us-irs-revenue-procedures-irb-2013-43-pdf•Internal Revenue Bulletin 2013-43 (PDF rendition): IRS Revenue Procedures
Internal Revenue Bulletin 2013-43 (PDF rendition): IRS Revenue Procedures
us-irs-revenue-procedures-irb-2013-43-pdfInternal Revenue Bulletin 2013-43 (PDF rendition): IRS Revenue ProceduresGuidance
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Bulletin No. 201 3-43 October 21, 2013 HIGHLIGHTS OF THIS ISSUE These synopses are intended only as aids to the reader in identifying the subject matter covered. They may not be relied upon as authoritative interpretations. INCOME TAX Rev. Rul. 2013–21, page 394. Federal rates; adjusted federalrates; adjusted federal long- term rate and the long-term exempt rate. For purposes of sections 382, 642, 1274, 1288, and other sections of the Code, tables set forth the rates for October 2013. T.D. 9636, page 331. These final regulations provide guidance on the application of sections 162(a) and 263(a) of the Code to amounts paid to acquire, produce, or improve tangible property. They also pro- vide guidance under section 167 regarding accounting for and retirement of depreciable property, and under section 168 re- garding accounting for property under the Modified Acceler- ated Cost Recovery System (MACRS) other than general as- set accounts. They do not finalize or remove the 2011 tem- porary regulations under section 168 regarding general asset accounts and disposition of property subject to section 168, which are addressed in a separate notice of proposed rulemak- ing on this subject (See REG–110732–13). REG–110732–13, page 404. Regulations are proposed regarding dispositions of property subject to depreciation under section 168 of the Code. The proposed regulations also amend the general asset account regulations under section 1.168(i)–1 and the accounting for MACRS property regulations under section 1.168(i)–7. Com- ments are requested by November 18, 2013. A public hearing is scheduled for December 19, 2013. Rev. Proc. 2013–34, page 397. This revenue procedure provides guidance for a requesting spouse seeking equitable relief from income tax liability under section 66(c) or section 6015(f) of the Code. Revenue Proce- dure 2003–61 is superseded. ADMINISTRATIVE Rev. Proc. 2013–34, page 397. This revenue procedure provides guidance for a requesting spouse seeking equitable relief from income tax liability under section 66(c) or section 6015(f) of the Code. Revenue Proce- dure 2003–61 is superseded. Finding Lists begin on page ii. The IRS Mission Provide Americ a’s taxpayers top-quality service by helping them understa nd and meet their tax responsibilities and en- force the law wi th integrity and fairness to all. Introduction The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conven- tions, legislation, court decisions, and other items of general interest. It is published weekly. It is the poli cy of the Service to publish in the Bulletin all sub- stantive ru lings necessary to promote a uniform application of the tax laws , including all rulings that supersede, revoke, mod- ify, or amen d any of those previously published in the Bulletin. All publish ed rulings apply retroactively unless otherwise indi- cated. Pro cedures relating solely to matters of internal man- agement ar e not published; however, statements of internal practices and procedures that affect the rights and duties of taxpayers are published. Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts stated in the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices, identifying details and information of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory requirements. Rulings and procedures reported in the Bulletin do not have the force and effect of Treasury Department Regulations, but they may be used as precedents. Unpublished rulings will not be relied on, used, or cited as precedents by Service personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances are substantially the same. The Bulletin is divided into four parts as follows: Part I.—1986 Code. This part includes rulings and decisions based on provisions of the Internal Revenue Code of 1986. Part II.—Treaties and Tax Legislation. This part is divided into two subparts as follows: Subpart A, Tax Conventions and Other Related Items, and Subpart B, Leg- islation and Related Committee Reports. Part III.—Administrative, Procedural, and Miscellaneous. To the extent practicable, pertinent cross references to these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rul- ings. Bank Secrecy Act Administrative Rulings are issued by the Department of the Treasury’s Office of the Assistant Secre- tary (Enforcement). Part IV.—Items of General Interest. This part includes notices of proposed rulemakings, disbar- ment and suspension lists, and announcements. The last Bulletin for each month includes a cumulative index for the matters published during the preceding months. These monthly indexes are cumulated on a semiannual basis, and are published in the last Bulletin of each semiannual period. The cont ents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate. October 21, 20132013–43 I.R.B. Part I. Rulings and Decisions Under the Internal Revenue Code of 1986 Section 42.—L ow-Income Housing Credi t The adjusted a pplicable federal short-term, mid- term, and long -term rates are set forth for the month of October 201 3. See Rev. Rul. 2013-21, page 394. Section 263.—Capital Expenditures T.D. 9636 DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 602 Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final regulations and removal of temporary regulations. SUMMARY: This document contains final regulati ons that provide guidance on the applica tion of sections 162(a) and 263(a) of the In ternal Revenue Code (Code) to amoun ts paid to acquire, produce, or improve tangible property. The final reg- ulation s clarify and expand the standards in the c urrent regulations under sections 162(a) and 263(a). These final regulations replac e and remove temporary regula- tions u nder sections 162(a) and 263(a) and withdr aw proposed regulations that cross refer enced the text of those temporary regul ations. This document also contains final regulations under section 167 re- gardi ng accounting for and retirement of depre ciable property and final regulations under section 168 regarding accounting for p roperty under the Modified Accel- erat ed Cost Recovery System (MACRS) othe r than general asset accounts. The fina l regulations will affect all taxpayers that acquire, produce, or improve tangible pro perty. These final regulations do not fin alize or remove the 2011 temporary regulations u nder section 168 regarding general asset accounts and disposition of property subj ect to section 168, which are addressed in this issue of the Bulletin. DATES:Effec tive Date:These regulations are effectiv e on September 19, 2013. Applicabili ty Date:In general, these final regula tions apply to taxable years be- ginning on or after January 1, 2014. How- ever, certai nrulesapplyonlytoamounts paid or incu rred in taxable years beginning on or after J anuary 1, 2014. For dates of applicabil ity of the final regulations, see §§1.162–3( j), 1.162–4(c), 1.162–11(b)(2), 1.165–2(d ), 1.167(a)–4(b), 1.167(a)–7(f), 1.167(a)– 8(h),1.168(i)–7(e), 1.263(a)– 1(h),1.263(a)–2(j), 1.263(a)– 3(r), 1.263(a)–6(c), 1.263A–1(l), and 1.1016 –3(j). FOR FURTHE R INFORMATION CONTACT: Concerning §§1.162–3, 1.162–4, 1.162–11,1.263(a)–1, 1.263(a) –2, 1.263(a)–3, and 1.263(a)–6, Merrill D . Feldstein or Alan S. Williams, Office o f Associate Chief Counsel (Income Tax and Accounting), (202) 622–495 0 (not a toll-free call); Concerning §§1.165 –2, 1.167(a)–4, 1.167(a)–7, 1.167(a )–8, 1.168(i)–7, 1.263A–1, and 1.1 016–3, Kathleen Reed or Patric k Clinton, Office Associate Chief Counse l (Income Tax and Accounting), (202) 6 22–4930 (not a toll-free call). SUPPLE MENTARY INFORMATION: Paperw ork Reduction Act The col lection of information contained in this final regulation has been reviewed and app roved by the Office of Manage- ment a nd Budget in accordance with the Paper work Reduction Act of 1995 (44 U.S.C . 3507(d)) under control number 1545– 2248. An agency may not conduct or spo nsor, and a person is not required to re spond to, a collection of information unle ss the collection of information dis- play s a valid control number assigned by the O ffice of Management and Budget. The c ollection of information in this regulation is in §§1.263(a)–1(f)(5), 1.26 3(a)–3(h)(6), and 1.263(a)–3(n)(2). This informat ion is required in order for a taxpayer to e lect to use thede minimis safe harbor, t o elect to use the safe har- bor for small taxpayers, and to elect to capitalize r epair and maintenance costs. This informa tion will inform the IRS that the taxpayer is electing to use these pro- visions, wh ich allows taxpayers to obtain beneficial treatment for the amounts that qualify for these elections. The collection of informat ion is voluntary to obtain a benefit und er the final regulations. The likely res pondents are business or other for-profi t institutions, and small busi- nesses or o rganizations. Estimated total annual reporting bur- den: 1,100 ,000 hours. Estimated annual burden hours per re- spondent v aries from .25 hours to .5 hours, dependin g on individual circumstances, with an es timated average of .275 hours. Estimate d number of respondents: 4,000,00 0. Estimate d frequency of responses: An- nually. Books or r ecords relating to a collection of inform ation must be retained as long as their c ontents may become material in the admin istration of any internal revenue law. Gene rally, tax returns and tax return informa tion are confidential, as required by secti on 6103. Backgro und Section 263(a) provides that no deduc- tion is a llowed for (1) any amount paid out for new b uildings or permanent improve- ments o r betterments made to increase the value o f any property or estate, or (2) any amount expendedinrestoringpropertyor in maki ng good the exhaustion thereof for which a n allowance has been made. Final regula tions previously issued under sec- tion 2 63(a) provided that capital expendi- tures included amounts paid or incurred to (1) ad d to the value, or substantially pro- long t he useful life, of property owned by the ta xpayer, or (2) adapt the property to a new o r different use. However, those regu- lati ons also provided that amounts paid or incu rred for incidental repairs and mainte- nanc e of property within the meaning of sect ion 162 and §1.162–4 of the Income 2013–43 I.R.B.331October 21, 2013 Tax Regulations are not capital expendi- tures under §1.263(a)–1. The determination of whether an ex- pense may be deducted as a repair or must be capitalized generally requires an ex- amination of all of a taxpayer’s particu- lar facts and circumstances. Moreover, the subjective nature of the existing standards described above has resulted in consider- able controversy between taxpayers and the IRS over many years. In 2006, in an effort to reduce the con- troversy in this area, the IRS and the Trea- sury Department published in theFederal RegisterAugust 21, 2006 (71 FR 48590) proposed amendments to the regulations under section 263(a) relating to amounts paid to acquire, produce, or improve tan- gible property. The IRS and the Trea- sury Department received numerous writ- ten comments in response to these pro- posed regulations. After considering these comments and the statements at the pub- lic hearing, in 2008 the IRS and the Trea- sury Department withdrew the 2006 pro- posed regulations and proposed new regu- lations in theFederal RegisterMarch 10, 2008 (73 FR 12838). The IRS and the Treasury Department also received many written comments and held a public hear- ing on the 2008 proposed regulations. On December 27, 2011, the IRS and the Trea- sury Department published temporary reg- ulations in theFederal Registerregard- ing the deduction and capitalization of ex- penditures related to tangible property (TD 9564; 76 FR 81060), withdrew the 2008 proposed regulations, and published new proposed regulations that cross referenced the text of the 2011 temporary regulations. The 2011 temporary regulations initially applied to taxable years beginning on or af- ter January 1, 2012. The IRS and the Trea- sury Department received numerous writ- ten comments in response to the 2011 tem- porary and proposed regulations and held a public hearing on May 9, 2012. After considering these comments and the state- ments at the public hearing, the IRS and the Treasury Department published No- tice 2012–73 (2012–51 I.R.B. 713), on November 20, 2012, announcing that, to assist taxpayers in their transitions to the 2011 temporary regulations and final reg- ulations, the IRS and the Treasury Depart- ment would change the applicability date of the 2011 temporary regulations to tax- able years beginning on or after January 1, 2014, while permitting taxpayers to choose to apply the 2011 temporary regulations to taxable years beginning on or after January 1, 2012, and before the applicability date of the final regulations. The Notice also alerted taxpayers that the IRS and the Trea- sury Department intended to publish final regulations in 2013 and expected the final regulations to apply to taxable years begin- ning on or after January 1, 2014, but that the final regulations would permit taxpay- ers to apply its provisions to taxable years beginning on or after January 1, 2012. On December 17, 2012, the Treasury De- partment and the IRS published technical amendments to TD 9564, which amended the applicability date of the 2011 tempo- rary regulations to taxable years beginning on or after January 1, 2014, while permit- ting taxpayers to choose to apply the 2011 temporary regulations to taxable years be- ginning on or after January 1, 2012, and before the applicability date of the final regulations. SeeFederal Register(77 FR 74583). After considering all of the comments and the statements made at the public hear- ing on the 2011 temporary and proposed regulations, the IRS and the Treasury De- partment are removing the 2011 temporary regulations under sections 162, 165, 167, 263(a), 263A, 1016, and §1.168(i)–7 and are issuing final regulations. The IRS and the Treasury Department are also remov- ing the 2011 proposed regulations and are issuing new proposed regulations regard- ing the disposition of property subject to section 168. The proposed regulations are set forth in this issue of the Bulletin. Explanation of Provisions I.Overview Section 263(a) generally requires the capitalization of amounts paid to acquire, produce, or improve tangible property. Section 162 allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, includ- ing the costs of certain supplies, repairs, and maintenance. These final regula- tions provide a general framework for distinguishing capital expenditures from supplies, repairs, maintenance, and other deductible business expenses. The final regulations retain many of the provisions of the 2011 temporary and proposed reg- ulations (2011 temporary regulations), which in many instances incorporated standards from case law and other ex- isting authorities under sections 162 and 263(a). The final regulations also modify several sections of the 2011 temporary regulations in response to comments re- ceived and to clarify and simplify the rules while achieving resultsthat are consistent with the case law. The final regulations adopt the same general format as the 2011 temporary regulations, where §1.162–3 provides rules for materials and supplies, §1.162–4 addresses repairs and main- tenance, §1.263(a)–1 provides general rules for capital expenditures, §1.263(a)–2 provides rules for amounts paid for the acquisition or production of tangible prop- erty, and §1.263(a)–3 provides rules for amounts paid for the improvement of tangible property. However, the final reg- ulations refine and simplify some of the rules contained in the 2011 temporary reg- ulations and create a number of new safe harbors. For example, the final regulations adopt a revised and simplifiedde min- imissafe harbor under §1.263(a)–1(f) and extend the safe harbor for routine mainte- nance under §1.263(a)–3(i) to buildings. The final regulations also add a safe harbor for small taxpayers to the rules governing improvements to tangible property under §1.263(a)–3. In addition, the final reg- ulations refine several of the criteria for defining betterments and restorations to tangible property. In addition, these regulations finalize certain temporary regulations under sec- tion 167 regarding accounting for and retirement of depreciable property and section 168 regarding accounting for MACRS property, other than general asset accounts. However, these regulations do not finalize the rules under §1.168(i)–1T or §1.168(i)–8T addressing the definition of disposition for property subject to sec- tion 168. Instead, to address significant changes in this area, revised regulations under section 168 are being proposed con- currently with these final regulations (and appear in this issue of the Bulletin). II.Materials and Supplies Under §1.162–3 Responding to generally favorable comments on the treatment of materi- October 21, 20133322013–43 I.R.B. als and supplies in the 2011 temporary regulations, the final regulations retain the framework and many of the rules set forth in the 2011 temporary regulations. In response to comments, however, the final regulations expand the definition of materials and supplies to include property that has an acquisition or production cost of $200 or less (increased from $100 or less), clarify application of the optional method of accounting for rotable and temporary spare parts, and simplify the application of thede minimissafe harbor of §1.263(a)–1(f) to materials and sup- plies. The final regulations also define standby emergency spare parts and limit the application of the election to capital- ize materials and supplies to only rotable, temporary, and standby emergency spare parts. A.Definition of materials and supplies Commenters requested that the dollar threshold for characterizing a unit of prop- erty as a material or supply be increased from property with an acquisition cost of $100 or less to property with an acquisition cost of $500 or $1,000. Specifically, com- menters were concerned that the low $100 threshold would not capture many com- mon supplies such as calculators and cof- fee makers. Balancing concerns over dis- tortions to income that could result from increasing the acquisition cost to $500 (or more) with the need to include the typical materials and supplies ordinarily used by many taxpayers, the final regulations in- crease the $100 threshold to $200. In ad- dition, the final regulations retain the lan- guage providing the IRS and the Treasury Department with the authority to change the amount of this threshold through pub- lished guidance. Commenters also continued to question the effect of the 2011 temporary regula- tions on the treatment of standby emer- gency spare parts under Rev. Rul. 81–185 (1981–2 C.B. 59). To resolve questions in this area, the final regulations generally in- corporate the definition of standby emer- gency spare parts provided in Rev. Rul. 81–185 into the definition of materials and supplies and provide that these parts are el- igible for the optional election to capitalize certain materials and supplies provided in §1.162–3(d). B.Election to capitalize certain materials and supplies The 2011 temporary regulations re- tained the rule from the 2008 proposed regulations permitting a taxpayer to elect to capitalize and depreciate amounts paid for certain materials and supplies. Sev- eral comments noted that the requirement to elect to capitalize certain material and supply costs continued to be inconsistent with prior IRS pronouncements that dis- tinguished certain depreciable property from materials and supplies. See, for ex- ample, Rev. Rul. 2003–37 (2003–1 C.B. 717) (permitting taxpayers to treat cer- tain rotable spare parts used in a service business as depreciable assets); Rev. Rul. 81–185 (1981–2 C.B. 59) (concluding that major standby emergency spare parts are depreciable property); Rev. Rul. 69–201 (1969–1 C.B. 60) (holding that standby replacement parts used in pit mining busi- ness are items for which depreciation is allowable); Rev. Rul. 69–200 (1969–1 C.B. 60) (holding that flight equipment rotable spare parts and assemblies are tangible property for which deprecia- tion is allowable while expendable flight equipment spare parts are materials and supplies); Rev. Proc. 2007–48 (2007–2 C.B. 110) (providinga safe harbor method of accounting to treat certain rotable spare parts as depreciable assets). In addition, several comments noted that the rule under the 2011 temporary regulations could lead to problematic results, such as permitting a component acquired to improve a unit of tangible property owned by the taxpayer to be treated as an asset and depreciated over a recovery period different from the unit of tangible property intended to be improved. To address these concerns, the final reg- ulations retain the rule permitting a tax- payer to elect to capitalize and depreciate amounts paid for certain materials and sup- plies but provide that this rule is only ap- plicable to rotable, temporary, or standby emergency spare parts. By limiting the ap- plication of the rule to rotable, temporary, or standby emergency spare parts, the final regulations resolve the potentially prob- lematic results arising in the 2011 tempo- rary regulations. And while the final rule modifies Rev. Rul. 2003–37, Rev. Rul. 81–185, Rev. Rul. 69–200, and Rev. Rul. 69–201 to the extent that the regulations characterize certain tangible properties ad- dressed in these rulingsas materials and supplies, the treatment is consistent with the holdings of the revenue rulings, which permit taxpayers to treat rotable, tempo- rary, or standby emergency spare parts as assets subject to the allowance for depreci- ation. The final regulations also clarify the procedure for a taxpayer that wants to re- voke the election tocapitalize and depre- ciate certain materials and supplies. The taxpayer may revoke this election by filing a request for a letter ruling and obtaining the consent of the Commissioner of Inter- nal Revenue to revoke this election. The Commissioner may grant a request to re- voke this election if the taxpayer acted rea- sonably and in good faith, and the revo- cation will not prejudice the interests of the Government. In deciding whether to grant such a request, the Commissioner an- ticipates applying standards similar to the standards under §301.9100–3 of this chap- ter for granting extensions of time for mak- ing regulatory elections. Finally, one commenter requested that the rules governing materials and sup- plies be modified to address the cost of acquiring or producing rotable spare parts that a taxpayer leases to customers in the ordinary course of the taxpayer’s leas- ing business. This commenter requested that the final regulations clarify that these leased rotable spare parts are included in the definition of rotable and temporary spare parts and that a taxpayer may elect to capitalize and depreciate these leased rotable spare parts under the materials and supplies rules. Under the 2011 temporary regulations, the definition of rotable and temporary spare parts includes only com- ponents acquired to maintain, repair, or improve a unit of property owned, leased, or serviced by the taxpayer. This defini- tion of rotable and temporary spare parts does not include components that the tax- payer leases to its customers and that are unrelated to other property owned, leased to other parties, or serviced by the tax- payer. The final regulations do not expand the definition of rotable and temporary spare parts to include leased rotable spare parts. The IRS and the Treasury Depart- ment believe that these parts are outside the scope of regulations governing materi- als and supplies. 2013–43 I.R.B.333October 21, 2013 C.Optional method for rotable and temporary spare parts One commenter requested that the final regulations remove the requirement that the optional method for rotable and tem- porary spare parts, if elected, be used for all of a taxpayer’s rotable and temporary spare parts in the same trade or business. Recognizing that taxpayers may have pools of rotable or temporary parts that are treated differently for financial statement purposes, the final regulations modify this rule. The final regulations provide that a taxpayer that uses the optional method for rotable and temporary spare parts for Federal tax purposes must use the optional method for all of the pools of rotable and temporary spare parts used in the same trade or business for which the optional method is used for the taxpayer’s books and records. Thus, a taxpayer generally is not required to use the optional method for those pools of rotable or temporary spare parts for which it does not use the optional method in its books and records for the trade or business. However, if a taxpayer chooses to use the optional method for any pool of rotable or temporary spare parts for which the taxpayer does not use the optional method in its books and records for the trade or business, then the taxpayer must use the optional method for all its pools of rotable and temporary spare parts in that trade or business. Commenters also requested that the optional method for rotable and temporary spare parts be treated as the default method of accounting for rotable and temporary spare parts, instead of treating rotable and temporary spare parts as used and con- sumed in the taxable year when disposed. Many taxpayers do not use the optional method of accounting for rotable and temporary spare parts, and that method requires a degree of record keeping that would be overly burdensome for all tax- payers. Therefore, the final regulations do not adopt this suggestion and continue to generally treat rotable and temporary spare parts as materials and supplies that are used and consumed in the taxable year when disposed of by the taxpayer, unless the taxpayer chooses a different treatment under §1.162–3. D.Materials and supplies under the de minimis safe harbor There were numerous comments on the application of thede minimisrule provided in the 2011 temporary regulations to ma- terials and supplies under §§1.162–3T(f) (electiontoapplyde minimisrule to ma- terials and supplies) and 1.263(a)–2T(g) (generalde minimisrule) and the interac- tion between the two sections. In response to these comments, the final regulations more clearly coordinate the two provisions as addressed below in the discussion of the de minimissafe harbor. E.Property treated as materials and supplies in published guidance Several commenters questioned the effect of the 2011 temporary regulations on prior published guidance that permits taxpayers to treat certain property as ma- terials and supplies. For example, Rev. Proc. 2002–12 (2002–1 C.B. 374) allows a taxpayer to treat smallwares as materials and supplies that are not incidental under §1.162–3. Similarly, Rev. Proc. 2002–28 (2002–1 C.B. 815) allows a qualifying small business taxpayer to treat certain inventoriable items in the same manner as materials and supplies that are not inciden- tal under §1.162–3. The final regulations do not supersede, obsolete, or replace these revenue procedures to the extent they deem certain property to constitute materials and supplies under §1.162–3. This designated property continues to qualify as materials and supplies under the final regulations, because the definition of material and supplies includes property that is identified as materials and supplies in published guidance. III.Repairs Under §1.162–4 The 2011 temporary regulations pro- vided that amounts paid for repairs and maintenance to tangible property are de- ductible if the amounts paid are not re- quired to be capitalized under §1.263(a)–3. The IRS and the Treasury Department re- ceived no comments on this regulation. The final regulations retain the rule from the 2011 temporary regulations. In addi- tion, the final regulations add a cross ref- erence to §1.263(a)–3(n), the new election to capitalize amounts paid for repair and maintenance consistent with the taxpayer’s books and records, discussed later in this preamble. IV.De Minimis Safe Harbor Under §§1.263(a)–1(f) and 1.162–3(f) A.De minimis safe harbor ceiling The 2011 temporary regulations re- quired a taxpayer to capitalize amounts paid to acquire or produce a unit of real or personal property, including the related transaction costs.However, §1.263(a)–2T(g) provided ade minimis exception permitting a taxpayer to deduct certain amounts paid for tangible property if the taxpayer had an applicable financial statement, had written accounting proce- dures for expensing amounts paid for such property under specified dollar amounts, and treated such amounts as expenses on its applicable financial statement. Under §1.263(a)–2T(g)(1)(iv), a taxpayer’sde minimisdeduction for the taxable year was limited to a ceiling: the greater of (1) 0.1 percent of the taxpayer’s gross receipts for the taxable year as determined for Fed- eral income tax purposes, or (2) 2 percent of the taxpayer’s total depreciation and amortization expense for the taxable year as determined on the taxpayer’s applicable financial statement. The IRS and the Treasury Department received a significant number of com- ments addressing thede minimissafe har- bor provided in §1.263(a)–2T(g). Nearly all comments raised concerns about the administrative burden the ceiling would place on taxpayers, noting that taxpay- ers would be required to keep detailed accounts of amounts that they generally do not track because such amounts are expensed under their financial accounting capitalization policies. Thus, while the ceiling itself could be calculated relatively simply, the financial accounting systems employed by most taxpayers would not allow them to easily determine which costs thede minimisrule applied to and, therefore, whether or not applicable costs exceeded the ceiling. Commenters also pointed out that the operation of the ceil- ing requirement did not allow taxpayers to anticipate when they had reached the gross receipts or depreciation limitation or to identify assets that would be excluded under thede minimisrule during a taxable year, because the ceiling amount could October 21, 20133342013–43 I.R.B. only be calculated after the end of a taxable year. Commenters also highlighted the complexities inherent in the application of the ceiling requirement for consoli- dated groups. In many cases, commenters suggested that the administrative burden imposed would outweigh any potential tax benefit. Many commenters suggested that this problem be resolved by remov- ing the ceiling altogether and permitting taxpayers to deduct for Federal income tax purposes amounts properly expensed under their financial accounting policies. The final regulations adopt com- menters’ suggestions that the ceiling in thede minimisrule in the 2011 tempo- rary regulations be eliminated and that amounts properly expensed under a tax- payer’s financial accounting policies be deductible for tax purposes. To both address taxpayers’ concerns and ensure that thede minimissafe harbor in the final regulations requires taxpayers to use a reasonable, consistent methodol- ogy that clearly reflects income for Fed- eral income tax purposes, the ceiling in §1.263(a)–2T(g)(1)(iv) has been replaced with a new safe harbor determined at the invoice or item level and based on the policies that the taxpayer utilizes for its financial accounting books and records. A taxpayer with an applicable financial statement may rely on thede minimissafe harbor under §1.263(a)–1(f) of the final regulations only if the amount paid for property does not exceed $5,000 per in- voice, or per item as substantiated by the invoice. The final regulations provide the IRS and the Treasury Department with the authority to change the safe harbor amount through published guidance. Commenters also asked that thede