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May 2013 WWW.BDO.COM
AN ALERT FROM THE BDO Natural Resources Practice
BDO knows: Natural Resources
SUBJECT
Units of Property and Major Components Defined for Steam or Electric Power Generation Property for Capitalization Determinations Pursuant to Section 263(a) u SUMMARY Taxpayers that generate steam or electric power incur significant costs to maintain, replace, or improve generation property. These can be significant annual expenditures, the tax treatment of which can have a significant effect on taxable income. Expenditures to maintain, replace, or improve property are either deducted as repairs under section 162 or capitalized as improvements under section 263(a), depending on the nature of the expenditure. To determine whether an expenditure is deductible or must be capitalized, taxpayers must first determine the appropriate unit of property being repaired or improved. In general, replacing a unit of property or major component requires capitalization. Determining appropriate units of property and major components has led to conflicts between taxpayers and the Internal Revenue Service. These disputes are largely due to the functional interdependence of units of property and components of machinery and equipment. On April 30, 2013, in an attempt to minimize such disputes, the Service issued Rev. Proc. 2013-24 to define units of property and major components for steam or electric power generation property. The revenue procedure includes an extensive appendix of definitions of units of property and major components. A taxpayer is not required to use all the unit-ofproperty definitions set forth in the guidance but may instead elect to use one or more of the definitions provided. However, once used, a unit-of-property definition and its corresponding major-component definition apply to all similar assets of the entity. For consolidated groups and pass-through entities, the determination of the unit of property is made at the entity level for each entity.
Contact: CHARLES DEWHURST Houston 713-986-3127 / [email protected] KEVIN HUBBARD Houston 713-986-3149 / [email protected] NATHAN CLARK Charlotte 704-887-4236 / [email protected]
2
BDO Natural Resources Practice Alert
According to Rev. Proc. 2013-24, taxpayers may implement a change in unit-of-property and major-component definitions for taxable years ending on or after December 31, 2012, by filing a Form 3115, Application for Change in Accounting Method. Under Rev. Proc. 2011-14, this process is an automatic change in accounting method that does not require the prior consent of the Service. The net section 481(a) adjustment is considered in computing taxable income in the year of change. The revenue procedure also includes guidance on how a taxpayer may use statistical sampling extrapolation in connection with a change in method of accounting.
u Considerations Where the taxpayer originally defined and capitalized power generation property using smaller units of property or components than those defined in the revenue procedure, an opportunity may exist to change to larger proper units of property or components and deduct as repair expenditures those costs previously capitalized that do not meet the capitalization requirements for the newly-adopted larger units of property or components. Conversely, where taxpayers relied on larger units of property or components than those outlined in the revenue procedure, taxpayers should consider filing an accounting method change to adopt appropriate units of property, capitalizing costs that were previously improperly deducted as repairs to the larger units of property. By doing so, taxpayers also secure audit protection for tax exposure in prior taxable years. Additionally, when the definitions for a unit of property or major component set forth in Rev. Proc. 2013-24 are used, the Service will not challenge such positions.
BDO’s Natural Resources industry practice BDO’s Natural Resources industry practice provides assurance, tax and advisory services to emerging and established businesses in the United States and all over the world who are involved in both the traditional and alternative energy industries. Our clients often operate across borders either raising capital or making acquisitions abroad. Our extensive industry knowledge is supported by our international network of 1,204 offices in 138 countries, allowing us to provide a consistently high level of service wherever our clients do business. About BDO BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through more than 40 offices and over 400 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multinational clients through a global network of 1,204 offices in 138 countries. BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information, please visit www.bdo.com. Material discussed is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual circumstances. To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. © 2013 BDO USA, LLP. All rights reserved.
AN ALERT FROM THE BDO Natural Resources Practice
BDO knows: Natural Resources
SUBJECT
Units of Property and Major Components Defined for Steam or Electric Power Generation Property for Capitalization Determinations Pursuant to Section 263(a) u SUMMARY Taxpayers that generate steam or electric power incur significant costs to maintain, replace, or improve generation property. These can be significant annual expenditures, the tax treatment of which can have a significant effect on taxable income. Expenditures to maintain, replace, or improve property are either deducted as repairs under section 162 or capitalized as improvements under section 263(a), depending on the nature of the expenditure. To determine whether an expenditure is deductible or must be capitalized, taxpayers must first determine the appropriate unit of property being repaired or improved. In general, replacing a unit of property or major component requires capitalization. Determining appropriate units of property and major components has led to conflicts between taxpayers and the Internal Revenue Service. These disputes are largely due to the functional interdependence of units of property and components of machinery and equipment. On April 30, 2013, in an attempt to minimize such disputes, the Service issued Rev. Proc. 2013-24 to define units of property and major components for steam or electric power generation property. The revenue procedure includes an extensive appendix of definitions of units of property and major components. A taxpayer is not required to use all the unit-ofproperty definitions set forth in the guidance but may instead elect to use one or more of the definitions provided. However, once used, a unit-of-property definition and its corresponding major-component definition apply to all similar assets of the entity. For consolidated groups and pass-through entities, the determination of the unit of property is made at the entity level for each entity.
Contact: CHARLES DEWHURST Houston 713-986-3127 / [email protected] KEVIN HUBBARD Houston 713-986-3149 / [email protected] NATHAN CLARK Charlotte 704-887-4236 / [email protected]
2
BDO Natural Resources Practice Alert
According to Rev. Proc. 2013-24, taxpayers may implement a change in unit-of-property and major-component definitions for taxable years ending on or after December 31, 2012, by filing a Form 3115, Application for Change in Accounting Method. Under Rev. Proc. 2011-14, this process is an automatic change in accounting method that does not require the prior consent of the Service. The net section 481(a) adjustment is considered in computing taxable income in the year of change. The revenue procedure also includes guidance on how a taxpayer may use statistical sampling extrapolation in connection with a change in method of accounting.
u Considerations Where the taxpayer originally defined and capitalized power generation property using smaller units of property or components than those defined in the revenue procedure, an opportunity may exist to change to larger proper units of property or components and deduct as repair expenditures those costs previously capitalized that do not meet the capitalization requirements for the newly-adopted larger units of property or components. Conversely, where taxpayers relied on larger units of property or components than those outlined in the revenue procedure, taxpayers should consider filing an accounting method change to adopt appropriate units of property, capitalizing costs that were previously improperly deducted as repairs to the larger units of property. By doing so, taxpayers also secure audit protection for tax exposure in prior taxable years. Additionally, when the definitions for a unit of property or major component set forth in Rev. Proc. 2013-24 are used, the Service will not challenge such positions.
BDO’s Natural Resources industry practice BDO’s Natural Resources industry practice provides assurance, tax and advisory services to emerging and established businesses in the United States and all over the world who are involved in both the traditional and alternative energy industries. Our clients often operate across borders either raising capital or making acquisitions abroad. Our extensive industry knowledge is supported by our international network of 1,204 offices in 138 countries, allowing us to provide a consistently high level of service wherever our clients do business. About BDO BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through more than 40 offices and over 400 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multinational clients through a global network of 1,204 offices in 138 countries. BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information, please visit www.bdo.com. Material discussed is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual circumstances. To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. © 2013 BDO USA, LLP. All rights reserved.
