systems in paragraph (e)(2)(ii)(B) of this owned by the taxpayer and the placed in service by the taxpayer— section. structural components (as defined in (1) Are for a betterment to the unit of (B) Building system. Each of the § 1.48–1(e)(2)) that are part of the unit. property (see paragraph (j) of this following structural components (as (B) Application of improvement rules section); defined in § 1.48–1(e)(2)), including the to a condominium. An amount is paid (2) Restore the unit of property (see components thereof, constitutes a to improve a condominium under paragraph (k) of this section); or building system that is separate from the paragraph (d) of this section if the (3) Adapt the unit of property to a building structure, and to which the amount is paid for an improvement new or different use (see paragraph (l) improvement rules must be applied— under paragraphs (j), (k), or paragraph of this section). (1) Heating, ventilation, and air (l) of this section to the building (e) Determining the unit of property— conditioning (‘‘HVAC’’) systems structure (as defined in paragraph (1) In general. The unit of property rules (including motors, compressors, boilers, (e)(2)(ii)(A) of this section) that is part in this paragraph (e) apply only for furnace, chillers, pipes, ducts, of the condominium or to the portion of purposes of section 263(a) and radiators); any building system (as defined in §§ 1.263(a)–1, 1.263(a)–2, 1.263(a)–3, (2) Plumbing systems (including paragraph (e)(2)(ii)(B) of this section) and 1.162–3. Unless otherwise pipes, drains, valves, sinks, bathtubs, that is part of the condominium. In the specified, the unit of property toilets, water and sanitary sewer case of the condominium management determination is based upon the collection equipment, and site utility association, the association must apply functional interdependence standard equipment used to distribute water and the improvement rules to the building

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structure or to any building system paragraph (e)(2)(ii)(B) of this section) paragraph (e)(3)(i) of this section is not described under paragraphs (e)(2)(ii)(A) subject to the lease. determinative. and (e)(2)(ii)(B) of this section. (3) Property other than building—(i) (iv) Leased property other than (iv) Cooperative—(A) In general. In In general. Except as otherwise buildings. In the case of a taxpayer that the case of a taxpayer that has an provided in paragraphs (e)(3), (e)(4), is a lessee of real or personal property ownership interest in a cooperative (e)(5), and (f)(1) of this section, in the other than property described in housing corporation, the unit of case of real or personal property other paragraph (e)(2) of this section, the unit property (‘‘cooperative’’) is the portion than property described in paragraph of property for the leased property is of the building in which the taxpayer (e)(2) of this section, all the components determined under paragraphs has possessory rights and the structural that are functionally interdependent (e)(3)(i),(ii), (iii), and (e)(5) of this components (as defined in § 1.48– comprise a single unit of property. section except that, after applying the 1(e)(2)) that are part of the portion of the Components of property are applicable rules under those paragraphs, building subject to the taxpayer’s functionally interdependent if the the unit of property may not be larger possessory rights (cooperative). placing in service of one component by than the property subject to the lease. (B) Application of improvement rules the taxpayer is dependent on the (4) Improvements to property. An to a cooperative. An amount is paid to placing in service of the other improvement to a unit of property improve a cooperative under paragraph component by the taxpayer. generally is not a unit of property (d) of this section if the amount is paid (ii) Plant property—(A) Definition. For separate from the unit of property for an improvement under paragraphs purposes of this paragraph (e), the term improved. For the unit of property for (j), (k), or (l) of this section to the plant property means functionally lessee improvements, see also paragraph portion of the building structure (as interdependent machinery or (f)(2)(ii)) of this section. If a taxpayer defined in paragraph (e)(2)(ii)(A) of this equipment, other than network assets, elects to treat as a capital expenditure section) in which the taxpayer has used to perform an industrial process, under § 1.162–3(d) the amount paid for a rotable spare part, temporary spare possessory rights or to the portion of such as manufacturing, generation, any building system (as defined in part, or standby emergency spare part, warehousing, distribution, automated paragraph (e)(2)(ii)(B) of this section) and such part is used in an materials handling in service industries, that is part of the portion of the building improvement to a unit of property, then or other similar activities. structure subject to the taxpayer’s for purposes of applying paragraph (d) (B) Unit of property for plant possessory rights. In the case of a of this section to the unit of property property. In the case of plant property, cooperative housing corporation, the improved, the part is not a unit of corporation must apply the the unit of property determined under property separate from the unit of improvement rules to the building the general rule of paragraph (e)(3)(i) of property improved. structure or to any building system as this section is further divided into (5) Additional rules—(i) Year placed described under paragraphs (e)(2)(ii)(A) smaller units comprised of each in service. Notwithstanding the unit of and (e)(2)(ii)(B) of this section. component (or group of components) property determination under paragraph (v) Leased building—(A) In general. In that performs a discrete and major (e)(3) of this section, a component (or a the case of a taxpayer that is a lessee of function or operation within the group of components) of a unit property all or a portion of a building (such as an functionally interdependent machinery must be treated as a separate unit of office, floor, or certain square footage), or equipment. property if, at the time the unit of the unit of property (‘‘leased building (iii) Network assets—(A) Definition. property is initially placed in service by property’’) is each building and its For purposes of this paragraph (e), the the taxpayer, the taxpayer has properly structural components or the portion of term network assets means railroad treated the component as being within each building subject to the lease and track, oil and gas pipelines, water and a different class of property under the structural components associated sewage pipelines, power transmission section 168(e) (MACRS classes) than the with the leased portion. and distribution lines, and telephone class of the unit of property of which (B) Application of improvement rules and cable lines that are owned or leased the component is a part, or the taxpayer to a leased building. An amount is paid by taxpayers in each of those respective has properly depreciated the component to improve a leased building property industries. The term includes, for using a different depreciation method under paragraphs (d) and (f)(2) of this example, trunk and feeder lines, pole than the depreciation method of the unit section if the amount is paid for an lines, and buried conduit. It does not of property of which the component is improvement, under paragraphs (j), (k), include property that would be a part. or (l) of this section, to any of the included as building structure or (ii) Change in subsequent taxable following: building systems under paragraphs year. Notwithstanding the unit of (1) Entire building. In the case of a (e)(2)(ii)(A) and (e)(2)(ii)(B) of this property determination under taxpayer that is a lessee of an entire section, nor does it include separate paragraphs (e)(2), (3), (4), or (5)(i) of this building, the building structure (as property that is adjacent to, but not part section, in any taxable year after the defined under paragraph (e)(2)(ii)(A) of of a network asset, such as bridges, unit of property is initially placed in this section) or any building system (as culverts, or tunnels. service by the taxpayer, if the taxpayer defined under paragraph (e)(2)(ii)(B) of (B) Unit of property for network or the Internal Revenue Service changes this section) that is part of the leased assets. In the case of network assets, the the treatment of that property (or any building. unit of property is determined by the portion thereof) to a proper MACRS (2) Portion of a building. In the case taxpayer’s particular facts and class or a proper depreciation method of a taxpayer that is a lessee of a portion circumstances except as otherwise (for example, as a result of a cost of a building (such as an office, floor, or provided in published guidance in the segregation study or a change in the use certain square footage), the portion of Federal Register or in the Internal of the property), then the taxpayer must the building structure (as defined under Revenue Bulletin (see change the unit of property paragraph (e)(2)(ii)(A) of this section) § 601.601(d)(2)(ii)(b) of this chapter). determination for that property (or the subject to the lease or the portion of any For these purposes, the functional portion thereof) under this section to be building system (as defined under interdependence standard provided in consistent with the change in treatment

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for depreciation purposes. Thus, for providing medical services. The mechanical energy into electrical energy. In example, if a portion of a unit of condominium unit contains two restrooms, addition, the turbine contains a series of property is properly reclassified to a each of which contains a sink, a toilet, water blades that cause the turbine to rotate when MACRS class different from the MACRS and drainage pipes and other bathroom affected by the steam. Because the plant is fixtures. C pays an amount for labor and composed of real and personal tangible class of the unit of property of which it materials to perform work on the pipes, property other than a building, the unit of was previously treated as a part, then sinks, toilets, and plumbing fixtures that are property for the generating equipment is the reclassified portion of the property part of the condominium. Under paragraph initially determined under the general rule in should be treated as a separate unit of (e)(2)(iii) of this section, C must treat the paragraph (e)(3)(i) of this section and is property for purposes of this section. individual unit that it owns, including the comprised of all the components that are (6) Examples. The following examples structural components that are part of that functionally interdependent. Under this rule, illustrate the application of this unit, as a single unit of property. As provided the initial unit of property is the entire plant paragraph (e) and assume that the under paragraph (e)(2)(iii)(B) of this section, because the components of the plant are an amount is paid to improve the functionally interdependent. However, taxpayer has not made a general asset condominium if it is for an improvement to because the power plant is plant property account election with regard to property the building structure that is part of the under paragraph (e)(3)(ii) of this section, the or accounted for property in a multiple condominium or to a portion of any initial unit of property is further divided into asset account. In addition, unless the designated building system that is part of the smaller units of property by determining the facts specifically indicate otherwise, condominium. Under paragraph components (or groups of components) that assume that the additional rules in (e)(2)(ii)(B)(2) of this section, the pipes, sinks, perform discrete and major functions within paragraph (e)(5) of this section do not toilets, and plumbing fixtures that are part of the plant. Under this paragraph, E must treat apply: C’s condominium comprise the plumbing the structure, the boiler, the turbine, the system for the condominium. Therefore, generator, and the pulverizer each as a Example 1. Building systems. A owns an under paragraph (e)(2)(iii) of this section, if separate unit of property because each of office building that contains a HVAC system. an amount paid by C for work on pipes, these components performs a discrete and The HVAC system incorporates ten roof- sinks, toilets, and plumbing fixtures is an major function within the power plant. E mounted units that service different parts of improvement (for example, a betterment) to may not treat components, such as the the building. The roof-mounted units are not the portion of the plumbing system that is turbine blades, as separate units of property connected and have separate controls and part of C’s condominium, C must treat this because each of these components does not duct work that distribute the heated or amount as an improvement to the perform a discrete and major function within cooled air to different spaces in the condominium. the plant. building’s interior. A pays an amount for Example 4. Building structure and systems; Example 6. Plant property; discrete and labor and materials for work performed on property other than buildings. D, a major function. F is engaged in a uniform the roof-mounted units. Under paragraph manufacturer, owns a building adjacent to its and linen rental business. F owns and (e)(2)(i) of this section, A must treat the manufacturing facility that contains office operates a plant that utilizes many different building and its structural components as a space and related facilities for D’s employees machines and equipment in an assembly single unit of property. As provided under that manage and administer D’s line-like process to treat, launder, and paragraph (e)(2)(ii) of this section, an amount manufacturing operations. The office prepare rental items for its customers. F is paid to improve a building if it is for an building contains equipment, such as desks, utilizes two laundering lines in its plant, improvement to the building structure or any designated building system. Under paragraph chairs, computers, telephones, and each of which can operate independently. (e)(2)(ii)(B)(1) of this section, the entire bookshelves that are not building structure or One line is used for uniforms and another HVAC system, including all of the roof- building systems. D pays an amount to add line is used for linens. Both lines incorporate mounted units and their components, an extension to the office building. Under a sorter, boiler, washer, dryer, ironer, folder, comprise a building system. Therefore, under paragraph (e)(2)(i) of this section, D must and waste water treatment system. Because paragraph (e)(2)(ii) of this section, if an treat the building and its structural the laundering equipment contained within amount paid by A for work on the roof- components as a single unit of property. As the plant is property other than a building, mounted units is an improvement (for provided under paragraph (e)(2)(ii) of this the unit of property for the laundering example, a betterment) to the HVAC system, section, an amount is paid to improve a equipment is initially determined under the A must treat this amount as an improvement building if it is for an improvement to the general rule in paragraph (e)(3)(i) of this to the building. building structure or any designated building section and is comprised of all the Example 2. Building systems. B owns a system. Therefore, under paragraph (e)(2)(ii) components that are functionally building that it uses in its retail business. The of this section, if an amount paid by D for interdependent. Under this rule, the initial building contains two elevator banks in the addition of an extension to the office units of property are each laundering line different locations in its building. Each building is an improvement (for example, a because each line is functionally elevator bank contains three elevators. B pays betterment) to the building structure or any independent and is comprised of an amount for labor and materials for work of the building systems, D must treat this components that are functionally performed on the elevators. Under paragraph amount as an improvement to the building. interdependent. However, because each line (e)(2)(i) of this section, B must treat the In addition, because the equipment is comprised of plant property under building and its structural components as a contained within the office building paragraph (e)(3)(ii) of this section, F must single unit of property. As provided under constitutes property other than the building, further divide these initial units of property paragraph (e)(2)(ii) of this section, an amount the units of property for the office equipment into smaller units of property by determining is paid to improve a building if it is for an are initially determined under paragraph the components (or groups of components) improvement to the building structure or any (e)(3)(i) of this section and are comprised of that perform discrete and major functions designated building system. Under paragraph all the components that are functionally within the line. Under paragraph (e)(3)(ii) of (e)(2)(ii)(B)(5) of this section, all six elevators, interdependent (for example, each desk, each this section, F must treat each sorter, boiler, including all their components, comprise a chair, and each book shelf). washer, dryer, ironer, folder, and waste water building system. Therefore, under paragraph Example 5. Plant property; discrete and treatment system in each line as a separate (e)(2)(ii) of this section, if an amount paid by major function. E is an electric utility unit of property because each of these B for work on the elevators is an company that operates a power plant to components performs a discrete and major improvement (for example, a betterment) to generate electricity. The power plant function within the line. the elevator system, B must treat this amount includes a structure that is not a building Example 7. Plant property; industrial as an improvement to the building. under § 1.48–1(e)(1), and, among other process. G operates a restaurant that prepares Example 3. Building structure and systems; things, one pulverizer that grinds coal, a and serves food to retail customers. Within condominium. C owns a condominium unit single boiler that produces steam, one turbine its restaurant, G has a large piece of in a condominium office building. C uses the that converts the steam into mechanical equipment that uses an assembly line-like condominium unit in its business of energy, and one generator that converts process to prepare and cook tortillas that G

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serves only to its restaurant customers. or to any building system within the leased second leased office space. Under paragraph Because the tortilla-making equipment is building. Therefore, under paragraphs (e)(2)(v)(B) of this section, if the amount paid property other than a building, the unit of (e)(2)(v)(B)(1) and (e)(2)(ii)(B)(1) of this by M for work on the HVAC system in one property for the equipment is initially section, if an amount paid by K for work on leased office space is for an improvement (for determined under the general rule in the HVAC system is for an improvement to example, a betterment) to the HVAC system paragraph (e)(3)(i) of this section and is the HVAC system in the leased building, K that is part of that leased space, then M must comprised of all the components that are must treat this amount as an improvement to treat the amount as an improvement to that functionally interdependent. Under this rule, the entire leased building property. individual leased property. the initial unit of property is the entire Example 11. Production of real property Example 14. Leased property; personal tortilla-making equipment because the related to leased property. Assume the same property. N is engaged in the business of various components of the equipment are facts as in Example 10, except that K receives transporting passengers on private jet aircraft. functionally interdependent. The equipment a construction allowance from L, and K uses To conduct its business, N leases several is not plant property under paragraph the construction allowance to build a aircraft from O. Under paragraph (e)(3)(iv) of (e)(3)(ii) of this section because the driveway adjacent to the leased building. this section (referencing paragraph (e)(3)(i) of equipment is not used in an industrial Assume that under the terms of the lease, K, this section), N must treat all of the process, as it performs a small-scale function the lessee, is treated as the owner of any components of each leased aircraft that are in G’s restaurant operations. Thus, G is not property that it constructs on or nearby the functionally interdependent as a single unit required to further divide the equipment into leased building. Also assume that section 110 of property. Thus, N must treat each leased separate units of property based on the does not apply to the construction allowance. aircraft as a single unit of property. components that perform discrete and major Finally, assume that the driveway is not Example 15. Improvement property. (i) P is functions. plant property or a network asset. Because a retailer of consumer products. In Year 1, P Example 8. Personal property. H owns the construction of the driveway consists of purchases a building from Q, which P locomotives that it uses in its railroad the production of real property other than a intends to use as a retail sales facility. Under business. Each locomotive consists of various building, all the components of the driveway paragraph (e)(2)(i) of this section, P must components, such as an engine, generators, are functionally interdependent and are a treat the building and its structural batteries, and trucks. H acquired a single unit of property under paragraphs components as a single unit of property. As locomotive with all its components. Because (e)(3)(i) and (e)(3)(iv) of this section. provided under paragraph (e)(2)(ii) of this H’s locomotive is property other than a Example 12. Leasehold improvements; section, an amount is paid to improve a building, the initial unit of property is construction allowance used for lessor-owned building if it is for an improvement to the determined under the general rule in improvements. Assume the same facts as building structure or any designated building paragraph (e)(3)(i) of this section and is Example 11, except that, under the terms of system. comprised of the components that are the lease, L, the lessor, is treated as the owner (ii) In Year 2, P pays an amount to functionally interdependent. Under of any property constructed on the leased construct an extension to the building to be paragraph (e)(3)(i) of this section, the premises. Because L, the lessor, is the owner used for additional warehouse space. Assume locomotive is a single unit of property of the driveway and the driveway is real that the extension involves the addition of because it consists entirely of components property other than a building, all the walls, floors, roof, and doors, but does not that are functionally interdependent. components of the driveway are functionally include the addition or extension of any Example 9. Personal property. J provides interdependent and are a single unit of building systems described in paragraph legal services to its clients. J purchased a property under paragraph (e)(3)(i) of this (e)(2)(ii)(B) of this section. Also assume that laptop computer and a printer for its section. the amount paid to build the extension is a employees to use in providing legal services. Example 13. Buildings and structural betterment to the building structure under Because the computer and printer are components; leased office space. M provides paragraph (j) of this section, and is therefore property other than a building, the initial consulting services to its clients. M conducts treated as an amount paid for an units of property are determined under the its consulting services business in two office improvement to the entire building under general rule in paragraph (e)(3)(i) of this spaces in the same building, each of which paragraph (e)(2)(ii) of this section. section and are comprised of the components it leases from N under separate lease Accordingly, P capitalizes the amount paid that are functionally interdependent. Under agreements. Each office space contains a as an improvement to the building under paragraph (e)(3)(i) of this section, the separate HVAC system, which is part of the paragraph (d) of this section. Under computer and the printer are separate units leased property. Both lease agreements paragraph (e)(4) of this section, the extension of property because the computer and the provide that M is responsible for is not a unit of property separate from the printer are not components that are maintaining, repairing, and replacing the building, the unit of property improved. functionally interdependent (that is, the HVAC system that is part of the leased Thus, to determine whether any future placing in service of the computer is not property. M pays amounts to perform work expenditure constitutes an improvement to dependent on the placing in service of the on the HVAC system in each office space. the building under paragraph (e)(2)(ii) of this printer). Because M leases two separate office spaces section, P must determine whether the Example 10. Building structure and subject to two leases, M must treat the expenditure constitutes an improvement to systems; leased building. K is a retailer of portion of the building structure and the the building structure, including the building consumer products. K conducts its retail structural components subject to each lease extension, or to any of the designated sales in a building that it leases from L. The as a separate unit of property under building systems. leased building consists of the building paragraph (e)(2)(v)(A) of this section. As Example 16. Additional rules; year placed structure (including the floor, walls, and provided under paragraph (e)(2)(v)(B) of this in service. R is engaged in the business of roof) and various building systems, including section, an amount is paid to improve a transporting freight throughout the United a plumbing system, an electrical system, an leased building property, if it is for an States. To conduct its business, R owns a HVAC system, a security system, and a fire improvement to the leased portion of the fleet of truck tractors and trailers. Each protection and prevention system. K pays an building structure or the portion of any tractor and trailer is comprised of various amount for labor and materials to perform designated building system subject to each components, including tires. R purchased a work on the HVAC system of the leased lease. Under paragraphs (e)(2)(v)(B)(1) and truck tractor with all of its components, building. Under paragraph (e)(2)(v)(A) of this (e)(2)(ii)(B)(1) of this section, M must treat including tires. The tractor tires have an section, because K leases the entire building, the HVAC system associated with each average useful life to R of more than one year. K must treat the leased building and its leased office space as a building system of At the time R placed the tractor in service, structural components as a single unit of that leased building property. Thus, M must it treated the tractor tires as a separate asset property. As provided under paragraph treat the HVAC system associated with the for depreciation purposes under section 168. (e)(2)(v)(B) of this section, an amount is paid first leased office space as a building system R properly treated the tractor (excluding the to improve a leased building property if it is of the first leased office space and the HVAC cost of the tires) as 3-year property and the for an improvement (for example, a system associated with the second leased tractor tires as 5-year property under section betterment) to the leased building structure office space as a building system of the 168(e). Because R’s tractor is property other