min- imissafe harbor be expanded to include not only amounts paid for property cost- ing less than a certain dollar amount but also amounts paid for property having a useful life less than a certain period of time. The final regulations adopt this sug- gestion and provide that thede minimis safe harbor also applies to a financial ac- counting procedure that expenses amounts paid for property with an economic use- ful life of 12 months or less as long as the amount per invoice (or item) does not ex- ceed $5,000. Such amounts are deductible under thede minimisrule whether this fi- nancial accounting procedure applies in isolation or in combination with a finan- cial accounting procedure for expensing amounts paid for property that does not ex- ceed a specified dollar amount. Under ei- ther procedure, if the cost exceeds $5,000 per invoice (or item), then the amounts paid for the property will not fall within thede minimissafe harbor. In addition, an anti-abuse rule is provided to aggregate costs that are improperly split among mul- tiple invoices. B.Taxpayers without an applicable financial statement The 2011 temporary regulations did not provide ade minimissafe harbor for taxpayers without an applicable financial statement, but the preamble requested comments addressing alternatives that would provide the IRS and the Treasury Department with assurance that a taxpayer is using a reasonable, consistent method- ology that clearly reflects income. One commenter suggested that the definition of applicable financial statement be ex- panded to include financial statements subject to a compliance review under the rules of the American Institute of Certified Public Accountants’ (AICPA) Statement of Standards for Accounting and Re- view Services. Numerous comments also requested that thede minimisrule be gen- erally expanded to taxpayers without an applicable financial statement. The final regulations include ade min- imisrule for taxpayers without an applica- ble financial statement. While careful con- sideration was given to the suggestion of relying on reviewed financial statements as defined in the AICPA’s Statement of Standards for Accounting and Review Ser- vices, the final regulations do not adopt this standard. While the AICPA standard for reviewed financial statements ensures that the taxpayer’s policies comply with the applicable financial accounting frame- work, the standard does not contemplate a review of the taxpayer’s internal control, fraud risk, or accounting records. Thus, the standard does not provide sufficient assurance to the IRS that such policies are being followed and, accordingly, that the taxpayer is using a reasonable, consis- tent methodology that clearly reflects its income. However, the final regulations do provide ade minimissafe harbor for taxpayers without an applicable financial statement if accounting procedures are in place to deduct amounts paid for property costing less than a specified dollar amount or amounts paid for property with an eco- nomic useful life of 12 months or less. Thede minimissafe harbor for taxpayers without an applicable financial statement provides a reduced per invoice (or item) threshold because there is less assurance that the accounting procedures clearly re- flect income. A taxpayer without an appli- cablefinancialstatementmayrelyonthe de minimissafe harbor only if the amount paid for property does not exceed $500 per invoice, or per item as substantiated by the invoice. If the cost exceeds $500 per in- voice (or item), then no portion of the cost of the property will fall within thede min- imissafe harbor. Similar to the safe harbor for a taxpayer with an applicable financial statement, this provision provides the IRS and the Treasury Department with the au- thority to change the safe harbor amount through published guidance. In addition, an anti-abuse rule is provided to aggregate costs that are improperly split among mul- tiple invoices. Finally, for both taxpayers with appli- cable financial statements and taxpayers without applicable financial statements, thede minimissafe harbor is not intended to prevent a taxpayer from reaching an agreement with its IRS examining agents that, as an administrative matter, based on risk analysis or materiality, the IRS exam- ining agents will not review certain items. It is not intended that examining agents must now revise their materiality thresh- olds in accordance with thede minimis safe harbor limitations provided in the fi- nal regulation. Thus, if examining agents and a taxpayer agree that certain amounts in excess of thede minimissafe harbor limitations are not material or otherwise should not be subject to review, that agree- ment should be respected, notwithstanding the requirements of thede minimissafe harbor. However, a taxpayer that seeks a deduction for amounts in excess of the amount allowed by the safe harbor has the burden of showing that such treatment clearly reflects income. C.Safe harbor election Commenters asked whether thede min- imisrule in the 2011 temporary regula- tions was mandatory or elective and, if mandatory, requested a change to make 2013–43 I.R.B.335October 21, 2013 the safe harbor elective. The final regula- tions adopt these suggestions and provide that thede minimisrule is a safe harbor, elected annually by including a statement on the taxpayer’s timely filed original Fed- eral tax return for the year elected. The final regulations provide that, if elected, thede minimissafe harbor must be ap- plied to all amounts paid in the taxable year for tangible property that meet the re- quirements of thede minimissafe harbor, including amounts paid for materials and supplies that meet the requirements. In ad- dition, the final regulations provide that a taxpayer may not revoke an election to use thede minimissafe harbor. An election to use thede minimissafe harbor may not be made through the filing of an application for change in accounting method. D.Written accounting procedures The 2011 temporary regulations re- quired that to utilize thede minimissafe harbor, a taxpayer must have written accounting procedures in place at the be- ginning of the taxable year treating the amounts paid for property costing less than a certain dollar amount as an expense for financial accounting purposes. Com- menters suggested that transition guidance be issued for taxpayers that did not have written accounting procedures in place at the beginning of 2012. Alternatively, one commenter suggested that taxpayers be allowed to make the drafting of a written accounting procedure retroactive to the beginning of 2012. The final regulations do not adopt these suggestions for transition relief. Although the publication of the 2011 temporary reg- ulations late in the calendar year (Decem- ber 27, 2011) likely prevented taxpayers without written accounting procedures at that time from implementing such proce- dures prior to the beginning of the 2012 taxable year, the provisions of the 2011 temporary regulationsare elective for tax- able years beginning prior to January 1, 2014. In addition, the final regulations are not applicable until taxable years begin- ning on or after January 1, 2014. There- fore, taxpayers without written account- ing procedures that choose to elect thede minimissafe harbor for their 2014 tax- able years should have sufficient time to consider and draft appropriate procedures prior to the applicability date of the fi- nal regulations. Moreover, thede minimis safe harbor is intendedtoproviderecord- keeping simplicity to taxpayers by allow- ing them to follow an established financial accounting policy for federal tax purposes, and allowing retroactive application is in- consistent with such purpose. E.Application to consolidated group members Several comments noted that the rule for use of a consolidated group’s applica- ble financial statement failed to consider situations in which taxpayers are included on a consolidated applicable financial statement but are not members in an under- lying consolidated group for Federal in- come tax purposes. Comments requested that taxpayers in this situation be permit- ted to rely on the financial policies of the group that apply to them as well as the group’s consolidated applicable financial statement to satisfy the requirements of thede minimisrule. The final regulations adopt this suggestion and provide that if a taxpayer’s financial results are reported on the applicable financial statement for a group of entities, then the group’s appli- cable financial statement may be treated as the applicable financial statement of the taxpayer. Furthermore, in this situ- ation, the written accounting procedures provided for the group and utilized for the group’s applicablefinancial statement may be treated as the written accounting procedures of the taxpayer. F.Transaction and other additional costs The preamble to the 2011 temporary regulations provided that thede minimis rule did not apply to amounts paid for labor and overhead incurred in repair- ing or improving property. Commenters pointed out that the preamble did not pro- vide any policy reason for excluding labor and overhead costs from thede minimis rule and that the exclusion would require rules to allocate additional invoice costs, such as freight and installation costs, be- tween tangible property costs and labor and overhead costs, requiring additional recordkeeping by taxpayers. Addition- ally, one commenter pointed out that the de minimisrule in the 2011 temporary regulations did not expressly provide for an exclusion of labor and overhead costs. Commenters requested that additional costs included on an invoice for tangible property be includedwithin the scope of thede minimisrule. The final regulations adopt the com- menters’ suggestions, in part, and clarify the treatment under thede minimissafe harbor of transaction costs and other ad- ditional costs of acquiring and producing property subject to the safe harbor. To simplify the application of thede minimis rule to tangible property, the final regula- tions provide that a taxpayer electing to ap- ply thede minimissafe harbor is not re- quired to include in the cost of the tan- gible property the additional costs of ac- quiring or producingsuch property if these costs are not included in the same invoice as the tangible property. However, the fi- nal regulations also provide that a taxpayer electing to apply thede minimissafe har- bor must include in the cost of such prop- erty all additional costs (for example, de- livery fees, installation services, or simi- lar costs) of acquiring or producing such property if these costs are included on the same invoice with the tangible property. If an invoice includesamounts paid for mul- tiple tangible properties and the invoice includes additional invoice costs related to the multiple properties, then the tax- payer must allocate the additional invoice costs to each property using a reasonable method. The final regulations specify that a reasonable allocation method includes, but is not limited to, specific identification, apro rataallocation, or a weighted aver- age method based on each property’s rela- tive cost. The final regulations also clarify that additional costs consist of the trans- action costs (that is, the facilitative costs under §1.263(a)–2(f)) of acquiring or pro- ducing the property and the costs under §1.263(a)–2(d) for work performed prior to the date that the unit of tangible prop- erty is placed in service. G.Materials and supplies The IRS and Treasury Department re- ceived numerous comments on the appli- cation of thede minimisrule to materials and supplies under §1.162–3T of the 2011 temporary regulations. Under the 2011 temporary regulations, taxpayers were per- mitted to select materials and supplies to be expensed under thede minimisrule pro- vided that these materials and supplies sat- isfied all requirements of thede minimis October 21, 20133362013–43 I.R.B. rule, including the ceiling. Many com- ments raised concernsabout the adminis- trative burdens associated with identifying and allocating materials and supplies be- tween thede minimisrule and the general rules for materials and supplies in a man- ner that would not exceed thede minimis rule ceiling. In many cases, commenters suggested that the administrative burden imposed would outweigh any potential tax benefit. Thus, commenters requested revi- sions to thede minimisrule to reduce tax- payers’ administrative burden of comply- ing with the 2011 temporary regulations. To simplify application of thede min- imissafe harbor, the final regulations re- quire that thede minimissafe harbor be ap- plied to all eligible materials and supplies (other than rotable, temporary, and standby emergency spare parts subject to the elec- tion to capitalize or rotable and temporary spare parts subject to the optional method of accounting for such parts) if the tax- payer elects thede minimissafe harbor un- der §1.263(a)–1(f). Unlike the 2011 tem- porary regulations rule permitting taxpay- ers to select materials and supplies for ap- plication of thede minimissafe harbor, the requirement in the final regulations to ap- ply thede minimissafe harbor, if elected, to all eligible materials and supplies sim- plifies the application of thede minimis rule and reduces the administrative burden on the IRS. Taxpayers that do not elect the de minimissafe harbor provided in the fi- nal regulations for the taxable year must treat their amounts paid for materials and supplies in accordance with the rules pro- vided in §1.162–3. H.Coordination with section 263A Commenters asked for clarification on the interaction of thede minimisrule with section 263A. Several comments asked whether the application of thede minimis rule resulted in property with an unad- justed basis of zero, which would then be subject to section 263A, or, alternatively, whether section 263A required taxpayers to capitalize the cost of property subject to section 263A, regardless of whether the de minimisrule applied. The final regulationsclarify the interac- tion between the two provisions. The final regulations provide that amounts paid for tangible property eligible for thede min- imissafe harbor may, nonetheless, be sub- ject to capitalization under section 263A if the amounts paid for this tangible prop- erty comprise the direct or allocable indi- rect costs of other property produced by the taxpayer or property acquired for re- sale. In general, under section 263A, if prop- erty is held for future production, taxpay- ers must capitalize direct and indirect costs allocable to such property (for example, purchasing, storage, and handling costs), even though production has not begun. If property is not held for production, indi- rect costs incurred prior to the beginning of the production period must be allocated to the property and capitalized if, at the time the costs are incurred, it is reasonably likely that production will occur at some future date. Thus, for example, a manu- facturer must capitalize the costs of stor- ing and handling raw materials before the raw materials are committed to production. In addition, §1.263A–1T(e)(2)(i) provides that indirect material costs include the cost of materials that are not an integral part of specific property produced and the cost of materials that are consumed in the ordinary course of performing production or resale activities that cannot be identified or asso- ciated with particular units of property. Therefore, if tangible property is ac- quired with the expectation of being used in the production of other property, and it is reasonably likely that production will oc- cur at some future date, section 263A may apply to capitalize the cost of the prop- erty acquired. Thus, for example, if a tax- payer acquires a component part, the cost of which is otherwise eligible for thede minimissafe harbor, but the component part is installed, or expected to be installed in the future, in the taxpayer’s manufac- turing equipment used to produce property for sale, under section 263A, the cost of the component part must be capitalized as an indirect cost of property produced by the taxpayer. On the other hand, if prop- erty is acquired without the expectation of being used in the production of property and the taxpayer elects and properly ap- plies thede minimisrule to the amount paid for property in the taxable year, if expecta- tions change in a subsequent taxable year and the property is actually used in pro- duction, then section 263A will not require capitalization of the cost of the property at the time the expectation changes or when the property is used in production. I.Change in accounting procedures not change in method of accounting Several commenters questioned whether a change in a taxpayer’s financial accounting procedures (for example, its financial accounting capitalization policy) is a change in method of accounting for de minimisexpenses to which the pro- visions of sections 446 and 481 and the accompanying regulations apply. The fi- nal regulations provide that the use of the de minimissafe harbor is a taxable year election and may not be made by the filing of an application for a change in method of accounting. Thus, if a taxpayer meets the requirements for the safe harbor, which requires, in part, having written account- ing procedures in place at the beginning of the taxable year and treating amounts paid for property as an expense in accordance with those procedures, then a change in the procedures, by itself, is not a change in accounting method.For example, if a taxpayer’s written financial accounting capitalization policy at the beginning of 2014 states that amounts paid for property costing less than $200 will be treated as an expense, and the taxpayer changes its written policy as of the beginning of 2015 to treat amounts paid for property costing less that $500 as an expense, the taxpayer is not required to file an application for its 2015 taxable year to change its method of accounting for applying thede minimis safe harbor or determining amounts paid to acquire or produce tangible property under §1.263(a)–1(f). V.Amounts Paid to Acquire or Produce Tangible Property Under §1.263(a)–2 Section 1.263(a)–2T of the 2011 tem- porary regulations provided rules for ap- plying section 263(a) to amounts paid to acquire or produce a unit of real or per- sonal property. In general, the final regu- lations retain the rules from the 2011 tem- porary regulations, including general re- quirements to capitalize amounts paid to acquire or produce a unit of real or per- sonal property, requirements to capitalize amounts paid to defend or perfect title to real or personal property, and rules for de- termining the extent to which taxpayers must capitalize transaction costs related to the acquisition of property. In the final reg- ulations, thede minimissafe harbor has 2013–43 I.R.B.337October 21, 2013 been moved to §1.263(a)–1(f) to reflect its broader application to amounts paid for tangible property, including amounts paid for improvements and materials and sup- plies, except as otherwise provided under section 263A. The 2011 temporary regulations pro- vided that a taxpayer must, in general, cap- italize amounts paid to facilitate the ac- quisition or production of real or personal property. To alleviate controversy between taxpayers and the IRS, the 2011 tempo- rary regulations included a list of inher- ently facilitative amounts. In addition, the 2011 temporary regulations provided that costs relating to activities performed in the process of determining whether to acquire real property and which real property to acquire generally are deductible pre-deci- sional costs unless they are described in the regulations as inherently facilitative costs. The 2011 temporary regulations also pro- vided that inherently facilitative amounts allocable to real or personal property are capital expenditures related to such prop- erty, even if such property is not eventually acquired or produced. Commenters requestedthat the require- ment to capitalize facilitative costs be re- moved as overbroad. Commenters also stated that it was inappropriate to provide a special rule that depends on the nature of the property acquired (real property or personal property) and inappropriate to re- quire capitalization of inherently facilita- tive amounts allocable to property not ac- quired. Other commenters recommended that the list describing inherently facili- tative amounts be revised to exclude ac- tivities that are dependent on the type of service provider (forexample, a broker), rather than being based on a specific ac- tivity (for example,securing an appraisal). One commenter asked for clarification re- garding the treatment of a broker’s com- mission if the commission was contingent on the buyer’s successful acquisition of real property but a portion of the broker’s activities were performed in investigating the acquisition. The final regulations generally retain the 2011 temporary regulation rules ad- dressing facilitative amounts. As in the 2011 temporary regulations, the final reg- ulations include the special rule for the acquisition of real property providing that, except for amounts specifically identified as inherently facilitative, an amount paid by a taxpayer in the process of investigat- ing or otherwise pursuing the acquisition of real property does not facilitate the ac- quisition if it relates to activities performed in the process of determining whether to acquire real property and which real prop- erty to acquire. The final regulations do not expand the deduction of such pre-de- cisional, investigatory costs to personal property because, unlike real property ac- quisitions, personal property acquisitions do not typically raise issues of whether the transaction costs should be charac- terized as deductible business expansion costs rather than costs to acquire a specific property. In addition, personal property acquisitions do not typically provide clear evidence establishingthe timing of deci- sions. Thus, such a rule could generate significant controversy over unduly small amounts. Moreover, the final regulations retain the list of inherently facilitative costs that generally must be capitalized as trans- action costs. However, in response to comments, the final regulations clarify the meaning of finders’ fees and brokers’ commissions and provide a definition of contingency fees. The final regulations provide that for purposes of §1.263(a)–2, a contingency fee is an amount paid that is contingent on the successful closing of the acquisition of real or personal property. The final regulations also clarify that con- tingency fees facilitate the acquisition of the property ultimately acquired and are not allocable to real or personal property not acquired. Therefore, if a real estate broker’s commission is contingent on the successful closing of the acquisition of real property, the amount paid as the bro- ker’s commission inherently facilitates the acquisition of the property acquired and, therefore, must be capitalized as part of the basis of such property. However, no portion of the broker’s contingency fee is allocable to real property that the taxpayer did not acquire. In addition, the final regulations retain the rule that inher- ently facilitative amounts allocable to real or personal property are capital expendi- tures related to such property, even if such property is not eventually acquired or pro- duced. As discussed in the preamble to the 2008 proposed regulations, the IRS and the Treasury Department believe that this rule is consistent with established author- ities. See, for example,Sibley, Lindsay & Curr Co. v. Commissioner,15 T.C. 106 (1950),acq., 1951–1 C.B. 3. The final regulations also clarify that, except for contingency fees as discussed above, inherently facilitative amounts allocable to property not acquired may be allocated to those properties and recovered in ac- cordance with the applicable provisions of the Code, includingsections 165, 167, and 168. VI.Amounts Paid to Improve Property Under §1.263(a)–3 A.Overview Comments received with respect to the rules under the 2011 temporary regulations for determining whether an amount im- proves, betters, or restores property largely focused on the application of the rules to building property, the lack of a safe har- bor for routine maintenance for building property, the standards to be applied in determining whether a betterment has oc- curred, the treatment of post-casualty ex- penditures under the restoration standards, and the standards to be applied in deter- mining whether a replacement of a ma- jor component or substantial structural part has occurred. The final regulations generally retain the rules of the 2011 temporary regulations for determining the unit of property and for determining whether there is an im- provement to a unit of property. The fi- nal regulations also retain the simplifying conventions set out in the 2011 temporary regulations, including the routine mainte- nance safe harbor and the optional regu- latory accounting method. In addition, in response to the comments, the final regu- lations modify the 2011 temporary regula- tions in several areas. The concerns raised by commenters and the relevant changes to the 2011 temporary regulations are dis- cussed in this preamble. B.Determining the unit of property The 2011 temporary regulations gen- erally defined the unit of property as consisting of all the components of prop- erty that are functionally interdependent, but provided special rules for determin- ing the unit of property for buildings, plant property, and network assets. The 2011 temporary regulations also provided special rules for determining the units of October 21, 20133382013–43 I.R.B. property for condominiums, cooperatives, and leased property, and for the treatment of improvements (including leasehold im- provements). The final regulations retain the unit of property rules contained in the 2011 temporary regulations. The 2011 temporary regulations gen- erally defined a building as a unit of property, but required the application of the improvement standards to the build- ing structure and the enumerated building systems. A number of comments ob- jected to the requirement that the taxpayer perform the improvement analysis at the building structure and system level. The comments stated that such treatment is inconsistent with the treatment of other complex property under the 2011 tem- porary regulations, is inconsistent with the treatment of building property under depreciation rules, and fails to take into account the relative importance of the var- ious building systems. Several comments requested that the building, including its structural components, should be treated as the unit of property for applying the improvement rules to buildings. Other commenters pointed out that a functional interdependence standard, used in the 2011 temporary regulations for non-build- ingpropertyandappliedbythecourtsand the IRS for determining when components of a single property are placed in service for cost recovery purposes, may be a more consistent general standard for identifying the relevant property upon which to apply the improvement analysis. Like plant property, buildings are com- plex properties composed of numerous component parts that perform discrete and major functions or operations. Unlike plant property, however, where the dis- crete and major functions or operations are not consistent from plant to plant, the discrete and major functions or operations performed from building to building are frequently similar. The building system definitions set forth in the 2011 temporary regulations are based on well understood costing standards that have been routinely applied to buildings for many years for valuations, cost accounting, and financial reporting. To help ensure that the im- provement standards are applied equitably and consistently across building property, the final regulations continue to apply the improvement rules to both the building structure and the defined building systems. To the extent the particular facts and cir- cumstances of a subset of buildings used in one or more industries present unique challenges to application of the building structure or building system definitions, taxpayers are encouraged to request guid- ance under the Industry Issue Resolution (IIR) procedures. C.Unit of property for leasehold improvements The 2011 temporary regulations pro- vide rules for determining the unit of property for leased property and for deter- mining the unit of property for leasehold improvements. The IRS and the Treasury Department received no written comments on these rules, and the final regulations retain the rules from the 2011 tempo- rary regulations, withsome clarifications. Under the rule in the 2011 temporary reg- ulations, a question could arise regarding the property to be analyzed for determin- ing whether an improvement to a lessee improvement constitutes an improvement to the lessee’s property. In this context, the 2011 temporary regulations suggested that the taxpayer must determine whether there has been an improvement to the lessee improvement by itself, rather than by applying the improvement standards to the general unit of property rules for leased buildings or for leased property other than buildings. The final regulations clarify that for purposes of determining whether an amount paid by a lessee con- stitutes a leasehold improvement, the unit of property and the improvement rules are applied in accordance with the rules for leased buildings (or leased portions of building) under §1.263(a)–3(e)(2)(v) or for leased property other than buildings under §1.263(a)–3(e)(3)(iv). Thus, for ex- ample, if a lessee pays an amount for work on an addition that it previously made to a leased building, the taxpayer determines whether the work performed constitutes an improvement to the entire leased building structure, not merely to the addition. The final regulations also clarify that when a lessee or lessor improvement is comprised of a building erectedon leased property, then the unit of property for the building and the application of the improvement rules are determined under the provisions for buildings, rather than under the provi- sions for leased buildings. D.Special rules for determining improvement costs 1. Costs incurred during an improvement The 2011 temporary regulations did not prescribe rules related to the “plan of re- habilitation” doctrine as traditionally de- scribed in the case law. The judicially-cre- ated plan of rehabilitation doctrine pro- vides that a taxpayer must capitalize oth- erwise deductible repair or maintenance costs if they are incurred as part of a gen- eral plan of rehabilitation, modernization, and improvement to the property. See, for example,Moss v. Commissioner,831 F.2d 833 (9th Cir. 1987);United States v. Wehrli, 400 F.2d 686 (10th Cir. 1968); Norwest Corp. v. Commissioner, 108 T.C. 265 (1997). The 2011 temporary regula- tions did not restate the plan of rehabil- itation doctrine but, rather, used the lan- guage of the section 263A rule providing that a taxpayer must capitalize both the di- rect costs of an improvement as well as the indirect costs that directly benefit or are in- curred by reason of the improvement. The 2011 temporary regulations also included an exception to this provision for an indi- vidual residence, which permitted an in- dividual taxpayer to capitalize repair and maintenance costs incurred at the time of a substantial residential remodel. The final regulations retain the rules from the 2011 temporary regulations and continue to provide that indirect costs, such as repair and maintenance costs, that do not directly benefit and that are not incurred by reason of an improvement are not required to be capitalized under section 263(a), regardless of whether they are incurred at the same time as an im- provement. In addition, in response to comments requesting examples of the ap- plication of this standard, the final regula- tions add this analysis to several examples. By providing a standard based on the sec- tion 263A language, the final regulations set out a clear rule for determining when otherwise deductible indirect costs must be capitalized as part of an improvement to property and obsolete the plan of re- habilitation doctrine to the extent that the court-created doctrineprovides different standards. 