Four ways to handle rotable spare parts
As taxpayers are sorting through the ramifications of comprehensive and complex temporary regs issued late last year on how to treat amounts paid to acquire, produce, or improve tangible property one topic of interest for businesses is how the temporary regs treat rotable and temporary spare parts. As this article shows, there actually are four different ways of handling such assets under the temporary regs.
Background.Rotable spare parts are materials and supplies acquired for installation on a unit of property, removable from that unit of property, generally repaired or improved, and either reinstalled on the same or other property or stored for later installation. Temporary spare parts are materials and supplies that are used temporarily until a new or repaired part can be installed and then are removed and stored for later (emergency or temporary) installation. For example, an express delivery service or airline may keep a warehouse full of vital parts necessary to keep its fleet of trucks or planes in service. Similarly, a company that sells and services equipment such as heavy duty copiers for businesses may keep a stock of frequently replaced parts on hand to keep customers from any downtime when a copier malfunctions.
Under the temporary capitalization regs, there are four ways to handle such rotables.
Choice #1—defer the deduction.The general rule for rotable spare parts and temporary spare parts is that are deducted when they are disposed of. The path for this result is that under the regs, non-incidental materials and supplies are deductible in the tax year in which they are used or consumed in the taxpayer's operations. For purposes of the rule for non-incidental materials and supplies, rotable and temporary spare parts are treated as used or consumed in the tax year in which the taxpayer disposes of the parts.
Choice #2 – Adopt new optional method for rotable and temporary spare parts.The regulations allow a taxpayer to use the following optional method for all of its rotable and temporary spare parts in the same trade or business:
(A) Deduct the amount paid to buy or produce the part in the tax year that it is first installed on a unit of property for use in the taxpayer's operations. (Installation costs also are deductible.)
(B) When the part is removed from the unit of property, include in gross income the part's fair market value (FMV).
(C) Include in the basis of the part (i) its FMV when removed (since tax has been paid on that FMV), and (ii) the amount paid to remove the part from the unit of property.
(D) Include in the basis of the part any amounts paid to maintain, repair, or improve the part in the tax year these amounts are paid.
(E) In the tax year the part is reinstalled, deduct the amounts paid to reinstall the part and those amounts included in the basis of the part under (C) and (D), above, to the extent that those amounts have not been previously deducted upon reinstallation.
(F) In the tax year the part is disposed of, deduct the amounts included in the basis of the part under (C) and (D), to the extent that those amounts have not been previously deducted upon reinstallation.
Choice #3—Use elective de minimis rule.A taxpayer may elect to apply a de minimis rule described in the regulations to rotables.
Under this elective de minimis rule, a taxpayer doesn't have to capitalize, nor treat as a material or supply, amounts paid to acquire or produce a unit of property (but not inventory or land) or for the acquisition or production of any material or supply, if:
(1) The taxpayer has an applicable financial statement (AFS), has written accounting procedures in place at the beginning of the tax year for expensing amounts paid for such property under certain dollar amounts, and treats such amounts as expenses on its AFS in accordance with such written accounting procedures. An AFS includes one required to be filed with the Securities and Exchange Commission, or a certified audited financial statement accompanied by an independent CPA's report and used for credit or reporting purposes.
(2) The aggregate of amounts paid and not capitalized under the de minimis rule for the tax year are less than or equal to the greater of (1) 0.1% of the taxpayer's gross receipts for the tax year as determined for federal income tax purposes; or (2) 2% of the taxpayer's total depreciation and amortization expense for the tax year as determined in its AFS.
The election for materials and supplies (including rotables) is made by deducting the amounts paid to acquire or produce a material or supply in the tax year that the amounts are paid. The election is made on the timely filed return for the year that amounts are paid for the material or supply. Once made, the election may be revoked only by filing a request for a private letter ruling and obtaining IRS's consent to revoke the election.
Choice #4—Elect to capitalize and depreciate rotables.A taxpayer may elect to capitalize and depreciate the cost of any material or supply. This election also applies to the cost of any rotable and temporary spare parts.
The election is made by capitalizing the amount paid in the tax year it is paid, and by beginning to depreciate the cost in that year. The election is made on the timely filed return for the year the asset is placed in service by the taxpayer for depreciation purposes. Once made, the election may be revoked with respect to a material or supply (or rotable) only by filing a request for a private letter ruling and obtaining IRS's consent to revoke the election.
Effective date.The above rules generally apply to amounts paid or incurred (to produce or acquire property) in tax years beginning on after January 1, 2012. However, taxpayers may apply the optional method (Choice #2, above) to tax years beginning on or after January 1, 2012.