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than a building, the initial units of property changed its method of accounting to treat the improvement to a leased property under for the tractor are determined under the wiring as nonresidential real property. Under paragraph (f)(2)(i) of this section, the general rule in paragraph (e)(3)(i) of this paragraph (e)(5)(ii) of this section, U must unit of property and the improvement section and are comprised of all the change the unit of property for the wiring in rules are applied to the leased property components that are functionally a manner that is consistent with the change in accordance with paragraph (e)(2)(v) interdependent. Under this rule, R must treat in treatment for depreciation purposes. the tractor, including its tires, as a single unit Therefore, U must change the unit of (leased buildings) or paragraph (e)(3)(iv) of property because the tractor and the tires property for the wiring to treat it as a (leased property other than buildings) of are functionally interdependent (that is, the structural component of the building, and as this section and include previous lessee placing in service of the tires is dependent part of the building unit of property, in improvements. However, if a lessee upon the placing in service of the tractor). accordance with paragraph (e)(2)(i) of this improvement is comprised of an entire However, under paragraph (e)(5)(i) of this section. building erected on leased property, section, R must treat the tractor and tires as (f) Improvements to leased property— then the unit of property for the separate units of property because R properly building and the application of the treated the tires as being within a different (1) In general. Except as provided in class of property under section 168(e). paragraph (h) of this section (safe harbor improvement rules to the building are Example 17. Additional rules; change in for small taxpayers) and under determined under paragraphs (e)(2)(i) subsequent year. S is engaged in the business § 1.263(a)–1(f) (de minimis safe harbor), and (e)(2)(ii) of this section. of leasing nonresidential real property to this paragraph (f) provides the exclusive (3) Lessor improvements—(i) retailers. In Year 1, S acquired and placed in rules for determining whether amounts Requirement to capitalize. A taxpayer service a building for use in its retail leasing lessor must capitalize the related paid by a taxpayer are for an operation. In Year 5, to accommodate the amounts (see paragraph (g)(3) of this improvement to a leased property and needs of a new lessee, S incurred costs to section) that it pays directly, or must be capitalized. In the case of a improve the building structure. S capitalized indirectly through a construction leased building or a leased portion of a the costs of the improvement under allowance to the lessee, to improve (as paragraph (d) of this section and depreciated building, an amount is paid to improve defined in paragraph (d) of this section) the improvement in accordance with section a leased property if the amount is paid a leased property when the lessor is the 168(i)(6) as nonresidential real property for an improvement to any of the owner of the improvement or to the under section 168(e). In Year 7, S determined properties specified in paragraph extent that section 110 applies to the that the structural improvement made in (e)(2)(ii) of this section (for lessor Year 5 qualified under section 168(e)(8) as construction allowance. A lessor must improvements) or in paragraph qualified retail improvement property and, also capitalize the related amounts that therefore, was 15-year property under section (e)(2)(v)(B) of this section (for lessee the lessee pays to improve a leased 168(e). In Year 7, S changed its method of improvements, except as provided in property (as defined in paragraph (e) of accounting to use a 15-year recovery period paragraph (f)(2)(ii) of this section). this section) when the lessee’s for the improvement. Under paragraph Section 1.263(a)–4 does not apply to improvement constitutes a substitute for (e)(5)(ii) of this section, in Year 7, S must amounts paid for improvements to rent. See § 1.61–8(c) for treatment of treat the improvement as a unit of property leased property or to amounts paid for separate from the building. expenditures by lessees that constitute a the acquisition or production of substitute for rent. Amounts capitalized Example 18. Additional rules; change in leasehold improvement property. subsequent year. In Year 1, T acquired and by the lessor under this paragraph placed in service a building and parking lot (2) Lessee improvements—(i) (f)(3)(i) may not be capitalized by the for use in its retail operations. Under Requirement to capitalize. A taxpayer lessee. If a lessor improvement is § 1.263(a)–2 of the regulations, T capitalized lessee must capitalize the related comprised of an entire building erected the cost of the building and the parking lot amounts (see paragraph (g)(3) of this on leased property, then the amount and began depreciating the building and the section) that it pays to improve (as paid for the building is treated as an parking lot as nonresidential real property defined under paragraph (d) of this amount paid by the lessor to acquire or under section 168(e). In Year 3, T completed section) a leased property except to the a cost segregation study under which it produce a unit of property under extent that section 110 applies to a § 1.263(a)–2(d)(1). See paragraphs (e)(2) properly determined that the parking lot construction allowance received by the qualified as 15-year property under section of this section for the unit of property 168(e). In Year 3, T changed its method of lessee for the purpose of such for a building and paragraph (e)(3) of accounting for the parking lot to use a 15- improvement or when the improvement this section for the unit of property for year recovery period and the 150-percent constitutes a substitute for rent. See real or personal property other than a declining balance method of depreciation. § 1.61–8(c) for the treatment of lessee building. Under paragraph (e)(5)(ii) of this section, expenditures that constitute a substitute (ii) Unit of property for lessor beginning in Year 3, T must treat the parking for rent. A taxpayer lessee must also improvements. In general, an amount lot as a unit of property separate from the capitalize the related amounts that a capitalized as a lessor improvement building. lessor pays to improve (as defined under under paragraph (f)(3)(i) of this section Example 19. Additional rules; change in paragraph (d) of this section) a leased subsequent year. In Year 1, U acquired and is not a unit of property separate from placed in service a building for use in its property if the lessee is the owner of the the unit of property improved. See manufacturing business. U capitalized the improvement, except to the extent that paragraph (e)(4) of this section. costs allocable to the building’s wiring section 110 applies to a construction However, if a lessor improvement is separately from the building and depreciated allowance received by the lessee for the comprised of an entire building erected the wiring as 7-year property under section purpose of such improvement. An on leased property, then the unit of 168(e). U capitalized the cost of the building amount paid for a lessee improvement property for the building and the and all other structural components of the under this paragraph (f)(2)(i) is treated application of the improvement rules to building and began depreciating them as as an amount paid to acquire or produce the building are determined under nonresidential real property under section a unit of real or personal property under 168(e). In Year 3, U completed a cost paragraphs (e)(2)(i) and (e)(2)(ii) of this segregation study under which it properly § 1.263(a)–2(d)(1) of the regulations. section. determined that the wiring is a structural (ii) Unit of property for lessee (4) Examples. The following examples component of the building and, therefore, improvements. For purposes of illustrate the application of this should have been depreciated as determining whether an amount paid by paragraph (f) and do not address nonresidential real property. In Year 3, U a lessee constitutes a lessee whether capitalization is required under

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another provision of the Code (for improved if the amount is paid for an improvement property) under § 1.263(a)– example, section 263A). For purposes of improvement to the building structure or any 2(d)(1). However, to determine whether a the following examples, assume that building system. Assume that the amount future amount paid by T is for a leasehold section 110 does not apply to the lessee paid to add the overhead door is for a improvement to the leased building, the unit betterment, under paragraph (j) of this of property and the improvement rules are and the amounts paid by the lessee are section, to the building structure, which again applied in accordance with paragraph not a substitute for rent. includes the extension. Accordingly, T must (e)(2)(v) of this section and include the new Example 1. Lessee improvements; capitalize the amounts paid to add the chiller. additions to building. (i) T is a retailer of overhead door as a leasehold improvement to Example 3. Lessor Improvements; consumer products. In Year 1, T leases a the leased building property. In addition, additions to building. (i) T is a retailer of building from L, which T intends to use as paragraph (f)(2)(i) of this section requires T consumer products. In Year 1, T leases a a retail sales facility. The leased building to treat the amount paid for the improvement building from L, which T intends to use as consists of the building structure under as the acquisition or production of a unit of a retail sales facility. Pursuant to the lease, paragraph (e)(2)(ii)(A) of this section and property (leasehold improvement property) L provides a construction allowance to T, various building systems under paragraph under § 1.263(a)–2(d)(1). However, to which T intends to use to construct an (e)(2)(ii)(B) of this section, including a determine whether a future amount paid by extension to the retail sales facility for plumbing system, an electrical system, and T is for a leasehold improvement to the additional warehouse space. Assume that the an HVAC system. Under the terms of the leased building, the unit of property and the amount paid for any improvement to the lease, T is permitted to improve the building improvement rules are again applied in building does not exceed the construction at its own expense. Under paragraph accordance with paragraph (e)(2)(v) of this allowance and that L is treated as the owner (e)(2)(v)(A) of this section, because T leases section and include the new overhead door. of any improvement to the building. Under the entire building, T must treat the leased Example 2. Lessee improvements; paragraph (e)(2)(i) of this section, L must building and its structural components as a additions to certain structural components of treat the building and its structural single unit of property. As provided under buildings. (i) Assume the same facts as components as a single unit of property. As paragraph (e)(2)(v)(B)(1) of this section, an Example 1 except that in Year 2, T also pays provided under paragraph (e)(2)(ii) of this amount is paid to improve a leased building an amount to construct an extension of the section, an amount is paid to improve a property if the amount is paid for an HVAC system into the building extension. building if it is paid for an improvement to improvement to the leased building structure Assume that the extension is a betterment, the building structure or to any building or to any building system within the leased under paragraph (j) of this section, to the system. building. Therefore, under paragraphs leased HVAC system (a building system (ii) In Year 2, T uses L’s construction (e)(2)(v)(B)(1) and (e)(2)(ii) of this section, if under paragraph (e)(2)(ii)(B)(1) of this allowance to construct an extension to the T pays an amount that improves the building section). Accordingly, the amount that T pays leased building to provide additional structure, the plumbing system, the electrical for the extension of the HVAC system is for warehouse space in the building. Assume system, or the HVAC system, then T must a betterment to the leased building system, that the extension is a betterment (as defined treat this amount as an improvement to the the HVAC system, and thus, under paragraph under paragraph (j) of this section) to the entire leased building property. (e)(2)(v)(B)(1) of this section, is treated as an building structure, and therefore, the amount (ii) In Year 2, T pays an amount to improvement to the entire leased building paid for the extension results in an construct an extension to the building to be property under paragraph (d) of this section. improvement to the building under used for additional warehouse space. Assume Because T, the lessee, pays an amount to paragraph (d) of this section. Under that this amount is for a betterment (as improve a leased building property, T is paragraph (f)(3)(i) of this section, L, the lessor defined under paragraph (j) of this section) to required to capitalize the amount paid as a and owner of the improvement, must T’s leased building structure and does not leasehold improvement under paragraph capitalize the amounts paid to T to construct affect any building systems. Accordingly, the (f)(2)(i) of this section. Under paragraph the extension to the retail sales facility. T is amount that T pays for the building (f)(2)(i) of this section, T must treat the not permitted to capitalize the amounts paid extension is for a betterment to the leased amount paid for the HVAC extension as the for the lessor-owned improvement. Finally, building structure, and thus, under paragraph acquisition and production of a unit of under paragraph (f)(3)(ii) of this section, the (e)(2)(v)(B)(1) of this section, is treated as an property (leasehold improvement property) extension to L’s building is not a unit of improvement to the entire leased building under § 1.263(a)–2(d)(1). property separate from the building and its under paragraph (d) of this section. Because (ii) In Year 5, T pays an amount to add an structural components. T, the lessee, paid an amount to improve a additional chiller to the portion of the HVAC Example 4. Lessee property; personal leased building property, T is required to system that it constructed in Year 2 to property added to leased building. T is a capitalize the amount paid for the building accommodate the climate control retailer of consumer products. T leases a extension as a leasehold improvement under requirements for new product offerings. building from L, which T intends to use as paragraph (f)(2)(i) of this section. In addition, Under paragraph (f)(2)(ii) of this section, to a retail sales facility. Pursuant to the lease, paragraph (f)(2)(i) of this section requires T determine whether the amount paid by T is L provides a construction allowance to T, to treat the amount paid for the improvement for a leasehold improvement, the unit of which T uses to acquire and construct as the acquisition or production of a unit of property and the improvement rules are partitions for fitting rooms, counters, and property (leasehold improvement property) applied in accordance with paragraph shelving. Assume that each partition, under § 1.263(a)–2(d)(1). (e)(2)(v) of this section and include T’s counter, and shelving unit is a unit of (iii) In Year 5, T pays an amount to add a previous improvements to the leased property under paragraph (e)(3) of this large overhead door to the building extension building property. Therefore, under section. Assume that for Federal income tax that it constructed in Year 2 to accommodate paragraph (e)(2)(v)(B) of this section, the purposes T is treated as the owner of the the loading of larger products into the leased building property is improved if the partitions, counters, and shelving. T’s warehouse space. Under paragraph (f)(2)(ii) amount is paid for an improvement to the expenditures for the partitions, counters, and of this section, to determine whether the building structure or any building system. shelving are not improvements to the leased amount paid by T is for a leasehold Assume that the amount paid to add the property under paragraph (d) of this section, improvement, the unit of property and the chiller is for a betterment, under paragraph but rather constitute amounts paid to acquire improvement rules are applied in accordance (j) of this section, to the HVAC system, which or produce separate units of personal with paragraph (e)(2)(v) of this section and includes the extension of the system in Year property under § 1.263(a)–2(d)(1). include T’s previous improvements to the 2. Accordingly, T must capitalize the Example 5. Lessor property; buildings on leased property. Therefore, under paragraph amounts paid to add the chiller as a leased property. L is the owner of a parcel (e)(2)(v)(A) of this section, the unit of leasehold improvement to the leased of unimproved real property that L leases to property is the entire leased building, building property. In addition, paragraph T. Pursuant to the lease, L provides a including the extension built in Year 2. In (f)(2)(i) of this section requires T to treat the construction allowance to T of $500,000, addition, under paragraph (e)(2)(v)(B) of this amount paid for the chiller as the acquisition which T agrees to use to construct a building section, the leased building property is or production of a unit of property (leasehold costing not more than $500,000 on the leased

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real property and to lease the building from improvements to units of property not paragraphs (d)(1) and (j) of this section. L after it is constructed. Assume that for used in the taxpayer’s trade or business Assume that X disposes of the original Federal income tax purposes, L is treated as or for the production of income if the columns and girders and the disposal of the owner of the building that T will amounts are paid as part of an these structural components is not a construct. T uses the $500,000 to construct disposition under Prop. Reg. § 1.168(i)–1(e) the building as required under the lease. The improvement (for example, a (September 19, 2013), or Prop. Reg. § 1.168(i)- building consists of the building structure remodeling) of the taxpayer’s residence. 8 (September 19, 2013). Under paragraphs and the following building systems: (1) a (2) Removal Costs—(i) In general. If a (g)(2)(i) and (j) of this section, the amount plumbing system; (2) an electrical system; taxpayer disposes of a depreciable asset, paid to remove the columns and girders must and (3) an HVAC system. Because L provides including a partial disposition under be capitalized as a cost of the improvement, a construction allowance to T to construct a Prop. Reg. § 1.168(i)–1(e)(2)(ix) because it directly benefits and is incurred by building and L is treated as the owner of the (September 19, 2013), or Prop. Reg. reason of the improvement to the building. building, L must capitalize the amounts that § 1.168(i)–8(d) (September 19, 2013), for Example 2. Component removed during it pays indirectly to T to construct the improvement; disposition. Assume the same building as a lessor improvement under Federal income tax purposes and has taken into account the adjusted basis of facts as Example 1, except X disposes of the paragraph (f)(3)(i) of this section. In addition, original columns and girders and elects to the amounts paid by L for the construction the asset or component of the asset in treat the disposal of these structural allowance are treated as amounts paid by L realizing gain or loss, then the costs of components as a partial disposition of the to acquire and produce the building under removing the asset or component are not factory building under Prop. Reg. § 1.168(i)- § 1.263(a)–2(d)(1). Further, under paragraph required to be capitalized under this 8(d) (September 19, 2013), taking into (e)(2)(i) of this section, L must treat the section. If a depreciable asset is account the adjusted basis of the components building and its structural components as a included in a general asset account in realizing loss on the disposition. Under single unit of property. Under paragraph under section 168(i)(4), and neither the paragraph (g)(2)(i) of this section, the amount (f)(3)(i) of this section, T, the lessee, may not paid to remove the columns and girders is capitalize the amounts paid (with the regulations under section 168(i)(4) and § 1.168(i)–1T(e)(3) nor Prop. Reg. not required to be capitalized as part of the construction allowance received from L) for cost of the improvement regardless of their construction of the building. § 1.168(i)–1(e)(3) (September 19, 2013), relation to the improvement. However, all the Example 6. Lessee contribution to apply to a disposition of such asset, or remaining costs of replacing the columns and construction costs. Assume the same facts as a portion of such asset under Prop. Reg. girders must be capitalized as improvements in Example 5, except T spends $600,000 to § 1.168(i)–1(e)(2)(ix) (September 19, to the building unit of property under construct the building. T uses the $500,000 2013), a loss is treated as being realized paragraphs (d)(1), (j), and (g)(1) of this construction allowance provided by L plus in the amount of zero upon the section. $100,000 of its own funds to construct the Example 3. Component removed during building that L will own pursuant to the disposition of the asset solely for purposes of this paragraph (g)(2)(i). If a repair or maintenance; no disposition. Y lease. Also assume that the additional owns a building in which it conducts its $100,000 that T pays is not a substitute for taxpayer disposes of a component of a unit of property, but the disposal of the retail business. The roof over Y’s building is rent. For the reasons discussed in Example 5, covered with shingles. Over time, the L must capitalize the $500,000 it paid T to component is not a disposition for shingles begin to wear and Y begins to construct the building under § 1.263(a)– Federal tax purposes, then the taxpayer experience leaks into its retail premises. 2(d)(1). In addition, because T spends its own must deduct or capitalize the costs of However, the building still functions in Y’s funds to complete the building, T has a removing the component based on business. To eliminate the problems, a depreciable interest of $100,000 in the whether the removal costs directly contractor recommends that Y remove the building and must capitalize the $100,000 it original shingles and replace them with new paid to construct the building as a leasehold benefit or are incurred by reason of a shingles. Accordingly, Y pays the contractor improvement under § 1.263(a)–2(d)(1) of the repair to the unit of property or an to replace the old shingles with new but regulations. Under paragraph (e)(2)(i) of this improvement to the unit of property. comparable shingles. The new shingles are section, L must treat the building as a single But see § 1.280B–1 for the rules comparable to original shingles but correct unit of property to the extent of its applicable to demolition of structures. depreciable interest of $500,000. In addition, the leakage problems. Assume that Y (ii) Examples. The following disposes of the original shingles, and the under paragraphs (f)(2)(ii) and (e)(2)(i) of this examples illustrate the application of section, T must also treat the building as a disposal of these shingles is not a disposition paragraph (g)(2)(i) of this section and, under Prop. Reg. § 1.168(i)–1(e) (September single unit of property to the extent of its unless otherwise stated, do not address depreciable interest of $100,000. 19, 2013), or Prop. Reg. § 1.168(i)–8 whether capitalization is required under (September 19, 2013). Assume that (g) Special rules for determining another provision of this section or replacement of old shingles with new improvement costs—(1) Certain costs another provision of the Code (for shingles to correct the leakage is not a incurred during an improvement—(i) In example, section 263A). For purposes of betterment or a restoration of the building general. A taxpayer must capitalize all the following examples, assume that structure or systems under paragraph (j) or (k) of this section and does not adapt the the direct costs of an improvement and Prop. Reg. § 1.168(i)–1(e) (September 19, all the indirect costs (including, for building structure or systems to a new or 2013), or Prop. Reg. § 1.168(i)–8 different use under paragraph (l) of this example, otherwise deductible repair (September 19, 2013), applies and that section. Thus, the amounts paid by Y to costs) that directly benefit or are § 1.280B–1 does not apply. replace the shingles are not improvements to incurred by reason of an improvement. Example 1. Component removed during the building unit of property under Indirect costs arising from activities that improvement; no disposition. X owns a paragraph (d) of this section. Under do not directly benefit and are not factory building with a storage area on the paragraph (g)(2)(i) of this section, the incurred by reason of an improvement second floor. X pays an amount to remove amounts paid to remove the shingles are not are not required to be capitalized under the original columns and girders supporting required to be capitalized because they section 263(a), regardless of whether the the second floor and replace them with new directly benefit and are incurred by reason of activities are performed at the same time columns and girders to permit storage of repair or maintenance to the building supplies with a gross weight 50 percent structure. as an improvement. Example 4. Component removed with (ii) Exception for individuals’ greater than the previous load-carrying capacity of the storage area. Assume that the disposition and restoration. Assume the same residences. A taxpayer who is an replacement of the columns and girders facts as Example 3 except Y disposes of the individual may capitalize amounts paid constitutes a betterment to the building original shingles, and Y elects to treat the for repairs and maintenance that are structure and is therefore an improvement to disposal of these components as a partial made at the same time as capital the building unit of property under disposition of the building under Prop. Reg.

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§ 1.168(i)–8(d) (September 19, 2013), and (h), the term qualifying taxpayer means taxes if, under the applicable state or deducts the adjusted basis of the components a taxpayer whose average annual gross local law, the tax is legally imposed on as a loss on the disposition. Under paragraph receipts as determined under this the purchaser of the good or service, and (k)(1)(i) of this section, amounts paid for paragraph (h)(3) for the three preceding the taxpayer merely collects and remits replacement of the shingles constitute a taxable years is less than or equal to the tax to the taxing authority. If, in restoration of the building structure because the amounts are paid for the replacement of $10,000,000. contrast, the tax is imposed on the a component of the structure and the (ii) Application to new taxpayers. If a taxpayer under the applicable law, then taxpayer has properly deducted a loss for that taxpayer has been in existence for less gross receipts include the amounts component. Thus, under paragraphs (d)(2) than three taxable years, the taxpayer received that are allocable to the and (k) of this section, Y is required to determines its average annual gross payment of such tax. capitalize the amounts paid for the receipts for the number of taxable years (4) Eligible building property. For replacement of the shingles as an (including short taxable years) that the purposes of this section, the term, improvement to the building unit of taxpayer (or its predecessor) has been in eligible building property refers to each property. However, under paragraph (g)(2)(i) existence. unit of property defined in paragraph of this section, the amounts paid by Y to (iii) Treatment of short taxable year. (e)(2)(i) (building), paragraph remove the original shingles are not required In the case of any taxable year of less (e)(2)(iii)(A) (condominium), paragraph to be capitalized as part of the costs of the improvement, regardless of their relation to than 12 months (a short taxable year), (e)(2)(iv)(A) (cooperative), or paragraph the improvement. the gross receipts shall be annualized (e)(2)(v)(A) (leased building or portion by— of building) of this section, as (3) Related amounts. For purposes of (A) Multiplying the gross receipts for applicable, that has an unadjusted basis paragraph (d) of this section, amounts the short period by 12; and of $1,000,0000 or less. paid to improve a unit of property (B) Dividing the product determined (5) Unadjusted basis—(i) Eligible include amounts paid over a period of in paragraph (h)(3)(iii)(A) of this section building property owned by taxpayer. more than one taxable year. Whether by the number of months in the short For purposes of this section, the amounts are related to the same period. unadjusted basis of eligible building improvement depends on the facts and (iv) Definition of gross receipts. For property owned by the taxpayer means circumstances of the activities being purposes of applying paragraph (h)(3)(i) the basis as determined under section performed. of this section, the term gross receipts 1012, or other applicable sections of (4) Compliance with regulatory means the taxpayer’s receipts for the Chapter 1, including subchapters O requirements. For purposes of this taxable year that are properly (relating to gain or loss on dispositions section, a Federal, state, or local recognized under the taxpayer’s of property), C (relating to corporate regulator’s requirement that a taxpayer methods of accounting used for Federal distributions and adjustments), K perform certain repairs or maintenance income tax purposes for the taxable (relating to partners and partnerships), on a unit of property to continue year. For this purpose, gross receipts and P (relating to capital gains and operating the property is not relevant in include total sales (net of returns and losses). Unadjusted basis is determined determining whether the amount paid allowances) and all amounts received without regard to any adjustments improves the unit of property. for services. In addition, gross receipts described in section 1016(a)(2) or (3) or (h) Safe harbor for small taxpayers— include any income from investments to amounts for which the taxpayer has (1) In general. A qualifying taxpayer (as and from incidental or outside sources. elected to treat as an expense (for defined in paragraph (h)(3) of this For example, gross receipts include example, under sections 179, 179B, or section) may elect to not apply interest (including original issue 179C). paragraph (d) or paragraph (f) of this discount and tax-exempt interest within (ii) Eligible building property leased section to an eligible building property the meaning of section 103), dividends, to the taxpayer. For purposes of this (as defined in paragraph (h)(4) of this rents, royalties, and annuities, section, the unadjusted basis of eligible section) if the total amount paid during regardless of whether such amounts are building property leased to the taxpayer the taxable year for repairs, derived in the ordinary course of the is the total amount of (undiscounted) maintenance, improvements, and taxpayer’s trade of business. Gross rent paid or expected to be paid by the similar activities performed on the receipts are not reduced by cost of goods lessee under the lease for the entire term eligible building property does not sold or by the cost of property sold if of the lease, including renewal periods exceed the lesser of— such property is described in section if all the facts and circumstances in (i) 2 percent of the unadjusted basis 1221(a)(1), (3), (4), or (5). With respect existence during the taxable year in (as defined under paragraph (h)(5) of to sales of capital assets as defined in which the lease is entered indicate a this section) of the eligible building section 1221, or sales of property reasonable expectancy of renewal. See property; or described in section 1221(a)(2) (relating § 1.263(a)–4(f)(5)(ii) for the factors (ii) $10,000. to property used in a trade or business), significant in determining whether there (2) Application with other safe harbor gross receipts shall be reduced by the exists a reasonable expectancy of provisions. For purposes of paragraph taxpayer’s adjusted basis in such renewal. (h)(1) of this section, amounts paid for property. Gross receipts do not include (6) Time and manner of election. A repairs, maintenance, improvements, the repayment of a loan or similar taxpayer makes the election described and similar activities performed on instrument (for example, a repayment of in paragraph (h)(1) of this section by eligible building property include those the principal amount of a loan held by attaching a statement to the taxpayer’s amounts not capitalized under the de a commercial lender) and, except to the timely filed original Federal tax return minimis safe harbor election under extent of gain recognized, do not (including extensions) for the taxable § 1.263(a)-1(f) and those amounts include gross receipts derived from a year in which amounts are paid for deemed not to improve property under non-recognition transaction, such as a repairs, maintenance, improvements, the safe harbor for routine maintenance section 1031 exchange. Finally, gross and similar activities performed on the under paragraph (i) of this section. receipts do not include amounts eligible building property providing that (3) Qualifying taxpayer—(i) In received by the taxpayer with respect to such amounts qualify under the safe general. For purposes of this paragraph sales tax or other similar state and local harbor provided in paragraph (h)(1) of