2013–43 I.R.B.339October 21, 2013 2. Removal Costs The 2011 temporary regulations did not provide a separate ruleforthetreatmentof removal costs. Rather, the 2011 temporary regulations addressed component removal costs as an example of a type of indirect cost that must be capitalized if the removal costs directly benefit or are incurred by reason of an improvement. The preamble to the 2011 temporary regulations stated that the costs of removing a component of a unit of property should be analyzed in the same manner as any other indirect cost (such as a repair cost) incurred dur- ing a repair or an improvement to prop- erty. Therefore, the preamble concluded, if the cost of removing a component of a unit of property directly benefitted or was in- curred by reason of an improvement to the unit of property, the cost must be capital- ized. The preamble to the 2011 temporary regulations also noted that the 2011 tempo- rary regulations werenot intended to affect the holding of Rev. Rul. 2000–7 (2000–1 C.B. 712) as it applied to the cost of remov- ing an entire unit of property. Under Rev. Rul. 2000–7, a taxpayer is not required to capitalize the cost of removing a retired depreciable asset under section 263(a) or section 263A, even when the retirement and removal occur in connection with the installation of a replacement asset. Rev. Rul. 2000–7 reasoned that the costs of re- moving a depreciable asset generally have been allocable to the removed asset and, thus, generally have been deductible when the asset is retired. See §§1.165–3(b); 1.167(a)–1(c); 1.167(a)–11(d)(3)(x); Rev. Rul. 74–455 (1974–2 C.B. 63); Rev. Rul. 75–150 (1975–1 C.B. 73). Commenters acknowledged the pream- ble language but observed that the 2011 temporary regulations did not explicitly state that the costs incurred to remove an entire unit of property are not required to be capitalized, even when incurred in con- nection with the installation of a replace- ment asset. Commenters requested that the final regulations include this explicit con- clusion. Commenters also asked whether the principles of Rev. Rul. 2000–7 would apply to allow the deduction of removal costs when the taxpayer disposes of a com- ponent of a unit of property and the tax- payer takes into account the adjusted basis of the component in realizing loss. Com- menters also questioned whether a tax- payer would be required to capitalize com- ponent removal costs if these costs were an indirect cost of a restoration (for example, the replacement of a component when the taxpayer has properly deducted a loss for that component) rather than a betterment to the underlying unit of property. The final regulations provide a spe- cific rule clarifying the treatment of re- moval costs in these contexts. The final regulations state that if a taxpayer dis- poses of a depreciable asset (including a partial disposition under Prop. Reg. §1.168(i)–1(e)(2)(ix) (September 19, 2013), or Prop. Reg. §1.168(i)–8(d) September 19, 2013)) for Federal tax purposes and has taken into account the adjusted basis of the asset or component of the asset in realizing gain or loss, the costs of removing the asset or component are not required to be capitalized under section 263(a). The final regulations also provide that if a taxpayer disposes of a component of a unit of property and the disposal is not a disposition for Federal tax purposes, then the taxpayer must deduct or capitalize the costs of removing the component based on whether the removal costs directly benefit or are incurred by reason of a repair to the unit of property or an improvement to the unit of property. In addition, the final regulations provide sev- eral examples illustrating these principles. E.Safe harbor for small taxpayers The 2011 temporary regulations did not provide any special rules for small tax- payers to assist them in applying the gen- eral rules for improvements to buildings. One commenter stated that small taxpayers generally do not have the administrative means or sufficientdocumentation or in- formation to apply the improvement rules to their building structures and systems as required under the 2011 temporary reg- ulations. Therefore, the commenter re- quested that an annual dollar threshold, such as $10,000, be established for build- ings with an initial cost of $1,000,000 or less and that taxpayers be permitted to deduct annual amounts spent on the build- ing if they did not exceed the threshold amount. In response to this request, the fi- nal regulations include a safe harbor elec- tionforbuildingpropertyheldbytaxpay- ers with gross receipts of $10,000,000 or less (“a qualifying small taxpayer”). The final regulations permit a qualifying small taxpayer to elect to not apply the improve- ment rules to an eligible building property if the total amount paid during the taxable year for repairs, maintenance, improve- ments, and similar activities performed on the eligible building does not exceed the lesser of $10,000 or 2 percent of the un- adjusted basis of the building. Eligible building property includes a building unit of property that is owned or leased by the qualifying taxpayer, provided the un- adjusted basis of the building unit of prop- erty is $1,000,000 or less. The final reg- ulations provide the IRS and the Treasury Department with the authority to adjust the amounts of the safe harbor and gross re- ceipts limitations through published guid- ance. The final regulations provide sim- ple rules for determining the unadjusted basis of both owned and leased building units of property. In this situation, the fi- nal regulations alsoeliminate the need to separately analyze the building structure and the building systems, as required else- where in the improvement rules in the final regulations. Under the safe harbor for small tax- payers, a taxpayer includes amounts not capitalized under thede minimissafe har- bor election of §1.263(a)–1(f) and under the routine maintenance safe harbor for buildings (discussed later in this pream- ble) to determine the annual amount paid for repairs, maintenance, improvements, and similar activities performed on the building. If the amount paid for repairs, maintenance, improvements, and similar activities performed on a building unit of property exceeds the safe harbor threshold for a taxable year, then the safe harbor is not applicable to any amounts spent during the taxable year. In that case, the taxpayer must apply the general rules for determining improvements, including the routine maintenance safe harbor for buildings. The taxpayer may also elect to apply thede minimissafe harbor under §1.263(a)–1(f) to amounts qualifying un- der thede minimissafe harbor, regardless of the application of the safe harbor for small taxpayers. The safe harbor for building property held small taxpayers may be elected an- nually on a building-by-building basis by including a statement on the taxpayer’s timely filed original Federal tax return, in- cluding extensions, for the year the costs October 21, 20133402013–43 I.R.B. are incurred for the building. Amounts paid by the taxpayer to which the tax- payer properly applies and elects the safe harbor are not treated as improvements to the building under §1.263(a)–3 and may be deducted under §1.162–1 or §1.212–1, as applicable, in the taxable year that the amounts are paid or incurred, provided the amounts otherwise qualify for deduction under those sections. A taxpayer may not revoke an election to apply the safe harbor for small taxpayers. F.Safe harbor for routine maintenance 1. Buildings The 2011 temporary regulations pro- vided that the costs of performing certain routine maintenance activities for property other than a building or the structural com- ponents of a building are not required to be capitalized as an improvement. Under the routine maintenance safe harbor, an amount paid was deemed not to improve a unit of property if it was for the recur- ring activities that a taxpayer (or a lessor) expected to perform as a result of the tax- payer’s (or the lessee’s) use of the unit of property to keep the unit of property in its ordinarily efficient operating condition. The 2011 temporary regulations provided that the activities are routine only if, at the time the unit of property was placed in service, the taxpayer reasonably ex- pected to perform the activities more than once during the period prescribed under sections 168(g)(2) and168(g)(3) (the Al- ternative Depreciation System class life), regardless of whether the property was depreciated under the Alternative Depre- ciation System. The preamble to the 2011 temporary regulations explained that the routine maintenance safe harbor did not apply to building property, because the long class life for such property (40 years under section 168(g)(2)) arguably could allow major remodeling or restoration projects to be deducted under the safe harbor, regardless of the nature or extent of the work involved, and that deducting such costs would be inconsistent with case law. The 2011 temporary regulations provided several factors for taxpayers to consider in determining whether a tax- payer is performing routine maintenance, including the recurring nature of the ac- tivity, industry practice, manufacturers’ recommendations, the taxpayer’s experi- ence, and the taxpayer’s treatment of the activity on its applicable financial state- ment. Comments on the routine maintenance safe harbor generally requested that the safe harbor be extended to building prop- erty. One commenter stated that because the improvement standards under the 2011 temporary regulations must now be ap- plied to the building structure and each building system separately, these compo- nents are more analogous to section 1245 property, which qualifies for the routine maintenance safe harbor. Commenters suggested that using a period shorter than a building’s class life, such as 20 years, could alleviate the IRS and the Treasury Department’s concern that the cost of true improvements would not be properly cap- italized if the safe harbor were extended to buildings. Another commenter argued that the distinction between building property and non-building property for purposes of the safe harbor is arbitrary because, in many respects, retail buildings are similar to other complex property, such as aircraft, which are not excluded from the safe har- bor. In response to these comments, the final regulations contain a safe harbor for rou- tine maintenance for buildings. The inclu- sion of a routine maintenance safe harbor for buildings is expected to alleviate some of the difficulties that could arise in ap- plying the improvement standards for cer- tain restorations to building structures and building systems. To balance commenters’ suggestions of using a shorter period, such as 20 years, with the concerns expressed in the preamble to the 2011 temporary regula- tions, the final regulations use 10 years as theperiodoftimeinwhichataxpayermust reasonably expect to perform the relevant activities more than once. While periods longer than 10 years were considered, the use of a period much longer than 10 years would, contrary to current authority, per- mit the costs of many major remodeling and restoration projects to be deducted un- der the safe harbor, regardless of the nature or extent of the work involved. 2. Other Changes The final regulations make several ad- ditional changes and clarifications to the safe harbor for routine maintenance, which are applicable to both buildings and other property. First, the regulations confirm that routine maintenance can be performed any time during the life of the property provided that the activities qualify as rou- tine under the regulation. Second, for pur- poses of determining whether a taxpayer is performing routine maintenance, the final regulations remove the taxpayer’s treat- ment of the activity on its applicable fi- nancial statement from the factors to be considered. Taxpayers may have several different reasons for capitalizing mainte- nance activities on their applicable finan- cial statements, and such treatment may not be indicative of whether the activi- ties are routine. Third, the final regula- tions clarify the applicability of the routine maintenance safe harbor by adding three items to the list of exceptions from the rou- tine maintenance safe harbor: (1) amounts paid for a betterment to a unit of property, (2) amounts paid to adapt a unit of property to a new or different use, and (3) amounts paid for repairs, maintenance, or improve- ment of network assets. The first two ex- ceptions were included in the general rule for the safe harbor in the 2011 temporary regulations, but were not clearly stated as exceptions. The exception for network as- sets was added because of the difficulty in defining the unit of property for network assets and the preference for resolving is- sues involving network assets through the IIR program. Finally, the exception relat- ingtoamountspaidforpropertyforwhich a taxpayer has taken a basis adjustment resulting from a casualty loss is slightly modified to be consistent with the revised casualty loss restoration rule, which is dis- cussed in this preamble. 3. Reasonable Expectation that Activities Will be Performed More than Once A taxpayer’s reasonable expectation of whether it will perform qualifying mainte- nance activities more than once during the relevant period will be determined at the time the unit of property (or building struc- ture or system, as applicable) is placed in service. The final regulations modify the safe harbor for routine maintenance by adding that a taxpayer’s expectation will not be deemed unreasonable merely be- cause the taxpayer does not actually per- form the maintenance a second time dur- ing the relevant period, provided that the 2013–43 I.R.B.341October 21, 2013 taxpayer can otherwise substantiate that its expectation was reasonable at the time the property was placedin service. Thus, for a unit of property previously placed in ser- vice, whether the maintenance is actually performed more than once during the rele- vant period is not controlling for assessing the reasonableness of a taxpayer’s original expectation. However, if a similar or iden- tical unit of property is placed in service in a future tax year, the taxpayer’s expe- rience with the original property may be taken into account as a factor in assess- ing whether the taxpayer reasonably ex- pects to perform the activities more than once during the relevant period for the sim- ilar or identical unit of property. The tax- payer’s actual experience, therefore, may be used in assessing the reasonableness of the taxpayer’s expectation of the frequency of restoration or replacement at the time a new unit of property is placed in service, but hindsight should not be used to inval- idate a taxpayer’s reasonable expectation as established at the time the unit of prop- erty was first placed in service when sub- sequent events do not conform to the tax- payer’s reasonable expectation. 4. Amounts Not Qualifying for the Routine Maintenance Safe Harbor The final regulations clarify that amounts incurred for activities falling out- side the routine maintenance safe harbor are not necessarily expenditures required to be capitalized under §1.263(a)–3. Amounts incurred for activities that do not meet the routine maintenance safe harbor are subject to analysis under the general rules for improvements. G.Betterments 1. Overview The 2011 temporary regulations pro- vided that an amount paid results in a betterment, and accordingly, an improve- ment, if it (1) ameliorates a material con- dition or defect that existed prior to the acquisition of the property or arose during the production of the property; (2) results in a material addition to the unit of prop- erty (including a physical enlargement, expansion, or extension); or (3) results in a material increase in the capacity, pro- ductivity, efficiency, strength, or quality of the unit of property or its output. As applied to buildings, an amount results in a betterment to the building if it results in a betterment to the building structure or any of the building systems. The final regulations retain the provi- sions of the 2011 temporary regulations related to betterments with several refine- ments. Specifically, the final regulations reorganize and clarify the types of activi- ties that constitute betterments to property. Also, the final regulations no longer phrase the betterment test in terms of amounts thatresult ina betterment. Rather, the final regulations provide that a taxpayer must capitalize amounts that are reason- ably expected to materially increase the productivity, efficiency, strength, quality, or output of a unit of property or that are for a material addition to a unit of prop- erty. Elimination of the “results in” stan- dard should reduce controversy for expen- ditures that span more than one tax year or when the outcome of the expenditure is un- certain when the expenditure is made. 2. Amelioration of Material Condition or Defect Commenters requested that certain ex- amples be clarified to distinguish more clearly between circumstances that require capitalization of amounts paid to ame- liorate a material condition or defect and circumstances that do not require capital- ization. One commenter requested that the final regulations include a rule that would provide for an allocation of expenditures between pre- and post-acquisition periods based on facts and circumstances if an expenditure both ameliorates a pre-ex- isting condition and ameliorates normal wear and tear that results from the tax- payer’s use of the property. With respect to whether amounts paid to ameliorate conditions are betterments, other com- ments reiterated suggestions provided in response to the 2008 proposed regulations, as described in the preamble to the 2011 temporary regulations. The final regulations do not adopt the comments with respect to expenditures to ameliorate pre-existing conditions or de- fects. The facts and circumstances rule provided in the final regulations is consis- tent with established case law and repre- sents an administrable standard for deter- mining whether an improvement has oc- curred. 3. Material Addition or Increase in Productivity, Efficiency, Strength, Quality, or Output Many commenters requested that the fi- nal regulations provide explanations and quantitative brightlines for determining the materiality of an addition to a unit of property or an increase in capacity, pro- ductivity, efficiency, strength, quality, or output of a unit of property. Addition- ally, commenters requested more explana- tion of terms such as productivity, qual- ity, and output, and how such standards should be applied across a variety of dif- ferent types of tangible property. These suggestions were extensively considered, but the final regulations do not adopt the suggestions to establish quan- titative bright lines. Quantitative bright lines, although objective, would produce inconsistent results given the broad array of factual settings where the betterment rules apply. Instead, the final regulations continue to rely on qualitative factors to provide fair and equitable treatment for all taxpayers in determining whether a particular cost constitutes a betterment. The final regulations clarify, how- ever, that not every single quantitative or qualitative factor listed in the betterment standard applies to every type of property. Whether any single factor applies to a particular unit of property depends on the nature of the property. For example, while amounts paid for work performed on an office building or a retail building may clearly comprise a physical enlargement or increase the capacity, efficiency, strength, or quality of such building under certain facts, it is unclear how to measure whether work performed on an office building or retail building increases the productiv- ity or output of such buildings, as those terms are generally understood. Thus, the productivity and output factors would not generally apply to buildings. On the other hand, it is appropriate to evaluate many items of manufacturing equipment intermsofoutputorproductivityaswell as size, capacity, efficiency, strength, and quality. Accordingly, the final regulations clarify that the applicability of each quan- titative and qualitative factor depends on the nature of the unit of property, and if an addition or increase in a particular factor cannot be measured in the context of a specific type of property, then the factor is October 21, 20133422013–43 I.R.B. not relevant in determining whether there has been a betterment to the property. 4. Application of Betterment Rule Several commenters questioned the bet- terment rule in the 2011 temporary regula- tions that requires consideration of all facts and circumstances, including the treatment of the expenditures on a taxpayer’s ap- plicable financial statement. One com- menter questioned whether the treatment of an expenditure on a taxpayer’s applica- ble financial statement should be relevant in determining whether an amount paid results in a betterment and suggested re- moval of this factor from the facts and cir- cumstances test provided in the 2011 tem- porary regulations. The IRS and the Trea- sury Department recognize that taxpayers may apply different standards for capital- izing amounts on their applicable finan- cial statements and such standards may not be controlling for whether the activities are betterments for Federal tax purposes. Thus, the final regulations remove the tax- payer’s treatment of the expenditure on its financial statement as a factor to be consid- ered in performing a betterment analysis under the final regulations. In addition, the final regulations omit the reference to the taxpayer’s facts and circumstances in de- termining whether amounts are paid for a betterment to the taxpayer’s property. The IRS and the Treasury Department believe that an analysis of a taxpayer’s particu- lar facts and circumstances is implicit in the application of all the final regulations governing improvements and need not be specifically providedin the application of the betterment rules. The 2011 temporary regulations pro- vided that, when an expenditure is ne- cessitated by a particular event, the de- termination of whether an expenditure is for the betterment of a unit of property is made by comparing the condition of the property immediately after the expen- diture with the condition of the property immediately prior to the event necessi- tating the expenditure. The IRS and the Treasury Department received comments requesting that the final regulations clarify the application of the appropriate com- parison rule for determining whether an expenditure is for a betterment of a unit of property. The final regulations retain this general rule but clarify that the rule applies when the event necessitating the expenditure is eithernormal wear and tear or damage to the unit of property during the taxpayer’s use of the property. Thus, the final regulations clarify that the appro- priate comparison rule focuses on events affecting the condition of the property and not on business decisions made by tax- payers. In addition, the final regulations confirm that the rule does not apply to wear, tear, or damage that occurs prior to the taxpayer’s acquisition or use of the property. In these situations, the ameliora- tion of a material condition or defect rule may apply. 5. Retail Store Refresh or Remodels A substantial number of comments were received with respect to the better- ment examples in the 2011 temporary regulations that addressretail store refresh or remodel projects, requesting the addi- tion of quantitative bright lines and the inclusion of additional detail in the exam- ples. As discussed previously in this pre- amble, the final regulations do not adopt the suggestions to provide quantitative bright lines in applying the betterment rules. However, the final regulations in- clude additional detail in a number of the examples, including the examples related to building refresh or remodels, illustrat- ing distinctions between betterments and maintenance activities when a taxpayer undertakes multiple simultaneous activi- ties on a building. To the extent the rules in the final regulations present situations that might be addressed through the IIR program, taxpayers may pursue additional guidance through the IIR process. H.Restorations 1. Overview The 2011 temporary regulations pro- vided that an amount is paid to restore, and therefore improve, a unit of property if it meets one of six tests: (1) it is for the replacement of a component of a unit of property and the taxpayer has properly deducted a loss for that component (other than a casualty loss under §1.165–7); (2) it is for the replacement of a component of a unit of property and the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from thesaleorexchangeof the component; (3) it is for the repair of damage to a unit of property for which the taxpayer has properly taken a basis adjust- ment as a result of a casualty loss under section 165, or relating to a casualty event described in section 165 (“casualty loss rule”); (4) it returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use; (5) it results in the rebuilding of the unit of property to a like-new condi- tion after the end of its class life; or (6) it is for the replacement of a major component or a substantial structural part of the unit of property (“major component rule”). The IRS and the Treasury Department received a number of comments regarding the 2011 temporary regulations restoration rules. The final regulations generally re- tain the restoration standards set forth in the 2011 temporary regulations but revise both the major component rule and the ca- sualty loss rule in response to comments. 2. Replacement of a Major Component or Substantial Structural Part a. Definition of major component and substantial structural part The 2011 temporary regulations pro- vided that an amount paid for the replace- ment of a major component or substan- tial structural part of a unit of property is an amount paid to restore (and, therefore, improve) the unit of property. The deter- mination of whether a component or part was “major” or “substantial” depended on the facts and circumstances, including both qualitative and quantitative factors. Commenters expressed concern that the lack of a bright-line test or additional defi- nitions would result in uncertainty and dis- putes in applying the restoration rules con- tained in the 2011 temporary regulations. Several commenters stated that the stan- dards provided in the 2011 temporary reg- ulations were too subjective, and numer- ous commenters requested that the final regulations reintroduce a bright-line def- inition of what constitutes a major com- ponent or substantial structural part for purposes of applying the restoration stan- dards, particularly with regard to build- ings. Several commenters suggested that a fixed percentage of a building should 2013–43 I.R.B.343October 21, 2013 be defined as the major component. In addition, commenters asked for clarifying guidance or more examples, arguing that the major component test of the 2011 tem- porary regulations uses broad, undefined, and subjective terms. The final regulations retain the sub- stantive rules of the 2011 temporary regu- lations, but clarify the definition of major component, and, more significantly, add a new definition for major components and substantial structural parts of build- ings. Although the IRS and the Treasury Department considered several bright-line tests, none were found to fairly, equitably, and in a readily implementable manner distinguish between expenditures that con- stitute restorations and expenditures that constitute deductible repairs or mainte- nance consistent with the case law and administrative rulings in the area. In many cases, particularly with regard to buildings, establishing a clear threshold, such as 30 percent of a defined amount, would be unworkable. Largely due to the complex nature of the property involved and the fact that units of property include assets placed in service in multiple tax- able years, applying a fixed percentage to a building structure or a building system in a way that creates a consistent and eq- uitable result proved exceedingly intricate and complex, thereby failing to achieve the simplifying objective of a bright line test. The final regulations, therefore, do not adopt any of the bright-line tests sug- gested. b. General rule for major component and substantial structural part To provide additional guidance for de- termining what constitutes a major compo- nent or substantial structural part, the final regulations clarify the distinction between a major component and a substantial struc- tural part. Specifically, the final regula- tions separate “major component,” which focuses on the function of the component in the unit of property, from “substantial structural part,” which focuses on the size of the replacement component in relation to the unit of property. The final regula- tions define a major component as a part or combination of parts that performs a dis- crete and critical function in the operation of the unit of property. The final regula- tions define a substantial structural part as a part or combination of parts that com- prises a large portion of the physical struc- ture of the unit of property. In response to comments, the final reg- ulations retain, but also clarify, the excep- tion to the major component rule. The 2011 temporary regulations provided that the replacement of a minor component, even though such component might affect the function of the unit of property, gener- ally would not, by itself, constitute a ma- jor component. The exception was meant to apply to relatively minor components, such as a switch, which generally performs a discrete function (turning property on and off) and is critical to the operation of a unit of property (that is, property will not run without it). To provide additional clar- ification regarding this exception, the final regulations clarify that an incidental com- ponent of a unit of property, even though such component performs a discrete and critical function in the operation of the unit of property, generally will not, by itself, constitute a major component. c. Major component and substantial structural part of buildings The final regulations address the re- quest for additional clarity regarding the definition of major component for build- ings by adding a new definition for ma- jor components and substantial structural parts of buildings. In the case of build- ings, the final regulations provide that an amount is for the replacement of a major component or substantial structural part if the replacement includes a part or combi- nation of parts that (1) comprises a ma- jor component or a significant portion of a major component of the building structure or any building system, or (2) comprises a large portion of the physical structure of the building structure or any building sys- tem. While the definition of major compo- nent for buildings introduces an additional level of analysis (a significant portion of a major component) that must be applied in determining whether an amount spent on a building constitutes a restoration, the rule provides an analytical framework and reaches conclusions that are generally con- sistent with the case law. Therefore, in practice this framework should be readily applicable for amountsspent on buildings. In combination with the addition of a rou- tine maintenance safe harbor for buildings, the modifications to the section 168 dispo- sition regulations, the safe harbor for small taxpayers, and the addition and revision of many examples, the revised definition of major component for buildings should relieve much of the controversy in deter- mining whether the replacement of a major component or a substantial structural part of a unit of property is an amount paid to restore a building. 