On March 15, the IRS issued a Large Business & Industry (LB&I) Directive for field examinations on the repair vs. capitalization issue that essentially suspended current examinations so as to permit taxpayers to file accounting method changes under just-issued revenue procedures (LB&I-4-0312-004).
Taxpayers that are subject to the new temporary regulations in T.D. 9564 are required to file for automatic changes in accounting methods under Rev. Procs. 2012-19 and 2012-20 for tax years beginning after Dec. 31, 2011. The IRS notes that the revenue procedures waive the scope limitations of Rev. Proc. 2011-14, Section 4.02, for a request to change a method of accounting, which normally apply to a taxpayer under examination, for taxpayers’ first or second tax year beginning after Dec. 31, 2011.
For examinations of tax years beginning before Jan. 1, 2012, examiners are instructed to discontinue current exam activity and not begin any new activity with regard to the “issues,” which are defined as:
Whether costs incurred to maintain, replace, or improve tangible property must be capitalized under Sec. 263(a); and
Any correlative issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets (other than a building or its structural components).
The IRS cautions that, if a taxpayer files a Form 3115, Application for Change in Accounting Method, with regard to the issues on or after Dec. 23, 2011 (the date the temporary regulations were issued), for a tax year not covered by the temporary regulations, examiners must determine, in consultation with the accounting method change issue group, whether to examine the form.
In addition, for tax years beginning before Jan. 1, 2012, examiners are told to:
- Withdraw the portions of Forms 4564, Information Document Request, that relate to the development of these issues.
- Withdraw all Forms 5701, Notice of Proposed Adjustment, related to these issues.
- Issue a new Form 5701 with a Form 886-A, Explanation of Adjustments, with language specified in the directive, the essence of which is that the IRS does not accept or reject the position the taxpayer took in its return on these issues; the taxpayer has a two-year period to adopt the appropriate method of accounting under the newly issued revenue procedures; if the taxpayer does not adopt the new method within that time, the taxpayer may be subject to exam for tax years ending after Dec. 31, 2011, going forward. A copy of this form signed by the taxpayer must be uploaded into the IRS’s information management system (IMS).
- Retain workpapers on these issues in the IMS.
- Complete Form 5426, Examination Information Report.
For tax years beginning after Dec. 31, 2011, and before Jan. 1, 2014, examiners should determine whether the taxpayer filed Form 3115. If the taxpayer did, the examiner should perform a “risk assessment” to determine whether to examine the form. If the taxpayer did not file Form 3115, and the period is still open, the examiner must wait until the period is closed; if the period is closed in which the taxpayer should have filed, the examiner must make a “risk assessment” about the issues.
As part of the risk assessment for any Sec. 481(a) adjustment resulting from the change, the examiner should:
- Consider if the adjustment properly accounts for amounts paid that were computed under the taxpayer's prior method and previously deducted;
- Determine if the Sec. 481(a) adjustment resulting from any prior year change was taken into account; and
- Consider the accuracy of the Sec. 481(a) adjustment.
For tax years beginning after Dec. 31, 2013, examiners must follow the regulations in effect and follow normal procedures.