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this section. See §§ 301.9100–1 through be modified through published activities performed on Building M. In Year 301.9100–3 of this chapter for the guidance in the Federal Register or in 1, B also pays $7,000 for repairs, provisions governing extensions of time the Internal Revenue Bulletin (see maintenance, improvements, and similar to make regulatory elections. The activities performed on Building N. § 601.601(d)(2)(ii)(b) of this chapter). (ii) The total amount paid by B during Year statement must be titled, ‘‘Section (10) Examples. The following 1 for repairs, maintenance, improvements 1.263(a)–3(h) Safe Harbor Election for examples illustrate the rules of this and similar activities on Building M ($5,000) Small Taxpayers’’ and include the paragraph (h). Assume that § 1.212–1 does not exceed the lesser of $6,000 (2 taxpayer’s name, address, taxpayer does not apply to the amounts paid. percent of the building’s unadjusted basis of $300,000) or $10,000. Therefore, under identification number, and a description Example 1. Safe harbor for small taxpayers paragraph (h)(1) of this section, for Year 1, B of each eligible building property to applicable. A is a qualifying taxpayer under may elect to not apply the capitalization rule which the taxpayer is applying the paragraph (h)(3) of this section. A owns an under paragraph (d) of this section to the election. In the case of an S corporation office building in which A provides amounts it paid for repairs, maintenance, consulting services. In Year 1, A’s building or a partnership, the election is made by improvements, and similar activities on has an unadjusted basis of $750,000 as the S corporation or by the partnership, Building M. If B properly makes the election determined under paragraph (h)(5)(i) of this and not by the shareholders or partners. under paragraph (h)(6) of this section for section. In Year 1, A pays $5,500 for repairs, An election may not be made through Building M and the amounts otherwise maintenance, improvements and similar constitute deductible ordinary and necessary the filing of an application for change in activities to the office building. Because A’s accounting method or, before obtaining expenses incurred in carrying on B’s trade or building unit of property has an unadjusted business, B may deduct these amounts under the Commissioner’s consent to make a basis of $1,000,000 or less, A’s building late election, by filing an amended § 1.162–1. constitutes eligible building property under (iii) The total amount paid by B during Federal tax return. A taxpayer may not paragraph (h)(4) of this section. The aggregate Year 1 for repairs, maintenance, revoke an election made under this amount paid by A during Year 1 for repairs, improvements and similar activities on paragraph (h). The time and manner of maintenance, improvements and similar Building N ($7,000) exceeds $6,000 (2 making the election under this activities on this eligible building property percent of the building’s unadjusted basis of paragraph (h) may be modified through does not exceed the lesser of $15,000 (2 $300,000), the lesser of the two limitations percent of the building’s unadjusted basis of guidance of general applicability (see provided under paragraph (h)(1) of this $750,000) or $10,000. Therefore, under section. Therefore, B may not apply the safe §§ 601.601(d)(2) and 601.602 of this paragraph (h)(1) of this section, A may elect chapter). harbor under paragraph (h)(1) of this section to not apply the capitalization rule of to the total amounts paid for repairs, (7) Treatment of safe harbor amounts. paragraph (d) of this section to the amounts maintenance, improvements, and similar Amounts paid by the taxpayer for paid for repair, maintenance, improvements, activities performed on Building N. Instead, repairs, maintenance, improvements, or similar activities on the office building in B must apply the general improvement rules and similar activities to which the Year 1. If A properly makes the election under this section to determine which of the taxpayer properly applies the safe under paragraph (h)(6) of this section for the total amounts paid for work performed on harbor under paragraph (h)(1) of this office building and the amounts otherwise Building N are for improvements and must section and for which the taxpayer constitute deductible ordinary and necessary be capitalized under paragraph (d) of this expenses incurred in carrying on a trade or section and which amounts are for repair and properly makes the election under business, A may deduct these amounts under paragraph (h)(6) of this section are not maintenance under § 1.162–4. § 1.162–1 in Year 1. Example 4. Safe harbor applied to leased treated as improvements under Example 2. Safe harbor for small taxpayers building property. C is a qualifying taxpayer paragraph (d) or (f) of this section and inapplicable. Assume the same facts as in under paragraph (h)(3) of this section. C is may be deducted under § 1.162–1 or Example 1, except that A pays $10,500 for the lessee of a building in which C operates § 1.212–1, as applicable, in the taxable repairs, maintenance, improvements, and a retail store. The lease is a triple-net lease, year these amounts are paid, provided similar activities performed on its office and the lease term is 20 years, including the amounts otherwise qualify for a building in Year 1. Because this amount reasonably expected renewals. C pays $4,000 exceeds $10,000, the lesser of the two deduction under these sections. per month in rent. In Year 1, C pays $7,000 limitations provided in paragraph (h)(1) of for repairs, maintenance, improvements, and (8) Safe harbor exceeded. If total this section, A may not apply the safe harbor amounts paid by a qualifying taxpayer similar activities performed on the building. for small taxpayers under paragraph (h)(1) of Under paragraph (h)(5)(ii) of this section, the during the taxable year for repairs, this section to the total amounts paid for unadjusted basis of C’s leased unit of maintenance, improvements, and repairs, maintenance, improvements, and property is $960,000 ($4,000 monthly rent × similar activities performed on an similar activities performed on the building. 12 months × 20 years). Because C’s leased eligible building property exceed the Therefore, A must apply the general building has an unadjusted basis of safe harbor limitations specified in improvement rules under this section to $1,000,000 or less, the building is eligible paragraph (h)(1) of this section, then the determine which of the aggregate amounts building property for Year 1 under paragraph safe harbor election is not available for paid are for improvements and must be (h)(4) of this section. The total amount paid that eligible building property and the capitalized under paragraph (d) of this by C during Year 1 for repairs, maintenance, section and which of the amounts are for taxpayer must apply the general improvements, and similar activities on the repair and maintenance under § 1.162–4. leased building ($7,000) does not exceed the improvement rules under this section to Example 3. Safe harbor applied building- lesser of $19,200 (2 percent of the building’s determine whether amounts are for by-building. (i) B is a qualifying taxpayer unadjusted basis of $960,000) or $10,000. improvements to the unit of property, under paragraph (h)(3) of this section. B Therefore, under paragraph (h)(1) of this including the safe harbor for routine owns two rental properties, Building M and section, for Year 1, C may elect to not apply maintenance under paragraph (i) of this Building N. Building M and Building N are the capitalization rule under paragraph (d) of section. The taxpayer may also elect to both multi-family residential buildings. In this section to the amounts it paid for repairs, apply the de minimis safe harbor under Year 1, each property has an unadjusted basis maintenance, improvements, and similar § 1.263(a)–1(f) to amounts qualifying of $300,000 under paragraph (h)(5) of this activities on the leased building. If C section. Because Building M and Building N under that safe harbor irrespective of the properly makes the election under paragraph each have an unadjusted basis of $1,000,000 (h)(6) of this section for the leased building application of this paragraph (h). or less, Building M and Building N each and the amounts otherwise constitute (9) Modification of safe harbor constitute eligible building property in Year deductible ordinary and necessary expenses amounts. The amount limitations 1 under paragraph (h)(4) of this section. In incurred in carrying on C’s trade or business, provided in paragraphs (h)(1)(i), Year 1, B pays $5,000 for repairs, C may deduct these amounts under § 1.162– (h)(1)(ii), and (h)(3) of this section may maintenance, improvements, and similar 1.

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(i) Safe harbor for routine condition. Routine maintenance a basis adjustment as a result of a maintenance on property—(1) In activities include, for example, the casualty loss under section 165, or general. An amount paid for routine inspection, cleaning, and testing of the relating to a casualty event described in maintenance (as defined in paragraph unit of property, and the replacement of section 165, subject to the limitation in (i)(1)(i) or (i)(1)(ii) of this section, as damaged or worn parts of the unit of paragraph (k)(4) of this section (see applicable) on a unit of tangible property with comparable and paragraph (k)(1)(iii) of this section); property, or in the case of a building, on commercially available replacement (v) Amounts paid to return a unit of any of the properties designated in parts. Routine maintenance may be property to its ordinarily efficient paragraphs (e)(2)(ii), (e)(2)(iii)(B), performed any time during the useful operating condition, if the property has (e)(2)(iv)(B), or paragraph (e)(2)(v)(B) of life of the unit of property. However, the deteriorated to a state of disrepair and this section, is deemed not to improve activities are routine only if, at the time is no longer functional for its intended that unit of property. the unit of property is placed in service use (see paragraph (k)(1)(iv) of this (i) Routine maintenance for buildings. by the taxpayer, the taxpayer reasonably section); Routine maintenance for a building unit expects to perform the activities more (vi) Amounts paid to adapt a unit of of property is the recurring activities than once during the class life (as property to a new or different use under that a taxpayer expects to perform as a defined in paragraph (i)(4) of this paragraph (l) of this section; result of the taxpayer’s use of any of the section) of the unit of property. A (vii) Amounts paid for repairs, properties designated in paragraphs taxpayer’s expectation will not be maintenance, or improvement of (e)(2)(ii), (e)(2)(iii)(B), (e)(2)(iv)(B), or deemed unreasonable merely because network assets (as defined in paragraph (e)(2)(v)(B) of this section to keep the the taxpayer does not actually perform (e)(3)(iii)(A) of this section); or building structure or each building the maintenance a second time during (viii) Amounts paid for repairs, system in its ordinarily efficient the class life of the unit of property, maintenance, or improvement of rotable operating condition. Routine provided that the taxpayer can and temporary spare parts to which the maintenance activities include, for otherwise substantiate that its taxpayer applies the optional method of example, the inspection, cleaning, and expectation was reasonable at the time accounting for rotable and temporary testing of the building structure or each the property was placed in service. spare parts under § 1.162–3(e). building system, and the replacement of Factors to be considered in determining (4) Class life. The class life of a unit damaged or worn parts with comparable whether maintenance is routine and of property is the recovery period and commercially available replacement whether the taxpayer’s expectation is prescribed for the property under parts. Routine maintenance may be reasonable include the recurring nature sections 168(g)(2) and (3) for purposes performed any time during the useful of the activity, industry practice, of the alternative depreciation system, life of the building structure or building manufacturers’ recommendations, and regardless of whether the property is systems. However, the activities are the taxpayer’s experience with similar depreciated under section 168(g). For routine only if the taxpayer reasonably or identical property. With respect to a purposes of determining class life under expects to perform the activities more taxpayer that is a lessor of a unit of this section, section 168(g)(3)(A) than once during the 10-year period property, the taxpayer’s use of the unit (relating to tax-exempt use property beginning at the time the building of property includes the lessee’s use of subject to lease) does not apply. If the structure or the building system upon the unit of property. unit of property is comprised of which the routine maintenance is (2) Rotable and temporary spare components with different class lives, performed is placed in service by the parts. Except as provided in paragraph then the class life of the unit of property taxpayer. A taxpayer’s expectation will (i)(3) of this section, for purposes of is deemed to be the same as the not be deemed unreasonable merely paragraph (i)(1)(ii) of this section, component with the longest class life. because the taxpayer does not actually amounts paid for routine maintenance (5) Coordination with section 263A. perform the maintenance a second time include routine maintenance performed Amounts paid for routine maintenance during the 10-year period, provided that on (and with regard to) rotable and under this paragraph (i) may be subject the taxpayer can otherwise substantiate temporary spare parts. to capitalization under section 263A if that its expectation was reasonable at (3) Exceptions. Routine maintenance these amounts comprise the direct or the time the property was placed in does not include the following: allocable indirect costs of other property service. Factors to be considered in (i) Amounts paid for a betterment to produced by the taxpayer or property determining whether maintenance is a unit of property under paragraph (j) of routine and whether a taxpayer’s this section; acquired for resale. See, for example, expectation is reasonable include the (ii) Amounts paid for the replacement § 1.263A–1(e)(3)(ii)(O) requiring recurring nature of the activity, industry of a component of a unit of property for taxpayers to capitalize the cost of practice, manufacturers’ which the taxpayer has properly repairing equipment or facilities recommendations, and the taxpayer’s deducted a loss for that component allocable to property produced or experience with similar or identical (other than a casualty loss under property acquired for resale. property. With respect to a taxpayer that § 1.165–7) (see paragraph (k)(1)(i) of this (6) Examples. The following examples is a lessor of a building or a part of the section); illustrate the application of this building, the taxpayer’s use of the (iii) Amounts paid for the paragraph (i) and, unless otherwise building unit of property includes the replacement of a component of a unit of stated, do not address the treatment lessee’s use of its unit of property. property for which the taxpayer has under other provisions of the Code (for (ii) Routine maintenance for property properly taken into account the adjusted example, section 263A). In addition, other than buildings. Routine basis of the component in realizing gain unless otherwise stated, assume that the maintenance for property other than or loss resulting from the sale or taxpayer has not applied the optional buildings is the recurring activities that exchange of the component (see method of accounting for rotable and a taxpayer expects to perform as a result paragraph (k)(1)(ii) of this section); temporary spare parts under § 1.162– of the taxpayer’s use of the unit of (iv) Amounts paid for the restoration 3(e). property to keep the unit of property in of damage to a unit of property for Example 1. Routine maintenance on its ordinarily efficient operating which the taxpayer is required to take component. (i) A is a commercial airline

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engaged in the business of transporting Example 3. Routine maintenance on B’s use. B acquired the machine just before passengers and freight throughout the United rotable spare parts. (i) Assume the same facts it had received its three-year scheduled States and abroad. To conduct its business, as in Example 1, except that in addition to maintenance. Accordingly, the amounts paid A owns or leases various types of aircraft. As the four engines purchased as part of the for the scheduled maintenance resulted from a condition of maintaining its airworthiness aircraft, A separately purchases four the prior owner’s, and not B’s, use of the certification for these aircraft, A is required additional new engines that A intends to use property and must be capitalized if those by the Federal Aviation Administration in its aircraft fleet to avoid operational amounts result in a betterment under (FAA) to establish and adhere to a downtime when ESVs are required to be paragraph (i) of this section, including the continuous maintenance program for each performed on the engines previously amelioration of a material condition or aircraft within its fleet. These programs, installed on an aircraft. Later in Year 1, A defect, or otherwise result in an improvement which are designed by A and the aircraft’s installs these four engines on an aircraft in under paragraph (d) of this section. manufacturer and approved by the FAA, are its fleet. In Year 5, A performs the first ESVs Example 5. Routine maintenance resulting incorporated into each aircraft’s maintenance on these four engines. Assume that these from new owner’s use. Assume the same facts manual. The maintenance manuals require a ESVs involve the same routine maintenance as in Example 4, except that after B pays variety of periodic maintenance visits at activities that were performed on the engines amounts for the maintenance in Year 1, B various intervals. One type of maintenance in Example 1, and that none of the continues to operate the machine in its visit is an engine shop visit (ESV), which A exceptions set out in paragraph (i)(3) of this manufacturing business. In Year 4, B pays expects to perform on its aircraft engines section apply to these ESVs. After the ESVs amounts to perform the next scheduled approximately every 4 years to keep its were performed, these engines were manufacturer recommended maintenance on aircraft in its ordinarily efficient operating reinstalled on other aircraft or stored for later the machine. Assume that the scheduled condition. In Year 1, A purchased a new installation. maintenance activities performed are the aircraft, which included four new engines (ii) The additional aircraft engines are same as those performed in Example 4 and attached to the airframe. The four aircraft rotable spare parts because they were that none of the exceptions set out in engines acquired with the aircraft are not acquired separately from the aircraft, they are paragraph (i)(3) of this section apply to the materials or supplies under § 1.162–3(c)(1)(i) removable from the aircraft, and are repaired amounts paid for the scheduled maintenance. because they are acquired as part of a single and reinstalled on other aircraft or stored for Because the scheduled maintenance unit of property, the aircraft. In Year 5, A later installation. See § 1.162–3(c)(2) performed in Year 4 involves the recurring performs its first ESV on the aircraft engines. (definition of rotable and temporary spare activities that B performs as a result of its use The ESV includes disassembly, cleaning, parts). Assume the class life of an engine is of the machine, keeps the machine in an inspection, repair, replacement, reassembly, the same as the airframe, 12 years. Because ordinarily efficient operating condition, and and testing of the engine and its component the ESVs involve the recurring activities that consists of maintenance activities that B parts. During the ESV, the engine is removed A expects to perform as a result of its use of expects to perform more than once during the from the aircraft and shipped to an outside the engines to keep the engines in ordinarily 10-year class life of the machine, B’s vendor who performs the ESV. If inspection efficient operating condition, and consist of scheduled maintenance costs are within the or testing discloses a discrepancy in a part’s maintenance activities that A expects to routine maintenance safe harbor under conformity to the specifications in A’s perform more than once during the 12 year paragraph (i)(1)(ii) of this section. maintenance program, the part is repaired, or class life of the engine, the ESVs fall within Accordingly, the amounts paid for the if necessary, replaced with a comparable and the routine maintenance safe harbor under scheduled maintenance in Year 4 are deemed commercially available replacement part. paragraph (i)(1)(ii) of this section. not to improve the machine and are not After the ESVs, the engines are returned to Accordingly, the amounts paid for the ESVs required to be capitalized under paragraph A to be reinstalled on another aircraft or for the four additional engines are deemed (d) of this section. stored for later installation. Assume that the not to improve these engines and are not Example 6. Routine maintenance; class life for A’s aircraft, including the required to be capitalized under paragraph replacement of substantial structural part; engines, is 12 years. Assume that none of the (d) of this section. For the treatment of coordination with section 263A. C is in the exceptions set out in paragraph (i)(3) of this amounts paid to acquire the engines, see business of producing commercial products section apply to the costs of performing the § 1.162–3(a). for sale. As part of the production process, ESVs. Example 4. Routine maintenance resulting C places raw materials into lined containers (ii) Because the ESVs involve the recurring from prior owner’s use. (i) In January, Year in which a chemical reaction is used to activities that A expects to perform as a result 1, B purchases a used machine for use in its convert raw materials into the finished of its use of the aircraft to keep the aircraft manufacturing operations. Assume that the product. The lining, which comprises 60 in ordinarily efficient operating condition machine is the unit of property and has a percent of the total physical structure of the and consist of maintenance activities that A class life of 10 years. B places the machine container, is a substantial structural part of expects to perform more than once during the in service in January, Year 1, and at that time, the container. Assume that each container, 12 year class life of the aircraft, A’s ESVs are B expects to perform manufacturer including its lining, is the unit of property within the routine maintenance safe harbor recommended scheduled maintenance on the and that a container has a class life of 12 under paragraph (i)(1)(ii) of this section. machine approximately every three years. years. At the time that C placed the container Accordingly, the amounts paid for the ESVs The scheduled maintenance includes the into service, C was aware that approximately are deemed not to improve the aircraft and cleaning and oiling of the machine, the every three years, the container lining would are not required to be capitalized under inspection of parts for defects, and the need to be replaced with comparable and paragraph (d) of this section. replacement of minor items such as springs, commercially available replacement Example 2. Routine maintenance after bearings, and seals with comparable and materials. At the end of three years, the class life. Assume the same facts as in commercially available replacement parts. At container will continue to function, but will Example 1, except that in year 15 A pays the time B purchased the machine, the become less efficient and the replacement of amounts to perform an ESV on one of the machine was approaching the end of a three- the lining will be necessary to keep the original aircraft engines after the end of the year scheduled maintenance period. As a container in an ordinarily efficient operating class life of the aircraft. Because this ESV result, in February, Year 1, B pays amounts condition. In Year 1, C acquired 10 new involves the same routine maintenance to perform the manufacturer recommended containers and placed them into service. In activities that were performed on aircraft scheduled maintenance. Assume that none of Year 4, Year 7, Year 9, and Year 12, C pays engines in Example 1, this ESV also is within the exceptions set out in paragraph (i)(3) of amounts to replace the containers’ linings the routine maintenance safe harbor under this section apply to the amounts paid for the with comparable and commercially available paragraph (i)(1)(ii) of this section. scheduled maintenance. replacement parts. Assume that none of the Accordingly, the amounts paid for this ESV, (ii) The majority of B’s costs do not qualify exceptions set out in paragraph (i)(3) of this even though performed after the class life of under the routine maintenance safe harbor in section apply to the amounts paid for the the aircraft, are deemed not to improve the paragraph (i)(1)(ii) of this section because the replacement linings. Because the aircraft and are not required to be capitalized costs were incurred primarily as a result of replacement of the linings involves recurring under paragraph (d) of this section. the prior owner’s use of the property and not activities that C expects to perform as a result