3. Casualty Loss Rule The 2011 temporary regulations pro- vided that an amount is paid to restore a unit of property if it is for the repair of damage to the unit of property for which the taxpayer has properly taken a basis ad- justment as a result of a casualty loss un- der section 165, or relating to a casualty event described in section 165 (“casualty loss rule”). Capitalization of restoration costs is required under the casualty loss rule, even when the amounts paid for the repair exceed the adjusted basis remaining in the property and regardless of whether the amounts may otherwise qualify as re- pair costs. The 2011 temporary regulations recognized a taxpayer’s ability to deduct a casualty loss under section 165 or, to the extent eligible, to deduct the repair ex- pense associated with the casualty damage. But the 2011 temporary regulations did not permit a taxpayer to deduct both amounts arising from the same event in the same taxable year. Commenters requested that the final regulations eliminate the casualty loss rule. Commenters argued that recogni- tion of a casualty loss under section 165 is irrelevant in determining whether the costs to restore the damage resulting from a casualty should be capitalized, and the 2011 temporary regulations should not deny one tax benefit (the ability to deduct repair costs) based on a taxpayer’s real- ization of another tax benefit (the ability to deduct a casualty loss). Similarly, com- menters argued that the Code allows both a casualty loss and a repair deduction, and the IRS and the Treasury Department had not offered any justification for denying a deduction for the cost to repair damaged property only because the taxpayer has taken a casualty loss deduction. Com- menters argued that the 2011 temporary regulations penalize taxpayers that have October 21, 20133442013–43 I.R.B. suffered a casualty as a result of property damage. Commenters suggested that the casualty loss rule in the 2011 temporary regulations results in similarly situated taxpayers being treated differently, based on whether an asset has adjusted basis at the time of a casualty event. As an alterna- tive to eliminating the casualty loss rule, commenters requestedthat the final regu- lations allow a taxpayer to elect to forego recognizing the casualty loss and making a corresponding adjustment to basis to avoid application of the casualty loss rule. The casualty loss rule in 2011 tempo- rary regulations was based on the capital- ization rule provided in section 263(a)(2), which states that no deduction shall be al- lowed for any amount expended in restor- ingpropertyorinmakinggoodtheex- haustion thereof for which an allowance is or has been made. When property has been damaged in a casualty and a loss for such property has been claimed, amounts paid to replace the damaged property are incurred to restore property for which an allowance has been made. Thus, under section 263(a)(2), when the basis in re- placed property has been recovered by the taxpayer, capitalization of the replacement property is appropriate. Recognizing that such a rule can pro- vide harsh results for a taxpayer with valuable property with low adjusted ba- sis that is destroyed in a casualty event, considerable consideration was given to the suggestion that the regulations pro- vide an election to forgo a casualty loss deduction. Ultimately, however, it was concluded that the IRS and the Treasury Department do not have the authority to permit taxpayers to electively avoid the basis adjustment requirement imposed by section 1016(a). Section 1016(a) states that “a proper adjustment in respect of the property shall in all cases be made for . . . losses, or other items, properly chargeable to capital account . . ..” Therefore, even if a taxpayer could choose to forgo claiming a loss for property damage under section 165, section 1016 requires an adjustment to the basis of the property because a loss properly could be claimed. In response to commenters’ sugges- tions, the final regulations revise the casualty loss rule to permit a deduction, where otherwise permissible, for amounts spent in excess of the adjusted basis of the property damaged in a casualty event. Thus, a taxpayer is still required to cap- italize amounts paid to restore damage to property for which the taxpayer has properly recorded a basis adjustment, but the costs required to be capitalized under the casualty loss ruleare limited to the excess of (1) the taxpayer’s basis adjust- ments resulting from the casualty event, over (2) the amount paid for restoration of damage to the unit of property that also constitutes a restoration under the other criteria of §1.263(a)–3(k)(1) (excluding the casualty loss rule). Casualty-related expenditures in excessof this limitation are not treated as restoration costs under §1.263(a)–3(k)(1)(iii) and may be prop- erly deducted if they otherwise constitute ordinary and necessary business expenses (for example, repair and maintenance expenses) under section 162. The final regulations contain several examples illus- trating the casualty loss rule, including one example that demonstrates the operation of the new limitation on amounts required to be capitalized. 4. Salvage Value Exception Under the 2011 temporary regulations, a restoration includes amounts paid for the replacement of a component of a unit of property when the taxpayer has properly deducted a loss for that component (other than a casualty loss under §1.165–7) and for the replacement of a component of a unit of property when the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component. In response to com- ments, the final regulations retain these rules but provide an exception for property that cannot be depreciated to an adjusted basis of zero due to the application of sal- vage value (for example, property placed in service before 1981, and post–1980 as- sets that do not qualify for the Acceler- ated Cost Recovery System of former sec- tion 168 (ACRS) or MACRS). When a loss is properly deducted or the adjusted ba- sis of the component is realized from a sale or exchange, and the amount of loss or basis adjustment is attributable only to the remaining salvage value (the amount a taxpayer is expected to receive in cash or trade-in allowance upon disposition of an asset at the end of its useful life) as com- puted for Federal income tax purposes, a taxpayer is not required to treat amounts paid for the replacement of the component as a restoration under §1.263(a)–3(k)(1)(i) or (k)(1)(ii). Amounts subject to this ex- ception must be evaluated under other pro- visions of the regulations to determine if the amounts are paid to improve tangible property. 5. Rebuild to Like-New Condition The 2011 temporary regulations pro- vided that a unit of property is rebuilt to a like-new condition if it is brought to the status of new, rebuilt, remanufac- tured, or similar status under the terms of any federal regulatory guideline or the manufacturer’s original specifications. Commenters asked for clarification on whether comprehensive maintenance pro- grams, conducted according to manufac- turer’s original specifications, constitute rebuilding a unit of property to like-new condition. The final regulations adopt the standard provided in the 2011 tempo- rary regulations but clarify that generally a comprehensive maintenance program, even though substantial, does not return a unit of property to like-new condition. I.Adaptation to a new or different use The 2011 temporary regulations re- quired a taxpayer to capitalize amounts paid to adapt a unit of property to a new or different use (that is, a use inconsistent with the taxpayer’s intended ordinary use at the time the property was originally placed in service by the taxpayer). As applied to buildings, the new or different use standard is applied separately to the building structure and its building sys- tems. Commenters requested clarification of the adaptation rules and additional ex- amples. Commenters also asked that, for specific industries, the regulations provide that changes to facilities in response to a change in product mix, a reallocation of floor space, the need to rebrand, or the introduction of a new product line do not constitute a new or different use. The final regulations retain the substan- tive rules of the 2011 temporary regula- tions but add additional examples to il- lustrate the rules. The final regulations provide that if an amount adapts the unit of property in a manner inconsistent with the taxpayer’s intended ordinary use of the property when placed in service, the 2013–43 I.R.B.345October 21, 2013 amount must be capitalized as an adapta- tion of the unit of property to a new or dif- ferent use. In response to comments, two new examples address circumstances in which part of a retail building unit of prop- erty is converted to provide new services or products. However, providing tailored guidance for specific industries or specific types of property (for example, retail sales facilities) is not appropriate for broadly ap- plicable guidance. Specific industry guid- ance is better addressed through the IIR program. VII.Optional Regulatory Accounting Method The 2011 temporary regulations pro- vided an optional regulatory method, which permitted certain regulated taxpay- ers to follow the method of accounting they used for regulatory accounting pur- poses in determining whether an amount paid improves property. For purposes of the optional method, a taxpayer in a regu- lated industry is a taxpayer subject to the regulatory accounting rules of the Federal Energy Regulatory Commission (FERC), the Federal Communications Commis- sion (FCC), or the Surface Transportation Board (STB). A taxpayer that uses the regulatory accounting method does not apply the rules under sections 162, 212, or 263(a) in determining whether amounts paid to repair, maintain, or improve prop- erty are capital expenditures or deductible expenses. Section 263A continues to ap- plytocostsrequiredtobecapitalizedto property produced by the taxpayer or to property acquired for resale. The IRS and the Treasury Department received no comments on this methodol- ogy, and the final regulations retain the rule from the 2011 temporary regulations, with one modification. The final regulations modify the description of the regulatory accounting method to clarify that, for pur- poses of determining whether an amount is for a capital expenditure, an eligible tax- payer must apply the method of accounting that it is required to follow by FERC, FCC, or STB (whichever is applicable). VIII.Election to Capitalize Repair and Maintenance Costs The 2011 temporary regulations did not contain an election for taxpayers to capitalize expenditures made with respect to tangible property that would otherwise be deductible under these regulations. Commenters requested that, to reduce un- certainty in applying subjective standards and to reduce administrative burden, the final regulations include an election to capitalize repair and maintenance expen- ditures as improvements if the taxpayer treats such costs as capital expenditures for financial accounting purposes. In response to these comments as well as in recognition of the significant admin- istrative burden reduction achieved by permitting a taxpayer to follow for Federal income tax purposes the capitalization policies used for its books and records, the final regulations permit a taxpayer to elect to treat amounts paid during the taxable year for repair and maintenance to tangi- ble property as amounts paid to improve that property and as an asset subject to the allowance for depreciation, as long as the taxpayer incurs the amounts in carrying on a trade or business and the taxpayer treats the amounts as capital expenditures on its books and records used for regu- larly computing income. Under the final regulations, a taxpayer that elects this treatment must apply the election to all amounts paid for repair and maintenance to tangible property that it treats as capi- tal expenditures on its books and records in that taxable year. A taxpayer making the election must begin to depreciate the cost of such improvements when the im- provements are placed in service by the taxpayer under the applicable provisions of the Code and regulations. The election is made by attaching a statement to the taxpayer’s timely filed original Federal tax return (including extensions) for the taxable year in which the improvement is placed in service. Once made, the election may not be revoked. A taxpayer that capitalizes repair and maintenance costs under the election is still eligible to apply thede minimissafe harbor, the safe harbor for small taxpayers, and the routine maintenance safe harbor to repair and maintenance costs that are not treated as capital expenditures on its books and records. IX.Applicability Dates The final regulations generally apply to taxable years beginning on or after January 1, 2014. However, certain provisions of the final regulations only apply to amounts paid or incurred in taxable years beginning on or after January 1, 2014. For exam- ple, thede minimissafe harbor election un- der §1.263(a)–1(f) only applies to amounts paid or incurred for tangible property after January 1, 2014, for taxable years begin- ning on or after January 1, 2014. Alternatively, a taxpayer may generally choose to apply the final regulations to tax- able years beginning on or after January 1, 2012. For taxpayers choosing this early application, certain provisions of the final regulations only apply to amounts paid or incurred in taxable years beginning on or after January 1, 2012. For example, for these taxpayers, thede minimissafe har- bor election only applies to amounts paid or incurred for tangible property after Jan- uary 1, 2012, for taxable years beginning on or after January 1, 2012. For taxpayers choosing to apply the fi- nal regulations to taxable years beginning on or after January 1, 2012, or where appli- cable, to amounts paid or incurred in tax- able years beginning on or after January 1, 2012, the final regulations provide transi- tion relief for taxpayers that did not make the certain elections (for example, the elec- tion to apply thede minimissafe harbor or the election to apply the safe harbor for small taxpayers) on their timely filed orig- inal Federal tax return for their 2012 or 2013 taxable year (the applicable taxable year). Specifically, for taxable years be- ginning on or after January 1, 2012, and ending on or before September 19, 2013, a taxpayer is permitted to make these elec- tions by filing an amended Federal tax re- turn (including any applicable statements) for the applicable taxable year on or be- fore 180 days from the due date includ- ing extensions of the taxpayer’s Federal tax return for the applicable taxable year, notwithstanding that the taxpayer may not have extended the due date. Finally, a taxpayer may also choose to apply the 2011 temporary regulations to taxable years beginning on or after Jan- uary 1, 2012, and before January 1, 2014. For taxpayers choosing to apply the tem- porary regulations to these taxable years, certain provisions of the temporary regu- lations only apply to amounts paid or in- curred in taxable years beginning on or af- ter January 1, 2012, and before January 1, 2014. October 21, 20133462013–43 I.R.B. X.Change in Method of Accounting The IRS and the Treasury Department received several comments regarding the procedures that a taxpayer should utilize to change its method ofaccounting to comply with the regulations. Several commenters favored the use of a cut-off method, pri- marily for reasons of administrative con- venience. However, other commenters as- serted that any change in method of ac- counting must include a section 481(a) ad- justment. The final regulations provide that, ex- cept as otherwise stated, a change to com- ply with the final regulations is a change in method of accounting to which the provi- sions of sections 446 and 481 and the ac- companying regulations apply. A taxpayer seeking to change to a method of account- ing permitted in the final regulations must secure the consent of the Commissioner in accordance with §1.446–1(e) and follow the administrative procedures issued under §1.446–1(e)(3)(ii) for obtaining the Com- missioner’s consent to change its account- ing method. In general, a taxpayer seek- ing a change in method of accounting to comply with these regulations must take into account a full adjustment under sec- tion 481(a). The imposition of a section 481(a) ad- justment for a change in method of ac- counting to conform to the final regula- tions provides for a uniform and consis- tent rule for all taxpayers and ultimately reduces the administrative burdens on tax- payers and the IRS in enforcing the re- quirements of section 263(a). Although the IRS and the Treasury Department rec- ognize that requiring a section 481(a) ad- justment may place a burden on taxpayers to calculate reasonable adjustments, tax- payers have shown a willingness and abil- ity to make these calculations in request- ing method changes after the publication of the 2008 proposed regulations and af- ter the publication of the 2011 temporary regulations. In addition, taxpayers and the IRS routinely reach agreements on calcu- lation methodologies and amounts. Separate procedures will be provided under which taxpayers may obtain auto- matic consent for a taxable year beginning on or after January 1, 2012, to change to a method of accounting provided in the fi- nal regulations. Although a taxpayer seek- ing a change in method of accounting to comply with these regulations generally must take into account a full adjustment under section 481(a), it is anticipated that for the specific situation where a taxpayer seeks to change to a method of account- ing that is applicable only to amounts paid or incurred in taxable years beginning on or after January 1, 2014, a limited section 481(a) adjustment will apply, taking into account only amounts paid or incurred in taxable years beginning on or after January 1, 2014, or at a taxpayer’s option, amounts paid or incurred in taxable years beginning on or after January 1, 2012. Special Analyses It has been determined that this Trea- sury decision is not a significant regula- tory action as defined in Executive Order 12866, as supplemented by Executive Or- der 13563. Therefore, a regulatory assess- ment is not required. It also has been deter- mined that section 553(b) of the Adminis- trative Procedure Act(5 U.S.C. chapter 5) does not apply to these regulations. Pursuant to the Regulatory Flexibil- ity Act (5 U.S.C. chapter 6), it is hereby certified that these final regulations will not have a significant economic impact on a substantial number of small entities. This regulation affects all small business taxpayers. While a collection of infor- mation is required by this regulation in §§1.263(a)–1(f)(5), 1.263(a)–2(h)(6), and 1.263(a)–3(n), this collection will not have a significant economic impact on small entities. This information is required for a taxpayer to elect to use thede minimis safe harbor, to elect a safe harbor for de- termining the treatment of amounts related to buildings owned or leased by small taxpayers, and to elect to capitalize cer- tain repair and maintenance costs. These elections were provided in the regulations in response to comment letters submitted on behalf of small business taxpayers re- questing that these types of provisions be added to the regulations to assist small businesses. All of these elections are vol- untary, beneficial, and were designed to simplify the application of sections 162 and 263(a) to small taxpayers. The provi- sions require a taxpayer to file a statement with the taxpayer’s timely filed original tax return to inform the IRS that the tax- payer is electing to use these provisions. The estimated time to prepare a statement should not exceed 15 minutes, and the filing of the statement allows the taxpayer to receive the beneficial treatment for the amounts that qualify for the statement. Based on these facts, a regulatory flexibil- ity analysis under Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, this regulation was submitted to the Chief Counsel for Advocacy of the Small Busi- ness Administration for comment on its impact on small business. Statement of Availability for IRS Documents For copies of recently issued rev- enue procedures, revenue rulings, notices, and other guidance published in the In- ternal Revenue Bulletin or Cumulative Bulletin, please visit the IRS website at http://www.irs.gov. Drafting Information The principal authors of these regulations are Merrill D. Feldstein and Kathleen Reed, Office of the Associate Chief Counsel (Income Tax and Accounting). Other personnel from the IRS and the Treasury Department have participated in their development. ***** Adoption of Amendments to the Regulations Accordingly, 26 CFR parts 1 and 602 are amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read in part as follows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.162–3 is revised to read as follows: §1.162–3 Materials and supplies. (a)In general—(1)Non-incidental ma- terials and supplies. Except as provided in paragraphs (d), (e), and (f) of this sec- tion, amounts paid to acquire or produce materials and supplies (as defined in para- graph (c) of this section) are deductible in the taxable year in which the materials and supplies are first used in the taxpayer’s op- erations or are consumed in the taxpayer’s operations. 2013–43 I.R.B.347October 21, 2013 (2)Incidental materials and supplies. Amounts paid to acquire or produce inci- dental materials and supplies (as defined in paragraph (c) of this section) that are carried on hand and for which no record of consumption is kept or of which phys- ical inventories at the beginning and end of the taxable year are not taken, are de- ductible in the taxable year in which these amounts are paid, provided taxable income is clearly reflected. (3)Use or consumption of rotable and temporary spare parts. Except as provided in paragraphs (d), (e), and (f) of this sec- tion, for purposes of paragraph (a)(1) of this section, rotable and temporary spare parts (defined under paragraph (c)(2) of this section) are first used in the taxpayer’s operations or are consumed in the tax- payer’s operations in the taxable year in which the taxpayer disposes of the parts. (b)Coordination with other provisions of the Internal Revenue Code. Nothing in this section changes the treatment of any amount that is specifically provided for un- der any provision of the Internal Revenue Code (Code) or regulations other than sec- tion 162(a) or section 212 and the regula- tions under those sections. For example, see §1.263(a)–3, which requires taxpay- ers to capitalize amounts paid to improve tangible property and section 263A and the regulations under section 263A, which require taxpayers to capitalize the direct and allocable indirectcosts, including the cost of materials and supplies, of prop- erty produced by the taxpayer and property acquired for resale. See also §1.471–1, which requires taxpayers to include in in- ventory certain materials and supplies. (c)Definitions—(1)Materials and sup- plies. For purposes of this section,mate- rials and suppliesmeans tangible property that is used or consumed in the taxpayer’s operations that is not inventory and that— (i) Is a component acquired to maintain, repair, or improve a unit of tangible prop- erty (as determined under §1.263(a)–3(e)) owned, leased, or serviced by the taxpayer and that is not acquired as part of any sin- gle unit of tangible property; (ii) Consists of fuel, lubricants, water, and similar items, reasonably expected to be consumed in 12 months or less, begin- ning when used in the taxpayer’s opera- tions; (iii) Is a unit of property as determined under §1.263(a)–3(e) that has an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer’s operations; (iv) Is a unit of property as determined under §1.263(a)–3(e) that has an acqui- sition cost or production cost (as deter- mined under section 263A) of $200 or less (or other amount as identified in pub- lished guidance in theFederal Register or in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b)ofthischapter);or (v) Is identified in published guid- ance in theFederal Registeror in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b)ofthischapter)as materials and supplies for which treatment is permitted under this section. (2)Rotable and temporary spare parts. For purposes of this section, rotable spare parts are materials and supplies under paragraph (c)(1)(i) of this section that are acquired for installation on a unit of prop- erty, removable from that unit of property, generally repaired or improved, and either reinstalled on the same or other property or stored for later installation. Tempo- rary spare parts are materials and supplies under paragraph (c)(1)(i) of this section that are used temporarily until a new or repaired part can be installed and then are removed and stored for later installation. (3)Standby emergency spare parts. Standby emergency spare parts are materi- als and supplies under paragraph (c)(1)(i) of this section that are— (i) Acquired when particular machinery or equipment is acquired (or later acquired and set aside for use in particular machin- ery or equipment); (ii) Set aside for use as replacements to avoid substantial operational time loss caused by emergencies due to particular machinery or equipment failure; (iii) Located at or near the site of the installed related machinery or equipment so as to be readily available when needed; (iv) Directly related to the particular machinery or piece of equipment they serve; (v) Normally expensive; (vi) Only available on special order and not readily available from a vendor or manufacturer; (vii) Not subject to normal periodic re- placement; (viii) Not interchangeable in other ma- chines or equipment; (x) Not acquired in quantity (generally only one is on hand for each piece of ma- chinery or equipment); and (xi) Not repaired and reused. (4)Economic useful life—(i)General rule. The economic useful life of a unit of property is not necessarily the useful life inherent in the property but is the period over which the property may reasonably be expected to be useful to the taxpayer or, if the taxpayer is engaged in a trade or busi- ness or an activity for the production of in- come, the period over which the property may reasonably be expected to be useful to the taxpayer in its trade or business or for the production of income, as applica- ble. See §1.167(a)–1(b) for the factors to be considered in determining this period. (ii)Taxpayers with an applicable finan- cial statement. For taxpayers with an ap- plicable financial statement (as defined in paragraph (c)(4)(iii) of this section), the economic useful life of a unit of prop- erty, solely for the purposes of applying the provisions of paragraph (c)(4) of this sec- tion, is the useful life initially used by the taxpayer for purposes of determining de- preciation in its applicable financial state- ment, regardless of any salvage value of the property. If a taxpayer does not have an applicable financial statement for the taxable year in which a unit of property was originally acquired or produced, the economic useful life of the unit of prop- erty must be determined under paragraph (c)(4)(i) of this section. Further, if a tax- payer treats amounts paid for a unit of property as an expense in its applicable fi- nancial statement on a basis other than the useful life of the property or if a taxpayer does not depreciate the unit of property on its applicable financial statement, the economic useful life of the unit of prop- erty must be determined under paragraph (c)(4)(i) of this section. For example, if a taxpayer has a policy of treating as an expense on its applicable financial state- ment amounts paid for a unit of property costing less than a certain dollar amount, notwithstanding that the unit of property has a useful life of more than one year, the economic useful life of the unit of prop- erty must be determined under paragraph (c)(4)(i) of this section. (iii)Definition of applicable finan- cial statement. The taxpayer’s applicable financial statement is the taxpayer’s fi- nancial statement listed in paragraphs October 21, 20133482013–43 I.R.B. (c)(4)(iii)(A) through (C) of this section that has the highest priority (including within paragraph (c)(4)(iii)(B) of this sec- tion). The financial statements are, in descending priority— (A) A financial statement required to be filed with the Securities and Exchange Commission (SEC) (the 10–K or the An- nual Statement to Shareholders); (B) A certified audited financial state- ment that is accompanied by the report of an independent certified public accountant (or in the case of a foreign entity, by the report of a similarly qualified independent professional), that is used for— (1) Credit purposes; (2) Reporting to shareholders, partners, or similar persons; or (3) Any other substantial non-tax pur- pose; or (C) A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or the Internal Revenue Service). (5)Amount paid. For purposes of this section, in the case of a taxpayer using an accrual method of accounting, the termsamount paidandpaymentmean a liability incurred (within the meaning of §1.446–1(c)(1)(ii)). A liability may not be taken into account under this section prior to the taxable year during which the liability is incurred. (6)Produce. For purposes of this sec- tion,producemeans construct, build, in- stall, manufacture, develop, create, raise, or grow. This definition is intended to have the same meaning as the definition used for purposes of section 263A(g)(1) and §1.263A–2(a)(1)(i), except that improve- ments are excluded from the definition in this paragraph (c)(6) and are separately defined and addressed in §1.263(a)–3. Amounts paid to produce materials and supplies are subject to section 263A. (d)Election to capitalize and depreci- ate certain materials and supplies—(1)In general. A taxpayer may elect to treat as a capital expenditure and to treat as an as- set subject to the allowance for deprecia- tion the cost of any rotable spare part, tem- porary spare part, or standby emergency spare part as defined in paragraph (c)(2) or (c)(3) of this section. Except as specified in paragraph (d)(2) of this section, an elec- tion made under this paragraph (d) applies to amounts paid during the taxable year to acquire or produce any rotable, temporary, or standby emergency spare part to which paragraph (a) of this section would apply (but for the election under this paragraph (d)). Any property for which this election is made shall not be treated as a material or a supply. (2)Exceptions. A taxpayer may not elect to capitalize and depreciate under paragraph (d) of this section any amount paid to acquire or produce a rotable, tem- porary, or standby emergency spare part defined in paragraph (c)(2) or (c)(3) of this section if— (i) The rotable, temporary, or standby emergency spare part is intended to be used as a component of a unit of property under paragraph (c)(1)(iii), (iv), or (v) of this sec- tion; (ii) The rotable, temporary, or standby emergency spare part is intended to be used as a component of a property described in paragraph (c)(1)(i) and the taxpayer cannot or has not elected to capitalize and depreci- ate that property under this paragraph (d); or (iii) The amount is paid to acquire or produce a rotable or temporary spare part and the taxpayer uses the optional method of accounting for rotable and temporary spare parts under paragraph (e) to of this section. (3)Manner of electing. A taxpayer makes the election under paragraph (d) of this section by capitalizing the amounts paid to acquire or produce a rotable, tem- porary, or standby emergency spare part in the taxable year the amounts are paid and by beginning to recover the costs when the asset is placed in service by the tax- payer for the purposes of determining de- preciation under the applicable provisions of the Internal Revenue Code and the Trea- sury Regulations. See §1.263(a)–2 for the treatment of amounts paid to acquire or produce real or personal tangible property. A taxpayer must make this election in its timely filed original Federal tax return (in- cluding extensions) for the taxable year the asset is placed in service by the taxpayer for purposes of determining depreciation. See §§301.9100–1 through 301.9100–3 of this chapter for the provisions governing extensions of time to make regulatory elec- tions. In the case of an S corporation or a partnership,theelectionismadebytheS corporation or partnership, and not by the shareholders or partners. A taxpayer may make an election for each rotable, tempo- rary, or standby emergency spare part that qualifies for the election under this para- graph (d). A taxpayer may revoke an elec- tion made under this paragraph (d) with re- spect to a rotable, temporary, or standby emergency spare part only by filing a re- quest for a private letter ruling and ob- taining the Commissioner’s consent to re- voke the election. The Commissioner may grant a request to revoke this election if the taxpayer acted reasonably and in good faith and the revocation will not prejudice the interests of the Government. See gen- erally §301.9100–3 of this chapter. The manner of electing and revoking the elec- tion to capitalize under this paragraph (d) may be modified through guidance of gen- eral applicability (see§§601.601(d)(2) and 601.602 of this chapter). An election may not be made or revoked through the filing of an application for change in account- ing method or, before obtaining the Com- missioner’s consent to make the late elec- tion or to revoke the election, by filing an amended Federal tax return. (e)Optional method of accounting for rotable and temporary spare parts—(1)In general. This paragraph (e) provides an optional method of accounting for rotable and temporary spare parts (the optional method for rotable parts). A taxpayer may use the optional method for rotable parts, instead of the general rule under paragraph (a)(3) of this section, to account for its rotable and temporary spare parts as de- fined in paragraph (c)(2) of this section. A taxpayer that uses the optional method for rotable parts must use this method for all of its pools of rotable and temporary spare parts used in the same trade or busi- ness and for which it uses this method for its books and records. If a taxpayer uses the optional method for rotable and tempo- rary spare parts for pools of rotable or tem- porary spare parts for which the taxpayer does not use the optional method for its book and records, then the taxpayer must use the optional method for all its pools of rotable spare parts in the same trade or business. The optional method for rotable parts is a method of accounting under sec- tion 446(a). Under the optional method for rotable parts, the taxpayer must apply the rules in this paragraph (e) to each rotable or temporary spare part(part) upon the tax- payer’s initial installation, removal, repair, 2013–43 I.R.B.349October 21, 2013 maintenance or improvement, reinstalla- tion, and disposal of each part. (2)Description of optional method for rotable parts—(i)Initial installation.The taxpayer must deduct the amount paid to acquire or produce the part in the taxable year that the part is first installed on a unit of property for use in the taxpayer’s oper- ations. (ii)Removalfromunitofproperty.In each taxable year in which the part is re- moved from a unit of property to which it was initially or subsequently installed, the taxpayer must— (A) Include in gross income the fair market value of the part; and (B) Include in the basis of the part the fair market value of the part included in in- come under paragraph (e)(2)(ii)(A) of this section and the amount paid to remove the part from the unit of property. (iii)Repair, maintenance, or improve- ment of part. The taxpayer may not cur- rently deduct and must include in the basis of the part any amounts paid to maintain, repair, or improve the part in the taxable year these amounts are paid. (iv)Reinstallation of part.Thetax- payer must deduct the amounts paid to re- install the part and those amounts included in the basis of the part under paragraphs (e)(2)(ii)(B) and (e)(2)(iii) of this section, to the extent that those amounts have not been previously deducted under this para- graph (e)(2)(iv), in the taxable year that the part is reinstalled on a unit of property. (v)Disposal of the part. The tax- payer must deduct the amounts included in the basis of the part under paragraphs (e)(2)(ii)(B) and (e)(2)(iii) of this section, to the extent that those amounts have not been previously deducted under paragraph (e)(2)(iv) of this section, in the taxable year in which the part is disposed of by the taxpayer. (f)Application of de minimis safe har- bor. If a taxpayer elects to apply thede minimissafe harbor under §1.263(a)–1(f) to amounts paid for the production or ac- quisition of tangible property, then the taxpayer must apply thede minimissafe harbor to amounts paid for all materials and supplies that meet the requirements of §1.263(a)–1(f), except for those mate- rials and supplies that the taxpayer elects to capitalize and depreciate under para- graph (d) of this section or for which the taxpayer properly uses the optional method of accounting for rotable and tem- porary spare parts under paragraph (e) of this section. If the taxpayer properly applies thede minimissafe harbor under §1.263(a)–1(f) to amounts paid for ma- terials and supplies, then these amounts are not treated as amounts paid for mate- rials and supplies under this section. See §1.263(a)–1(f)(5) for the time and manner of electing thede minimissafe harbor and §1.263(a)–1(f)(3)(iv) for the treatment of safe harbor amounts. (g)Sale or disposition of materials and supplies. Upon sale or other disposition, materials and supplies as defined in this section are not treated as a capital asset under section 1221 or as property used in the trade or business under section 1231. Any asset for which the taxpayer makes the election to capitalize and depreciate under paragraph (d) of this section shall not be treated as a material or supply, and the recognition and character of the gain or loss for such depreciable asset are deter- mined under other applicable provisions of the Code. (h)Examples. The rules of this section areillustratedbythefollowingexamples, in which it is assumed, unless otherwise stated, that the property is not an incidental material or supply, that the taxpayer com- putes its income on a calendar year basis, that the taxpayer does not make the elec- tion to apply paragraph (d) of this section, or use the method of accounting described in paragraph (e) of this section, and that the taxpayer has not elected to apply thede minimissafe harbor under §1.263(a)–1(f). The following examples illustrate only the application of thissection and, unless oth- erwise stated, do notaddress the treatment under other provisions of the Code (for ex- ample, section 263A). Example 1.Non-rotable components. A owns a fleet of aircraft that it operates in its business. In Year 1, A purchases a stock of spare parts, which it uses to maintain and repair itsaircraft. A keeps a record of consumption of these spare parts. In Year 2, A uses the spare parts for the repair and maintenance of one of its aircraft. Assume each aircraft is a unit of property under §1.263(a)–3(e) and that spare parts are not rotable or temporary spare parts under para- graph (c)(2) of this section. Assume these repair and maintenance activities do not improve the aircraft un- der §1.263(a)–3. These parts are materials and sup- plies under paragraph (c)(1)(i) of this section because they are components acquired and used to maintain and repair A’s aircraft. Under paragraph (a)(1) of this section, the amounts that A paid for the spare parts in Year 1 are deductible in Year 2, the taxable year in which the spare parts are first used to repair and maintain the aircraft. Example 2.Rotable spare parts; disposal method . B operates a fleet of specialized vehicles that it uses in its service business. Assume that each vehicle is a unit of property under §1.263(a)–3(e). At the time that it acquires a new type of vehicle, B also acquires a substantial number of rotable spare partsthatitwillkeeponhandtoquicklyreplace similar parts in B’s vehicles as those parts break down or wear out. These rotable parts are removable from the vehicles and are repaired so that they can be reinstalled on the same or similar vehicles. In Year 1, B acquires several vehicles and a number of rotable spare parts to be used as replacement parts in these vehicles. In Year 2, B repairs several vehicles by using these rotable spare parts to replace worn or damaged parts. In Year 3, B removes these rotable spare parts from its vehicles, repairs the parts, and reinstalls them on other similar vehicles. In Year 5, B can no longer use the rotable parts it acquired in Year 1 and disposes of them as scrap. Assume that B does not improve any of the rotable spare parts under §1.263(a)–3. Under paragraph (c)(1)(i) of this section, the rotable spare parts acquired in Year 1 are materials and supplies. Under paragraph (a)(3) of this section, rotable spare parts are generally used or consumed in the taxable year in which the taxpayer disposes of the parts. Therefore, under paragraph (a)(1) of this section, the amounts that B paid for the rotable spare parts in Year 1 are deductible in Year 5, the taxable year in which B disposes of the parts. Example 3.Rotable spare parts; application of optional method of accounting . C operates a fleet of specialized vehicles that it uses in its service business. Assume that each vehicle is a unit of property under §1.263(a)–3(e). At the time that it acquires a new type of vehicle, C also acquires a substantial number of rotable spare parts that it will keep on hand to re- place similar parts in C’s vehicles as those parts break down or wear out. These rotable parts are removable from the vehicles and are repaired so that they can be reinstalled on the same or similar vehicles. C uses the optional method of accounting for all its rotable and temporary spare parts under paragraph (e) of this section. In Year 1, C acquires several vehicles and a number of rotable spare parts (the “Year 1 rotable parts”) to be used as replacement parts in these vehi- cles. In Year 2, C repairs several vehicles and uses the Year 1 rotable parts to replace worn or damaged parts. In Year 3, C pays amounts to remove these Year 1 rotable parts from its vehicles. In Year 4, C pays amounts to maintain, repair, or improve the Year 1 rotable parts. In Year 5, C pays amounts to reinstall the Year 1 rotable parts on other similar vehicles. In Year 8, C removes the Year 1 rotable parts from these vehicles and stores these parts for possible later use. In Year 9, C disposes of the Year 1 rotable parts. Un- der paragraph (e) of this section, C must deduct the amounts paid to acquire and install the Year 1 rotable parts in Year 2, the taxable year in which the rotable partsarefirstinstalledbyCinC’svehicles.InYear 3, when C removes the Year 1 rotable parts from its vehicles, C must include in its gross income the fair market value of each part. Also, in Year 3, C must in- clude in the basis of each Year 1 rotable part the fair market value of the rotable part and the amount paid to remove the rotable part from the vehicle. In Year 4, C must include in the basis of each Year 1 rotable October 21, 20133502013–43 I.R.B. part the amounts paid to maintain, repair, or improve each rotable part. In Year 5, the year that C reinstalls the Year 1 rotable parts (as repaired or improved) in other vehicles, C must deduct the reinstallation costs and the amounts previously included in the basis of each part. In Year 8, the year that C removes the Year 1 rotable parts from the vehicles, C must include in income the fair market value of each rotable part re- moved. In addition, in Year 8, C must include in the basis of each part the fair market value of that part and the amount paid to remove each rotable part from the vehicle. In Year 9, the year that C disposes of the Year 1 rotable parts, C may deduct the amounts remaining in the basis of each rotable part. Example 4.Rotable part acquired as part of a single unit of property; not material or supply .D operates a fleet of aircraft. In Year 1, D acquires a new aircraft, which includes two new aircraft en- gines. The aircraft costs $500,000 and has an eco- nomic useful life of more than 12 months, beginning when it is placed in service. In Year 5, after the air- craft is operated for several years in D’s business, D removes the engines from the aircraft, repairs or im- proves the engines, and either reinstalls the engines on a similar aircraft or stores the engines for later re- installation. Assume the aircraft purchased in Year 1, including its two engines, is a unit of property under §1.263(a)–3(e). Because the engines were acquired as part of the aircraft, a single unit of property, the engines are not materials or supplies under paragraph (c)(1)(i) of this section nor rotable or temporary spare parts under paragraph (c)(2) of this section. Accord- ingly, D may not apply the rules of this section to the aircraft engines upon the original acquisition of the aircraft nor after the removal of the engines from the aircraft for use in the same or similar aircraft. Rather, D must apply the rules under §§1.263(a)–2 and 1.263(a)–3 to the aircraft, including its engines, to determine the treatment of amounts paid to acquire, produce, or improve the unit of property. Example 5.Consumable property. E operates a fleet of aircraft that carries freight for its customers. E has several storage tanks on its premises, which hold jet fuel for its aircraft. Assume that once the jet fuel is placed in E’s aircraft, the jet fuel is reasonably ex- pected to be consumed within 12 months or less. On December 31, Year 1, E purchases a two-year sup- plyofjetfuel. InYear2,Eusesaportionofthejet fuel purchased on December 31, Year 1, to fuel the aircraft used in its business. The jet fuel that E pur- chased in Year 1 is a material or supply under para- graph (c)(1)(ii) of this section because it is reason- ably expected to be consumed within 12 months or less from the time it is placed in E’s aircraft. Under paragraph (a)(1) of this section, E may deduct in Year 2 the amounts paid for the portion of jet fuel used in the operation of E’s aircraft in Year 2. Example 6.Unit of property that costs $200 or less . F operates a business that rents out a variety of small individual items to customers (rental items). F maintains a supply of rental items on hand. In Year 1, F purchases a large quantity of rental items to use in its rental business. Assume that each rental item is a unit of property under §1.263(a)–3(e) and costs $200 or less. In Year 2, F begins using all the rental items purchased in Year 1 by providing them to cus- tomers of its rental business. F does not sell or ex- change these items on established retail markets at any time after the items are used in the rental busi- ness. The rental items are materials and supplies un- der paragraph (c)(1)(iv) of this section. Under para- graph (a)(1) of this section, the amounts that F paid for the rental items in Year 1 are deductible in Year 2, the taxable year in which the rental items are first used in F’s business. Example 7.Unit of property that costs $200 or less . G provides billing services to its customers. In Year 1, G pays amounts to purchase 50 scanners to be used by its employees. Assume each scanner is a unit of property under §1.263(a)–3(e) and costs less than $200. In Year 1, G’s employees begin using 35 of the scanners, and F stores the remaining 15 scanners for use in a later taxable year. The scanners are ma- terials and supplies under paragraph (c)(1)(iv) of this section. Under paragraph (a)(1) of this section, the amounts G paid for 35 of the scanners are deductible in Year 1, the taxable year in which G first uses each of those scanners. The amounts that G paid for each of the remaining 15 scanners are deductible in the tax- able year in which each machine is first used in G’s business. Example 8.Materials and supplies that cost less than $200; de minimis safe harbor . Assume the same factsasin Example 7except that G’s scanners qualify for the de minimissafe harbor under §1.263(a)–1(f), and G properly elects to apply the de minimissafe harbor under §1.263(a)–1(f) to amounts paid in Year 1. G must apply the de minimissafe harbor under §1.263(a)–1(f) to amounts paid for the scanners, rather than treat these amounts as costs of materials and supplies under this section. In accordance with §1.263(a)–1(f)(3)(iv), G may deduct the amounts paid for all 50 scanners under §1.162–1 in the taxable year the amounts are paid. Example 9.Unit of property that costs $200 or less; bulk purchase . H provides consulting services to its customers. In Year 1, H pays $500 to purchase one box of 10 toner cartridges to use as needed for H’s printers. Assume each toner cartridge is a unit of property under §1.263(a)–3(e). In Year 1, H’s em- ployees place 8 of the toner cartridges in printers in H’s office, and store the remaining 2 cartridges for use in a later taxable year. The toner cartridges are mate- rials and supplies under paragraph (c)(1)(iv) of this section because even though purchased in one box costing more than $200, the allocable cost of each unit of property equals $50. Therefore, under para- graph (a)(1) of this section, the $400 paid by H for 8 of the cartridges is deductible in Year 1, the taxable year in which H first uses each of those cartridges. The amounts paid by H for each of the remaining 2 car- tridges ($50 each) are deductible in the taxable year in which each cartridge is first used in H’s business. Example 10.Materials and supplies used in improvements; coordination with §1.263(a)–3 .J owns various machines that are used in its business. Assume that each machine is a unit of property under §1.263(a)–3(e). In Year 1, J purchases a supply of spare parts for its machines. J acquired the parts to use in the repair or maintenance of the machines under §1.162–4 or in the improvement of the ma- chines under §1.263(a)–3. The spare parts are not rotable or temporary spare parts under paragraph (c)(2) of this section. In Year 2, J uses all of these spare parts in an activity that improves a machine under §1.263(a)–3. Under paragraph (c)(1)(i) of this section, the spare parts purchased by J in Year 1 are materials and supplies. Under paragraph (a)(1) of this section, the amounts paid for the spare parts are otherwise deductible as materials and supplies in Year 2, the taxable year in which J uses those parts. However, because these materials and supplies are used to improve J’s machine, J is required to capi- talize the amounts paid for those spare parts under §1.263(a)–3. Example 11.Cost of producing materials and supplies; coordination with section 263A .Kisaman- ufacturer that produces liquid waste as part of its op- erations. K determines that its current liquid waste disposal process is inadequate. To remedy the prob- lem, in Year 1, K constructs a leaching pit to provide a draining area for the liquid waste. Assume the leach- ing pit is a unit of property under §1.263(a)–3(e) and hasaneconomicusefullifeof12monthsorless,start- ing on the date that K begins to use the leaching pit as a draining area. At the end of this period, K’s fac- tory will be connected to the local sewer system. In Year 2, K starts using the leaching pit in its operations. The amounts paid to construct the leaching pit (in- cluding the direct and allocable indirect costs of prop- erty produced under section 263A) are amounts paid for a material or supply under paragraph (c)(1)(iii) of this section. However, the amounts paid to construct the leaching pit may be subject to capitalization under section 263A if these amounts comprise the direct or allocable indirect costs of property produced by K. Example 12.Costs of acquiring materials and supplies for production of property; coordination with section 263A . In Year 1, L purchases jigs, dies, molds, and patterns for use in the manufacture of L’s products. Assume each jig, die, mold, and pattern is a unit of property under §1.263(a)–3(e). The eco- nomic useful life of each jig, die, mold, and pattern is 12 months or less, beginning when each item is used in the manufacturing process. The jigs, dies, molds, and patterns are not components acquired to maintain, repair, or improve any of L’s equipment under paragraph (c)(1)(i) of this section. L begins using the jigs, dies, molds and patterns in Year 2 to manufacture its products. These items are materi- als and supplies under paragraph (c)(1)(iii) of this section. Under paragraph (a)(1) of this section, the amounts paid for the items are otherwise deductible in Year 2, the taxable year in which L first uses those items. However, the amounts paid for these materials and supplies may be subject to capitalization under section 263A if these amounts comprise the direct or allocable indirect costs of property produced by L. Example 13.Election to capitalize and depreci- ate . M is in the mining business. M acquires cer- tain temporary spare parts, which it keeps on hand to avoid operational time loss in the event it must make temporary repairs to a unit of property that is subject to depreciation. These parts are not used to improve property under §1.263(a)–3(d). These tem- porary spare parts are used until a new or repaired part can be installed and then are removed and stored for later temporary installation. M does not use the optional method of accounting for rotable and tem- porary spare parts in paragraph (e) of this section for any of its rotable or temporary spare parts. The tem- porary spare parts are materials and supplies under paragraph (c)(1)(i) of this section. Under paragraphs (a)(1) and (a)(3) of this section, the amounts paid for the temporary spare parts are deductible in the tax- able year in which they are disposed of by M. How- ever, because it is unlikely that the temporary spare 2013–43 I.R.B.351October 21, 2013 parts will be disposed of in the near future, M would prefer to treat the amounts paid for the spare parts as capital expenditures subject to depreciation. M may elect under paragraph (d) of this section to treat the cost of each temporary spare part as a capital expen- diture and as an asset subject to an allowance for de- preciation. M makes this election by capitalizing the amounts paid for each spare part in the taxable year that M acquires the spare parts and by beginning to recover the costs of each part on its timely filed Fed- eral tax return for the taxable year in which the part is placed in service for purposes of determining depre- ciation under the applicable provisions of the Inter- nal Revenue Code and the Treasury Regulations. See §1.263(a)–2(g) for the treatment of capital expendi- tures. Example 14.Election to apply de minimis safe harbor. (i) N provides consulting services to its cus- tomers. In Year 1, N pays amounts to purchase 50 laptop computers. Each laptop computer is a unit of property under §1.263(a)–3(e), costs $400, and has an economic useful life of more than 12 months. Also in Year 1, N purchases 50 office chairs to be used by its employees. Each office chair is a unit of property that costs $100. N has an applicable financial statement (as defined in §1.263(a)–1(f)(4)) and N has a written accountingpolicyatthebeginningYear1toexpense amounts paid for units of property costing $500 or less. N treats amounts paid for property costing $500 or less as an expense on its applicable financial state- ment in Year 1. (ii) The laptop computers are not materials or supplies under paragraph (c) of this section. There- fore, the amounts N pays for the computers must generally be capitalized under §1.263(a)–2(d) as amounts paid for the acquisition of tangible property. The office chairs are materials and supplies under paragraph (c)(1)(iv) of this section. Thus, under paragraph (a)(1) of this section, the amounts paid for the office chairs are deductible in the taxable year in which they are first used in N’s business. However, under paragraph (f) of this section, if N properly elects to apply the de minimissafe harbor under §1.263(a)–1(f) to amounts paid in Year 1, then N must apply the de minimissafe harbor under §1.263(a)–1(f) to amounts paid for the computers and the office chairs, rather than treat the office chairs as the costs of materials and supplies under §1.162–3. Under the de minimissafe harbor, N may not cap- italize the amounts paid for the computers under §1.263(a)–2 nor treat the office chairs as materials and supplies under §1.162–3. Instead, in accordance with §1.263(a)–1(f)(3)(iv), under §1.162–1, N may deduct the amounts paid for the computers and the office chairs in the taxable year paid. (i)Accounting method changes.Ex- cept as otherwise provided in this section, a change to comply with this section is a change in method of accounting to which the provisions of sections 446 and 481 and the accompanying regulations apply. A taxpayer seeking to change to a method of accounting permitted in this section must secure the consent of the Commissioner in accordance with §1.446–1(e) and follow the administrative procedures issued under §1.446–1(e)(3)(ii) for obtaining the Com- missioner’s consent to change its account- ing method. (j)Effective/applicability date—(1)In general. This section generally applies to amounts paid or incurred in taxable years beginning on or after January 1, 2014. However, a taxpayer may apply paragraph (e) of this section (the optional method of accounting for rotable and temporary spare parts) to taxable years beginning on or af- ter January 1, 2014. Except as provided in paragraphs (j)(2) and (j)(3) of this section, §1.162–3 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of this sec- tion—(i)In general. Except for paragraph (e) of this section, a taxpayer may choose to apply this section to amounts paid or incurred in taxable years beginning on or after January 1, 2012. A taxpayer may choose to apply paragraph (e) of this sec- tion (the optional method of accounting for rotable and temporary spare parts) to taxable years beginning on or after Jan- uary 1, 2012. (ii)Transition rule for election to capi- talize materials and supplies on 2012 and 2013 returns. If under paragraph (j)(2)(i) of this section, a taxpayer chooses to make the election to capitalize and depreciate certain materials and supplies under para- graph (d) of this section for its taxable year beginning on or after January 1, 2012, and ending on or before September 19, 2013 (applicable taxable year), and the taxpayer did not make the election specified in para- graph (d)(3) of this section on its timely filed original Federal tax return for the ap- plicable taxable year, the taxpayer must make the election specified in paragraph (d)(3) of this section for the applicable tax- able year by filing an amended Federal tax return for the applicable taxable year on or before 180 days from the due date includ- ing extensions of the taxpayer’s Federal tax return for the applicable taxable year, notwithstanding that the taxpayer may not have extended the due date. (3)Optional application of TD 9564. Except for section 1.162–3T(e), a tax- payer may choose to apply §1.162–3T as contained in TD 9564 (76 FR 81060) December 27, 2011, to amounts paid or incurred (to acquire or produce property) in taxable years beginning on or after January 1, 2012, and before January 1, 2014. A taxpayer may choose to apply section 1.162–3T(e) (the optional method of accounting for rotable and temporary spare parts) as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014. §1.162–3T [Removed] Par. 3. Section 1.162–3T is removed. Par. 4. Section 1.162–4 is revised to read as follows: §1.162–4 Repairs. (a)In general. A taxpayer may deduct amounts paid for repairs and maintenance to tangible property if the amounts paid are not otherwise required to be capital- ized. For the election to capitalize amounts paid for repair and maintenance consistent with the taxpayer’s books and records, see §1.263(a)–3(n). (b)Accounting method changes.A change to comply with this section is a change in method of accounting to which the provisions of sections 446 and 481 and the accompanying regulations apply. A taxpayer seeking to change to a method of accounting permitted in this section must secure the consent of the Commissioner in accordance with §1.446–1(e) and fol- low the administrative procedures issued under §1.446–1(e)(3)(ii) for obtaining the Commissioner’s consent to change its ac- counting method. (c)Effective/applicability date—(1)In general. This section applies to taxable years beginning on or after January 1, 2014. Except as provided in paragraphs (c)(2) and (c)(3) of this section, §1.162–4 ascontainedin26CFRpart1editionre- vised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of this section.A taxpayer may choose to apply this section to taxable years beginning on or after Jan- uary 1, 2012. (3)Optional application of TD 9564.A taxpayer may choose to apply §1.162–4T as contained in TD 9564 (76 FR 81060), December 27, 2011, to taxable years be- ginning on or after January 1, 2012, and before January 1, 2014. §1.162–4T [Removed] Par. 5. Section 1.162–4T is removed. October 21, 20133522013–43 I.R.B. Par. 6. Section 1.162–11 is amended by: 1. Revising paragraph (b). 2. Removing paragraphs (c) and (d). Therevisionreadsasfollows: §1.162–11 Rentals. ***** (b)Improvements by lessee on lessor’s property—(1) In general. The cost to a taxpayer of erecting buildings or making permanent improvements on property of which the taxpayer is a lessee is a capi- tal expenditure. For the rules regarding improvements to leased property when the improvements are tangible property, see §1.263(a)–3(f). For the rules regarding de- preciation or amortization deductions for leasehold improvements, see §1.167(a)–4. (2)Effective/applicability date—(i)In general. This paragraph (b) applies to taxable years beginning on or after Jan- uary 1, 2014. Except as provided in para- graphs (b)(2)(ii) and (b)(2)(iii) of this sec- tion, §1.162–11(b) as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (ii)Early application of this paragraph. A taxpayer may choose to apply this para- graph (b) to taxable years beginning on or after January 1, 2012. (iii)Optional application of TD 9564. A taxpayer may choose to apply §1.162–11T(b) as contained in TD 9564 (76 FR 81060) December 27, 2011, to tax- able years beginning on or after January 1, 2012, and before January 1, 2014. §1.162–11T [Removed] Par. 7. Section 1.162–11T is removed. Par. 8. Section 1.165–2 is amended by: 1. Revising paragraphs (c) and (d). 2. Removing paragraph (e). The revisions read as follows: §1.165–2 Obsolescence of nondepreciable property. ***** (c)Cross references. For the allowance under section 165(a) of losses arising from the permanent withdrawal of depreciable property from use in the trade or busi- ness or in the production of income, see §1.167(a)–8, §1.168(i)–1, §1.168(i)–1T, §1.168(i)–8T, Prop. Reg. §1.168(i)–1 (September 19, 2013), or Prop. Reg. §1.168(i)–8 (September 19, 2013), as ap- plicable. For provisions respecting the obsolescence of depreciable property for which depreciation is determined under section 167 (but not under section 168, section 1400I, section 1400L(c), section 168 prior to its amendment by the Tax Reform Act of 1986, Public Law 99–514 (100 Stat. 2121 (1986)), or under an ad- ditional first year depreciation deduction provision of the Internal Revenue Code (for example, section 168(k) through (n), 1400L(b), or 1400N(d))), see §1.167(a)–9. For the allowance of casualty losses, see §1.165–7. (d)Effective/applicability date—(1)In general. This section applies to taxable years beginning on or after January 1, 2014. Except as provided in paragraphs (d)(2) and (d)(3) of this section, §1.165–2 as contained in 26 CFR part 1 edition re- vised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of §1.165–2(c).A taxpayer may choose to apply paragraph (c) of this section to taxable years begin- ning on or after January 1, 2012. (3)Optional application of TD 9564.A taxpayer may choose to apply §1.165–2T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years be- ginning on or after January 1, 2012, and before January 1, 2014. §1.165–2T [Removed] Par. 9. Section 1.165–2T is removed. Par. 10. Section 1.167(a)–4 is revised to read as follows: §1.167(a)–4 Leased property. (a)In general. Capital expenditures made by either a lessee or lessor for the erection of a building or for other perma- nent improvements on leased property are recovered by the lessee or lessor under the provisions of the Internal Revenue Code (Code) applicable to the cost recovery of the building or improvements, if subject to depreciation or amortization, without regard to the period of the lease. For example, if the building or improvement is property to which section 168 applies, the lessee or lessor determines the depre- ciation deduction for the building or im- provement under section 168. See section 168(i)(8)(A). If the improvement is prop- erty to which section 167 or section 197 applies, the lessee or lessor determines the depreciation or amortization deduction for the improvement under section 167 or sec- tion 197, as applicable. (b)Effective/applicability date—(1)In general. Except as provided in paragraph (b)(2) or (b)(3) of this section, this section applies to taxable years beginning on or after January 1, 2014. (2)Application of this section to lease- hold improvements placed in service after December 31, 1986, in taxable years be- ginning before January 1, 2014. For lease- hold improvements placed in service after December 31, 1986, in taxable years be- ginning before January 1, 2014, a taxpayer may— (i) Apply the provisions of this section; or (ii) Depreciate any leasehold improve- ment to which section 168 applies under the provisions of section 168 and depre- ciate or amortize any leasehold improve- ment to which section 168 does not ap- ply under the provisions of the Code that are applicable to the cost recovery of that leasehold improvement, without regard to the period of the lease. (3) Application of this section to lease- hold improvements placed in service be- fore January 1, 1987. Section 1.167(a)–4 ascontainedin26CFRpart1editionre- vised as of April 1, 2011, applies to lease- hold improvements placed in service be- fore January 1, 1987. (4)Change in method of ac- counting.Except as provided in §1.446–1(e)(2)(ii)(d)(3)(i),achangeto comply with this section for deprecia- ble assets placed in service in a taxable year ending on or after December 30, 2003, is a change in method of account- ing to which the provisions of section 446(e) and the regulations under sec- tion 446(e) apply. Except as provided in §1.446–1(e)(2)(ii)(d)(3)(i), a taxpayer also may treat a change to comply with this section for depreciable assets placed in service in a taxable year ending before December 30, 2003, as a change in method of accounting to which the provisions of 2013–43 I.R.B.353October 21, 2013 section 446(e) and the regulations under section 446(e) apply. §1.167(a)–4T [Removed] Par. 11. Section 1.167(a)–4T is re- moved. Par. 12. Section 1.167(a)–7 is amended by: 1. Revising paragraphs (e) and (f). 2. Removing paragraph (g). The revisions read as follows: §1.167(a)–7 Accounting for depreciable property. ***** (e)Applicability. Paragraphs (a), (b), and (d) of this section apply to property for which depreciation is determined under section 167 (but not under section 168, sec- tion 1400I, section 1400L(c), section 168 prior to its amendment by the Tax Reform Act of 1986, Public Law 99–514 (100 Stat. 2121 (1986)), or under an additional first year depreciation deduction provision of the Internal Revenue Code (for example, section 168(k) through (n), 1400L(b), or 1400N(d))). Paragraph (c) of this section does not apply to general asset accounts as provided by section 168(i)(4), §1.168(i)–1, §1.168(i)–1T and Prop. Reg. §1.168(i)–1 (September 19, 2013). (f)Effective/applicability date—(1) In general. This section applies to tax- able years beginning on or after January 1, 2014. Except as provided in para- graphs (f)(2) and (f)(3) of this section, §1.167(a)–7 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of §1.167(a)–7(e). A taxpayer may choose to apply paragraph (e) of this section to taxable years begin- ning on or after January 1, 2012. (3)Optional application of TD 9564. A taxpayer may choose to apply §1.167(a)–7T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014. §1.167(a)–7T [Removed] Par. 13. Section 1.167(a)–7T is re- moved. Par. 14. Section 1.167(a)–8 is amended by: 1. Revising paragraphs (g) and (h). 2. Removing paragraph (i). The revisions read as follows: §1.167(a)–8 Retirements. ***** (g)Applicability. This section ap- plies to property for which depreciation is determined under section 167 (but not under section 168, section 1400I, section 1400L(c), section 168 prior to its amend- ment by the Tax Reform Act of 1986, Pub- lic Law 99–514 (100 Stat. 2121(1986)), or under an additional first year depreciation deduction provision of the Internal Rev- enue Code (for example, section 168(k) through (n), 1400L(b), or 1400N(d))). (h)Effective/applicability date—(1) In general. This section applies to tax- able years beginning on or after January 1, 2014. Except as provided in para- graphs (h)(2) and (h)(3) of this section, §1.167(a)–8 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Earlyapplicationof §1.167(a)–8(g). A taxpayer may choose to apply paragraph (g) of this section to taxable years beginning on or after January 1, 2012. (3)Optional application of TD 9564. A taxpayer may choose to apply §1.167(a)–8T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014. §1.167(a)–8T [Removed] Par. 15. Section 1.167(a)–8T is re- moved. Par.16.Section1.168(i)–7isaddedto read as follows: §1.168(i)–7 Accounting for MACRS property. (a)In general. A taxpayer may ac- count for MACRS property (as defined in §1.168(b)–1(a)(2)) by treating each indi- vidual asset as an account (a “single as- set account” or an “item account”) or by combining two or more assets in a single account (a “multiple asset account” or a “pool”). A taxpayer may establish as many accounts for MACRS property as the tax- payer wants. This section does not apply to assets included in general asset accounts. For rules applicable to general asset ac- counts, see §1.168(i)–1, §1.168(i)–1T, or Prop. Reg. §1.168(i)–1 (September 19, 2013), as applicable. (b)Required use of single asset ac- counts. A taxpayer must account for an as- set in a single asset account if the taxpayer uses the asset both in a trade or business (or for the production of income) and in a personal activity, or if the taxpayer places in service and disposes of the asset during the same taxable year. Also, if general asset account treatment for an asset ter- minates under §1.168(i)–1T(c)(1)(ii)(A), (e)(3)(iii), (e)(3)(vii), (g), or (h)(2) or Prop. Reg. §1.168(i)–1(c)(1)(ii)(A), (e)(3)(iii), (e)(3)(vii), (g), or (h)(2) (September 19, 2013),as applicable, the taxpayer must account for the asset in a single asset account beginning in the taxable year in which the general asset account treatment for the asset termi- nates. If a taxpayer accounts for an asset in a multiple asset account or a pool and the taxpayer disposes of the asset, the taxpayer must account for the asset in a single asset account beginning in the taxable year in which the disposition oc- curs. See §1.168(i)–8T(g)(2)(i) or Prop. Reg. §1.168(i)–8(h)(2)(i) (September 19, 2013), as applicable. If a taxpayer dis- poses of a component of a larger asset and the unadjusted depreciable basis of the disposed of component is included in the unadjusted depreciable basis of the larger asset, the taxpayer must account for the component in a single asset ac- count beginning in the taxable year in which the disposition occurs. See Prop. Reg. §1.168(i)–8(g)(3)(i) (September 19, 2013). (c)Establishment of multiple asset ac- counts or pools—(1)Assets eligible for multiple asset accounts or pools. Except as provided in paragraph (b) of this section, assets that are subject to either the general depreciation system of section 168(a) or the alternative depreciation system of sec- tion 168(g) may be accounted for in one or more multiple asset accounts or pools. (2)Grouping assets in multiple asset accounts or pools—(i)General rules.As- sets that are eligible to be grouped into a single multiple asset account or pool may be divided into more than one multiple as- set account or pool. Each multiple asset October 21, 20133542013–43 I.R.B. account or pool must include only assets that— (A) Have the same applicable deprecia- tion method; (B) Have the same applicable recovery period; (C) Have the same applicable conven- tion; and (D) Are placed in service by the tax- payer in the same taxable year. (ii)Special rules.Inadditiontothegen- eral rules in paragraph (c)(2)(i) of this sec- tion, the following rules apply when estab- lishing multiple asset accounts or pools— (A) Assets subject to the mid-quarter convention may only be grouped into a multiple asset account or pool with assets that are placed in service in the same quar- terofthetaxableyear; (B) Assets subject to the mid-month convention may only be grouped into a multiple asset account or pool with as- sets that are placed in service in the same month of the taxable year; (C) Passenger automobiles for which the depreciation allowance is limited un- der section 280F(a) must be grouped into a separate multipleasset account or pool; (D) Assets not eligible for any addi- tional first year depreciation deduction (including assets for which the taxpayer elected not to deduct the additional first year depreciation) provided by, for exam- ple, section 168(k) through (n), 1400L(b), or 1400N(d), must be grouped into a sep- arate multipleasset account or pool; (E) Assets eligible for the additional first year depreciation deduction may only be grouped into a multiple asset account or pool with assets for which the taxpayer claimed the same percentage of the addi- tional first year depreciation (for example, 30 percent, 50 percent, or 100 percent); (F) Except for passenger automobiles described in paragraph (c)(2)(ii)(C) of this section, listed property (as defined in sec- tion 280F(d)(4)) must be grouped into a separate multiple asset account or pool; (G) Assets for which the depreciation allowance for the placed-in-service year is not determined by using an optional depre- ciation table (for further guidance, see sec- tion 8 of Rev. Proc. 87–57, 1987–2 C.B. 687, 693 (see §601.601(d)(2) of this chap- ter)) must be grouped into a separate mul- tiple asset account or pool; and (H) Mass assets (as defined in §1.168(i)–8T(b)(2) or Prop.Reg. §1.168(i)–8(b)(3) (September 19, 2013), as applicable) that are or will be subject to §1.168(i)–8T(f)(2)(iii) or Prop. Reg. §1.168(i)–8(g)(2)(iii) (September 19, 2013) as applicable, (disposed of or con- verted mass asset is identified by a mortal- ity dispersion table) must be grouped into a separate multiple asset account or pool. (d)Cross references.See §1.167(a)–7(c) for the records to be main- tained by a taxpayer for each account. In addition, see §1.168(i)–1(l)(3) for the records to be maintained by a taxpayer for each general asset account. (e)Effective/applicability date—(1)In general. This section applies to taxable years beginning on or after January 1, 2014. (2)Early application of this section.A taxpayer may choose to apply the provi- sions of this section to taxable years begin- ning on or after January 1, 2012. (3)Optional application of TD 9564. A taxpayer may choose to apply §1.168(i)–7T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014. (4)Change in method of accounting.A change to comply with this section for de- preciable assets placedin service in a tax- able year ending on or after December 30, 2003, is a change in method of accounting to which the provisions of section 446(e) and the regulations under section 446(e) apply. A taxpayer also may treat a change to comply with this section for deprecia- ble assets placed in service in a taxable year ending before December 30, 2003, as a change in method of accounting to which the provisions of section 446(e) and the regulations under section 446(e) apply. §1.168(i)–7T [Removed] Par. 17. Section 1.168(i)–7T is re- moved. Par. 18. Section 1.263(a)–0 is amended by: 1. The table of contents introductory text is revised. 2. Revising the section heading and entries to the table of contents for §§1.263(a)–1, 1.263(a)–2 and 1.263(a)–3. 3. Adding §1.263(a)–6 to the table of contents. The revisions and additions read as fol- lows: §1.263(a)–0 Outline of regulations under section 263(a). This section lists the paragraphs in §§1.263(a)–1 through 1.263(a)–3 and §1.263(a)–6. §1.263(a)–1 Capital expenditures; in general. (a) General rule for capital expendi- tures. (b) Coordination with other provisions of the Internal Revenue Code. (c) Definitions. (1) Amount paid. (2) Produce. (d) Examples of capital expenditures. (e) Amounts paid to sell property. (1) In general. (2) Dealer in property. (3) Examples. (f)De minimissafe harbor election. (1) In general. (i) Taxpayer with applicable financial statement. (ii) Taxpayer without applicable finan- cial statement. (iii) Taxpayer with both an applicable financial statement and a non-qualifying financial statement. (2) Exceptions to de minimissafe har- bor. (3) Additional rules. (i) Transaction and other additional costs. (ii) Materials and supplies. (iii) Sale or disposition. (iv) Treatment ofde minimisamounts. (v) Coordination with section 263A. (vi) Written accounting procedures for groups of entities. (vii) Combined expensing accounting procedures. (4) Definition of applicable financial statement. (5) Time and manner of making elec- tion. (6) Anti-abuse rule. (7) Examples. (g) Accounting method changes. (h) Effective/applicability date. (1) In general. (2) Early application of this section. (i) In general. (ii) Transition rule forde minimissafe harbor election on 2012 or 2013 returns. (3) Optional application of TD 9564. 2013–43 I.R.B.355October 21, 2013 §1.263(a)–2 Amounts paid to acquire or produce tangible property. (a) Overview. (b) Definitions. (1) Amount paid. (2) Personal property. (3) Real property. (4) Produce. (c) Coordination with other provisions of the Internal Revenue Code. (1) In general. (2) Materials and supplies. (d) Acquired or produced tangible prop- erty. (1) Requirement to capitalize. (2) Examples. (e) Defense or perfection of title to property. (1) In general. (2) Examples. (f) Transaction costs. (1) In general. (2) Scope of facilitate. (i) In general. (ii) Inherently facilitative amounts. (iii) Special rule for acquisitions of real property. (A) In general. (B) Acquisitions of real and personal property in a single transaction. (iv) Employee compensation and over- head costs. (A) In general. (B) Election to capitalize. (3) Treatment of transaction costs. (i) In general. (ii) Treatment of inherently facilitative amounts. (iii) Contingency fees. (4) Examples. (g) Treatment of capital expenditures. (h) Recovery of capitalized amounts. (1) In general. (2) Examples. (i) Accounting method changes. (j) Effective/applicability date. (1) In general. (2) Early application of this section. (i) In general. (ii) Transition rule for election to cap- italize employee compensation and over- head costs on 2012 or 2013 returns. (3) Optional application of TD 9564. §1.263(a)–3 Amounts paid to improve tangible property. (a) Overview. (b) Definitions. (1) Amount paid. (2) Personal property. (3) Real property. (4) Owner. (c) Coordination with other provisions of the Internal Revenue Code. (1) In general. (2) Materials and supplies. (3) Example. (d) Requirement to capitalize amounts paid for improvements. (e) Determining the unit of property. (1) In general. (2) Building. (i) In general. (ii) Application of improvement rules to a building. (A) Building structure. (B) Building system. (iii) Condominium. (A) In general. (B) Application of improvement rules to a condominium. (iv) Cooperative. (A) In general. (B) Application of improvement rules to a cooperative. (v) Leased building. (A) In general. (B) Application of improvement rules to a leased building. (1) Entire building. (2) Portion of building. (3) Property other than a building. (i) In general. (ii) Plant property. (A) Definition. (B) Unit of property for plant property. (iii) Network assets. (A) Definition. (B) Unit of property for network assets. (iv) Leased property other than build- ings. (4) Improvements to property. (5) Additional rules. (i) Year placed in service. (ii) Change in subsequent taxable year. (6) Examples. (f) Improvements toleased property. (1) In general. (2) Lessee improvements. (i) Requirement to capitalize. (ii) Unit of property for lessee improve- ments. (3) Lessor improvements. (i) Requirement to capitalize. (ii) Unit of property for lessor improve- ments. (4) Examples. (g) Special rules for determining im- provement costs. (1) Certain costs incurred during an im- provement. (i) In general. (ii) Exception for individuals’ resi- dences. (2) Removal costs. (i) In general. (ii) Examples. (3) Related amounts. (4) Compliance with regulatory re- quirements. (h) Safe harbor for small taxpayers. (1) In general. (2) Application with other safe harbor provisions. (3) Qualifying taxpayer. (i) In general. (ii) Application to new taxpayers. (iii) Treatment of short taxable year. (iv) Definition of gross receipts. (4) Eligible building property. (5) Unadjusted basis. (i) Eligible building property owned by the taxpayer. (ii) Eligible building property leased to the taxpayer. (6)Timeandmannerofelection. (7) Treatment of safe harbor amounts. (8) Safe harbor exceeded. (9) Modification of safe harbor amounts. (10) Examples. (i) Safe harbor for routine maintenance. (1) In general. (i) Routine maintenance for buildings. (ii) Routine maintenance for property other than buildings. (2) Rotable and temporary spare parts. (3) Exceptions. (4) Class life. (5) Coordination with section 263A. (6) Examples. (j) Capitalization of betterments. (1) In general. (2) Application of betterment rules. (i) In general. (ii) Application of betterment rules to buildings. October 21, 20133562013–43 I.R.B. (iii) Unavailability of replacement parts. (iv) Appropriate comparison. (A) In general. (B) Normal wear and tear. (C) Damage to property. (4) Examples. (k) Capitalization of restorations. (1) In general. (2) Application of restorations to build- ings. (3) Exception for losses based on sal- vage value. (4) Restoration of damage from casu- alty. (i) Limitation. (ii) Amounts in excess of limitation. (5) Rebuild to like-new condition. (6) Replacement of a major component or substantial structural part. (i) In general. (A) Major component. (B) Substantial structural part. (ii) Major components and substantial structural parts of buildings. (7) Examples. (l) Capitalization of amounts to adapt property to a new or different use. (1) In general. (2) Application of adaptation rule to buildings. (3) Examples. (m) Optional regulatory accounting method. (1) In general. (2) Eligibility for regulatory accounting method. (3) Description of regulatory account- ing method. (4) Examples. (n) Election to capitalize repair and maintenance costs. (1) In general. (2) Time and manner of election. (3) Exception. (4) Examples. (o) Treatment of capital expenditures. (p) Recovery of capitalized amounts. (q) Accounting method changes. (r) Effective/applicability date. (1) In general. (2) Early application of this section. (i) In general. (ii) Transition rule for elections on 2012 and2013returns. (3) Optional application of TD 9564. ***** §1.263(a)–6 Election to deduct or capitalize certain expenditures. (a) In general. (b) Election provisions. (c) Effective/applicability date. (1) In general. (2) Early application of this section. (3) Optional application of TD 9564. §1.263(a)–0T [Removed] Par. 19. Section 1.263(a)–0T is re- moved. Par. 20. Section 1.263(a)–1 is revised to read as follows: §1.263(a)–1 Capital expenditures; in general. (a)General rule for capital expendi- tures. Except as provided in chapter 1 of the Internal Revenue Code, no deduction is allowed for— (1) Any amount paid for new buildings or for permanent improvements or better- ments made to increase the value of any property or estate; or (2) Any amount paid in restoring prop- erty or in making good the exhaustion thereof for which an allowance is or has been made. (b)Coordination with other provisions of the Internal Revenue Code. Nothing in this section changes the treatment of any amount that is specifically provided for un- der any provision of the Internal Revenue Code or the Treasury Regulations other than section 162(a) or section 212 and the regulations under those sections. For ex- ample, see section 263A, which requires taxpayers to capitalize the direct and allo- cable indirect costs to property produced by the taxpayer and property acquired for resale. See also section 195 requiring tax- payers to capitalize certain costs as start-up expenditures. (c)Definitions. For purposes of this section, the following definitions apply: (1)Amount paid. In the case of a tax- payer using an accrual method of account- ing, the termsamount paidandpayment mean a liability incurred (within the mean- ing of §1.446–1(c)(1)(ii)). A liability may not be taken into account under this section prior to the taxable year during which the liability is incurred. (2)Producemeans construct, build, in- stall, manufacture, develop, create, raise, or grow. This definition is intended to have the same meaning as the definition used for purposes of section 263A(g)(1) and §1.263A–2(a)(1)(i), except that improve- ments are excluded from the definition in this paragraph (c)(2) and are separately de- fined and addressed in §1.263(a)–3. (d)Examples of capital expenditures. The following amounts paid are examples of capital expenditures: (1) An amount paid to acquire or pro- duce a unit of real or personal tangible property. See §1.263(a)–2. (2)Anamountpaidtoimproveaunit of real or personal tangible property. See §1.263(a)–3. (3) An amount paid to acquire or create intangibles. See §1.263(a)–4. (4)Anamountpaidorincurredtofacil- itate an acquisition of a trade or business, a change in capital structure of a business entity, and certain other transactions. See §1.263(a)–5. (5) An amount paid to acquire or create interests in land, such as easements, life es- tates, mineral interests, timber rights, zon- ing variances, or other interests in land. (6) An amount assessed and paid un- der an agreement between bondholders or shareholders of a corporation to be used in a reorganization of the corporation or vol- untary contributions by shareholders to the capital of the corporation for any corporate purpose. See section 118 and §1.118–1. (7)Anamountpaidbyaholdingcom- pany to carry out a guaranty of dividends at a specified rate on the stock of a sub- sidiary corporation for the purpose of se- curing new capital for the subsidiary and increasing the value of its stockholdings in the subsidiary. This amount must be added to the cost of the stock in the subsidiary. (e)Amounts paid to sell property—(1) In general. Commissions and other trans- action costs paid to facilitate the sale of property are not currently deductible under section 162 or 212. Instead, the amounts are capitalizedcosts that reduce the amount realizedin the taxable year in which the sale occurs or are taken into account in the taxable year in which the sale is abandoned if a deduction is per- missible. These amounts are not added to the basis of the property sold or treated as an intangible asset under §1.263(a)–4. See §1.263(a)–5(g) for the treatment of amounts paid to facilitate the disposition of assets that constitute a trade or business. 2013–43 I.R.B.357October 21, 2013 (2)Dealer in property. In the case of a dealer in property, amounts paid to facili- tate the sale of such property are treated as ordinary and necessary business expenses. (3)Examples. The following examples, which assume the sale is not an installment sale under section 453, illustrate the rules of this paragraph (e): Example 1.Sales costs of real property.Aowns a parcel of real estate. A sells the real estate and pays legal fees, recording fees, and sales commissions to facilitate the sale. A must capitalize the fees and com- missions and, in the taxable year of the sale, must re- duce the amount realized from the sale of the real es- tate by the fees and commissions. Example 2.Sales costs of dealers.Assume the same facts as in Example 1, except that A is a dealer in real estate. The commissions and fees paid to fa- cilitate the sale of the real estate may be deducted as ordinary and necessary business expenses under sec- tion 162. Example 3.Sales costs of personal property used in a trade or business . B owns a truck for use in B’s trade or business. B decides to sell the truck on November 15, Year 1. B pays for an appraisal to determine a reasonable asking price. On February 15,Year2,BsellsthetrucktoC.InYear1,Bmust capitalize the amount paid to appraise the truck, and in Year 2, must reduce the amount realized from the sale of the truck by the amount paid for the appraisal. Example 4.Costs of abandoned sale of personal property used in a trade or business. Assume the same facts as in Example 3, except that, instead of selling the truck on February 15, Year 2, B decides on that date not to sell the truck and takes the truck off the market. In Year 1, B must capitalize the amount paid to appraise the truck. However, B may recognize the amount paid to appraise the truck as a loss under section 165 in Year 2, the taxable year when the sale is abandoned. Example 5.Sales costs of personal property not used in a trade or business. Assume the same facts as in Example 3, except that B does not use the truck in B’s trade or business but instead uses it for personal purposes. In Year 1, B must capitalize the amount paid to appraise the truck, and in Year 2, must reduce the amount realized from the sale of the truck by the amount paid for the appraisal. Example 6.Costs of abandoned sale of personal property not used in a trade or business . Assume the same facts as in Example 5, except that, instead of selling the truck on February 15, Year 2, B decides on that date not to sell the truck and takes the truck off the market. In Year 1, B must capitalize the amount paid to appraise the truck. Although B abandons the sale in Year 2, B may not treat the amount paid to appraise the truck as a loss under section 165 because the truck was not used in B’s trade or business or in a transaction entered into for profit. (f)De minimis safe harbor elec- tion—(1)In general. Except as otherwise provided in paragraph (f)(2) of this section, a taxpayer electing to apply thede minimis safe harbor under this paragraph (f) may not capitalize under §1.263(a)–2(d)(1) or §1.263(a)–3(d) any amount paid in the tax- able year for the acquisition or production of a unit of tangible property nor treat as a material or supply under §1.162–3(a) any amount paid in the taxable year for tangi- ble property if the amount specified under this paragraph (f)(1) meets the require- ments of paragraph (f)(1)(i) or (f)(1)(ii) of this section. But see section 263A and the regulations under section 263A, which require taxpayers to capitalize the direct and allocable indirect costs of property produced by the taxpayer (for example, property improved by the taxpayer) and property acquired for resale. (i)Taxpayer with applicable financial statement. A taxpayer electing to apply the de minimissafe harbor may not capitalize under §1.263(a)–2(d)(1) or §1.263(a)–3(d) nor treat as a material or supply under §1.162–3(a) any amount paid in the tax- able year for property described in para- graph (f)(1) of this section if— (A) The taxpayer has an applicable fi- nancial statement (as defined in paragraph (f)(4) of this section); (B) The taxpayer has at the beginning of the taxable year written accounting pro- cedures treating as an expense for non-tax purposes— (1) Amounts paid for property costing less than a specified dollar amount; or (2) Amounts paid for property with an economic useful life (as defined in §1.162–3(c)(4)) of 12 months or less; (C) The taxpayer treats the amount paid for the property as an expense on its ap- plicable financial statement in accordance with its written accounting procedures; and (D) The amount paid for the property does not exceed $5,000 per invoice (or per item as substantiated by the invoice) or other amount as identified in pub- lished guidance in theFederal Register or in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter). (ii)Taxpayer without applicable fi- nancial statement.A taxpayer electing to apply thede minimissafe harbor may not capitalize under §1.263(a)–2(d)(1) or §1.263(a)–3(d) nor treat as a material or supply under §1.162–3(a) any amount paid in the taxable year for property described in paragraph (f)(1) of this section if— (A) The taxpayer does not have an ap- plicable financial statement (as defined in paragraph (f)(4) of this section); (B) The taxpayer has at the beginning of the taxable yearaccounting procedures treating as an expense for non-tax pur- poses— (1) Amounts paid for property costing less than a specified dollar amount; or (2) Amounts paid for property with an economic useful life (as defined in §1.162–3(c)(4)) of 12 months or less; (C) The taxpayer treats the amount paid for the property as an expense on its books and records in accordance with these ac- counting procedures; and (D) The amount paid for the prop- erty does not exceed $500 per invoice (or per item as substantiated by the in- voice) or other amount as identified in published guidance in theFederal Reg- isteror in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b)ofthischapter). (iii)Taxpayer with both an applicable financial statement and a non-qualifying financial statement. For purposes of this paragraph (f)(1), if a taxpayer has an appli- cable financial statement defined in para- graph(f)(4)ofthissectioninadditiontoa financial statement that does not meet re- quirements of paragraph (f)(4) of this sec- tion, the taxpayer must meet the require- ments of paragraph (f)(1)(i) of this section to qualify to elect thede minimissafe har- bor under this paragraph (f). (2)Exceptions to de minimis safe har- bor.Thede minimissafe harbor in para- graph (f)(1) of this section does not apply to the following: (i) Amounts paid for property that is or is intended to be included in inventory property; (ii) Amounts paid for land; (iii) Amounts paid for rotable, tempo- rary, and standby emergency spare parts that the taxpayer elects to capitalize and depreciate under §1.162–3(d); and (iv) Amounts paid for rotable and tem- porary spare parts that the taxpayer ac- counts for under the optional method of accounting for rotable parts pursuant to §1.162–3(e). (3) Additional rules—(i)Transaction and other additional costs.A taxpayer electing to apply thede minimissafe har- bor under paragraph (f)(1) of this section is not required to include in the cost of the tangible property the additional costs of acquiring or producing such property if these costs are not included in the same invoice as the tangible property. However, October 21, 20133582013–43 I.R.B. the taxpayer electing to apply thede min- imissafe harbor under paragraph (f)(1) of this section must include in the cost of such property all additional costs (for example, delivery fees,installation ser- vices, or similar costs) if these additional costs are included on the same invoice with the tangible property. For purposes of this paragraph, if the invoice includes amounts paid for multiple tangible prop- erties and such invoice includes additional invoice costs related to these multiple properties, then the taxpayer must allocate the additional invoice costs to each prop- erty using a reasonable method, and each property, including allocable labor and overhead, must meet the requirements of paragraph (f)(1)(i) or paragraph (f)(1)(ii) of this section, whichever is applicable. Reasonable allocation methods include, but are not limited to specific identifica- tion, apro rataallocation, or a weighted average method based on the property’s relative cost. For purposes of this para- graph (f)(3)(i), additional costs consist of the costs of facilitating the acquisition or production of such tangible property un- der §1.263(a)–2(f) and the costs for work performed prior to the date that the tan- gible property is placed in service under §1.263(a)–2(d). (ii)Materials and supplies.Ifatax- payer elects to apply thede minimissafe harbor provided under this paragraph (f), then the taxpayer must also apply thede minimissafe harbor to amounts paid for all materials and supplies (as defined un- der §1.162–3) that meet the requirements of §1.263(a)–1(f). See paragraph (f)(3)(iv) of this section for treatment of materials and supplies under thede minimissafe har- bor. (iii)Sale or disposition. Property to which a taxpayer applies thede minimis safe harbor contained in this paragraph (f) is not treated upon sale or other disposition as a capital asset under section 1221 or as property used in the trade or business under section 1231. (iv)Treatment of de minimis amounts. An amount paid for property to which a taxpayer properly applies thede minimis safe harbor contained in this paragraph (f) is not treated as a capital expenditure un- der §1.263(a)–2(d)(1) or §1.263(a)–3(d) or as a material and supply under §1.162–3, and may be deducted under §1.162–1 in the taxable year the amount is paid pro- vided the amount otherwise constitutes an ordinary and necessary expense incurred in carrying on a trade or business. (v)Coordination with section 263A. Amounts paid for tangible property de- scribed in paragraph (f)(1) of this section may be subject to capitalization under section 263A if the amounts paid for tangible property comprise the direct or allocable indirect costs of other property produced by the taxpayer or property acquired for resale. See, for example, §1.263A–1(e)(3)(ii)(R) requiring taxpay- ers to capitalize the cost of tools and equipment allocableto property produced or property acquired for resale. (vi)Written accounting procedures for groups of entities.Ifthetaxpayer’sfi- nancial results are reported on the applica- ble financial statement (as defined in para- graph (f)(4) of this section) for a group of entities then, for purposes of paragraph (f)(1)(i)(A) of this section, the group’s ap- plicable financial statement may be treated as the applicable financial statement of the taxpayer, and for purposes of para- graphs (f)(1)(i)(B) and (f)(1)(i)(C) of this section, the written accounting procedures provided for the group and utilized for the group’s applicable financial statement may be treated as the written accounting proce- dures of the taxpayer. (vii)Combined expensing accounting procedures. For purposes of paragraphs (f)(1)(i) and (f)(1)(ii) of this section, if the taxpayer has, at the beginning of the taxable year accounting procedures treat- ing as an expense for non-tax purposes (1) amounts paid for property costing less than a specified dollar amount; and (2) amounts paid for property with an economic use- ful life (as defined in §1.162–3(c)(4)) of 12 months or less, then a taxpayer elect- ingtoapplythede minimissafe harbor un- der this paragraph (f) must apply the provi- sions of this paragraph (f) to amounts qual- ifying under either accounting procedure. (4)Definition of applicable financial statement. For purposes of this para- graph (f), the taxpayer’s applicable fi- nancial statement (AFS) is the taxpayer’s financial statement listed in paragraphs (f)(4)(i) through (iii) of this section that has the highest priority (including within paragraph (f)(4)(ii) of this section). The financial statements are, in descending priority— (i) A financial statement required to be filed with the Securities and Exchange Commission (SEC) (the 10–K or the An- nual Statement to Shareholders); (ii) A certified audited financial state- ment that is accompanied by the report of an independent certified public accountant (or in the case of a foreign entity, by the report of a similarly qualified independent professional) that is used for— (A) Credit purposes; (B) Reporting to shareholders, partners, or similar persons; or (C) Any other substantial non-tax pur- pose; or (iii) A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or the Internal Revenue Service). (5)Time and manner of election.A taxpayer that makes the election under this paragraph (f) must make the election for all amounts paid during the taxable year for property described in paragraph (f)(1) of this section and meeting the require- ments of paragraph (f)(1)(i) or paragraph (f)(1)(ii) of this section, as applicable. A taxpayer makes the election by attaching a statement to the taxpayer’s timely filed original Federal tax return (including ex- tensions) for the taxable year in which these amounts are paid. See §§301.9100–1 through 301.9100–3 of this chapter for the provisions governing extensions of time to make regulatory elections. The statement must be titled “Section 1.263(a)–1(f)de minimissafe harbor election” and include the taxpayer’s name, address, taxpayer identification number, and a statement that the taxpayer is making thede minimis safe harbor election under §1.263(a)–1(f). In the case of a consolidated group fil- ing a consolidated income tax return, the election is made for each member of the consolidated group by the common parent, and the statement must also include the names and taxpayer identification num- bers of each member for which the election is made. In the case of an S corporation or a partnership, the election is made by the S corporation or the partnership and not by the shareholders or partners. An election may not be made through the filing of an application forchange in accounting method or, before obtaining the Commis- sioner’s consent to make a late election, by filing an amended Federal tax return. 2013–43 I.R.B.359October 21, 2013 A taxpayer may not revoke an election made under this paragraph (f). The man- ner of electing thede minimissafe harbor under this paragraph (f) may be modified through guidance of general applicability (see §§601.601(d)(2) and 601.602 of this chapter). (6)Anti-abuse rule. If a taxpayer acts to manipulate transactions with the intent to achieve a tax benefit or to avoid the application of the limitations provided un- der paragraphs (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, appropriate adjustments will be made to carry out the purposes of this sec- tion. For example, a taxpayer is deemed to act to manipulate transactions with an intent to avoid the purposes and require- ments of this section if— (i) The taxpayer applies thede minimis safe harbor to amounts substantiated with invoices created to componentize property that is generally acquired or produced by the taxpayer (or other taxpayers in the same or similar trade or business) as a single unit of tangible property; and (ii) This property, if treated as a single unit, would exceed any of the limitations provided under para- graphs (f)(1)(i)(B)(1),(f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, as applicable. (7)Examples. The following examples illustrate the application of this paragraph (f). Unless otherwise provided, assume that section 263A does not apply to the amounts described. Example 1.De minimis safe harbor; taxpayer without AFS . In Year 1, A purchases 10 printers at $250 each for a total cost of $2,500 as indicated by the invoice. Assume that each printer is a unit of prop- erty under §1.263(a)–3(e). A does not have an AFS. A has accounting procedures in place at the beginning of Year 1 to expense amounts paid for property cost- ing less than $500, and A treats the amounts paid for the printers as an expense on its books and records. The amounts paid for the printers meet the require- ments for the de minimissafe harbor under paragraph (f)(1)(ii) of this section. If A elects to apply the de minimis safe harbor under this paragraph (f) in Year 1, A may not capitalize the amounts paid for the 10 printers or any other amounts meeting the criteria for the de minimissafe harbor under paragraph (f)(1). In- stead, in accordance with paragraph (f)(3)(iv) of this section, A may deduct these amounts under §1.162–1 in the taxable year the amounts are paid provided the amounts otherwise constitute deductible ordinary and necessary expenses incurred in carrying on a trade or business. Example 2.De minimis safe harbor; taxpayer without AFS . In Year 1, B purchases 10 computers at $600 each for a total cost of $6,000 as indicated by the invoice. Assume that each computer is a unit of property under §1.263(a)–3(e). B does not have an AFS. B has accounting procedures in place at the be- ginning of Year 1 to expense amounts paid for prop- erty costing less than $1,000 and B treats the amounts paid for the computers as an expense on its books and records. The amounts paid for the printers do not meet the requirements for the de minimissafe har- bor under paragraph (f)(1)(ii) of this section because the amount paid for the property exceeds $500 per invoice (or per item as substantiated by the invoice). B may not apply the de minimissafe harbor election to the amounts paid for the 10 computers under para- graph (f)(1) of this section. Example 3.De minimis safe harbor; taxpayer with AFS . C is a member of a consolidated group for Federal income tax purposes. C’s financial re- sults are reported on the consolidatedapplicable fi- nancial statements for the affiliated group. C’s affili- ated group has a written accounting policy at the be- ginningofYear1,whichisfollowedbyC,toexpense amounts paid for property costing $5,000 or less. In Year 1, C pays $6,250,000 to purchase 1,250 com- puters at $5,000 each. C receives an invoice from its supplier indicating the total amount due ($6,250,000) and the price per item ($5,000). Assume that each computer is a unit of property under §1.263(a)–3(e). The amounts paid for the computers meet the require- ments for the de minimissafe harbor under paragraph (f)(1)(i)ofthissection. IfCelectstoapplythe de minimis safe harbor under this paragraph (f) for Year 1, C may not capitalize the amounts paid for the 1,250 computers or any other amounts meeting the criteria for the de minimissafe harbor under paragraph (f)(1) of this section. Instead, in accordance with paragraph (f)(3)(iv) of this section, C may deduct these amounts under §1.162–1 in the taxable year the amounts are paid provided the amounts otherwise constitute de- ductible ordinary and necessary expenses incurred in carrying on a trade or business. Example 4.De minimis safe harbor; taxpayer with AFS . D is a member of a consolidated group for Federal income tax purposes. D’s financial re- sults are reported on the consolidatedapplicable fi- nancial statements for the affiliated group. D’s affili- ated group has a written accounting policy at the be- ginning of Year 1, which is followed by D, to expense amounts paid for property costing less than $15,000. In Year 1, D pays $4,800,000 to purchase 800 el- liptical machines at $6,000 each. D receives an in- voice from its supplier indicating the total amount due ($4,800,000) and the price per item ($6,000). Assume that each elliptical machine is a unit of property un- der §1.263(a)–3(e). D may not apply the de minimis safe harbor election to the amounts paid for the 800 elliptical machines under paragraph (f)(1) of this sec- tion because the amount paid for the property exceeds $5,000 per invoice (or per item as substantiated by the invoice). Example 5.De minimis safe harbor; additional invoice costs . E is a member of a consolidated group for Federal income tax purposes. E’s financial re- sults are reported on the consolidatedapplicable fi- nancial statements for the affiliated group. E’s af- filiated group has a written accounting policy at the beginningofYear1,whichisfollowedbyE,toex- pense amounts paid for property costing less than $5,000. In Year 1, E pays $45,000 for the purchase and installation of wireless routers in each of its 10 office locations. Assume that each wireless router is a unit of property under §1.263(a)–3(e). E re- ceives an invoice from its supplier indicating the total amount due ($45,000), including the material price per item ($2,500), and total delivery and installation ($20,000). E allocates the additional invoice costs to the materials on a pro ratabasis, bringing the cost of each router to $4,500 ($2,500 materials + $2,000 la- bor and overhead). The amounts paid for each router, including the allocable additional invoice costs, meet the requirements for the de minimissafe harbor under paragraph (f)(1)(i) of this section. If E elects to ap- ply the de minimissafe harbor under this paragraph (f) for Year 1, E may not capitalize the amounts paid for the 10 routers (including the additional invoice costs) or any other amounts meeting the criteria for the de minimissafe harbor under paragraph (f)(1) of this section. Instead, in accordance with paragraph (f)(3)(iv) of this section, E may deduct these amounts under §1.162–1 in the taxable year the amounts are paid provided the amounts otherwise constitute de- ductible ordinary and necessary expenses incurred in carryingonatradeorbusiness. Example 6.De minimis safe harbor; non-invoice additional costs . F is a corporation that provides consulting services to its customer. F does not have an AFS, but F has accounting procedures in place at the beginning of Year 1 to expense amounts paid for property costing less than $500. In Year 1, F pays $600 to an interior designer to shop for, eval- uate, and make recommendations regarding purchas- ing new furniture for F’s conference room. As a re- sult of the interior designer’s recommendations, F ac- quires a conference table for $500 and 10 chairs for $300 each. In Year 1, F receives an invoice from the interior designer for $600 for his services, and F re- ceives a separate invoice from the furniture supplier indicating a total amount due of $500 for the table and $300 for each chair. For Year 1, F treats the amount paid for the table and each chair as an expense on its books and records, and F elects to use the de minimis safe harbor for amounts paid for tangible property that qualify under the safe harbor. The amount paid to the interior designer is a cost of facilitating the ac- quisition of the table and chairs under §1.263(a)–2(f). Under paragraph (f)(3)(i) of this section, F is not re- quired to include in the cost of tangible property the additional costs of acquiring such property if these costs are not included in the same invoice as the tan- gible property. Thus, F is not required to include a pro rata allocation of the amount paid to the interior de- signer to determine the application of the de minimis safe harbor to the table and the chairs. Accordingly, the amounts paid by F for the table and each chair meet the requirements for the de minimissafe harbor under paragraph (f)(1)(ii) of this section, and F may not capitalize the amounts paid for the table or each chair under paragraph (f)(1) of this section. In addi- tion, F is not required to capitalize the amounts paid to the interior designer as a cost that facilitates the acqui- sition of tangible property under §1.263(a)–2(f)(3)(i). Instead, F may deduct the amounts paid for the ta- ble, chairs, and interior designer under §1.162–1 in the taxable year the amounts are paid provided the amounts otherwise constitute deductible ordinary and necessary expenses incurred in carrying on a trade or business. Example 7.De minimis safe harbor; 12-month economic useful life . G operates a restaurant. In Year October 21, 20133602013–43 I.R.B. 1, G purchases 10 hand-held point-of-service devices at $300 each for a total cost of $3,000 as indicated by invoice. G also purchases 3 tablet computers at $500 each for a total cost of $1,500 as indicated by invoice. Assume each point-of-service device and each tablet computer has an economic useful life of 12 months or less, beginning when they are used in G’s business. Assume that each device and each tablet is a unit of property under §1.263(a)–3(e). G does not have an AFS, but G has accounting procedures in place at the beginning of Year 1 to expense amounts paid for property costing $300 or less and to expense amounts paid for property with an economic useful life of 12 months or less. Thus, G expenses the amounts paid for the hand-held devices on its books and records because each device costs $300. G also expenses the amounts paid for the tablet computers on its books and records because the computers have an economic useful life of 12 months of less, beginning when they are used. The amounts paid for the hand-held devices and the tablet computers meet the requirements for the de minimissafe harbor under paragraph (f)(1)(ii) of this section. If G elects to apply the de minimis safe harbor under this paragraph (f) in Year 1, G may not capitalize the amounts paid for the hand-held de- vices, the tablet computers, or any other amounts meeting the criteria for the de minimissafe harbor un- der paragraph (f)(1) of this section. Instead, in accor- dance with paragraph (f)(3)(iv) of this section, G may deduct the amounts paid for the hand-held devices and tablet computers under §1.162–1 in the taxable year the amounts are paid provided the amounts oth- erwise constitute deductible ordinary and necessary businessexpensesincurredincarryingonatradeor business. Example 8.De minimis safe harbor; limitation. Assume the facts as in Example 7, except G purchases the 3 tablet computers at $600 each for a total cost of $1,800. The amounts paid for the tablet computers do not meet the de minimisrule safe harbor under para- graphs (f)(1)(ii) and (f)(3)(vii) of this section because the cost of each computer exceeds $500. Therefore, the amounts paid for the tablet computers may not be deducted under the safe harbor. Example 9.De minimis safe harbor; materi- als and supplies . H is a corporation that provides consulting services to its customers. H has an AFS and a written accounting policy at the beginning of the taxable year to expense amounts paid for prop- erty costing $5,000 or less. In Year 1, H purchases 1,000 computers at $500 each for a total cost of $500,000. Assume that each computer is a unit of property under §1.263(a)–3(e) and is not a material or supply under §1.162–3. In addition, H purchases 200 office chairs at $100 each for a total cost of $20,000 and 250 customized briefcases at $80 each for a total cost of $20,000. Assume that each office chair and each briefcase is a material or supply under §1.162–3(c)(1). H treats the amounts paid for the computers, office chairs, and briefcases as expenses on its AFS. The amounts paid for computers, office chairs, and briefcases meet the requirements for the de minimissafe harbor under paragraph (f)(1)(i) of this section. If H elects to apply the de minimissafe harbor under this paragraph (f) in Year 1, H may not capitalize the amounts paid for the 1,000 computers, the 200 office chairs, and the 250 briefcases under paragraph (f)(1) of this section. H may deduct the amounts paid for the computers, the office chairs, and the briefcases under §1.162–1 in the taxable year the amounts are paid provided the amounts other- wise constitute deductible ordinary and necessary expenses incurred in carryingonatradeorbusiness. Example 10.De minimis safe harbor; coordina- tion with section 263A . J is a member of a consoli- dated group for Federal income tax purposes. J’s fi- nancial results are reported on the consolidated AFS for the affiliated group. J’s affiliated group has a written accounting policy at the beginning of Year 1, which is followed by J, to expense amounts paid for property costing less than $1,000 or that has an eco- nomic useful life of 12 months or less. In Year 1, J acquires jigs, dies, molds, and patterns for use in the manufacture of J’s products. Assume each jig, die, mold, and pattern is a unit of property under §1.263(a)–3(e) and costs less than $1,000. In Year 1, J begins using the jigs, dies, molds and patterns to manufacture its products. Assume these items are materials and supplies under §1.162–3(c)(1)(iii), and J elects to apply the de minimissafe harbor under paragraph (f)(1)(i) of this section to amounts quali- fyingunderthesafeharbor in Year 1. Under para- graph (f)(3)(v) of this section, the amounts paid for the jigs, dies, molds, and patterns may be subject to capitalization under section 263A if the amounts paid for these tangible properties comprise the direct or al- locable indirect costs of other propertyproduced by the taxpayer or property acquired for resale. Example 11.De minimis safe harbor; anti-abuse rule . K is a corporation that provides hauling services to its customers. In Year 1, K decides to purchase a truck to use in its business. K does not have an AFS. K has accounting procedures in place at the begin- ning of Year 1 to expense amounts paid for property costing less than $500. K arranges to purchase a used truck for a total of $1,500. Prior to the acquisition, K requests the seller to provide multiple invoices for different parts of the truck. Accordingly, the seller provides K with four invoices during Year 1—one in- voice of $500 for the cab, one invoice of $500 for the engine, one invoice of $300 for the trailer, and a fourth invoice of $200 for the tires. K treats the amounts paid under each invoice as an expense on its books and records. K elects to apply the de minimis safe harbor under paragraph (f) of this section in Year 1 and does not capitalize the amounts paid for each invoice pursuant to the safe harbor. Under paragraph (f)(6) of this section, K has applied the de minimis rule to amounts substantiated with invoices created to componentize property that is generally acquired as a single unit of tangible property in the taxpayer’s type of business, and this property, if treated as sin- gle unit, would exceed the limitations provided under the de minimisrule. Accordingly, K is deemed to ma- nipulate the transaction to acquire the truck with the intent to avoid the purposes of this paragraph (f). As a result, K may not apply the de minimisrule to these amounts and is subject to appropriate adjustments. (g)Accounting method changes.Ex- cept for paragraph (f) of this section (the de minimissafe harbor election), a change to comply with this section is a change in method of accounting to which the pro- visions of sections 446 and 481 and the accompanying regulations apply. A tax- payer seeking to change to a method of ac- counting permitted in this section must se- cure the consent of the Commissioner in accordance with §1.446–1(e) and follow the administrative procedures issued under §1.446–1(e)(3)(ii) for obtaining the Com- missioner’s consent to change its account- ing method. (h)Effective/applicability date—(1) In general. Except for paragraph (f) of this section, this section generally applies to taxable years beginning on or after January 1, 2014. Paragraph (f) of this section applies to amounts paid in taxable years beginning on or after January 1, 2014. Except as provided in paragraph (h)(1) and paragraph (h)(2) of this section, §1.263(a)–1 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of this sec- tion—(i)In general. Except for paragraph (f) of this section, a taxpayer may choose to apply this section to taxable years be- ginning on or after January 1, 2012. A taxpayer may choose to apply paragraph (f) of this section to amounts paid in tax- able years beginning on or after January 1, 2012. (ii)Transition rule for de minimis safe harbor election on 2012 or 2013 returns. If under paragraph (h)(2)(i) of this section, a taxpayer chooses to make the election to apply thede minimissafe harbor under paragraph (f) of this section for amounts paid in its taxable year beginning on or af- ter January 1, 2012, and ending on or be- fore September 19, 2013 (applicable tax- able year), and the taxpayer did not make the election specifiedin paragraph (f)(5) of this section on its timely filed original Fed- eral tax return for the applicable taxable year, the taxpayer must make the election specified in paragraph (f)(5) of this section for the applicable taxable year by filing an amended Federal tax return for the appli- cable taxable year on or before 180 days from the due date including extensions of the taxpayer’s Federal tax return for the ap- plicable taxable year,notwithstanding that the taxpayer may not have extended the due date. (3)Optional application of TD 9564. A taxpayer may choose to apply §1.263(a)–1T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014. 2013–43 I.R.B.361October 21, 2013 §1.263(a)–1T [Removed] Par. 21. Section 1.263(a)–1T is re- moved. Par. 22. Section 1.263(a)–2 is revised to read as follows: §1.263(a)–2 Amounts paid to acquire or produce tangible property. (a)Overview. This section provides rules for applying section 263(a) to amounts paid to acquire or produce a unit of real or personal property. Paragraph (b) of this section contains definitions. Para- graph (c) of this section contains the rules for coordinating this section with other provisions of the Internal Revenue Code (Code). Paragraph (d) of this section pro- vides the general requirement to capitalize amounts paid to acquire or produce a unit of real or personal property. Paragraph (e) of this section provides the requirement to capitalize amounts paid to defend or perfect title to real or personal property. Paragraph (f) of this section provides the rules for determining the extent to which taxpayers must capitalize transaction costs related to the acquisition of tangible prop- erty. Paragraphs (g) and (h) of this section address the treatment and recovery of cap- ital expenditures. Paragraph (i) of this section provides for changes in methods of accounting to comply with this section, and paragraph (j) of this section provides the effective and applicability dates for the rules under this section. (b)Definitions.For purposes of this section, the following definitions apply: (1)Amount paid. In the case of a tax- payer using an accrual method of account- ing, the termsamount paidandpayment mean a liability incurred (within the mean- ing of §1.446–1(c)(1)(ii)). A liability may not be taken into account under this section prior to the taxable year during which the liability is incurred. (2)Personal propertymeans tangible personal property as defined in §1.48–1(c). (3)Real propertymeans land and im- provements thereto, such as buildings or other inherently permanent structures (in- cluding items that are structural compo- nents of the buildings or structures) that are not personal property as defined in para- graph (b)(2) of this section. Any property that constitutes other tangible property un- der §1.48–1(d) is treated as real property for purposes of this section. Local law is not controlling in determining whether property is real property for purposes of this section. (4)Producemeans construct, build, in- stall, manufacture, develop, create, raise, or grow. This definition is intended to have the same meaning as the definition used for purposes of section 263A(g)(1) and §1.263A–2(a)(1)(i), except that improve- ments are excluded from the definition in this paragraph (b)(4) and are separately de- fined and addressed in §1.263(a)–3. (c)Coordination with other provisions of the Code—(1)In general. Nothing in this section changes the treatment of any amount that is specifically provided for un- der any provision of the Code or the Trea- sury Regulations other than section 162(a) or section 212 and the regulations under those sections. For example, see section 263A requiring taxpayers to capitalize the direct and allocable indirect costs of prop- erty produced by the taxpayer and prop- erty acquired for resale. See also section 195 requiring taxpayers to capitalize cer- tain costs as start-up expenditures. (2)Materials and supplies. Nothing in this section changes the treatment of amounts paid to acquire or produce prop- erty that is properly treated as materials and supplies under §1.162–3. (d)Acquired or produced tangible property—(1)Requirement to capitalize. Except as provided in §1.162–3 (relat- ing to materials and supplies) and in §1.263(a)–1(f) (providing ade minimis safe harbor election), a taxpayer must cap- italize amounts paid to acquire or produce a unit of real or personal property (as de- termined under §1.263(a)–3(e)), including leasehold improvements, land and land improvements, buildings, machinery and equipment, and furniture and fixtures. See §1.263(a)–3(f) for the rules for determin- ing whether amounts are for leasehold improvements. Amounts paid to acquire or produce a unit of real or personal prop- erty include the invoice price, transaction costs as determined under paragraph (f) of this section, and costs for work performed prior to the date that the unit of property is placed in service by the taxpayer (without regard to any applicable convention under section 168(d)). A taxpayer also must capitalize amounts paid to acquire real or personal property for resale. (2)Examples.The following exam- ples illustrate the rules of this paragraph (d). Unless otherwise provided, assume that the taxpayer does not elect thede min- imissafe harbor under §1.263(a)–1(f) and that the property isnot acquired for resale under section 263A. Example 1.Acquisition of personal property.A purchases new cash registers for use in its retail store located in leased space in a shopping mall. Assume each cash register is a unit of property as determined under §1.263(a)–3(e) and is not a material or supply under §1.162–3. A must capitalize under paragraph (d)(1) of this section the amount paid to acquire each cash register. Example 2.Acquisition of personal property that is a material or supply; coordination with §1.162–3 . B operates a fleet of aircraft. In Year 1, B acquires a stock of component parts, which it intends to use to maintain and repair its aircraft. Assume that each component part is a material or supply under §1.162–3(c)(1) and B does not make elections under §1.162–3(d) to treat the materials and supplies as capital expenditures. In Year 2, B uses the component parts in the repair and maintenance of its aircraft. Because the parts are materials and supplies under §1.162–3, B is not required to capitalize the amounts paid for the parts under paragraph (d)(1) of this section. Rather, to determine the treatment of these amounts, B must apply the rules under §1.162–3, governing the treatment of materials and supplies. Example 3.Acquisition of unit of personal property; coordination with §1.162–3 . C operates a rental business that rents out a variety of small individual items to customers (rental items). C maintains a supply of rental items on hand to re- place worn or damaged items. C purchases a large quantity of rental items to be used in its business. Assume that each of these rental items is a unit of property under §1.263(a)–3(e). Also assume that a portion of the rental items are materials and supplies under §1.162–3(c)(1). Under paragraph (d)(1) of this section, C must capitalize the amounts paid for the rental items that are not materials and supplies under §1.162–3(c)(1). However, C must apply the rules in §1.162–3 to determine the treatment of the rental items that are materials and supplies under §1.162–3(c)(1). Example 4.Acquisition or production cost.D purchases and produces jigs, dies, molds, and patterns for use in the manufacture of D’s products. Assume that each of these items is a unit of property as deter- mined under §1.263(a)–3(e) and is not a material and supply under §1.162–3(c)(1). D is required to capital- ize under paragraph (d)(1) of this section the amounts paid to acquire and produce the jigs, dies, molds, and patterns. Example 5.Acquisition of land.F purchases a parcel of undeveloped real estate. F must capitalize under paragraph (d)(1) of this section the amount paid to acquire the real estate. See paragraph (f) of this section for the treatment of amounts paid to facilitate the acquisition of real property. Example 6.Acquisition of building.G purchases a building. G must capitalize under paragraph (d)(1) of this section the amount paid to acquire the building. See paragraph (f) of this section for the treatment of October 21, 20133622013–43 I.R.B. amounts paid to facilitate the acquisition of real prop- erty. Example 7.Acquisition of property for resale and production of property for sale; coordination with section 263A . H purchases goods for resale and pro- duces other goods for sale. H must capitalize under paragraph (d)(1) of this section the amounts paid to acquire and produce the goods. See section 263A for the amounts required to be capitalized to the property produced or to the property acquired for resale. Example 8.Production of building; coordination with section 263A . J constructs a building. J must capitalize under paragraph (d)(1) of this section the amount paid to construct the building. See section 263A for the costs required to be capitalized to the real property produced by J. Example 9.Acquisition of assets constituting a trade or business. K owns tangible and intangible assets that constitute a trade or business. L purchases all the assets of K in a taxable transaction. L must capitalize under paragraph (d)(1) of this section theamountpaidforthetangibleassetsofK.See §1.263(a)–4 for the treatment of amounts paid to acquire or create intangibles and §1.263(a)–5 for the treatment of amounts paid to facilitate the acquisition of assets that constitute a trade or business. See section 1060 for special allocation rules for certain asset acquisitions. Example 10.Work performed prior to placing the property in service . In Year 1, M purchases a building for use as a business office. Prior to placing the build- ing in service, M pays amounts to repair cement steps, refinish wood floors, patch holes in walls, and paint the interiors and exteriors of the building. In Year 2, M places the building in service and begins using the building as its business office. Assume that the work that M performs does not constitute an improve- ment to the building or its structural components un- der §1.263(a)–3. Under §1.263–3(e)(2)(i), the build- ing and its structural components is a single unit of property. Under paragraph (d)(1) of this section, the amounts paid must be capitalized as amounts to ac- quire the building unit of property because they were for work performed prior to M’s placing the building in service. Example 11.Work performed prior to placing the property in service . In January Year 1, N purchases a new machine for use in an existing production line of its manufacturing business. Assume that the ma- chine is a unit of property under §1.263(a)–3(e) and is not a material or supply under §1.162–3. N pays amounts to install the machine, and after the machine is installed, N pays amounts to perform a critical test on the machine to ensure that it will operate in ac- cordance with quality standards. On November 1, Year 1, the critical test is complete, and N places the machine in service on the production line. N pays amounts to perform periodic quality control testing after the machine is placed in service. Under para- graph (d)(1) of this section, the amounts paid for the installation and the critical test performed before the machine is placed in service must be capitalized by N as amounts to acquire the machine. However, amounts paid for periodic quality control testing after N placed the machine in service are not required to be capitalized as amounts paid to acquire the machine. (e)Defense or perfection of title to property—(1)In general.Amounts paid to defend or perfect title to real or personal property are amounts paid to acquire or produce property within the meaning of this section and must be capitalized. (2)Examples.The following examples illustrate the rule of this paragraph (e): Example 1. Amounts paid to contest condemna- tion . X owns real property located in County. County files an eminent domain complaint condemning a por- tion of X’s property to use as a roadway. X hires an attorney to contest the condemnation. The amounts that X paid to the attorney must be capitalized be- cause they were to defend X’s title to the property. Example 2.Amounts paid to invalidate or- dinance . Y is in the business of quarrying and supplying for sale sand and stone in a certain munic- ipality. Several years after Y establishes its business, the municipality in which it is located passes an or- dinance that prohibits the operation of Y’s business. Y incurs attorney’s fees in a successful prosecution of a suit to invalidate the municipal ordinance. Y prosecutes the suit to preserve its business activities and not to defend Y’s title in the property. Therefore, the attorney’s fees that Y paid are not required to be capitalized under paragraph (e)(1) of this section. Example 3. Amounts paid to challenge building line . The board of public works of a municipality es- tablishes a building line across Z’s business property, adversely affecting the value of the property. Z in- curs legal fees in unsuccessfully litigating the estab- lishment of the building line. The amounts Z paid to the attorney must be capitalized because they were to defend Z’s title to the property. (f)Transaction costs—(1)In general. Except as provided in §1.263(a)–1(f)(3)(i) (for purposes of thede minimissafe har- bor), a taxpayer must capitalize amounts paid to facilitate the acquisition of real or personal property. See §1.263(a)–5 for the treatment of amounts paid to facilitate the acquisition of assets that constitute a trade or business. See §1.167(a)–5 for alloca- tions of facilitative costs between depre- ciable and non-depreciable property. (2)Scope of facilitate—(i)In general. Except as otherwise provided in this sec- tion, an amount is paid to facilitate the ac- quisition of real or personal property if the amount is paid in the process of investigat- ing or otherwise pursuing the acquisition. Whether an amount is paid in the process of investigating or otherwise pursuing the acquisition is determined based on all of the facts and circumstances. In determin- ing whether an amount is paid to facili- tate an acquisition, the fact that the amount would (or would not) have been paid but for the acquisition is relevant but is not de- terminative. Amounts paid to facilitate an acquisition include, but are not limited to, inherently facilitative amounts specified in paragraph (f)(2)(ii) of this section. (ii)Inherently facilitative amounts.An amount is paid in the process of investigat- ing or otherwise pursuing the acquisition of real or personal property if the amount is inherently facilitative. An amount is in- herently facilitative if the amount is paid for— (A) Transporting the property (for ex- ample, shipping fees and moving costs); (B) Securing an appraisal or determin- ing the value or price of property; (C) Negotiating the terms or structure of the acquisition and obtaining tax advice on the acquisition; (D) Application fees, bidding costs, or similar expenses; (E) Preparing and reviewing the docu- ments that effectuate the acquisition of the property (for example, preparing the bid, offer, sales contract, or purchase agree- ment); (F) Examining and evaluating the title of property; (G) Obtaining regulatory approval of the acquisition or securing permits related to the acquisition, including application fees; (H) Conveying property between the parties, including sales and transfer taxes, and title registration costs; (I) Finders’ fees or brokers’ commis- sions, including contingency fees (defined in paragraph (f)(3)(iii) of this section); (J) Architectural, geological, survey, engineering, environmental, or inspection services pertaining toparticular proper- ties; or (K) Services provided by a qualified in- termediary or other facilitator of an ex- change under section 1031. (iii)Special rule for acquisitions of real property—(A)In general. Except as provided in paragraph (f)(2)(ii) of this section (relating to inherently facilitative amounts), an amount paid by the tax- payer in the process of investigating or otherwise pursuing the acquisition of real property does not facilitate the acquisition if it relates to activities performed in the process of determining whether to acquire real property and which real property to acquire. (B)Acquisitions of real and personal property in a single transaction.An amount paid by the taxpayer in the process of investigating or otherwise pursuing the acquisition of personal property facilitates the acquisition of such personal property, 2013–43 I.R.B.363October 21, 2013 even if such property is acquired in a single transaction that also includes the acquisi- tion of real property subject to the special rule set out in paragraph (f)(2)(iii)(A) of this section. A taxpayer may use a rea- sonable allocation method to determine which costs facilitate the acquisition of personal property and which costs relate to the acquisition of real property and are subject to the special rule of paragraph (f)(2)(iii)(A) of this section. (iv)Employee compensation and over- head costs—(A)In general. For purposes of paragraph (f) of this section, amounts paid for employee compensation (within the meaning of §1.263(a)–4(e)(4)(ii)) and overhead are treated as amounts that do not facilitate the acquisition of real or personal property. See section 263A, however, for the treatment of employee compensation and overhead costs required to be capital- ized to property produced by the taxpayer or to property acquired for resale. (B)Election to capitalize.Atax- payer may elect to treat amounts paid for employee compensation or overhead as amounts that facilitate the acquisition of property. The election is made separately for each acquisition and applies to em- ployee compensation oroverhead,orboth. For example, a taxpayer may elect to treat overhead, but not employee compensation, as amounts that facilitate the acquisition of property. A taxpayer makes the election by treating the amounts to which the elec- tion applies as amounts that facilitate the acquisition in the taxpayer’s timely filed original Federal tax return (including ex- tensions) for the taxable year during which the amounts are paid. See §§301.9100–1 through 301.9100–3 of this chapter for the provisions governing extensions of time to make regulatory elections. In the case of an S corporation or a partnership, the election is made by the S corporation or by the partnership, andnot by the sharehold- ers or partners. A taxpayer may revoke an election made under this paragraph (f)(2)(iv)(B) with respect to each acquisi- tion only by filing a request for a private letter ruling and obtaining the Commis- sioner’s consent to revoke the election. The Commissioner may grant a request to revoke this election if the taxpayer acted reasonably and in good faith and the re- vocation will not prejudice the interests of Government. See generally §301.9100–3 of this chapter. The manner of electing and revoking the election to capitalize under this paragraph (f)(2)(iv)(B) may be modified through guidance of general applicability (see §§606.601(d)(2) and 601.602 of this section). An election may not be made or revoked through the filing of an application forchange in accounting method or, before obtaining the Commis- sioner’s consent to make the late election or to revoke the election, by filing an amended Federal tax return. (3)Treatment of transaction costs—(i) In general. Except as provided under §1.263(a)–1(f)(3)(i) (for purposes of the de minimissafe harbor), all amounts paid to facilitate the acquisition of real or per- sonal property are capital expenditures. Facilitative amountsallocable to real or personal property must be included in the basis of the property acquired. (ii)Treatment of inherently facilitative amounts. Inherently facilitative amounts allocable to real or personal property are capital expenditures related to such prop- erty, even if the property is not eventually acquired. Except for contingency fees as defined in paragraph (f)(3)(iii) of this sec- tion, inherently facilitative amounts allo- cable to real or personal property not ac- quired may be allocated to those proper- ties and recovered as appropriate in accor- dance with the applicable provisions of the Code and the Treasury Regulations (for ex- ample, sections 165, 167, or 168). See paragraph (h) of this section for the recov- ery of capitalized amounts. (iii)Contingency Fees. For purposes of this section, a contingency fee is an amount paid that is contingent on the successful closing of the acquisition of real or per- sonal property. Contingency fees must be included in the basis of the property ac- quired and may not be allocated to the property not acquired. (4)Examples.The following exam- ples illustrate the rules of paragraph (f) of this section. For purposes of these examples, assume that the taxpayer does not elect thede minimissafe harbor under §1.263(a)–1(f): Example 1. Broker’s fees to facilitate an acqui- sition . A decides to purchase a building in which to relocate its offices and hires a real estate broker to find a suitable building. A pays fees to the bro- ker to find property for A to acquire. Under para- graph (f)(2)(ii)(I) of this section, A must capitalize the amounts paid to the broker because these costs are inherently facilitative of the acquisition of real prop- erty. Example 2.Inspection and survey costs to facil- itate an acquisition . B decides to purchase Build- ing X and pays amounts to third-party contractors for a termite inspection and an environmental survey of Building X. Under paragraph (f)(2)(ii)(J) of this sec- tion, B must capitalize the amounts paid for the in- spection and the survey of the building because these costs are inherently facilitative of the acquisition of real property. Example 3.Moving costs to facilitate an acqui- sition . C purchases all the assets of D and, in con- nection with the purchase, hires a transportation com- pany to move storage tanks from D’s plant to C’s plant. Under paragraph (f)(2)(ii)(A) of this section, C must capitalize the amount paid to move the stor- age tanks from D’s plant to C’s plant because this cost is inherently facilitative to the acquisition of personal property. Example 4.Geological and geophysical costs; coordination with other provisions . E is in the busi- ness of exploring, purchasing, and developing prop- erties in the United States for the production of oil and gas. E considers acquiring a particular property but first incurs costs for the services of an engineering firm to perform geological and geophysical studies to determine if the property is suitable for oil or gas pro- duction. Assume that the amounts that E paid to the engineering firm constitute geological and geophysi- cal expenditures under section 167(h). Although the amounts that E paid for the geological and geophys- ical services are inherently facilitative to the acqui- sition of real property under paragraph (f)(2)(ii)(J) of this section, E is not required to include those amounts in the basis of the real property acquired. Rather, under paragraph (c) of this section, E must capitalize these costs separately and amortize such costs as required under section 167(h) (addressing the amortization of geological and geophysical expendi- tures). Example 5.Scope of facilitate. F is in the busi- ness of providing legal services to clients. F is inter- ested in acquiring a new conference table for its of- fice. F hires and incurs fees for an interior designer to shop for, evaluate, and make recommendations to F regarding which new table to acquire. Under para- graphs (f)(1) and (2) of this section, F must capitalize the amounts paid to the interior designer to provide these services because they are paid in the process of investigating or otherwise pursuing the acquisition of personal property. Example 6.Transaction costs allocable to multi- ple properties . G, a retailer, wants to acquire land for the purpose of building a new distribution facility for its products. G considers various properties on High- way X in State Y. G incurs fees for the services of an architect to advise and evaluate the suitability of the sites for the type of facility that G intends to construct on the selected site. G must capitalize the architect fees as amounts paid to acquire land because these amounts are inherently facilitative to the acquisition of land under paragraph (f)(2)(ii)(J) of this section. Example 7.Transaction costs; coordination with section 263A . H, a retailer, wants to acquire land for the purpose of building a new distribution facility for its products. H considers various properties on High- way X in State Y. H incurs fees for the services of an architect to prepare preliminary floor plans for a building that H could construct at any of the sites. Un- der these facts, the architect’s fees are not facilitative October 21, 20133642013–43 I.R.B. to the acquisition of land under paragraph (f) of this section. Therefore, H is not required to capitalize the architect fees as amounts paid to acquire land. How- ever, the amounts paid for the architect’s fees may be subject to capitalization under section 263A if these amounts comprise the direct or allocable indirect cost of property produced by H, such as the building. Example 8.Special rule for acquisitions of real property . J owns several retail stores. J decides to examine the feasibility of opening a new store in City X. In October, Year 1, J hires and incurs costs for a development consulting firm to study City X and per- form market surveys, evaluate zoning and environ- mental requirements, and make preliminary reports and recommendations as to areas that J should con- sider for purposes of locating a new store. In De- cember, Year 1, J continues to consider whether to purchase real property in City X and which property to acquire. J hires, and incurs fees for, an appraiser to perform appraisals on two different sites to deter- mine a fair offering price for each site. In March, Year 2, J decides to acquire one of these two sites for the location of its new store. At the same time, J determines not to acquire the other site. Under para- graph (f)(2)(iii) of this section, J is not required to capitalize amounts paid to the development consul- tant in Year 1 because the amounts relate to activities performed in the process of determining whether to acquire real property and which real property to ac- quire, and the amounts are not inherently facilitative costs under paragraph (f)(2)(ii) of this section. How- ever, J must capitalize amounts paid to the appraiser in Year 1 because the appraisal costs are inherently facilitative costs under paragraph (f)(2)(ii)(B) of this section. In Year 2, J must include the appraisal costs allocable to property acquired in the basis of the prop- erty acquired. In addition, J may recover the appraisal costs allocable to the property not acquired in accor- dance with paragraphs (f)(3)(ii) and (h) of this sec- tion. See, for example, §1.165–2 for losses on the permanent withdrawal of non-depreciable property. Example 9.Contingency fee. K owns several restaurant properties. K decides to open a new restau- rant in City X. In October, Year 1, K hires a real estate consultant to identify potential property upon which K may locate its restaurant, and is obligated to com- pensate the consultant upon the acquisition of prop- erty. The real estate consultant identifies three prop- erties, and K decides to acquire one of those proper- ties. Upon closing of the acquisition of that property, K pays the consultant its fee. The amount paid to the consultant constitutes a contingency fee under para- graph (f)(3)(iii) of this section because the payment is contingent on the successful closing of the acquisition of property. Accordingly, under paragraph (f)(3)(iii) of this section, K must include the amount paid to the consultant in the basis of the property acquired. K is not permitted to allocate the amount paid between the properties acquired and not acquired. Example 10.Employee compensation and over- head . L, a freight carrier, maintains an acquisition department whose sole function is to arrange for the purchase of vehicles and aircraft from manufacturers or other parties to be used in its freight carrying busi- ness. As provided in paragraph (f)(2)(iv)(A) of this section, L is not required to capitalize any portion of the compensation paid to employees in its acquisi- tion department or any portion of its overhead allo- cable to its acquisition department. However, under paragraph (f)(2)(iv)(B) of this section, L may elect to capitalize the compensation and/or overhead costs allocable to the acquisition of a vehicle or aircraft by treating these amounts as costs that facilitate the ac- quisition of that property in its timely filed original Federal tax return for the year the amounts are paid. (g)Treatment of capital expenditures. Amounts required to be capitalized un- der this section are capital expenditures and must be taken into account through a charge to capital account or basis, or in the case of property that is inventory in the hands of a taxpayer, through inclusion in inventory costs. (h)Recovery of capitalized amounts—(1)In general. Amounts that are capitalized under this section are recovered through depreciation, cost of goods sold, or by an adjustment to basis at the time the property is placed in service, sold, used, or otherwise disposed of by the taxpayer. Cost recovery is determined by the applicable provisions of the Code and regulations relating to the use, sale, or disposition of property. (2)Examples. The following examples illustrate the rule of paragraph (h)(1) of this section. For purposes of these ex- amples, assume that the taxpayer does not elect thede minimissafe harbor under sec- tion §1.263(a)–1(f). Example 1.Recovery when property placed in service . X owns a 10-unit apartment building. The refrigerator in one of the apartments stops function- ing, and X purchases a new refrigerator to replace the old one. X pays for the acquisition, delivery, and in- stallation of the new refrigerator. Assume that the re- frigerator is the unit of property, as determined under §1.263(a)–3(e), and is not a material or supply under §1.162–3. Under paragraph (d)(1) of this section, X is required to capitalize the amounts paid for the ac- quisition, delivery, and installation of the refrigerator. Under this paragraph (h), the capitalized amounts are recovered through depreciation, which begins when the refrigerator is placed in service by X. Example 2.Recovery when property used in the production of property . Y operates a plant where it manufactures widgets. Y purchases a tractor loader to move raw materials into and around the plant for use in the manufacturing process. Assume that the tractor loader is a unit of property, as determined un- der §1.263(a)–3(e), and is not a material or supply un- der §1.162–3. Under paragraph (d)(1) of this section, Y is required to capitalize the amounts paid to ac- quire the tractor loader. Under this paragraph (h), the capitalized amounts are recovered through deprecia- tion, which begins when Y places the tractor loader in service. However, because the tractor loader is used in the production of property, under section 263A the cost recovery (that is, the depreciation) may also be capitalized to Y’s property produced, and, conse- quently, recovered through cost of goods sold. See §1.263A–1(e)(3)(ii)(I). (i)Accounting method changes.Un- less otherwise provided under this section, a change to comply with this section is a change in method of accounting to which the provisions of sections 446 and 481 and the accompanying regulations apply. A taxpayer seeking to change to a method of accounting permitted in this section must secure the consent of the Commissioner in accordance with §1.446–1(e) and follow the administrative procedures issued under §1.446–1(e)(3)(ii) for obtaining the Com- missioner’s consent to change its account- ing method. (j)Effective/applicability date—(1)In general. Except for paragraphs (f)(2)(iii), (f)(2)(iv), and (f)(3)(ii) of this section, this section generally applies to taxable years beginning on or after January 1, 2014. Paragraphs (f)(2)(iii), (f)(2)(iv), and (f)(3)(ii) of this section apply to amounts paid in taxable years beginning on or after January 1, 2014. Except as provided in paragraphs (j)(1) and (j)(2) of this section, §1.263(a)–2 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of this sec- tion—(i)In general. Except for para- graphs (f)(2)(iii), (f)(2)(iv), and (f)(3)(ii) of this section of this section, a taxpayer may choose to apply this section to tax- able years beginning on or after January 1, 2012. A taxpayer may choose to ap- ply paragraphs (f)(2)(iii), (f)(2)(iv), and (f)(3)(ii) of this section to amounts paid in taxable years beginning on or after Jan- uary 1, 2012. (ii)Transition rule for election to cap- italize employee compensation and over- head costs on 2012 or 2013 returns. If un- der paragraph (j)(2)(i) of this section, a tax- payer chooses to make the election to cap- italize employee compensation and over- head costs under paragraph (f)(2)(iv)(B) of this section for amounts paid in its tax- able year beginning on or after January 1, 2012, and ending on or before September 19, 2013 (applicable taxable year), and the taxpayer did not make the election speci- fied in paragraph (f)(2)(iv)(B) of this sec- tion on its timely filed original Federal tax return for the applicable taxable year, the taxpayer must make the election specified in paragraph (f)(2)(iv)(B) of this section for the applicable taxable year by filing an amended Federal tax return for the appli- 2013–43 I.R.B.365October 21, 2013 cable taxable year on or before 180 days from the due date including extensions of the taxpayer’s Federaltax return for the ap- plicable taxable year, notwithstanding that the taxpayer may not have extended the due date. (3)Optional application of TD 9564. Except for §1.263(a)–2T(f)(2)(iii), (f)(2)(iv), (f)(3)(ii), and (g), a taxpayer may choose to apply §1.263(a)–2T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years be- ginning on or after January 1, 2012, and before January 1, 2014. A taxpayer may choose to apply §1.263(a)–2T(f)(2)(iii), (f)(2)(iv), (f)(3)(ii) and (g) as contained in TD 9564 (76 FR 81060) December 27, 2011, to amounts paid in taxable years beginning on or after January 1, 2012, and before January 1, 2014. §1.263(a)–2T [Removed] Par. 23. Section 1.263(a)–2T is re- moved. Par. 24. Section 1.263(a)–3 is revised to read as follows: §1.263(a)–3 Amounts paid to improve tangible property. (a)Overview. This section provides rules for applying section 263(a) to amounts paid to improve tangible prop- erty. Paragraph (b) of this section provides definitions. Paragraph (c) of this section provides rules for coordinating this sec- tion with other provisions of the Internal Revenue Code (Code). Paragraph (d) of this section provides the requirement to capitalize amounts paid to improve tangi- ble property and provides the general rules for determining whether a unit of property is improved. Paragraph (e) of this section provides the rules for determining the ap- propriate unit of property. Paragraph (f) of this section provides rules for leasehold improvements. Paragraph (g) of this sec- tion provides special rules for determining improvement costs in particular contexts, including indirect costs incurred during an improvement, removal costs, aggregation of related costs, and regulatory compli- ance costs. Paragraph (h) of this section provides a safe harbor for small taxpay- ers. Paragraph (i) provides a safe harbor for routine maintenance costs. Paragraph (j) of this section provides rules for de- termining whether amounts are paid for betterments to the unit of property. Para- graph (k) of this section provides rules for determining whether amounts are paid to restore the unit of property. Paragraph (l) of this section provides rules for amounts paid to adapt the unit of property to a new or different use. Paragraph (m) of this section provides an optional regulatory accounting method. Paragraph (n) of this section provides an election to capitalize repair and maintenance costs consistent with books and records. Paragraphs (o) and (p) of this section provide for the treat- ment and recovery of amounts capitalized under this section. Paragraphs (q) and (r) of this section provide for accounting method changes and state the effective/ap- plicability date for the rules in this section. (b)Definitions.For purposes of this section, the following definitions apply: (1)Amount paid. In the case of a tax- payer using an accrual method of account- ing, the termsamounts paidandpayment mean a liability incurred (within the mean- ing of §1.446–1(c)(1)(ii)). A liability may not be taken into account under this section prior to the taxable year during which the liability is incurred. (2)Personal propertymeans tangible personal property as defined in §1.48–1(c). (3)Real propertymeans land and im- provements thereto, such as buildings or other inherently permanent structures (in- cluding items that are structural compo- nents of the buildings or structures) that are not personal property as defined in para- graph (b)(2) of this section. Any property that constitutes other tangible property un- der §1.48–1(d) is also treated as real prop- erty for purposes of this section. Local law is not controlling in determining whether property is real property for purposes of this section. (4)Ownermeans the taxpayer that has the benefits and burdens of ownership of the unit of property for Federal income tax purposes. (c)Coordination with other provisions of the Code—(1)In general. Nothing in this section changes the treatment of any amount that is specifically provided for un- der any provision of the Code or the reg- ulations other than section 162(a) or sec- tion 212 and the regulations under those sections. For example, see section 263A requiring taxpayers to capitalize the di- rect and allocable indirect costs of property produced and property acquired for resale. (2)Materials and supplies. A material or supply as defined in §1.162–3(c)(1) that is acquired and used to improve a unit of tangible property is subject to this section and is not treated as a material or supply under §1.162–3. (3)Example.The following example illustrates the rules of this paragraph (c): Example.Railroad rolling stock.X is a railroad that properly treats amounts paid for the rehabilitation of railroad rolling stock as deductible expenses un- der section 263(d). X is not required to capitalize the amounts paid because nothing in this section changes the treatment of amounts specifically provided for un- der section 263(d). (d)Requirement to capitalize amounts paid for improvements. Except as pro- vided in paragraph (h) or paragraph (n) of this section or under §1.263(a)–1(f), a tax- payer generally must capitalize the related amounts (as defined in paragraph (g)(3) of this section) paid to improve a unit of prop- erty owned by the taxpayer. However, see paragraph (f) of this section for the treat- ment of amounts paid to improve leased property. See section 263A for the require- ment to capitalize the direct and alloca- ble indirect costs of property produced by the taxpayer and property acquired for re- sale; section 1016 for adding capitalized amounts to the basis of the unit of prop- erty; and section 168 for the treatment of additions or improvements for deprecia- tion purposes. Forpurposes of this sec- tion, a unit of property is improved if the amounts paid for activities performed after the property is placed in service by the tax- payer— (1) Are for a betterment to the unit of property (see paragraph (j) of this section); (2) Restore the unit of property (see paragraph (k) of this section); or (3) