In September 2013, the IRS released the highly anticipated Final Tangible Asset Regulations (often referred as the Repair Regulations). With these new regulations in place, healthcare organizations will face some changes in how they handle the amounts paid to buy or improve tangible property—like their healthcare facilities, fixtures, and much more.
While the new regulations increase healthcare organizations' eligibility for tax benefits, it's important to recognize that the regulations also present many compliance obstacles. Organizations will need to reevaluate their tax practices to ensure they meet the regulations and also secure all possible benefits.
The regulations can have a significant impact in two areas for healthcare organizations:
1. Tax treatment of repairs or improvements to tangible property
Before the repair regulations were issued, little direction was given on whether organizations should capitalize or deduct repairs or improvements. Because of this, many organizations implemented a "capitalize all repairs" policy to avoid any issues with the IRS. Fortunately, the new regulations eliminate any confusion and provide organizations detailed guidelines for how they can "test" a repair and decide if it needs to be capitalized or not. The regulations also have numerous safe harbors that will let taxpayers choose to deduct particular repair expenses securely.
When deciding whether a cost is a repair or improvement, an organization must first determine what actually constitutes the asset being repaired or improved. The IRS uses the term Unit of Property (UOP) to describe the asset and defines UOP based on several rules. UOP is typically comprised of components or assets that rely on each other to function properly, but a specific set of rules pertain to healthcare facilities that have separate structures and subsystems as defined by the IRS.
After the UOP is categorized, there's then a series of three tests taxpayers must evaluate to determine if the repair should be capitalized:
1. Betterment. Is the repair reasonably anticipated to significantly increase the strength or capacity of the UOP?
2. Restoration. Does the repair restore the UOP to original working order? For example, replacement of hospital windows that were damaged during a storm.
3. Adaption. Does the repair adapt the UOP to be used for another function? For instance, converting an old staff break room into an extra patient care area.
If after the process is completed, the organization believes the repair falls into one of the three areas above, the IRS expects the repair to be capitalized. However, if the repair also applies to one of these safe harbors, then it doesn't need to be capitalized.
• De Minimis – With proper documentation and an applicable financial statement (AFS), repair line items or invoices up to $5,000 may be deducted. If lacking an AFS, repair line items or invoices up to $500 may be deducted.
• Routine Maintenance – Taxpayers that document routine maintenance policies and reasonably expect to perform such maintenance more than once in a 10-year period may be able to deduct costs for such maintenance.
These two safe harbors allow healthcare organizations to gain possible tax savings on elements that may have otherwise been capitalized.
2. Deduction of portions of an asset disposed of during a repair / improvement (Partial dispositions)
Historically, one of the most taxpayer unfriendly positions of the IRS had to do with reporting portions of tangible property—specifically the portions of property that were lost as the result of casualty or replaced for a repair. Before the new regulations, healthcare organizations were not able to recognize or deduct these losses until the asset was sold in its entirety or removed from service.. For instance, if a hospital's windows were damaged during a hurricane and later replaced, the hospital had to record the original value of the windows and continue to depreciate the property (over a 39 year life). Now, organizations can choose to perform a partial disposition and recognize a loss on the value of the lost or replaced property value.
The new repair regulations definitely provide better insight into how healthcare organizations should handle their tangible property, but there's a strong possibility that many organizations' current tax accounting practices—especially their fixed asset management systems—are not compliant with the regulations or even effective. Because of this, healthcare organizations should go back and reassess how they deal with their tangible property to guarantee that the switch to the new regulations is both smooth and beneficial.
Dean Sonderegger is the executive director of product management, Bloomberg BNA, Software Segment. Bloomberg BNA is a wholly owned subsidiary of Bloomberg, which is a leading source of legal, regulatory, and business information for professionals. Dean has more than 20 years of experience in the development and delivery of tax and accounting software solutions, with a specific focus on large enterprise clients. During that time, he has helped some of the largest publicly traded corporations in the world select and implement BNA Fixed Assets™ in order to strengthen accounting controls and gain significant efficiencies.
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