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of its use of the containers to keep the reasonable expectation that it would perform typical scheduled maintenance activities containers in their ordinarily efficient the reconditioning every 6 years will not be such as cleaning, inspecting, reconditioning, operating condition and consists of deemed unreasonable merely because D did and replacing minor parts, but at the same maintenance activities that C expects to not actually perform the reconditioning a time, E incurs costs to upgrade certain engine perform more than once during the 12-year second time during the 14-year class life, parts to increase the towing capacity of the class life of the containers, C’s lining provided that D can substantiate that its boats in excess of the capacity of the boats replacement costs are within the routine expectation was reasonable at the time the when E placed them in service. In maintenance safe harbor under paragraph property was placed in service. If D can combination with the replacement of parts (i)(1)(ii) of this section. Accordingly, the demonstrate that its expectation was with new and upgraded parts, the scheduled amounts that C paid for the replacement of reasonable in Year 1 using the factors maintenance must be completed to perform the container linings are deemed not to provided in paragraph (i)(1)(ii) of this the horsepower and propulsion upgrade. improve the containers and are not required section, then the amounts paid by D to Thus, the work done on the engines to be capitalized under paragraph (d) of this recondition the refrigerated freight car encompasses more than the recurring section. However, the amounts paid to components in Year 6 and in Year 15 are activities that E expected to perform as a replace the lining may be subject to within the routine maintenance safe harbor result of its use of the towboats and did more capitalization under section 263A if the under paragraph (i)(1)(ii) of this section. than keep the towboat in its ordinarily amounts paid for this maintenance comprise Example 9. Routine maintenance on non- efficient operating condition. Rather under the direct or allocable indirect costs of the rotable part. E is a towboat operator that paragraph (j) of this section, the amounts property produced by C. See § 1.263A– owns and leases a fleet of towboats. Each paid to increase the horsepower and 1(e)(3)(ii)(O). towboat is equipped with two diesel- propulsion of the engines are for a betterment Example 7. Routine maintenance once powered engines. Assume that each towboat, to the towboat, and such amounts are during class life. D is a Class I railroad that including its engines, is the unit of property excepted from the routine maintenance safe owns a fleet of freight cars. Assume that a and that a towboat has a class life of 18 years. harbor under paragraph (i)(3)(i) of this freight car, including all its components, is At the time that E places its towboats into section. In addition, under paragraph (g)(1)(i) a unit of property and has a class life of 14 service, E is aware that approximately every of this section, the scheduled maintenance years. At the time that D places a freight car three to four years E will need to perform procedures directly benefit the upgrades. into service, D expects to perform cyclical scheduled maintenance on the two towboat Therefore, the amounts that E paid in Year reconditioning to the car every 8 to 10 years engines to keep the engines in their 9 for the maintenance and upgrade of the to keep the freight car in ordinarily efficient ordinarily efficient operating condition. This engines do not qualify for the routine operating condition. During this maintenance is completed while the engines maintenance safe harbor described under reconditioning, D pays amounts to are attached to the towboat and involves the paragraph (i)(1)(ii) of this section. Rather, E disassemble, inspect, and recondition or cleaning and inspecting of the engines to must capitalize the amounts paid for replace components of the freight car with determine which parts are within acceptable maintenance and upgrades of the engines as comparable and commercially available operating tolerances and can continue to be an improvement to the towboats under replacement parts. Ten years after D places used, which parts must be reconditioned to paragraph (d) of this section. the freight car in service, D pays amounts to be brought back to acceptable tolerances, and Example 11. Routine maintenance with perform a cyclical reconditioning on the car. which parts must be replaced. Engine parts unrelated improvements. Assume the same Because D expects to perform the replaced during these procedures are facts as Example 9, except in Year 5, in reconditioning only once during the 14 year replaced with comparable and commercially addition to paying amounts to perform the class life of the freight car, the amounts D available replacement parts. Assume the scheduled engine maintenance on both pays for the reconditioning do not qualify for towboat engines are not rotable spare parts engines, E also incurs costs to upgrade the the routine maintenance safe harbor under under § 1.162–3(c)(2). In Year 1, E acquired communications and navigation systems in paragraph (i)(1)(ii) of this section. a new towboat, including its two engines, the pilot house of the towboat with new Accordingly, D must capitalize the amounts and placed the towboat into service. In Year state-of-the-art systems. Assume the amounts paid for the reconditioning of the freight car 5, E pays amounts to perform scheduled paid to upgrade the communications and if these amounts result in an improvement maintenance on both engines in the towboat. navigation systems are for betterments under under paragraph (d) of this section. Assume that none of the exceptions set out paragraph (j) of this section, and therefore Example 8. Routine maintenance; in paragraph (i)(3) of this section apply to the result in an improvement to the towboat reasonable expectation. Assume the same scheduled maintenance costs. Because the under paragraph (d) of this section. In facts as Example 7, except in Year 1, D scheduled maintenance involves recurring contrast with Example 9, the amounts paid acquires and places in service several activities that E expects to perform more than for the scheduled maintenance on E’s refrigerated freight cars, which also have a once during the 18-year class life of the towboat engines are not otherwise related to class life of 14 years. Because of the special towboat, the maintenance results from E’s the upgrades to the navigation systems. requirements of these cars, at the time they use of the towboat, and the maintenance is Because the scheduled maintenance on the are placed in service, D expects to perform performed to keep the towboat in an towboat engines does not directly benefit and a reconditioning of the refrigeration ordinarily efficient operating condition, the is not incurred by reason of the upgrades to components of the freight car every 6 years scheduled maintenance on E’s towboat is the communication and navigation systems, to keep the freight car in an ordinarily within the routine maintenance safe harbor the amounts paid for the scheduled engine efficient operating condition. During the under paragraph (i)(1)(ii) of this section. maintenance are not a direct or indirect cost reconditioning, D pays amounts to Accordingly, the amounts paid for the of the improvement under paragraph (g)(1)(i) disassemble, inspect, and recondition or scheduled maintenance to its towboat of this section. Accordingly, the amounts replace the refrigeration components of the engines in Year 5 are deemed not to improve paid for the scheduled maintenance to its freight car with comparable and the towboat and are not required to be towboat engines in Year 5 are routine commercially available replacement parts. capitalized under paragraph (d) of this maintenance deemed not to improve the Assume that none of the exceptions set out section. towboat and are not required to be in paragraph (i)(3) of this section apply to the Example 10. Routine maintenance with capitalized under paragraph (d) of this amounts paid for the reconditioning of these related betterments. Assume the same facts section. freight cars. In Year 6, D pays amounts to as Example 9, except that in Year 9 E’s Example 12. Exceptions to routine perform a reconditioning on the refrigeration towboat engines are due for another maintenance. F owns and operates a farming components on one of the freight cars. scheduled maintenance visit. At this time, E and cattle ranch with an irrigation system However, because of changes in the decides to upgrade the engines to increase that provides water for crops. Assume that frequency that D utilizes this freight car, D their horsepower and propulsion, which each canal in the irrigation system is a single does not perform the second reconditioning would permit the towboats to tow heavier unit of property and has a class life of 20 on the same freight car until Year 15, after loads. Accordingly, in Year 9, E pays years. At the time F placed the canals into the end of the 14-year class life of the car. amounts to perform many of the same service, F expected to have to perform major Under paragraph (i)(1)(ii) of this section, D’s activities that it would perform during the maintenance on the canals every three years

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to keep the canals in their ordinarily efficient in Example 13, except that in Year 9, G pays (i) Ameliorates a material condition or operating condition. This maintenance amounts to replace the steps of the escalators. defect that either existed prior to the includes draining the canals, and then In Year 1, when G placed its building into taxpayer’s acquisition of the unit of cleaning, inspecting, repairing, and service, G reasonably expected that property or arose during the production reconditioning or replacing parts of the canal approximately every 18 to 20 years G would with comparable and commercially available need to replace the steps to keep the escalator of the unit of property, whether or not replacement parts. F placed the canals into system in its ordinarily efficient operating the taxpayer was aware of the condition service in Year 1 and did not perform any condition. Because the replacement does not or defect at the time of acquisition or maintenance on the canals until Year 6. At involve recurring activities that G expects to production; that time, the canals had fallen into a state perform more than once during the 10-year (ii) Is for a material addition, of disrepair and no longer functioned for period beginning at the time the building including a physical enlargement, irrigation. In Year 6, F pays amounts to drain structure or the building system was placed expansion, extension, or addition of a the canals and do extensive cleaning, in service, the costs of these activities do not major component (as defined in repairing, reconditioning, and replacing parts fall within the routine maintenance safe of the canals with comparable and harbor. Accordingly, amounts that G pays to paragraph (k)(6) of this section) to the commercially available replacement parts. replace the steps in Year 9 must be unit of property or a material increase Although the work performed on F’s canals capitalized if they result in improvements in the capacity, including additional was similar to the activities that F expected under paragraph (d) of this section (for cubic or linear space, of the unit of to perform, but did not perform, every three example, restorations under paragraph (k) of property; or years, the costs of these activities do not fall this section). (iii) Is reasonably expected to within the routine maintenance safe harbor. Example 15. Routine maintenance on materially increase the productivity, Specifically, under paragraph (i)(3)(v) of this building; reasonable expectation. In Year 1, efficiency, strength, quality, or output of section, routine maintenance does not H acquires a new office building, which it the unit of property. include activities that return a unit of uses to provide services. The building (2) Application of betterment rules— property to its former ordinarily efficient contains an HVAC system, which is a operating condition if the property has building system under paragraph (i) In general. The applicability of each deteriorated to a state of disrepair and is no (e)(2)(ii)(B)(1) of this section. In Year 1, when quantitative and qualitative factor longer functional for its intended use. H placed its building into service, H provided in paragraphs (j)(1)(ii) and Accordingly, amounts that F pays for work reasonably expected that every four years H (j)(1)(iii) of this section to a particular performed on the canals in Year 6 must be would need to pay an outside contractor to unit of property depends on the nature capitalized if they result in improvements perform detailed testing, monitoring, and of the unit of property. For example, if under paragraph (d) of this section (for preventative maintenance on its HVAC an addition or an increase in a example, restorations under paragraph (k) of system to keep the HVAC system in its particular factor cannot be measured in this section). ordinarily efficient operating condition. This Example 13. Routine maintenance on a scheduled maintenance includes the context of a specific type of building; escalator system. In Year 1, G disassembly, cleaning, inspection, repair, property, this factor is not relevant in acquires a large retail mall in which it leases replacement, reassembly, and testing of the the determination of whether an amount space to retailers. The mall contains an HVAC system and many of its component has been paid for a betterment to the escalator system with 40 escalators, which parts. If inspection or testing discloses a unit of property. includes landing platforms, trusses, tracks, problem with any component, the part is (ii) Application of betterment rules to steps, handrails, and safety brushes. In Year repaired, or if necessary, replaced with a buildings. An amount is paid to improve 1, when G placed its building into service, G comparable and commercially available a building if it is paid for a betterment, replacement part. The scheduled reasonably expected that it would need to as defined under paragraph (j)(1) of this replace the handrails on the escalators maintenance at these intervals is approximately every four years to keep the recommended by the manufacturer of the section, to a property specified under escalator system in its ordinarily efficient HVAC system and is routinely performed on paragraph (e)(2)(ii) (building), paragraph operating condition. After a routine similar systems in similar buildings. Assume (e)(2)(iii)(B) (condominium), paragraph inspection and test of the escalator system in that none of the exceptions in paragraph (e)(2)(iv)(B) (cooperative), or paragraph Year 4, G determines that the handrails need (i)(3) of this section apply to the amounts (e)(2)(v)(B) (leased building or leased to be replaced and pays an amount to replace paid for the maintenance on the HVAC portion of building) of this section. For the handrails with comparable and system. In Year 4, H pays amounts to a example, an amount is paid to improve contractor to perform the scheduled commercially available handrails. The a building if it is paid for an increase in escalator system, including the handrails, is maintenance. However, H does not perform a building system under paragraph this scheduled maintenance on its building the efficiency of the building structure (e)(2)(ii)(B)(4) of this section. Assume that again until Year 11. Under paragraph (i)(1)(i) or any one of its building systems (for none of the exceptions in paragraph (i)(3) of of this section, H’s reasonable expectation example, the HVAC system). this section apply to the scheduled that it would perform the maintenance every (iii) Unavailability of replacement maintenance costs. Because the replacement 4 years will not be deemed unreasonable parts. If a taxpayer replaces a part of a of the handrails involves recurring activities merely because H did not actually perform unit of property that cannot reasonably that G expects to perform as a result of its use the maintenance a second time during the 10- be replaced with the same type of part of the escalator system to keep the escalator year period, provided that H can substantiate (for example, because of technological that its expectation was reasonable at the system in an ordinarily efficient operating advancements or product condition, and G reasonably expects to time the property was placed in service. If H perform these activities more than once can demonstrate that its expectation was enhancements), the replacement of the during the 10-year period beginning at the reasonable in Year 1 using the other factors part with an improved, but comparable, time building system was placed in service, considered in paragraph (i)(1)(i), then the part does not, by itself, result in a the amounts paid by G for the handrail amounts H paid for the maintenance of the betterment to the unit of property. replacements are within the routine HVAC system in Year 4 and in Year 11 are (iv) Appropriate comparison—(A) In maintenance safe harbor under paragraph within the routine maintenance safe harbor general. In cases in which an (i)(1)(i) of this section. Accordingly, the under paragraph (i)(1)(i) of this section. expenditure is necessitated by normal amounts paid for the replacement of the (j) Capitalization of betterments—(1) wear and tear or damage to the unit of handrails in Year 4 are deemed not to property that occurred during the improve the building unit of property and are In general. A taxpayer must capitalize as not required to be capitalized under an improvement an amount paid for a taxpayer’s use of the unit of property, paragraph (d) of this section. betterment to a unit of property. An the determination of whether an Example 14. Not routine maintenance; amount is paid for a betterment to a unit expenditure is for the betterment of the escalator system. Assume the same facts as of property only if it— unit of property is made by comparing

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the condition of the property replace it with new insulation that is safer to ameliorate a material condition or defect in immediately after the expenditure with employees, but no more efficient or effective the machine under paragraph (j)(1)(i) of this the condition of the property than the asbestos insulation. Under section, is not for a material addition to or immediately prior to the circumstances paragraphs (e)(2)(ii) and (j)(2)(ii) of this increase in capacity of the machine under section, an amount is paid to improve a paragraph (j)(1)(ii) of this section, and is not necessitating the expenditure. building unit of property if the amount is reasonably expected to materially increase (B) Normal wear and tear. If the paid for a betterment to the building the productivity, efficiency, strength, quality, expenditure is made to correct the structure or any building system. Although or output of the machine under paragraph effects of normal wear and tear to the the asbestos is determined to be unsafe under (j)(1)(iii) of this section. Therefore, C is not unit of property that occurred during certain circumstances, the presence of required to capitalize the amount paid for the the taxpayer’s use of the unit of asbestos insulation in a building, by itself, is scheduled maintenance as a betterment to the property, the condition of the property not a preexisting material condition or defect unit of property under this paragraph (j). immediately prior to the circumstances of the building structure under paragraph Example 4. Not amelioration of pre- necessitating the expenditure is the (j)(1)(i) of this section. In addition, the existing material condition or defect. D removal and replacement of the asbestos is purchases a used ice resurfacing machine for condition of the property after the last not for a material addition to the building use in the operation of its ice skating rink. time the taxpayer corrected the effects of structure or a material increase in the To comply with local regulations, D is normal wear and tear (whether the capacity of the building structure under required to routinely monitor the air quality amounts paid were for maintenance or paragraphs (j)(1)(ii) and (j)(2)(iv) of this in the ice skating rink. One week after D improvements) or, if the taxpayer has section as compared to the condition of the places the machine into service, during a not previously corrected the effects of property prior to the deterioration of the routine air quality check, D discovers that the normal wear and tear, the condition of insulation. Similarly, the removal and operation of the machine is adversely the property when placed in service by replacement of asbestos is not reasonably affecting the air quality in the skating rink. expected to materially increase the As a result, D pays an amount to inspect and the taxpayer. productivity, efficiency, strength, quality, or retune the machine, which includes (C) Damage to property. If the output of the building structure under replacing minor components of the engine expenditure is made to correct damage paragraphs (j)(1)(iii) and (j)(2)(iv) of this that had worn out prior to D’s acquisition of to a unit of property that occurred section as compared to the condition of the the machine. Assume the resurfacing during the taxpayer’s use of the unit of property prior to the deterioration of the machine, including the engine, is the unit of property, the condition of the property insulation. Therefore, the amount paid to property. The routine maintenance safe immediately prior to the circumstances remove and replace the asbestos insulation is harbor in paragraph (i) of this section does necessitating the expenditure is the not for a betterment to the building structure not apply to the amounts paid, because the condition of the property immediately or an improvement to the building under activities performed do not relate solely to prior to damage. paragraph (j) of this section. the taxpayer’s use of the machine. The (3) Examples. The following examples Example 3. Not amelioration of pre- amount that D pays to inspect, retune, and existing material condition or defect. (i) In replace minor components of the ice illustrate the application of this January, Year 1, C purchased a used machine resurfacing machine ameliorates a condition paragraph (j) only and do not address for use in its manufacturing operations. or defect that existed prior to D’s acquisition whether capitalization is required under Assume that the machine is a unit of of the equipment. Nevertheless, considering another provision of this section or property and has a class life of 10 years. C the purpose and minor nature of the work another provision of the Internal placed the machine in service in January, performed, this amount does not ameliorate Revenue Code (for example, section Year 1 and at that time expected to perform a material condition or defect in the machine 263A). Unless otherwise provided, manufacturer recommended scheduled under paragraph (j)(1)(i) of this section. In assume that the appropriate comparison maintenance on the machine every three addition, the amount is not paid for a in paragraph (j)(2)(iv) of this section is years. The scheduled maintenance includes material addition to the machine or a cleaning and oiling the machine, inspecting material increase in the capacity of the not applicable under the facts. parts for defects, and replacing minor items, machine under paragraph (j)(1)(ii) of this Example 1. Amelioration of pre-existing such as springs, bearings, and seals, with section. Also, the activities are not material condition or defect. In Year 1, A comparable and commercially available reasonably expected to materially increase purchases a store located on a parcel of land replacement parts. The scheduled the productivity, efficiency, strength, quality, that contains underground gasoline storage maintenance does not include any material or output of the machine under paragraph tanks left by prior occupants. Assume that additions or materially increase the capacity, (j)(1)(iii) of this section. Therefore, D is not the parcel of land is the unit of property. The productivity, efficiency, strength, quality, or required to capitalize the amount paid to tanks had leaked prior to A’s purchase, output of the machine. At the time C inspect, retune, and replace minor causing soil contamination. A is not aware of purchased the machine, it was approaching components of the machine as a betterment the contamination at the time of purchase. In the end of a three-year scheduled under this paragraph (j). Year 2, A discovers the contamination and maintenance period. As a result, in February, Example 5. Amelioration of material incurs costs to remediate the soil. The Year 1, C pays an amount to perform the condition or defect. (i) E acquires a building remediation costs are for a betterment to the manufacturer recommended scheduled for use in its business of providing assisted land under paragraph (j)(1)(i) of this section maintenance to keep the machine in its living services. Before and after the purchase, because A incurred the costs to ameliorate a ordinarily efficient operating condition. the building functions as an assisted living material condition or defect that existed prior (ii) The amount that C pays does not facility. However, at the time of the purchase, to A’s acquisition of the land. qualify under the routine maintenance safe E is aware that the building is in a condition Example 2. Not amelioration of pre- harbor in paragraph (i) of this section, that is below the standards that E requires for existing condition or defect. B owns an office because the cost primarily results from the facilities used in its business. Immediately building that was constructed with insulation prior owner’s use of the property and not the after the acquisition and during the following that contained asbestos. The health dangers taxpayer’s use. C acquired the machine just two years, while E continues to use the of asbestos were not widely known when the before it had received its three-year building as an assisted living facility, E pays building was constructed. Several years after scheduled maintenance. Accordingly, the amounts for extensive repairs and B places the building into service, B amount that C pays for the scheduled maintenance, and the acquisition of new determines that certain areas of asbestos- maintenance results from the prior owner’s property to bring the facility into the high- containing insulation have begun to use of the property and ameliorates quality condition for which E’s facilities are deteriorate and could eventually pose a conditions or defects that existed prior to C’s known. The work on E’s building includes health risk to employees. Therefore, B pays ownership of the machine. Nevertheless, repairing damaged drywall, repainting, re- an amount to remove the asbestos-containing considering the purpose and minor nature of wallpapering, replacing windows, repairing insulation from the building structure and the work performed, this amount does not and replacing doors, replacing and regrouting

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tile, repairing millwork, and repairing and purpose of the expenditure, the physical and are not incurred by reason of the replacing roofing materials. The work also nature of the work performed, and the effect additions to the building structure and involves the replacement of section 1245 of the expenditure on the buildings’ structure electrical system. As in Example 6, F is property, including window treatments, and systems, the amounts paid for the refresh required to capitalize the amounts paid to furniture, and cabinets. The work that E of each building are not for any material acquire and install each section 1245 performs affects only the building structure additions to, or material increases in the property in accordance with § 1.263(a)– under paragraph (e)(2)(ii)(A) of this section capacity of, the buildings’ structure or 2(d)(1). and does not affect any of the building systems as compared with the condition of Example 8. Betterment; building remodel. systems described in paragraph (e)(2)(ii)(B) of the structure or systems after the previous (i) G owns a large chain of retail stores that this section. Assume that each section 1245 refresh. Moreover, the amounts paid are not sell a variety of items. G determines that due property is a separate unit of property. reasonably expected to materially increase to changes in the retail market, it can no (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) the productivity, efficiency, strength, quality, longer compete in its current store class and of this section, an amount is paid to improve or output of any building structure or system decides to upgrade its stores to offer higher a building unit of property if the amount is under as compared to the condition of the end products to a different type of customer. paid for a betterment to the building structures or systems after the previous To offer these products and attract different structure or any building system. Considering refresh. Rather, the work performed keeps F’s types of customers, G must substantially the purpose of the expenditure and the effect store buildings’ structures and buildings’ remodel its stores. Thus, G pays amounts to of the expenditures on the building structure, systems in their ordinarily efficient operating remodel its stores by performing work on the the amounts that E paid for repairs and condition. Therefore, F is not required to buildings’ structures and systems as defined maintenance to the building structure treat the amounts paid for the refresh of its under paragraphs (e)(2)(ii)(A) and (e)(2)(ii)(B) comprise a betterment to the building store buildings’ structures and buildings’ of this section. This work includes replacing structure under paragraph (j)(1)(i) of this systems as betterments under paragraphs large parts of the exterior walls with section because the amounts ameliorate (j)(1)(ii), (j)(1)(iii), and (j)(2)(iv) of this windows, replacing the escalators with a material conditions that existed prior to E’s section. However, F is required to capitalize monumental staircase, adding a new glass acquisition of the building. Therefore, E must the amounts paid to acquire and install each enclosed elevator, rebuilding the interior and treat the amounts paid for the betterment to section 1245 property in accordance with exterior facades, replacing vinyl floors with the building structure as an improvement to § 1.263(a)–2(d)(1). ceramic flooring, replacing ceiling tiles with the building and must capitalize the amounts Example 7. Building refresh; limited acoustical tiles, and removing and rebuilding under paragraphs (j) and (d)(1) of this improvement. (i) Assume the same facts as walls to move changing rooms and create section. Moreover, E is required to capitalize Example 6 except, in the course of the refresh specialty departments. The work also the amounts paid to acquire and install each to one of its store buildings, F also pays includes upgrades to increase the capacity of section 1245 property, including each amounts to increase the building’s storage the buildings’ electrical system to window treatment, each item of furniture, space, add a second loading dock, and add accommodate the structural changes and the and each cabinet, in accordance with a second overhead door. Specifically, at the addition of new section 1245 property, such § 1.263(a)–2(d)(1). same time F pays amounts to perform the as new product information kiosks and point Example 6. Not a betterment; building refresh, F pays additional amounts to of sale systems. The work to the electrical refresh. (i) F owns a nationwide chain of construct an addition to the back of the store system also involves the installation of new retail stores that sell a wide variety of items. building, including adding a new overhead more efficient and mood enhancing lighting To maintain the appearance and door and loading dock to the building. The fixtures. In addition, the work includes functionality of its store buildings after work also involves upgrades to the electrical remodeling all bathrooms by replacing several years of wear, F periodically pays system of the building, including the contractor-grade plumbing fixtures with amounts to refresh the look and layout of its addition of a second service box with designer-grade fixtures that conserve water stores. The work that F performs during a increased amperage and new wiring from the and energy. Finally, G also pays amounts to refresh consists of cosmetic and layout service box to provide lighting and power clean debris resulting from construction changes to the store’s interiors and general throughout the new space. Although it is during the remodel, patch holes in walls that repairs and maintenance to the store building performed at the same time, the construction were made to upgrade the electrical system, to modernize the store buildings and of the additions does not affect, and is not repaint existing walls with a new color reorganize the merchandise displays. The otherwise related to, the refresh of the retail scheme to match the new interior work to each store consists of replacing and space. construction, and to power wash building reconfiguring display tables and racks to (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) exteriors to enhance the new exterior facade. provide better exposure of the merchandise, of this section, an amount is paid to improve (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) making corresponding lighting relocations a building unit of property if the amount is of this section, an amount is paid to improve and flooring repairs, moving one wall to paid for a betterment to the building a building unit of property if the amount is accommodate the reconfiguration of tables structure or any building system. Under paid for a betterment to the building and racks, patching holes in walls, repainting paragraph (j)(1)(ii) of this section, the structure or any building system. Considering the interior structure with a new color amounts paid by F to add the storage space, the facts and circumstances, including the scheme to coordinate with new signage, loading dock, overhead door, and expand the purpose of the expenditure, the physical replacing damaged ceiling tiles, cleaning and electrical system are for betterments to F’s nature of the work performed, and the effect repairing wood flooring throughout the store building structure and to the electrical of the work on the buildings’ structures and building, and power washing building system because they are for material buildings’ systems, the amounts that G pays exteriors. The display tables and the racks all additions to, and a material increase in for the remodeling of its stores result in constitute section 1245 property. F pays capacity of, the structure and the electrical betterments to the buildings’ structures and amounts to refresh 50 stores during the system of F’s store building. Accordingly, F several of its systems under paragraph (j) of taxable year. Assume that each section 1245 must treat the amounts paid for these this section. Specifically, the amounts paid to property within each store is a separate unit betterments as improvements to the building replace large parts of the exterior walls with of property. Finally, assume that the work unit of property and capitalize these amounts windows, replace the escalators with a does not ameliorate any material conditions under paragraphs (d)(1) and (j) of this monumental staircase, add a new elevator, or defects that existed when F acquired the section. However, for the reasons discussed rebuild the interior and exterior facades, store buildings or result in any material in Example 6, F is not required to treat the replace vinyl floors with ceramic flooring, additions to the store buildings. amounts paid for the refresh of its store replace the ceiling tiles with acoustical tiles, (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) building structure and systems as a and to remove and rebuild walls are for of this section, an amount is paid to improve betterments under paragraph (j)(1) of this material additions, that is the addition of a building unit of property if the amount is section. In addition, F is not required under major components, to the building structure paid for a betterment to the building paragraph (g)(1) of this section to capitalize under paragraph (j)(1)(ii) of this section and structure or any building system. Considering the refresh costs described in Example 6 are reasonably expected to increase the the facts and circumstances including the because these costs do not directly benefit quality of the building structure under

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paragraph (j)(1)(iii) of this section. Similarly, improvement to the machine under Moreover, the amount paid is not reasonably the amounts paid to upgrade the electrical paragraphs (j) and (d)(1) of this section. J is expected to materially increase the system are to materially increase the capacity also required to capitalize the costs of productivity, efficiency, strength, quality, or of the electrical system under paragraph disassembling and moving the machine to output of the building structure under (j)(1)(ii) of this section and are reasonably Building B because these costs directly paragraphs (j)(1)(iii) and (j)(2)(iv) as expected to increase the quality of this benefit and are incurred by reason of the compared to the condition of the structure system under paragraph (j)(1)(iii) of this improvement to the machine under prior to the seepage of the oil Therefore, L section. In addition, the amounts paid to paragraph (g)(1) of this section. is not required to treat the amount paid to remodel the bathrooms with higher grade and Example 11. Betterment; regulatory correct the seepage as a betterment to the more resource-efficient materials are requirement. K owns a building that it uses building under paragraph (d)(1) or (j) of this reasonably expected to increase the in its business. In Year 1, City C passes an section. The federal inspectors’ requirement efficiency and quality of the plumbing ordinance setting higher safety standards for that L correct the seepage to continue system under paragraph (j)(1)(iii) of this buildings because of the hazardous operating the plant is not relevant in section. Finally, the amounts paid to clean conditions caused by earthquakes. To comply determining whether the amount paid debris, patch and repaint existing walls with with the ordinance, K pays an amount to add improves the plant. a new color scheme, and to power wash expansion bolts to its building structure. Example 13. Not a betterment; new roof building exteriors, while not betterments by These bolts anchor the wooden framing of membrane. M owns a building that it uses for themselves, directly benefitted and were K’s building to its cement foundation, its retail business. Over time, the waterproof incurred by reason of the improvements to providing additional structural support and membrane (top layer) on the roof of M’s G’s store buildings’ structures and electrical resistance to seismic forces, making the building begins to wear, and M began to systems under paragraph (g)(1) of this building more resistant to damage from experience water seepage and leaks section. Therefore, G must treat the amounts lateral movement. Under paragraphs (e)(2)(ii) throughout its retail premises. To eliminate paid for betterments to the store buildings’ and (j)(2)(ii) of this section, an amount is the problems, a contractor recommends that structures and systems, including the costs of paid to improve a building unit of property M put a new rubber membrane on the worn cleaning, patching, repairing, and power if the amount is paid for a betterment to the membrane. Accordingly, M pays the washing the building, as improvements to G’s building structure or any building system. contractor to add the new membrane. The buildings and must capitalize these amounts The framing and foundation are part of the new membrane is comparable to the worn under paragraphs (d)(1) and (j) of this building structure as defined in paragraph membrane when it was originally placed in section. Moreover, G is required to capitalize (e)(2)(ii)(A) of this section. Prior to the service by the taxpayer. Under paragraphs the amounts paid to acquire and install each ordinance, the old building was in good (e)(2)(ii) and (j)(2)(ii) of this section, an section 1245 property in accordance with condition but did not meet City C’s new amount is paid to improve a building unit of § 1.263(a)–2(d)(1). For the treatment of requirements for earthquake resistance. The property if the amount is paid for a amounts paid to remove components of amount paid by K for the addition of the betterment to the building structure or any property, see paragraph (g)(2) of this section. expansion bolts met City C’s new building system. The roof is part of the Example 9. Not betterment; relocation and requirement, but also materially increased building structure under paragraph reinstallation of personal property. In Year 1, the strength of the building structure under (e)(2)(ii)(A) of this section. The condition H purchases new cash registers for use in its paragraph (j)(1)(iii) of this section. Therefore, necessitating the expenditure was the normal retail store located in leased space in a K must treat the amount paid to add the wear of M’s roof. Under paragraph (j)(2)(iv) shopping mall. Assume that each cash expansion bolts as a betterment to the of this section, to determine whether the register is a unit of property as determined building structure and must capitalize this amounts are for a betterment, the condition under paragraph (e)(3) of this section. In Year amount as an improvement to building under of the building structure after the 1, H capitalizes the costs of acquiring and paragraphs (d)(1) and (j) of this section. City expenditure must be compared to the installing the new cash registers under C’s new requirement that K’s building meet condition of the structure when M placed the § 1.263(a)–2(d)(1). In Year 3, H’s lease certain safety standards to continue to building into service because M has not expires, and H decides to relocate its retail operate is not relevant in determining previously corrected the effects of normal store to a different building. In addition to whether the amount paid improved the wear and tear. Under these facts, the amount various other costs, H pays $5,000 to move building. See paragraph (g)(4) of this section. paid to add the new membrane to the roof the cash registers and $1,000 to reinstall Example 12. Not a betterment; regulatory is not for a material addition or a material them in the new store. The cash registers are requirement. L owns a meat processing plant. increase in the capacity of the building used for the same purpose and in the same After operating the plant for many years, L structure under paragraph (j)(1)(ii) of this manner that they were used in the former discovers that oil is seeping through the section as compared to the condition of the location. The amounts that H pays to move concrete walls of the plant. Federal structure when it was placed in service. and reinstall the cash registers into its new inspectors advise L that it must correct the Moreover, the new membrane is not store do not result in a betterment to the cash seepage problem or shut down its plant. To reasonably expected to materially increase registers under paragraph (j) of this section. correct the problem, L pays an amount to add the productivity, efficiency, strength, quality, Example 10. Betterment; relocation and a concrete lining to the walls from the floor or output of the building structure under reinstallation of equipment. J operates a to a height of about four feet and also to add paragraph (j)(1)(iii) of this section as manufacturing facility in Building A, which concrete to the floor of the plant. Under compared to the condition of the building contains various machines that J uses in its paragraphs (e)(2)(ii) and (j)(2)(ii) of this structure when it was placed in service. manufacturing business. J decides to expand section, an amount is paid to improve a Therefore, M is not required to treat the part of its operations by relocating a machine building unit of property if the amount is amount paid to add the new membrane as a to Building B to reconfigure the machine paid for a betterment to the building betterment to the building under paragraph with additional components. Assume that the structure or any building system. The walls (d)(1) or (j) of this section. machine is a single unit of property under are part of the building structure as defined Example 14. Material increase in capacity; paragraph (e)(3) of this section. J pays in paragraph (e)(2)(ii)(A) of this section. The building. N owns a factory building with a amounts to disassemble the machine, to condition necessitating the expenditure was storage area on the second floor. N pays an move the machine to the new location, and the seepage of the oil into the plant. Prior to amount to reinforce the columns and girders to reinstall the machine in a new the seepage, the walls did not leak and were supporting the second floor to permit storage configuration with additional components. functioning for their intended use. L is not of supplies with a gross weight 50 percent Assume that the reinstallation, including the required to treat the amount paid as a greater than the previous load-carrying reconfiguration and the addition of betterment under paragraphs (j)(1)(ii) and capacity of the storage area. Under components, is for an increase in capacity of (j)(2)(iv) of this section because it is not paid paragraphs (e)(2)(ii) and (j)(2)(ii) of this the machine, and therefore is for a betterment for a material addition to, or a material section, an amount is paid to improve a to the machine under paragraph (j)(1)(ii) of increase in the capacity of, the building’s building unit of property if the amount is this section. Accordingly, J must capitalize structure as compared to the condition of the paid for a betterment to the building the costs of reinstalling the machine as an structure prior to the seepage of oil. structure or any building system. The

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columns and girders are part of the building improvement, O is also required to capitalize recommends that R replace two of the roof- structure defined under paragraph the portion of the redredge costs allocable to mounted units. R pays an amount to replace (e)(2)(ii)(A) of this section. N must treat the restoring the depth lost to the siltation the two specified units. The two new units amount paid to reinforce the columns and because, under paragraph (g)(1)(i) of this are expected to eliminate the climate control girders as a betterment under paragraphs section, these amounts directly benefit and problems and to be 10 percent more energy (j)(1)(ii) and (j)(1)(iii) of this section because are incurred by reason of the improvement to efficient than the replaced units in their it materially increases the load-carrying the unit of property. original condition. No work is performed on capacity and the strength of the building Example 18. Not a material increase in the other roof-mounted heating/cooling units, structure. Therefore, N must capitalize this capacity; building. P owns a building used in the duct work, or the controls. Under amount as an improvement to the building its trade or business. The first floor has a paragraphs (e)(2)(ii) and (j)(2)(ii) of this under paragraphs (d)(1) and (j) of this drop-ceiling. To fully expose windows on the section, an amount is paid to improve a section. first floor, P pays an amount to remove the building unit of property if the amount is Example 15. Material increase in capacity; drop-ceiling and repaint the original ceiling. paid for a betterment to the building channel. O owns harbor facilities consisting Under paragraphs (e)(2)(ii) and (j)(2)(ii) of structure or any building system. The HVAC of a slip for the loading and unloading of this section, an amount is paid to improve a system, including the two-roof mounted barges and a channel leading from the slip to building unit of property if the amount is units, is a building system under paragraph the river. At the time of purchase, the paid for a betterment to the building (e)(2)(ii)(B)(1) of this section. The channel was 150 feet wide, 1,000 feet long, structure or any building system. The ceiling replacement of the two roof-mounted units is and 10 feet deep. Several years after is part of the building structure as defined not a material addition to or a material purchasing the harbor facilities, to allow for under paragraph (e)(2)(ii)(A) of this section. increase in the capacity of the HVAC system ingress and egress and for the unloading of P is not required to treat the amount paid to under paragraphs (j)(1)(ii) and (j)(3)(ii) of this larger barges, O decides to deepen the remove the drop-ceiling as a betterment to section as compared to the condition of the channel to a depth of 20 feet. O pays a the building because it was not for a material system prior to the climate control problems. contractor to dredge the channel to 20 feet. addition or material increase in the capacity In addition, given the 10 percent efficiency Assume the channel is the unit of property. of the building structure under paragraph increase in two units of the entire HVAC O must capitalize the amounts paid for the (j)(1)(ii) of this section and it was not system, the replacement is not expected to dredging as an improvement to the channel reasonably expected to materially increase to materially increase the productivity, because they are for a material increase in the the efficiency, strength, or quality of the efficiency, strength, quality, or output of the capacity of the unit of property under building structure under paragraph (j)(1)(iii) HVAC system under paragraphs (j)(1)(iii) and paragraph (j)(1)(ii) of this section. of this section. In addition, under paragraph (j)(2)(iv) of this section as compared to the Example 16. Not a material increase in (j)(2)(i) of this section, because the effect on condition of the system prior to the climate capacity; channel. Assume the same facts as productivity and output of the building control problems. Therefore, R is not in Example 15, except that the channel was structure cannot be measured in this context, required to capitalize the amounts paid for susceptible to siltation and, after dredging to these factors are not relevant in determining these replacements as betterments to the 20 feet, the channel depth had been reduced whether there is a betterment to the building building unit of property under paragraphs to 18 feet. O pays a contractor to redredge the structure. (d)(1) and (j) of this section. channel to a depth of 20 feet. The Example 19. Material increase in capacity; Example 21. Material increase in expenditure was necessitated by the siltation building. Q owns a building that it uses in efficiency; building. S owns a building that it of the channel. Both prior to the siltation and its retail business. The building contains one uses in its service business. S conducts an after the redredging, the depth of the channel floor of retail space with very high ceilings. energy assessment and determines that it was 20 feet. Applying the comparison rule Q pays an amount to add a stairway and a could significantly reduce its energy costs by under paragraph (j)(2)(iv) of this section, the mezzanine for the purposes of adding adding insulation to its building. S pays an amounts paid by O to redredge the channel additional selling space within its building. insulation contractor to apply a combination are not for a betterment under paragraph Under paragraphs (e)(2)(ii) and (j)(2)(ii) of of loose-fill, spray foam, and blanket (j)(1)(ii) of this section because they are not this section, an amount is paid to improve a insulation throughout S’s building structure, for a material addition to, or a material building unit of property if the amount is including within the attic, walls, and crawl increase in the capacity of, the unit of paid for a betterment to the building spaces. S reasonably expects the new property as compared to the condition of the structure or any building system. The insulation to make the building more energy property prior to the siltation. Similarly, stairway and the mezzanine are part of the efficient because the contractor indicated that these amounts are not for a betterment under building structure as defined under the new insulation would reduce its annual paragraph (j)(1)(iii) of this section because paragraph (e)(2)(ii)(A) of this section. Q is energy and power costs by approximately 50 the amounts are not reasonably expected to required to treat the amount paid to add the percent of its annual costs during the last five increase the productivity, efficiency, stairway and mezzanine as a betterment years. Under paragraphs (e)(2)(ii) and (j)(2)(ii) strength, quality, or output of the unit of because it is for a material addition to, and of this section, an amount is paid to improve property as compared to the condition of the an increase in the capacity of, the building a building if the amount is paid for a property before the siltation. Therefore, O is structure under paragraph (j)(1)(ii) of this betterment to the building structure or any not required to capitalize these amounts as section. Therefore, Q must capitalize this building system. Therefore, under paragraphs improvement under paragraphs (d)(1) and (j) amount as an improvement to the building (d)(1) and (j) of this section, S must capitalize of this section. unit of property under paragraphs (d)(1) and as a betterment the amount paid to add the Example 17. Material increase in capacity; (j) of this section. insulation because the insulation is channel. Assume the same facts as in Example 20. Not material increase in reasonably expected to materially increase Example 16 except that after the redredging, efficiency; HVAC system. R owns an office the efficiency of the building structure under there is more siltation, and the channel depth building that it uses to provide services to paragraph (j)(1)(iii) of this section. is reduced back to 18 feet. In addition, to customers. The building contains an HVAC Example 22. Material addition; building. T allow for additional ingress and egress and system that incorporates 10 roof-mounted owns and operates a restaurant, which for the unloading of even larger barges, O units that provide heating and air provides a variety of prepared foods to its decides to deepen the channel to a depth of conditioning for different parts of the customers. To better accommodate its 25 feet. O pays a contractor to redredge the building. The HVAC system also consists of customers and increase customer traffic, T channel to 25 feet. O must capitalize the controls for the entire system and duct work decides to add a drive-through service area. amounts paid for the dredging as an that distributes the heated or cooled air to the As a result, T pays amounts to partition an improvement to the channel because the various spaces in the building’s interior. area within its restaurant for a drive-through amounts are for a material increase in the After many years of use of the HVAC system, service counter, to construct a service capacity of the unit of property under R begins to experience climate control window with necessary security features, to paragraph (j)(1)(ii) of this section as problems in various offices throughout the build an overhang for vehicles, and to compared to condition of the unit of property office building and consults with a contractor construct a drive-up menu board. Assume before the siltation. As part of this to determine the cause. The contractor that the drive-up menu board is section 1245

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property that is a separate unit of property into account the adjusted basis of the (B) The amount paid for restoration of under paragraph (e)(3) of this section. Under component in realizing gain or loss damage to the unit of property under paragraphs (e)(2)(ii) and (j)(2)(ii) of this resulting from the sale or exchange of paragraph (k)(1)(iii) of this section that section, an amount is paid to improve a the component; also constitutes an improvement under building unit of property if the amount is paid for a betterment to the building (iii) Is for the restoration of damage to any other provision of paragraph (k)(1) structure or any building system. The a unit of property for which the of this section. amounts paid for the partition, service taxpayer is required to take a basis (ii) Amounts in excess of limitation. window and overhang are betterments to the adjustment as a result of a casualty loss The amounts paid for restoration of building structure because they comprise a under section 165, or relating to a damage to a unit of property as material addition (that is, a physical casualty event described in section 165, described in paragraph (k)(1)(iii) of this expansion, extension, and addition of a major subject to the limitation in paragraph section, but that exceed the limitation component) to the building structure under (k)(4) of this section; provided in paragraph (k)(4)(i) of this paragraph (j)(1)(ii) of this section. (iv) Returns the unit of property to its section, must be treated in accordance Accordingly, T must capitalize as an with the provisions of the Internal improvement the amounts paid to add the ordinarily efficient operating condition partition, drive-through window, and if the property has deteriorated to a state Revenue Code and regulations that are overhang under paragraphs (d)(1) and (j) of of disrepair and is no longer functional otherwise applicable. See, for example, this section. T is also required to capitalize for its intended use; § 1.162–4 (repairs and maintenance); the amounts paid to acquire and install each (v) Results in the rebuilding of the § 1.263(a)–2 (costs to acquire and section 1245 property in accordance with unit of property to a like-new condition produce units of property); and § 1.263(a)–2(d)(1). after the end of its class life as defined § 1.263(a)-3 (costs to improve units of Example 23. Costs incurred during property). betterment. U owns a building that it uses in in paragraph (i)(4) of this section (see paragraph (k)(5) of this section); or (5) Rebuild to like-new condition. For its service business. To accommodate new purposes of paragraph (k)(1)(v) of this employees and equipment, U pays amounts (vi) Is for the replacement of a part or section, a unit of property is rebuilt to to increase the load capacity of its electrical a combination of parts that comprise a a like-new condition if it is brought to system by adding a second electrical panel major component or a substantial the status of new, rebuilt, with additional circuits and adding wiring structural part of a unit of property (see remanufactured, or a similar status and outlets throughout the electrical system paragraph (k)(6) of this section). of its building. To complete the upgrades to under the terms of any federal (2) Application of restorations to the electrical system, the contractor makes regulatory guideline or the several holes in walls. As a result, U also buildings. An amount is paid to improve manufacturer’s original specifications. incurs costs to patch the holes and repaint a building if it is paid to restore (as Generally, a comprehensive several walls. Under paragraphs (e)(2)(ii) and defined under paragraph (k)(1) of this maintenance program, even though (j)(2)(ii) of this section, an amount is paid to section) a property specified under substantial, does not return a unit of improve a building unit of property if the paragraph (e)(2)(ii) (building), paragraph property to a like-new condition. amount is paid for a betterment to the (e)(2)(iii)(B) (condominium), paragraph building structure or any building system. (6) Replacement of a major (e)(2)(iv)(B) (cooperative), or paragraph component or a substantial structural The amounts paid to upgrade the panel and (e)(2)(v)(B) (leased building or portion of wiring are for betterments to U’s electrical part—(i) In general. To determine system because they increase the capacity of building) of this section. For example, whether an amount is for the the electrical system under paragraph an amount is paid to improve a building replacement of a part or a combination (j)(1)(ii) of this section and increase the if it is paid for the replacement of a part of parts that comprise a major strength and output of the electrical system or combination of parts that comprise a component or a substantial structural under paragraph (j)(1)(iii) of this section. major component or substantial part of the unit of property under Accordingly, U is required to capitalize the structural part of the building structure paragraph (k)(1)(vi) of this section, it is costs of the upgrade to the electrical system or any one of its building systems (for as an improvement to the building unit of appropriate to consider all the facts and example, the HVAC system). See circumstances. These facts and property under paragraphs (d)(1) and (j) of paragraph (k)(6) of this section. this section. Moreover, under paragraph circumstances include the quantitative (g)(1) of this section, U is required to (3) Exception for losses based on and qualitative significance of the part capitalize the amounts paid to patch holes salvage value. A taxpayer is not or combination of parts in relation to the and repaint several walls in its building required to treat as a restoration unit of property. because these costs directly benefit and are amounts paid under paragraph (k)(1)(i) (A) Major component. A major incurred by reason of the improvement to U’s or paragraph (k)(1)(ii) of this section if component is a part or combination of building unit of property. the unit of property has been fully parts that performs a discrete and (k) Capitalization of restorations—(1) depreciated and the loss is attributable critical function in the operation of the In general. A taxpayer must capitalize as only to remaining salvage value as unit of property. An incidental an improvement an amount paid to computed for federal income tax component of the unit of property, even restore a unit of property, including an purposes. though such component performs a amount paid to make good the (4) Restoration of damage from discrete and critical function in the exhaustion for which an allowance is or casualty—(i) Limitation. For purposes of operation of the unit of property, has been made. An amount restores a paragraph (k)(1)(iii) of this section, the generally will not, by itself, constitute a unit of property only if it— amount paid for restoration of damage major component. (i) Is for the replacement of a to the unit of property that must be (B) Substantial structural part. A component of a unit of property for capitalized under this paragraph (k) is substantial structural part is a part or which the taxpayer has properly limited to the excess (if any) of— combination of parts that comprises a deducted a loss for that component, (A) The amount prescribed by large portion of the physical structure of other than a casualty loss under § 1.165– § 1.1011–1 as the adjusted basis of the the unit of property. 7; single, identifiable property (under (ii) Major components and substantial (ii) Is for the replacement of a § 1.167–7(b)(2)(i)) for determining the structural parts of buildings. In the case component of a unit of property for loss allowable on account of the of a building, an amount is for the which the taxpayer has properly taken casualty, over replacement of a major component or a

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substantial structural part of the realizing a loss from the sale of the paragraphs (k)(1)(iii) and (k)(4)(i), C must building unit of property if— components. treat as a restoration the remaining costs, (A) The replacement includes a part Example 3. Restoration after casualty loss. limited to the excess of the adjusted basis of or combination of parts that comprise a B owns an office building that it uses in its the building over the amounts paid for the trade or business. A storm damages the office improvement under paragraph (k)(1)(vi). major component (as defined in building at a time when the building has an Accordingly, C must treat as a restoration paragraph (k)(6)(i)(A) of this section), or adjusted basis of $500,000. B deducts under $150,000 ($500,000—$350,000) of the a significant portion of a major section 165 a casualty loss in the amount of $400,000 paid for the portion of the costs component, of any of the properties $50,000, and properly reduces its basis in the related to repairing and cleaning the building designated in paragraph (e)(2)(ii) office building to $450,000. B hires a structure under paragraph (k)(1)(iii) of this (building), paragraph (e)(2)(iii)(B) contractor to repair the damage to the section. Thus, in addition to the $350,000 to (condominium), paragraph (e)(2)(iv)(B) building, including the repair of the building replace the roof structure, C must also (cooperative), or paragraph (e)(2)(v)(B) roof and the removal of debris from the capitalize the $150,000 as an improvement to (leased building or leased portion of a building premises. B pays the contractor the building unit of property under $50,000 for the work. Under paragraph paragraph (d)(2) of this section. C is not building) of this section; or (k)(1)(iii) of this section, B must treat the required to capitalize the remaining $250,000 (B) The replacement includes a part or $50,000 amount paid to the contractor as a repair and cleaning costs under paragraph combination of parts that comprises a restoration of the building structure because (k)(1)(iii) of this section. large portion of the physical structure of B properly adjusted its basis in that amount Example 6. Restoration of property in a any of the properties designated in as a result of a casualty loss under section state of disrepair. D owns and operates a farm paragraph (e)(2)(ii) (building), paragraph 165, and the amount does not exceed the with several barns and outbuildings. D did (e)(2)(iii)(B) (condominium), paragraph limit in paragraph (k)(4) of this section. not use or maintain one of the outbuildings (e)(2)(iv)(B) (cooperative), or paragraph Therefore, B must treat the amount paid as on a regular basis, and the outbuilding fell (e)(2)(v)(B) (leased building or portion of an improvement to the building unit of into a state of disrepair. The outbuilding property and, under paragraph (d)(2) of this previously was used for storage but can no building) of this section. section, must capitalize the amount paid. longer be used for that purpose because the (7) Examples. The following examples Example 4. Restoration after casualty building is not structurally sound. D decides illustrate the application of this event. Assume the same facts as in Example to restore the outbuilding and pays an paragraph (k) only and do not address 3, except that B receives insurance proceeds amount to shore up the walls and replace the whether capitalization is required under of $50,000 after the casualty to compensate siding. Under paragraphs (e)(2)(ii) and (k)(2) another provision of this section or for its loss. B cannot deduct a casualty loss of this section, an amount is paid to improve another provision of the Code (for under section 165 because its loss was a building if the amount is paid to restore the example, section 263A). Unless compensated by insurance. However, B building structure or any building system. otherwise stated, assume that the properly reduces its basis in the property by The walls and siding are part of the building structure under paragraph (e)(2)(ii)(A) of this taxpayer has not properly deducted a the amount of the insurance proceeds. Under paragraph (k)(1)(iii) of this section, B must section. Under paragraph (k)(1)(iv) of this loss for, nor taken into account the treat the $50,000 amount paid to the section, D must treat the amount paid to adjusted basis on a sale or exchange of, contractor as a restoration of the building shore up the walls and replace the siding as any unit of property, asset, or structure because B has properly taken a a restoration of the building structure component of a unit of property that is basis adjustment relating to a casualty event because the amounts return the building replaced. described in section 165, and the amount structure to its ordinarily efficient operating does not exceed the limit in paragraph (k)(4) condition after it had deteriorated to a state Example 1. Replacement of loss of this section. Therefore, B must treat the of disrepair and was no longer functional for component. A owns a manufacturing amount paid as an improvement to the its intended use. Therefore, D must treat the building containing various types of amount paid to shore up the walls and manufacturing equipment. A does a cost building unit of property and, under segregation study of the manufacturing paragraph (d)(2) of this section, must replace the siding as an improvement to the building and properly determines that a capitalize the amount paid. building unit of property and, under walk-in freezer in the manufacturing building Example 5. Restoration after casualty loss; paragraph (d)(2) of this section, must is section 1245 property as defined in section limitation. (i) C owns a building that it uses capitalize the amount paid. 1245(a)(3). The freezer is not part of the in its trade or business. A storm damages the Example 7. Rebuild of property to like-new building structure or the HVAC system under building at a time when the building has an condition before end of class life. E is a Class paragraph (e)(2)(i) or (e)(2)(ii)(B)(1) of this adjusted basis of $500,000. C determines that I railroad that owns a fleet of freight cars. section. Several components of the walk-in the cost of restoring its property is $750,000, Assume the freight cars have a recovery freezer cease to function, and A decides to deducts a casualty loss under section 165 in period of 7 years under section 168(c) and a replace them. A abandons the old freezer the amount of $500,000, and properly class life of 14 years. Every 8 to 10 years, E components and properly recognizes a loss reduces its basis in the building to $0. C hires rebuilds its freight cars. Ten years after E from the abandonment of the components. A a contractor to repair the damage to the places the freight car in service, E performs replaces the abandoned freezer components building and pays the contractor $750,000 for a rebuild to the manufacturer’s original with new components and incurs costs to the work. The work involves replacing the specification, which includes a complete acquire and install the new components. entire roof structure of the building at a cost disassembly, inspection, and reconditioning Under paragraph (k)(1)(i) of this section, A of $350,000 and pumping water from the or replacement of components of the must capitalize the amounts paid to acquire building, cleaning debris from the interior suspension and draft systems, trailer hitches, and install the new freezer components and exterior, and replacing areas of damaged and other special equipment. E also modifies because A replaced components for which it dry wall and flooring at a cost of $400,000. the car to upgrade various components to the had properly deducted a loss. Although resulting from the casualty event, latest engineering standards. The freight car Example 2. Replacement of sold the pumping, cleaning, and replacing is stripped to the frame, with all of its component. Assume the same facts as in damaged drywall and flooring, does not substantial components either reconditioned Example 1, except that A did not abandon directly benefit and is not incurred by reason or replaced. The frame itself is the longest- the components but instead sold them to of the roof replacement. lasting part of the car and is reconditioned. another party and properly recognized a loss (ii) Under paragraph (k)(1)(vi) of this The walls of the freight car are replaced or on the sale. Under paragraph (k)(1)(ii) of this section, C must capitalize as an improvement are sandblasted and repainted. New wheels section, A must capitalize the amounts paid the $350,000 amount paid to the contractor are installed on the car. All the remaining to acquire and install the new freezer to replace the roof structure because the roof components of the car are restored before components because A replaced components structure constitutes a major component and they are reassembled. At the end of the for which it had properly taken into account a substantial structural part of the building rebuild, the freight car has been restored to the adjusted basis of the components in unit of property. In addition, under like-new condition under the manufacturer’s

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specifications. Assume the freight car is the or a similar status under FAA guidelines or of a major component, do not directly unit of property. E is not required to treat as the manufacturer’s original specifications. benefit, and are not incurred by reason of the an improvement and capitalize the amounts After the heavy maintenance, the aircraft was replacement of the cab or the engine under paid to rebuild the freight car under reassembled. Assume the aircraft, including paragraph (g)(1)(i) of this section, even paragraph (k)(1)(v) of this section because, the engines, is a unit of property and has a though the repair was performed at the same although the amounts paid restore the freight class life of 12 years under section 168(c). time as these replacements. Thus, G is not car to like-new condition, the amounts were Although the heavy maintenance is required to capitalize the amounts paid to not paid after the end of the class life of the performed after the end of the class life of the repair the broken taillight. freight car. However, see paragraphs (k)(1)(vi) aircraft, F is not required to treat the heavy Example 12. Related amounts to replace and (k)(6) of this section to determine maintenance as a restoration and major component or substantial structural whether any amounts must be capitalized improvement of the unit of property under part; personal property. (i) H owns a retail because they are paid for the replacement of paragraph (k)(1)(v) of this section because, gasoline station, consisting of a paved area a major component or a substantial structural although extensive, the amounts paid do not used for automobile access to the pumps and part of the unit of property. restore the aircraft to like-new condition. See parking areas, a building used to market Example 8. Rebuild of property to like-new also paragraph (i)(1)(iii) of this section for the gasoline, and a canopy covering the gasoline condition after end of class life. Assume the application of the safe harbor for routine pumps. The premises also consist of same facts as in Example 7, except that E maintenance. underground storage tanks (USTs) that are rebuilds the freight car 15 years after E places Example 10. Replacement of major connected by piping to the pumps and are it in service. Under paragraph (k)(1)(v) of this component or substantial structural part; part of the gasoline pumping system used in section, E must treat as an improvement and personal property. G is a common carrier that the immediate retail sale of gas. The USTs are capitalize the amounts paid to rebuild the owns a fleet of petroleum hauling trucks. G components of the gasoline pumping system. freight car because the amounts paid restore pays amounts to replace the existing engine, To comply with regulations issued by the the freight car to like-new condition after the cab, and petroleum tank with a new engine, Environmental Protection Agency, H is end of the class life of the freight car. cab, and tank. Assume the tractor of the truck required to remove and replace leaking USTs. Example 9. Not a rebuild to a like-new (which includes the cab and the engine) is a In Year 1, H hires a contractor to perform the condition. F is a commercial airline engaged single unit of property and that the trailer removal and replacement, which consists of in the business of transporting freight and (which contains the petroleum tank) is a removing the old tanks and installing new passengers. To conduct its business, F owns separate unit of property. The new engine tanks with leak detection systems. The several aircraft. As a condition of and the cab each constitute a part or removal of the old tanks includes removing maintaining its airworthiness certificates, F is combination of parts that comprise a major the paving material covering the tanks, required by the FAA to establish and adhere component of G’s tractor, because they excavating a hole large enough to gain access to a continuous maintenance program for perform a discrete and critical function in the to the old tanks, disconnecting any strapping each aircraft in its fleet. F performs heavy operation of the tractor. In addition, the cab and pipe connections to the old tanks, and maintenance on its airframes every 8 to 10 constitutes a part or combination of parts that lifting the old tanks out of the hole. years. In Year 1, F purchased an aircraft for comprise a substantial structural part of G’s Installation of the new tanks includes $15 million. In Year 16, F paid $2 million for tractor. Therefore, the amounts paid for the placement of a liner in the excavated hole, the labor and materials necessary to perform replacement of the engine and the cab must placement of the new tanks, installation of a the second heavy maintenance visit on the be capitalized under paragraph (k)(1)(vi) of leak detection system, installation of an airframe of an aircraft. To perform the heavy this section. Moreover, the new petroleum overfill system, connection of the tanks to the maintenance visit, F extensively tank constitutes a part or combination of pipes leading to the pumps, backfilling of the disassembles the airframe, removing items parts that comprise a major component and hole, and replacement of the paving. H also such as engines, landing gear, cabin and a substantial structural part of the trailer. is required to pay a permit fee to the county passenger compartment seats, side and Accordingly, the amounts paid for the to undertake the installation of the new ceiling panels, baggage stowage bins, galleys, replacement of the tank also must be tanks. lavatories, floor boards, cargo loading capitalized under paragraph (k)(1)(vi) of this (ii) H pays the permit fee to the county on systems, and flight control surfaces. As section. October 15, Year 1. On December 15, Year 1, specified by F’s maintenance manual for the Example 11. Repair performed during the contractor completes the removal of the aircraft, F then performs certain tasks on the restoration. Assume the same facts as in old USTs and bills H for the costs of removal. disassembled airframe for the purpose of Example 10, except that, at the same time the On January 15, Year 2, the contractor preventing deterioration of the inherent engine and cab of the tractor are replaced, G completes the installation of the new USTs safety and reliability levels of the airframe. pays amounts to paint the cab of the tractor and bills H for the remainder of the work. These tasks include lubrication and service, with its company logo and to fix a broken Assume that H computes its taxes on a operational and visual checks, inspection taillight on the tractor. The repair of the calendar year basis and H’s gasoline pumping and functional checks, reconditioning of broken taillight and the painting of the cab system is the unit of property. Under minor parts and components, and removal, generally are deductible expenses under paragraph (k)(1)(vi) of this section, H must discard, and replacement of certain life- § 1.162–4. However, under paragraph (g)(1)(i) capitalize the amounts paid to replace the limited single cell parts, such as cartridges, of this section, a taxpayer must capitalize all USTs as a restoration to the gasoline canisters, cylinders, and disks. the direct costs of an improvement and all pumping system because the USTs are parts Reconditioning of parts includes burnishing the indirect costs that directly benefit or are or combinations of parts that comprise a corrosion, repairing cracks, dents, gouges, incurred by reason of an improvement. major component and substantial structural punctures, tightening or replacing loose or Repairs and maintenance that do not directly part of the gasoline pumping system. missing fasteners, replacing damaged seals, benefit or are not incurred by reason of an Moreover, under paragraph (g)(2) of this gaskets, or valves, and similar activities. In improvement are not required to be section, H must capitalize the costs of addition to the tasks described above, to capitalized under section 263(a), regardless removing the old USTs because H has not comply with certain FAA airworthiness of whether they are made at the same time taken a loss on the disposition of the USTs, directives, F inspects specific skin locations, as an improvement. For the amounts paid to and the amounts to remove the USTs directly applies doublers over small areas where paint the logo on the cab, G’s need to paint benefit and are incurred by reason of the cracks were found, adds structural the logo arose from the replacement of the restoration of, and improvement to, the reinforcements, and replaces skin panels on cab with a new cab. Therefore, under gasoline pumping system. In addition, under a small section of the fuselage. However, the paragraph (g)(1)(i) of this section, G must paragraph (g)(1) of this section, H must heavy maintenance does not include the capitalize the amounts paid to paint the cab capitalize the permit fees because they replacement of any major components or as part of the improvement to the tractor directly benefit and are incurred by reason of substantial structural parts of the aircraft because these amounts directly benefit and the improvement to the gasoline pumping with new components. In addition, the heavy are incurred by reason of the restoration of system. Finally, under paragraph (g)(3) of this maintenance visit does not bring the aircraft the tractor. The amounts paid to repair the section, H must capitalize the related to the status of new, rebuilt, remanufactured, broken taillight are not for the replacement amounts paid to improve the gasoline

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pumping system, including the permit fees, rubber membrane begins to wear, and L pumps, duct work, diffusers, air handlers, the amount paid to remove the old USTs, and begins to experience leaks into its retail outside air intake, and a cooling tower. The the amount paid to install the new USTs, premises. However, the building is still chiller unit includes the compressor, even though the amounts were separately functioning in L’s business. To eliminate the evaporator, condenser, and expansion valve, invoiced, paid to different parties, and problems, a contractor recommends that L and it functions to cool the water used to incurred in different tax years. replace the membrane on the roof with a new generate air conditioning throughout the Example 13. Not replacement of major rubber membrane. Accordingly, L pays the building. N pays an amount to replace the component; incidental. J owns a machine contractor to strip the original membrane and chiller with a comparable unit. Under shop in which it makes dies used by replace it with a new rubber membrane. The paragraphs (e)(2)(ii) and (k)(2) of this section, manufacturers. In Year 1, J purchased a drill new membrane is comparable to the original an amount is paid to improve a building if press for use in its production process. In membrane but corrects the leakage problems. the amount is paid to restore the building Year 3, J discovers that the power switch Under paragraphs (e)(2)(ii) and (k)(2) of this structure or any building system. The HVAC assembly, which controls the supply of section, an amount is paid to improve a system, including the chiller unit, is a electric power to the drill press, has become building if the amount is paid to restore the building system under paragraph damaged and cannot operate. To correct this building structure or any building system. (e)(2)(ii)(B)(1) of this section. The chiller unit problem, J pays amounts to replace the power The roof, including the membrane, is part of performs a discrete and critical function in switch assembly with comparable and the building structure as defined under the operation of the HVAC system because it commercially available replacement parts. paragraph (e)(2)(ii)(A) of this section. provides the cooling mechanism for the Assume that the drill press is a unit of Because the entire roof performs a discrete entire system. Therefore, the chiller unit is a property under paragraph (e) of this section and critical function in the building major component of the HVAC system under and the power switch assembly is a small structure, the roof comprises a major paragraph (k)(6)(ii)(A) of this section. component of the drill press that may be component of the building structure under Because the chiller unit comprises a major removed and installed with relative ease. The paragraph (k)(6)(ii)(A) of this section. component of a building system, N must treat power switch assembly is not a major Although the replacement membrane may the amount paid to replace the chiller unit component of the unit of property under aid in the function of the building structure, as a restoration to the building under paragraph (k)(6)(i)(A) of this section because, it does not, by itself, comprise a significant paragraphs (k)(1)(vi) and (k)(2) of this section although the power assembly may affect the portion of the roof major component under and must capitalize the amount paid as an function of J’s drill press by controlling the paragraph (k)(6)(ii)(A) of this section. In improvement to the building under supply of electric power, the power assembly addition, the replacement membrane does paragraph (d)(2) of this section. is an incidental component of the drill press. not comprise a substantial structural part of Example 18. Not replacement of major component or substantial structural part; In addition, the power assembly is not a L’s building structure under paragraph HVAC system. O owns an office building that substantial structural part of J’s drill press (k)(6)(ii)(B) of this section. Therefore, L is not it uses to provide services to customers. The under paragraph (k)(6)(i)(B) of this section. required to capitalize the amount paid to building contains a HVAC system that Therefore, J is not required to capitalize the replace the membrane as a restoration of the incorporates ten roof-mounted units that costs to replace the power switch assembly building under paragraph (k)(1)(vi) of this provide heating and air conditioning for the under paragraph (k)(1)(vi) of this section. section. building. The HVAC system also consists of Example 14. Replacement of major Example 16. Not a replacement of major controls for the entire system and duct work component or substantial structural part; component or substantial structural part; that distributes the heated or cooled air to the roof. K owns a manufacturing building. K HVAC system. M owns a building in which various spaces in the building’s interior. O discovers several leaks in the roof of the it operates an office that provides medical begins to experience climate control building and hires a contractor to inspect and services. The building contains one HVAC problems in various offices throughout the fix the roof. The contractor discovers that a system, which is comprised of three furnaces, office building and consults with a contractor major portion of the decking has rotted and three air conditioning units, and duct work to determine the cause. The contractor recommends the replacement of the entire that runs throughout the building to recommends that O replace three of the roof- roof. K pays the contractor to replace the distribute the hot or cold air throughout the mounted heating and cooling units. O pays entire roof, including the decking, insulation, building. One furnace in M’s building breaks an amount to replace the three specified asphalt, and various coatings. Under down, and M pays an amount to replace it units. No work is performed on the other paragraphs (e)(2)(ii) and (k)(2) of this section, with a new furnace. Under paragraphs roof-mounted heating and cooling units, the an amount is paid to improve a building if (e)(2)(ii) and (k)(2) of this section, an amount duct work, or the controls. Under paragraphs the amount is paid to restore the building is paid to improve a building if the amount (e)(2)(ii) and (k)(2) of this section, an amount structure or any building system. The roof is is paid to restore the building structure or is paid to improve a building if the amount part of the building structure as defined any building system. The HVAC system, restores the building structure or any under paragraph (e)(2)(ii)(A) of this section. including the furnaces, is a building system building system. The HVAC system, Because the entire roof performs a discrete under paragraph (e)(2)(ii)(B)(1) of this including the 10 roof-mounted heating and and critical function in the building section. As the parts that provide the heating cooling units, is a building system under structure, the roof comprises a major function in the system, the three furnaces, paragraph (e)(2)(ii)(B)(1) of this section. As component of the building structure under together, perform a discrete and critical the components that generate the heat and paragraph (k)(6)(ii)(A) of this section. In function in the operation of the HVAC the air conditioning in the HVAC system, the addition, because the roof comprises a large system and are therefore a major component 10 roof-mounted units, together, perform a portion of the physical structure of the of the HVAC system under paragraph discrete and critical function in the operation building structure, the roof comprises a (k)(6)(i)(A) of this section. However, the of the HVAC system and, therefore, are a substantial structural part of the building single furnace is not a significant portion of major component of the HVAC system under structure under paragraph (k)(6)(ii)(B) of this this major component of the HVAC system paragraph (k)(6)(ii)(A) of this section. The section. Therefore, under either analysis, K under paragraph (k)(6)(ii)(A) of this section, three roof-mounted heating and cooling units must treat the amount paid to replace the or a substantial structural part of the HVAC are not a significant portion of a major roof as a restoration of the building under system under paragraph (k)(6)(ii)(B) of this component of the HVAC system under paragraphs (k)(1)(vi) and (k)(2) of this section section. Therefore, M is not required to treat (k)(6)(ii)(A) of this section, or a substantial and must capitalize the amount paid as an the amount paid to replace the furnace as a structural part of the HVAC system, under improvement under paragraph (d)(2) of this restoration of the building under paragraph paragraph (k)(6)(ii)(B) of this section. section. (k)(1)(vi) of this section. Accordingly, O is not required to treat the Example 15. Not replacement of major Example 17. Replacement of major amount paid to replace the three roof- component or substantial structural part; component or substantial structural part; mounted heating and cooling units as a roof membrane. L owns a building in which HVAC system. N owns a large office building restoration of the building under paragraph it conducts its retail business. The roof in which it provides consulting services. The (k)(1)(iv) of this section. decking over L’s building is covered with a building contains one HVAC system, which Example 19. Replacement of major waterproof rubber membrane. Over time, the is comprised of one chiller unit, one boiler, component or substantial structural part; fire

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protection system. P owns a building that it wiring major component under paragraph customers and to remain competitive, it uses to operate its business. P pays an (k)(6)(ii)(A) of this section, nor does it needs to update the guest rooms in its amount to replace the sprinkler system in the comprise a substantial structural part of the facility. Accordingly, T pays amounts to building with a new sprinkler system. Under electrical system under paragraph (k)(6)(ii)(B) replace the bathtubs, toilets, and sinks, and paragraphs (e)(2)(ii) and (k)(2) of this section, of this section. Therefore, under paragraph to repair, repaint, and retile the bathroom an amount is paid to improve a building if (k)(6) of this section, the replacement of 30 walls and floors, which is necessitated by the the amount restores the building structure or percent of the wiring is not the replacement installation of the new plumbing any building system. The fire protection and of a major component or substantial components. The replacement bathtubs, alarm system, including the sprinkler system, structural part of the building, and R is not toilets, sinks, and tile are new and in a is a building system under paragraph required to treat the amount paid to replace different style, but are similar in function and (e)(2)(ii)(B)(6) of this section. As the 30 percent of the wiring as a restoration to quality to the replaced items. T also pays component that provides the fire suppression the building under paragraph (k)(1)(iv) of this amounts to replace certain section 1245 mechanism in the system, the sprinkler section. property, such as the guest room furniture, system performs a discrete and critical Example 22. Replacement of major carpeting, drapes, table lamps, and partition function in the operation of the fire component or substantial structural part; walls separating the bathroom area. T protection and alarm system and is therefore plumbing system. S owns a building in completes this work on two floors at a time, a major component of the system under which it conducts a retail business. The retail closing those floors and leaving the rest of paragraph (k)(6)(ii)(A) of this section. building has three floors. The retail building the hotel open for business. In Year 1, T pays Because the sprinkler system comprises a has men’s and women’s restrooms on two of amounts to perform the updates for 4 of the major component of a building system, P the three floors. S decides to update the 20 hotel room floors and expects to complete must treat the amount paid to replace the restrooms by paying an amount to replace the the renovation of the remaining rooms over sprinkler system as restoration to the plumbing fixtures in all of the restrooms, the next two years. building unit of property under paragraphs including all the toilets and sinks, with (ii) Under paragraphs (e)(2)(ii) and (k)(2) of (k)(1)(vi) and (k)(2) of this section and must modern style plumbing fixtures of similar this section, an amount is paid to improve a capitalize the amount paid as an quality and function. S does not replace the building if the amount restores the building improvement to the building under pipes connecting the fixtures to the structure or any building system. The paragraph (d)(2) of this section. building’s plumbing system. Under plumbing system, including the bathtubs, Example 20. Replacement of major paragraphs (e)(2)(ii) and (k)(2) of this section, toilets, and sinks, is a building system under component or substantial structural part; an amount is paid to improve a building if paragraph (e)(2)(ii)(B)(2) of this section. All electrical system. Q owns a building that it the amount restores the building structure or the bathtubs, together, all the toilets, uses to operate its business. Q pays an any building system. The plumbing system, together, and all the sinks together in the amount to replace the wiring throughout the including the plumbing fixtures, is a building hotel building perform discrete and critical building with new wiring that meets building system under paragraph (e)(2)(ii)(B)(2) of this functions in the operation of the plumbing code requirements. Under paragraphs section. All the toilets together perform a system under paragraph (k)(6)(ii)(A) of this (e)(2)(ii) and (k)(2) of this section, an amount discrete and critical function in the operation section and comprise a large portion of the is paid to improve a building if the amount of the plumbing system, and all the sinks, physical structure of the plumbing system restores the building structure or any together, also perform a discrete and critical under paragraph (k)(6)(ii)(B) of this section. building system. The electrical system, function in the operation of the plumbing Therefore, under paragraph (k)(6)(ii) of this including the wiring, is a building system system. Therefore, under paragraph section, these plumbing components under paragraph (e)(2)(ii)(B)(3) of this (k)(6)(ii)(A) of this section, all the toilets comprise major components and substantial section. As the component that distributes comprise a major component of the plumbing structural parts of the plumbing system, and the electricity throughout the system, the system, and all the sinks comprise a major T must treat the amount paid to replace these wiring performs a discrete and critical component of the plumbing system. plumbing components as a restoration of, and function in the operation of the electrical Accordingly, S must treat the amount paid to improvement to, the building under system under paragraph (k)(6)(ii)(A) of this replace all of the toilets and all of the sinks paragraphs (k)(1)(vi) and (k)(2) of this section. The wiring also comprises a large as a restoration of the building under section. In addition, under paragraph (g)(1)(i) portion of the physical structure of the paragraphs (k)(1)(vi) and (k)(2) of this section of this section, T must treat the costs of electrical system under paragraph (k)(6)(ii)(B) and must capitalize the amount paid as an repairing, repainting, and retiling the of this section. Because the wiring comprises improvement to the building under bathroom walls and floors as improvement a major component and a substantial paragraph (d)(2) of this section. costs because these costs directly benefit and structural part of a building system, Q must Example 23. Not replacement of major are incurred by reason of the improvement to treat the amount paid to replace the wiring component or substantial structural part; the building. Further, under paragraph (g)(3) as a restoration to the building under plumbing system. Assume the same facts as of this section, T must treat the costs paragraphs (k)(1)(vi) and (k)(2) of this section Example 22 except that S does not update all incurred in Years 1, 2, and 3 for the bathroom and must capitalize the amount paid as an the bathroom fixtures. Instead, S only pays remodeling as improvement costs, even improvement to the building under an amount to replace 8 of the total of 20 sinks though they are incurred over a period of paragraph (d)(2) of this section. located in the various restrooms. The 8 several taxable years, because they are related Example 21. Not a replacement of major replaced sinks, by themselves, do not amounts paid to improve the building unit of component or substantial structural part; comprise a significant portion of a major property. Accordingly, under paragraph electrical system. R owns a building that it component (the 20 sinks) of the plumbing (d)(2) of this section, T must treat all the uses to operate its business. R pays an system under paragraph (k)(6)(ii)(A) of this amounts it incurs to update its hotel amount to replace 30 percent of the wiring section nor do they comprise a large portion restrooms as an improvement to the hotel throughout the building with new wiring that of the physical structure of the plumbing building and capitalize these amounts. In meets building code requirements. Under system under paragraph (k)(6)(ii)(B) of this addition, under § 1.263(a)–2 of the paragraphs (e)(2)(ii) and (k)(2) of this section, section. Therefore, under paragraph (k)(6) of regulations, T must capitalize the amounts an amount is paid to improve a building if this section, the replacement of the eight paid to acquire and install each section 1245 the amount restores the building structure or sinks does not constitute the replacement of property. any building system. The electrical system, a major component or substantial structural Example 25. Not replacement of major including the wiring, is a building system part of the building, and S is not required to component or substantial structural part; under paragraph (e)(2)(ii)(B)(3) of this treat the amount paid to replace the eight windows. U owns a large office building that section. All the wiring in the building sinks as a restoration of a building under it uses to provide office space for employees comprises a major component because it paragraph (k)(1)(iv) of this section. that manage U’s operations. The building has performs a discrete and critical function in Example 24. Replacement of major 300 exterior windows that represent 25 the operation of the electrical system. component or substantial structural part; percent of the total surface area of the However, the portion of the wiring that was plumbing system. (i) T owns and operates a building. In Year 1, U pays an amount to replaced is not a significant portion of the hotel building. T decides that, to attract replace 100 of the exterior windows that had

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become damaged. At the time of these of property under paragraphs (k)(1)(vi) and and must capitalize the amounts as an replacements, U has no plans to replace any (k)(2) of this section and must capitalize the improvement to the building under other windows in the near future. Under amount paid as an improvement to the paragraph (d)(2) of this section. paragraphs (e)(2)(ii) and (k)(2) of this section, building under paragraph (d)(2) of this Example 30. Replacement with no an amount is paid to improve a building if section. disposition. (i) X owns an office building the amount restores the building structure or Example 28. Not replacement of major with four elevators serving all floors in the any building system. The exterior windows component or substantial structural part; building. X replaces one of the elevators. The are part of the building structure as defined floors. V owns and operates a hotel building. elevator is a structural component of the under paragraph (e)(2)(ii)(A) of this section. V decides to refresh the appearance of the office building. X chooses to apply Prop. Reg. The 300 exterior windows perform a discrete hotel lobby by replacing the floors in the § 1.168(i)–8 to taxable years beginning on or and critical function in the operation of the lobby. The hotel lobby comprises less than 10 after January 1, 2012, and before the building structure and are, therefore, a major percent of the square footage of the entire applicability date of the final regulations. In component of the building structure under hotel building. V pays an amount to replace accordance with Prop. Reg. § 1.168(i)– paragraph (k)(6)(i)(A) of this section. the wood flooring in the lobby with new 8(c)(4)(ii)(A) (September 19, 2013), the office However, the 100 windows do not comprise wood flooring of a similar quality. V did not building (including its structural a significant portion of this major component replace any other flooring in the building. components) is the asset for tax disposition of the building structure under paragraph Assume that the wood flooring constitutes purposes. X does not treat the structural (k)(6)(ii)(A) of this section or a substantial section 1250 property. Under paragraphs components of the office building as assets structural part of the building structure under (e)(2)(ii) and (k)(2) of this section, an amount under Prop. Reg. § 1.168(i)–8(c)(4)(iii) paragraph (k)(6)(ii)(B) of this section. is paid to improve a building if the amount (September 19, 2013). X also does not make Therefore, under paragraph (k)(6) of this restores the building structure or any the partial disposition election provided section, the replacement of the 100 windows building system. The wood flooring is part of under Prop. Reg. § 1.168(i)–8(d)(2) does not constitute the replacement of a the building structure under paragraph (September 19, 2013), for the elevator. Thus, major component or substantial structural (e)(2)(ii)(A) of this section. All the floors in the retirement of the replaced elevator is not part of the building, and U is not required to the hotel building comprise a major a disposition under section 168, and no loss treat the amount paid to replace the 100 component of the building structure because is taken into account for purposes of windows as restoration of the building under they perform a discrete and critical function paragraph (k)(1)(i) of this section. paragraph (k)(1)(iv) of this section. in the operation of the building structure. (ii) Under paragraphs (e)(2)(ii) and (k)(2) of Example 26. Replacement of major However, the lobby floors are not a this section, an amount is paid to improve a component; windows. Assume the same facts significant portion of a major component building if the amount restores the building as Example 25, except that that U replaces (that is, all the floors) under paragraph structure or any building system. The 200 of the 300 windows on the building. The (k)(6)(ii)(A) of this section, nor do the lobby elevator system, including all four elevators, 300 exterior windows perform a discrete and floors comprise a substantial structural part is a building system under paragraph critical function in the operation of the of the building structure under paragraph (e)(2)(ii)(B)(5) of this section. The building structure and are, therefore, a major (k)(6)(ii)(B) of this section. Therefore, under replacement elevator does not perform a component of the building structure under paragraph (k)(6) of this section, the discrete and critical function in the operation paragraph (k)(6)(i)(A) of this section. The 200 replacement of the lobby floors is not the of elevator system under paragraph windows comprise a significant portion of replacement of a major component or (k)(6)(ii)(A) of this section nor does it this major component of the building substantial structural part of the building comprise a large portion of the physical structure under paragraph (k)(6)(ii)(A) of this unit of property, and V is not required to structure of the elevator system under section. Therefore, under paragraph (k)(6) of treat the amount paid for the replacement of paragraph (k)(6)(ii)(B) of this section. this section, the replacement of the 200 the lobby floors as a restoration to the Therefore, under paragraph (k)(6) of this windows comprise the replacement of a building under paragraph (k)(1)(iv) of this section, the replacement elevator does not major component of the building structure. section. constitute the replacement of a major Accordingly, U must treat the amount paid Example 29. Replacement of major component or substantial structural part of to replace the 200 windows as a restoration component or substantial structural part; the elevator system. Accordingly, X is not of the building under paragraphs (k)(1)(vi) floors. Assume the same facts as Example 28, required to treat the amount paid to replace and (k)(2) of this section and must capitalize except that V decides to refresh the the elevator as a restoration to the building the amount paid as an improvement to the appearance of all the public areas of the hotel under either paragraph (k)(1)(i) or paragraph building under paragraph (d)(2) of this building by replacing all the floors in the (k)(1)(vi) of this section. section. public areas. To that end, V pays an amount Example 31. Replacement with disposition. Example 27. Replacement of substantial to replace all the wood floors in all the public The facts are the same as in Example 30, structural part; windows. Assume the same areas of the hotel building with new wood except X makes the partial disposition facts as Example 25, except that the building floors. The public areas include the lobby, election provided under paragraph Prop. Reg. is a modern design and the 300 windows the hallways, the meeting rooms, the § 1.168(i)–8(d)(2) (September 19, 2013), for represent 90 percent of the total surface area ballrooms, and other public rooms the elevator. Although the office building of the building. U replaces 100 of the 300 throughout the hotel interiors. The public (including its structural components) is the windows on the building. The 300 exterior areas comprise approximately 40 percent of asset for disposition purposes, the result of windows perform a discrete and critical the square footage of the entire hotel X making the partial disposition election for function in the operation of the building building. All the floors in the hotel building the elevator is that the retirement of the structure and are, therefore, a major comprise a major component of the building replaced elevator is a disposition. Thus, component of the building structure under structure because they perform a discrete and depreciation for the retired elevator ceases at paragraph (k)(6)(i)(A) of this section. The 100 critical function in the operation of the the time of its retirement (taking into account windows do not comprise a significant building structure. The floors in all the the applicable convention), and X recognizes portion of this major component of the public areas of the hotel comprise a a loss upon this retirement. Accordingly, X building structure under paragraph significant portion of a major component must treat the amount paid to replace the (k)(6)(ii)(A) of this section, however, they do (that is, all the building floors) of the elevator as a restoration of the building under comprise a substantial structural part of the building structure. Therefore, under paragraphs (k)(1)(i) and (k)(2) of this section building structure under paragraph paragraph (k)(6)(ii)(A) of this section, the and must capitalize the amount paid as an (k)(6)(ii)(B) of this section. Therefore, under replacement of all the public area floors improvement to the building under paragraph (k)(6) of this section, the constitutes the replacement of a major paragraph (d)(2) of this section. In addition, replacement of the 100 windows comprise component of the building structure. the replacement elevator is treated as a the replacement of a substantial structural Accordingly, V must treat the amount paid to separate asset for tax disposition purposes part of the building structure. Accordingly, U replace the public area floors as a restoration pursuant to Prop. Reg. § 1.168(i)–8(c)(4)(ii)(D) must treat the amount paid to replace the 100 of the building unit of property under (September 19, 2013), and for depreciation windows as a restoration of the building unit paragraphs (k)(1)(vi) and (k)(2) of this section purposes pursuant to section 168(i)(6).

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(l) Capitalization of amounts to adapt in a building consisting of twenty retail intended ordinary use of the property at the property to a new or different use—(1) spaces. The space was designed to be time it was placed in service. Accordingly, In general. A taxpayer must capitalize as reconfigured; that is, adjoining spaces could the amounts paid to regrade the land must be an improvement an amount paid to be combined into one space. One of the capitalized as improvements to the land tenants expands its occupancy by leasing two under paragraphs (d)(3) and (l) of this adapt a unit of property to a new or adjoining retail spaces. To facilitate the new section. different use. In general, an amount is lease, B pays an amount to remove the walls Example 5. New or different use; part of paid to adapt a unit of property to a new between the three retail spaces. Assume that building. (i) E owns a building in which it or different use if the adaptation is not the walls between spaces are part of the operates a retail drug store. The store consists consistent with the taxpayer’s ordinary building and its structural components. of a pharmacy for filling medication use of the unit of property at the time Under paragraphs (l)(2) and (e)(2)(ii) of this prescriptions and various departments where originally placed in service by the section, an amount is paid to improve B’s customers can purchase food, toiletries, taxpayer. building if it adapts the building structure or home goods, school supplies, cards, over-the- (2) Application of adaption rule to any of the building systems to a new or counter medications, and other similar items. different use. Under paragraph (l)(1) of this E decides to create a walk-in medical clinic buildings. In the case of a building, an section, the amount paid to convert three where nurse practitioners and physicians’ amount is paid to improve a building if retail spaces into one larger space for an assistants diagnose, treat, and write it is paid to adapt to a new or different existing tenant does not adapt B’s building prescriptions for common illnesses and use a property specified under structure to a new or different use because injuries, administer common vaccinations, paragraph (e)(2)(ii) (building), paragraph the combination of retail spaces is consistent conduct physicals and wellness screenings, (e)(2)(iii)(B) (condominium), paragraph with B’s intended, ordinary use of the and provide routine lab tests and services for (e)(2)(iv)(B) (cooperative), or paragraph building structure. Therefore, the amount common chronic conditions. To create the (e)(2)(v)(B) (leased building or leased paid by B to remove the walls does not clinic, E pays amounts to reconfigure the portion of building) of this section. For improve the building under paragraph (l) of pharmacy building. E incurs costs to build this section and is not required to be new walls creating an examination room, lab example, an amount is paid to improve capitalized under paragraph (d)(3) of this room, reception area, and waiting area. E a building if it is paid to adapt the section. installs additional plumbing, electrical building structure or any one of its Example 3. Not a new or different use; wiring, and outlets to support the lab. E also buildings systems to a new or different preparing building for sale. C owns a acquires section 1245 property, such as use. building consisting of twenty retail spaces. C computers, furniture, and equipment (3) Examples. The following examples decides to sell the building. In anticipation necessary for the new clinic. E treats the illustrate the application of this of selling the building, C pays an amount to amounts paid for those units of property as paragraph (l) only and do not address repaint the interior walls and to refinish the costs of acquiring new units of property whether capitalization is required under hardwood floors. Under paragraphs (l)(2) and under § 1.263(a)–2. another provision of this section or (e)(2)(ii) of this section, an amount is paid to (ii) Under paragraphs (l)(2) and (e)(2)(ii) of improve C’s building to a new or different this section, an amount is paid to improve E’s under another provision of the Code (for use if it adapts the building structure or any building if it adapts the building structure or example, section 263A). Unless of the building systems to a new or different any of the building systems to a new or otherwise stated, assume that the use. Preparing the building for sale does not different use. Under paragraph (l)(1) of this taxpayer has not properly deducted a constitute a new or different use for the section, the amount paid to convert part of loss for any unit of property, asset, or building structure under paragraph (l)(1) of the retail drug store building structure into a component of a unit of property that is this section. Therefore, the amount paid by medical clinic adapts the building structure removed and replaced. C to prepare the building structure for sale to a new and different use, because the use does not improve the building under of the building structure to provide clinical Example 1. New or different use; change in paragraph (l) of this section and is not medical services is not consistent with E’s building use. A is a manufacturer and owns required to be capitalized under paragraph intended ordinary use of the building a manufacturing building that it has used for (d)(3) of this section. structure at the time it was placed in service. manufacturing since Year 1, when A placed Example 4. New or different use; land. D Similarly, the amounts paid to add to the it in service. In Year 30, A pays an amount owns a parcel of land on which it previously plumbing system and the electrical systems to convert its manufacturing building into a operated a manufacturing facility. Assume to support the new medical services is not showroom for its business. To convert the that the land is the unit of property. During consistent with E’s intended ordinary use of facility, A removes and replaces various the course of D’s operation of the these systems when the systems were placed structural components to provide a better manufacturing facility, the land became in service. Therefore, E must treat the amount layout for the showroom and its offices. A contaminated with wastes from its paid for the conversion of the building also repaints the building interiors as part of manufacturing processes. D discontinues structure, plumbing system, and electrical the conversion. When building materials are manufacturing operations at the site and system as an improvement to the building removed and replaced, A uses comparable and commercially available replacement decides to develop the property for and capitalize the amount under paragraphs materials. Under paragraphs (l)(2) and residential housing. In anticipation of (d)(3) and (l) of this section. (e)(2)(ii) of this section, an amount is paid to building residential property, D pays an Example 6. Not a new or different use; part improve A’s manufacturing building if the amount to remediate the contamination of building. (i) F owns a building in which amount adapts the building structure or any caused by D’s manufacturing process. In it operates a grocery store. The grocery store designated building system to a new or addition, D pays an amount to regrade the includes various departments for fresh different use. Under paragraph (l)(1) of this land so that it can be used for residential produce, frozen foods, fresh meats, dairy section, the amount paid to convert the purposes. Amounts that D pays to clean up products, toiletries, and over-the-counter manufacturing building into a showroom wastes do not adapt the land to a new or medicines. The grocery store also includes adapts the building structure to a new or different use, regardless of the extent to separate counters for deli meats, prepared different use because the conversion to a which the land was cleaned, because this foods, and baked goods, often made to order. showroom is not consistent with A’s ordinary cleanup merely returns the land to the To better accommodate its customers’ use of the building structure at the time it condition it was in before the land was shopping needs, F decides to add a sushi bar was placed in service. Therefore, A must contaminated in D’s operations. Therefore, D where customers can order freshly prepared capitalize the amount paid to convert the is not required to capitalize the amount paid sushi from the counter for take-home or to eat building into a showroom as an improvement for the cleanup under paragraph (l)(1) of this at the counter. To create the sushi bar, F pays to the building under paragraphs (d)(3) and section. However, the amount paid to regrade amounts to add a sushi counter and chairs, (l) of this section. the land so that it can be used for residential add additional wiring and outlets to support Example 2. Not a new or different use; purposes adapts the land to a new or the counter, and install additional pipes and leased building. B owns and leases out space different use that is inconsistent with D’s a sink, to provide for the safe handling of the

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food. F also pays amounts to replace flooring method) for regulated taxpayers to method of accounting under section and wall coverings in the sushi bar area with determine whether amounts paid to 446(a). decorative coverings to reflect more repair, maintain, or improve tangible (4) Examples. The following examples ´ appropriate decor. Assume the sushi counter property are to be treated as deductible illustrate the application of this and chairs are section 1245 property, and F treats the amounts paid for those units of expenses or capital expenditures. A paragraph (m): property as costs of acquiring new units of taxpayer that uses the regulatory Example 1. Taxpayer subject to regulatory property under § 1.263(a)–2. accounting method described in accounting rules of FERC. W is an electric (ii) Under paragraphs (l)(2) and (e)(2)(ii) of paragraph (m)(3) of this section must utility company that operates a power plant this section, an amount is paid to improve F’s use that method for property subject to that generates electricity and that owns and building if it adapts the building structure or regulatory accounting instead of operates network assets to transmit and any of the building systems to a new or determining whether amounts paid to distribute the electricity to its customers. W different use. Under paragraph (l)(1) of this repair, maintain, or improve property is subject to the regulatory accounting rules section, the amount paid to convert a part of are capital expenditures or deductible of FERC, and W uses the regulatory F’s retail grocery into a sushi bar area does expenses under the general principles of accounting method under paragraph (m) of not adapt F’s building structure, plumbing sections 162(a), 212, and 263(a). Thus, this section. W does not capitalize on its system, or electrical system to a new or books and records for regulatory accounting different use, because the sale of sushi is the capitalization rules in paragraph (d) purposes the cost of repairs and maintenance consistent with F’s intended, ordinary use of (and the routine maintenance safe performed on its turbines or its network the building structure and these systems in harbor described in paragraph (i)) of this assets. Under the regulatory accounting its grocery sales business, which includes section do not apply to amounts paid to method, W may not capitalize for Federal selling food to its customers at various repair, maintain, or improve property income tax purposes amounts paid for specialized counters. Accordingly, the subject to regulatory accounting by repairs performed on its turbines or its amount paid by F to replace the wall and taxpayers that use the regulatory network assets. floor finishes, add wiring, and add plumbing accounting method under this Example 2. Taxpayer not subject to to create the sushi bar space does not paragraph (m). regulatory accounting rules of FERC. X is an improve the building unit of property under (2) Eligibility for regulatory electric utility company that operates a paragraph (l) of this section and is not power plant to generate electricity. X required to be capitalized under paragraph accounting method. A taxpayer that is previously was subject to the regulatory (d)(3) of this section. engaged in a trade or business in a accounting rules of FERC, but currently X is Example 7. Not a new or different use; part regulated industry is a regulated not required to use FERC’s regulatory of building. (i) G owns a hospital with taxpayer and may use the regulatory accounting rules. X cannot use the regulatory various departments dedicated to the accounting method under this accounting method provided in this provision of clinical medical care. To better paragraph (m). For purposes of this paragraph (m). accommodate its patients’ needs, G decides paragraph (m), a taxpayer is in a Example 3. Taxpayer subject to regulatory to modify the emergency room space to regulated industry only if the taxpayer accounting rules of FCC. Y is a provide both emergency care and outpatient is subject to the regulatory accounting telecommunications company that is subject surgery. To modify the space, G pays rules of the Federal Energy Regulatory to the regulatory accounting rules of the FCC. amounts to move interior walls, add Y uses the regulatory accounting method additional wiring and outlets, replace floor Commission (FERC), the Federal under this paragraph (m). Y’s assets include tiles and doors, and repaint the walls. To Communications Commission (FCC), or a telephone central office switching center, complete the outpatient surgery center, G the Surface Transportation Board (STB). which contains numerous switches and also pays amounts to install miscellaneous (3) Description of regulatory various switching equipment. Y capitalizes medical equipment necessary for the accounting method. Under the on its books and records for regulatory provision of surgical services. Assume the regulatory accounting method, a accounting purposes the cost of replacing medical equipment is section 1245 property, taxpayer must follow the method of each switch. Under the regulatory accounting and G treats the amounts paid for those units accounting for regulatory accounting method, Y is required to capitalize for of property as costs of acquiring new units purposes that it is required to follow for Federal income tax purposes amounts paid to of property under § 1.263(a)–2. FERC, FCC, or STB (whichever is replace each switch. (ii) Under paragraphs (l)(2) and (e)(2)(ii) of applicable) in determining whether an Example 4. Taxpayer subject to regulatory this section, an amount is paid to improve accounting rules of STB. Z is a Class I G’s building if it adapts the building amount paid repairs, maintains, or railroad that is subject to the regulatory structure or any of the building systems to a improves property under this section. accounting rules of the STB. Z uses the new or different use. Under paragraph (l)(1) Therefore, a taxpayer must capitalize for regulatory accounting method under this of this section, the amount paid to convert Federal income tax purposes an amount paragraph (m). Z capitalizes on its books and part of G’s emergency room into an paid that is capitalized as an records for regulatory accounting purposes outpatient surgery center does not adapt G’s improvement for regulatory accounting the cost of locomotive rebuilds. Under the building structure or electrical system to a purposes. A taxpayer may not capitalize regulatory accounting method, Z is required new or different use, because the provision for Federal income tax purposes under to capitalize for Federal income tax purposes of outpatient surgery is consistent with G’s this section an amount paid that is not amounts paid to rebuild its locomotives. intended, ordinary use of the building capitalized as an improvement for (n) Election to capitalize repair and structure and these systems in its clinical maintenance costs—(1) In general. A medical care business. Accordingly, the regulatory accounting purposes. A amounts paid by G to relocate interior walls, taxpayer that uses the regulatory taxpayer may elect to treat amounts paid add additional wiring and outlets, replace accounting method must use that during the taxable year for repair and floor tiles and doors, and repaint the walls method for all of its tangible property maintenance (as defined under § 1.162– to create outpatient surgery space do not that is subject to regulatory accounting 4) to tangible property as amounts paid improve the building under paragraph (l) of rules. The method does not apply to to improve that property under this this section and are not required to be tangible property that is not subject to section and as an asset subject to the capitalized under paragraph (d)(3) of this regulatory accounting rules. The method allowance for depreciation if the section. also does not apply to property for the taxpayer incurs these amounts in (m) Optional regulatory accounting taxable years in which the taxpayer carrying on the taxpayer’s trade or method—(1) In general. This paragraph elected to apply the repair allowance business and if the taxpayer treats these (m) provides an optional simplified under § 1.167(a)–11(d)(2). The amounts as capital expenditures on its method (the regulatory accounting regulatory accounting method is a books and records regularly used in

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computing income (‘‘books and spare parts to which the taxpayer building. In Year 1, R pays an amount to records’’). A taxpayer that elects to applies the optional method of replace 2 of the 10 units to address climate apply this paragraph (n) in a taxable accounting for rotable and temporary control problems in various offices year must apply this paragraph to all throughout the office building. Assume that spare parts under § 1.162–3(e). the replacement of the two units does not amounts paid for repair and (4) Examples. The following examples constitute an improvement to the HVAC maintenance to tangible property that it illustrate the application of this system, and, accordingly, to the building unit treats as capital expenditures on its paragraph (n): of property under paragraph (d) of this books and records in that taxable year. Example 1. Election to capitalize routine section, and that R may deduct these Any amounts for which this election is maintenance on non-rotable part. (i) Q is a amounts as repairs and maintenance under made shall not be treated as amounts towboat operator that owns a fleet of § 1.162–4. paid for repair or maintenance under towboats that it uses in its trade or business. (ii) On its books and records, R treats § 1.162–4. Each towboat is equipped with two diesel- amounts paid for the two HVAC components powered engines. Assume that each towboat, as capital expenditures. R determines that it (2) Time and manner of election. A would prefer to account for these amounts in taxpayer makes this election under this including its engines, is the unit of property and that a towboat has a class life of 18 years. the same way for Federal income tax paragraph (n) by attaching a statement purposes. Under this paragraph (n), in Year to the taxpayer’s timely filed original Assume the towboat engines are not rotable spare parts under § 1.162–3(c)(2). In Year 1, 1, R may elect to capitalize the amounts paid Federal tax return (including Q acquired a new towboat, including its two for the new HVAC components. If R elects to extensions) for the taxable year in which engines, and placed the towboat into service. capitalize such amounts, R must capitalize the taxpayer pays amounts described In Year 4, Q pays amounts to perform all amounts paid for repair and maintenance to tangible property that R treats as capital under paragraph (n)(1) of this scheduled maintenance on both engines in expenditures on its books and records in the towboat. Assume that none of the paragraph. See §§ 301.9100–1 through Year 1. 301.9100–3 of this chapter for the exceptions set out in paragraph (i)(3) of this provisions governing extensions of time section apply to the scheduled maintenance (o) Treatment of capital expenditures. to make regulatory elections. The costs and that the scheduled maintenance on Amounts required to be capitalized Q’s towboat is within the routine under this section are capital statement must be titled ‘‘Section maintenance safe harbor under paragraph 1.263(a)–3(n) Election’’ and include the expenditures and must be taken into (i)(1)(ii) of this section. Accordingly, the account through a charge to capital taxpayer’s name, address, taxpayer amounts paid for the scheduled maintenance identification number, and a statement to its towboat engines in Year 4 are deemed account or basis, or in the case of that the taxpayer is making the election not to improve the towboat and are not property that is inventory in the hands to capitalize repair and maintenance required to be capitalized under paragraph of a taxpayer, through inclusion in costs under § 1.263(a)–3(n). In the case (d) of this section. inventory costs. of a consolidated group filing a (ii) On its books and records, Q treats (p) Recovery of capitalized amounts. consolidated income tax return, the amounts paid for scheduled maintenance on Amounts that are capitalized under this its towboat engines as capital expenditures. section are recovered through election is made for each member of the For administrative convenience, Q decides to consolidated group by the common depreciation, cost of goods sold, or by account for these costs in the same way for an adjustment to basis at the time the parent, and the statement must also Federal income tax purposes. Under include the names and taxpayer paragraph (n) of this section, in Year 4, Q property is placed in service, sold, used, identification numbers of each member may elect to capitalize the amounts paid for or otherwise disposed of by the for which the election is made. In the the scheduled maintenance on its towboat taxpayer. Cost recovery is determined case of an S corporation or a engines. If Q elects to capitalize such by the applicable Code and regulation partnership, the election is made by the amounts, Q must capitalize all amounts paid provisions relating to the use, sale, or S corporation or partnership and not by for repair and maintenance to tangible disposition of property. the shareholders or partners. A taxpayer property that Q treats as capital expenditures (q) Accounting method changes. on its books and records in Year 4. making this election for a taxable year Except as otherwise provided in this Example 2. No election to capitalize section, a change to comply with this must treat any amounts paid for repairs routine maintenance. Assume the same facts and maintenance during the taxable as Example 1, except in Year 8, Q pays section is a change in method of year that are capitalized on the amounts to perform scheduled maintenance accounting to which the provisions of taxpayer’s books and records as for a second time on the towboat engines. On sections 446 and 481 and the improvements to tangible property. The its books and records, Q treats the amounts accompanying regulations apply. A taxpayer must begin to depreciate the paid for this scheduled maintenance as taxpayer seeking to change to a method cost of such improvements amounts capital expenditures. However, in Year 8, Q of accounting permitted in this section when they are placed in service by the decides not to make the election to capitalize must secure the consent of the taxpayer under the applicable the amounts paid for scheduled maintenance Commissioner in accordance with under paragraph (n) of this section. Because § 1.446–1(e) and follow the provisions of the Code and regulations. Q does not make the election under An election may not be made through paragraph (n) for Year 8, Q may apply the administrative procedures issued under the filing of an application for change in routine maintenance safe harbor under § 1.446–1(e)(3)(ii) for obtaining the accounting method or, before obtaining paragraph (i)(1)(ii) of this section to the Commissioner’s consent to change its the Commissioner’s consent to make a amounts paid in Year 8, and not treat these accounting method. late election, by filing an amended amounts as capital expenditures. Because the (r) Effective/applicability date—(1) In Federal tax return. The time and manner election is made for each taxable year, there general. Except for paragraphs (h), (m), of electing to capitalize repair and is no effect on the scheduled maintenance and (n) of this section, this section maintenance costs under this paragraph costs capitalized by Q on its Federal tax applies to taxable years beginning on or (n) may be modified through guidance return for Year 4. after January 1, 2014. Paragraphs (h), Example 3. Election to capitalize (m), and (n) of this section apply to of general applicability (see replacement of building component. (i) R §§ 601.601(d)(2) and 601.602 of this owns an office building that it uses to amounts paid in taxable years beginning chapter). provide services to customers. The building on or after January 1, 2014. Except as (3) Exception. This paragraph (n) does contains a HVAC system that incorporates provided in paragraphs (r)(2) and (r)(3) not apply to amounts paid for repairs or ten roof-mounted units that provide heating of this section, § 1.263(a)–3 as contained maintenance of rotable or temporary and air conditioning for different parts of the in 26 CFR part 1 edition revised as of

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April 1, 2011, applies to taxable years (2) Section 174 (research and § 1.263(a)–6T [Removed] beginning before January 1, 2014. experimental expenditures); ■ Par. 27. Section 1.263(a)–6T is (2) Early application of this section— (3) Section 175 (soil and water removed. (i) In general. Except for paragraphs (h), conservation expenditures; endangered ■ Par. 28. Section 1.263A–0 is amended (m), and (n) of this section, a taxpayer species recovery expenditures); by adding new entries in the outline for may choose to apply this section to (4) Section 179 (election to expense § 1.263A–1(k) and (l) to read as follows: taxable years beginning on or after certain depreciable business assets); January 1, 2012. A taxpayer may choose § 1.263A–0 Outline of the Regulations (5) Section 179A (deduction for clean- under Section 263A. to apply paragraphs (h), (m), and (n) of fuel vehicles and certain refueling this section to amounts paid in taxable property); * * * * * years beginning on or after January 1, (6) Section 179B (deduction for § 1.263A–1 Uniform Capitalization of Costs. 2012. capital costs incurred in complying with * * * * * (ii) Transition rule for certain environmental protection agency sulfur (k) Change in method of accounting. elections on 2012 or 2013 returns. If regulations); (1) In general. (2) Scope limitations. under paragraph (r)(2)(i) of this section, (7) Section 179C (election to expense a taxpayer chooses to make the election (3) Audit protection. certain refineries); (4) Section 481(a) adjustment. to apply the safe harbor for small (8) Section 179D (energy efficient (5) Time for requesting change. taxpayers under paragraph (h) of this commercial buildings deduction); (l) Effective/applicability date. section or the election to capitalize (9) Section 179E (election to expense (1) In general. repair and maintenance costs under advanced mine safety equipment); (2) Mixed service costs; self-constructed paragraph (n) of this section for amounts (10) Section 180 (expenditures by tangible personal property produced on a paid in its taxable year beginning on or farmers for fertilizer); routine and repetitive basis. after January 1, 2012, and ending on or (3) Materials and supplies. (11) Section 181 (treatment of certain (i) In general before September 19, 2013 (applicable qualified film and television taxable year), and the taxpayer did not (ii) Early application of this section. productions); (iii) Optional application of TD 9564. make the election specified in paragraph (12) Section 190 (expenditures to * * * * * (h)(6) or paragraph (n)(2) of this section remove architectural and transportation ■ Par. 29. Section 1.263A–1 is amended on its timely filed original Federal tax barriers to the handicapped and by: return for the applicable taxable year, elderly); ■ 1. Removing paragraphs (b)(14) and the taxpayer must make the election (13) Section 193 (tertiary injectants); specified in paragraph (h)(6) or (m). (14) Section 194 (treatment of ■ 2. Revising paragraphs (c)(4), paragraph (n)(2) of this section for the reforestation expenditures); applicable taxable year by filing an (e)(2)(i)(A), (e)(3)(ii)(E) and (l). (15) Section 195 (start-up The revisions read as follows: amended Federal tax return (including expenditures); the required statements) for the (16) Section 198 (expensing of § 1.263A–1 Uniform capitalization of costs. applicable taxable year on or before 180 environmental remediation costs); * * * * * days from the due date including (17) Section 198A (expensing of (c) * * * extensions of the taxpayer’s Federal tax qualified disaster expenses); (4) Recovery of capitalized costs. return for the applicable taxable year, (18) Section 248 (organization Costs that are capitalized under section notwithstanding that the taxpayer may expenditures of a corporation); 263A are recovered through not have extended the due date. (19) Section 266 (carrying charges); depreciation, amortization, cost of goods (3) Optional application of TD 9564. (20) Section 616 (development sold, or by an adjustment to basis at the A taxpayer may choose to apply expenditures); and time the property is used, sold, placed § 1.263(a)–3T as contained in TD 9564 (21) Section 709 (organization and in service, or otherwise disposed of by (76 FR 81060) December 27, 2011, to syndication fees of a partnership). the taxpayer. Cost recovery is taxable years beginning on or after (c) Effective/applicability date—(1) In determined by the applicable Internal January 1, 2012, and before January 1, general. This section applies to taxable Revenue Code and regulation provisions 2014. years beginning on or after January 1, relating to use, sale, or disposition of § 1.263(a)–3T [Removed] 2014. Except as provided in paragraphs property. ■ Par. 25. Section 1.263(a)–3T is (c)(2) and (c)(3) of this section, * * * * * removed. § 1.263(a)–3 as contained in 26 CFR part (e) * * * ■ 1 edition revised as of April 1, 2011, (2) * * * Par. 26. Section 1.263(a)–6 is added to applies to taxable years beginning before (i) * * * read as follows: January 1, 2014. For the effective dates (A) Direct material costs. Direct § 1.263(a)–6 Election to deduct or of the enumerated election provisions, materials costs include the cost of those capitalize certain expenditures. see those Code sections and the materials that become an integral part of (a) In general. Under certain regulations under those sections. specific property produced and those provisions of the Internal Revenue Code (2) Early application of this section. A materials that are consumed in the (Code), taxpayers may elect to treat taxpayer may choose to apply this ordinary course of production and that capital expenditures as deductible section to taxable years beginning on or can be identified or associated with expenses or as deferred expenses, or to after January 1, 2012. particular units or groups of units of treat deductible expenses as capital (3) Optional application of TD 9564. property produced. For example, a cost expenditures. A taxpayer may choose to apply described in § 1.162–3, relating to the (b) Election provisions. The sections § 1.263(a)–6T as contained in TD 9564 cost of a material or supply, may be a referred to in paragraph (a) of this (76 FR 81060) December 27, 2011, to direct material cost. section include: taxable years beginning on or after * * * * * (1) Section 173 (circulation January 1, 2012, and before January 1, (3) * * * expenditures); 2014. (ii) * * *

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(E) Indirect material costs. Indirect § 1.1016–3 Exhaustion, wear and tear, paragraphs (j)(2) and (j)(3) of this material costs include the cost of obsolescence, amortization, and depletion section, this section applies on or after materials that are not an integral part of for periods since February 13, 1913. December 30, 2003. For the applicability specific property produced and the cost (a) * * * of regulations before December 30, 2003, of materials that are consumed in the (1) * * * see § 1.1016–3 in effect prior to (ii) The determination of the amount ordinary course of performing December 30, 2003 (§ 1.1016–3 as production or resale activities that properly allowable for exhaustion, wear and tear, obsolescence, amortization, contained in 26 CFR part 1 edition cannot be identified or associated with revised as of April 1, 2003). particular units of property. Thus, for and depletion must be made on the example, a cost described in § 1.162–3, basis of facts reasonably known to exist * * * * * relating to the cost of a material or at the end of the taxable year. A (3) Application of § 1.1016– supply, may be an indirect cost. taxpayer is not permitted to take 3T(a)(1)(ii)—(i) In general. Paragraph advantage in a later year of the * * * * * (a)(1)(ii) of this section applies to taxpayer’s prior failure to take any such taxable years beginning on or after (l) Effective/applicability dates—(1) In allowance or the taxpayer’s taking an general. Except as provided in January 1, 2014. Except as provided in allowance plainly inadequate under the paragraphs (j)(3)(ii) and (j)(3)(iii) of this paragraphs (l)(2) and (l)(3) of this known facts in prior years. In the case section, § 1.1016–3(a)(1)(ii) as contained section, the effective dates for this of depreciation, if in prior years the in 26 CFR part 1 edition revised as of section are provided in paragraph (a)(2) taxpayer has consistently taken proper April 1, 2011, applies to taxable years of this section. deductions under one method, the beginning before January 1, 2014. (2) Mixed service costs; self- amount allowable for such prior years constructed tangible personal property may not be increased, even though a (ii) Early application of § 1.1016– produced on a routine and repetitive greater amount would have been 3(a)(1)(ii). A taxpayer may choose to basis. Paragraphs (h)(2)(i)(D), (k), and allowable under another proper method. apply paragraph (a)(1)(ii) of this section (l)(2) of this section apply for taxable For rules governing losses on retirement to taxable years beginning on or after years ending on or after August 2, 2005. or disposition of depreciable property, January 1, 2012. (3) Materials and supplies—(i) In including rules for determining basis, (iii) Optional application of TD 9564. general. The last sentence of paragraphs see § 1.167(a)–8, § 1.168(i)–1T(e), A taxpayer may choose to apply § 1.168(i)–8T, Prop. Reg. § 1.168(i)–1(e) (e)(2)(i)(A) and (e)(2)(ii)(E) of this § 1.1016–3T(a)(1)(ii) as contained in TD (September 19, 2013), or Prop. Reg. section, and paragraph (l)(3) of this 9564 (76 FR 81060) December 27, 2011, § 1.168(i)–8 (September 19, 2013), as section apply to amounts paid (to to taxable years beginning on or after acquire or produce property) in taxable applicable. The application of this paragraph is illustrated by the following January 1, 2012, and before January 1, years beginning on or after January 1, 2014. 2014. Except as provided in paragraph example (for purposes of this example, (l)(3)(ii) or paragraph (l)(3)(iii) of this assume section 167(f)(1) as in effect on § 1.1016–3T [Removed] section, section 1.263A–1 as contained September 19, 2013, applies to taxable in 26 CFR part 1 edition revised as of years beginning on or after January 1, ■ Par. 32. Section 1.1016–3T is April 1, 2011, applies to taxable years 2014): removed. beginning before January 1, 2014. Example. On July 1, 2014, A, a calendar- year taxpayer, purchased and placed in PART 602—OMB CONTROL NUMBERS (ii) Early application of this section. A UNDER THE PAPERWORK taxpayer may choose to apply the last service ‘‘off-the-shelf’’ computer software at a cost of $36,000. This computer software is REDUCTION ACT sentence of paragraphs (e)(2)(i)(A) and not an amortizable section 197 intangible. (e)(2)(ii)(E) of this section, and Pursuant to section 167(f)(1), the useful life ■ paragraph (l)(3) of this section to Par. 33. The authority citation for part of the computer software is 36 months. It has 602 continues to read as follows: amounts paid (to acquire or produce no salvage value. Computer software placed property) in taxable years beginning on in service in 2014 is not eligible for the Authority: 26 U.S.C. 7805. or after January 1, 2012. additional first year depreciation deduction provided by section 168(k). A did not deduct ■ Par. 34. In § 602.101, paragraph (b) is (iii) Optional application of TD 9564. any depreciation for the computer software amended by adding the following A taxpayer may choose to apply for 2014 and deducted depreciation of entries to the table in numerical order § 1.263A–1T(b)(14), the introductory $12,000 for the computer software for 2015. to read as follows: phrase of § 1.263A–1T(c)(4), the last As a result, the total amount of depreciation sentence of § 1.263A–1T(e)(2)(i)(A), the allowed for the computer software as of § 602.101 OMB Control numbers. last sentence of § 1.263A–1T(e)(2)(ii)(E), December 31, 2015, was $12,000. However, * * * * * § 1.263A–1T(l), and § 1.263A–1T(m)(2), the total amount of depreciation allowable as these provisions are contained in TD for the computer software as of December 31, (b) * * * 9564 (76 FR 81060) December 27, 2011, 2015, is $18,000 ($6,000 for 2014 + $12,000 for 2015). As a result, the unrecovered cost CFR part or section where Current OMB to amounts paid (to acquire or produce of the computer software as of December 31, Identified and described control No. property) in taxable years beginning on 2015, is $18,000 (cost of $36,000 less the or after January 1, 2012, and before depreciation allowable of $18,000 as of January 1, 2014. December 31, 2015). Accordingly, ***** depreciation for 2016 for the computer 1.263(a)–1 ...... 1545–2248 § 1.263A–1T [Removed] software is $12,000 (unrecovered cost of 1.263(a)–3 ...... 1545–2248 ■ $18,000 divided by the remaining useful life Par. 30. Section 1.263A–1T is of 18 months as of January 1, 2016, ***** removed. multiplied by 12 full months in 2016). ■ Par. 31. Section 1.1016–3 is amended * * * * * by revising paragraphs (a)(1)(ii), (j)(1), (j) Effective/applicability dates—(1) In and (j)(3) to read as follows: general. Except as provided in

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Beth Tucker, Deputy Commissioner for Operations Support. Approved: August 15, 2013. Mark J. Mazur, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2013–21756 Filed 9–13–13; 11:15 am] BILLING CODE 4830–01–P

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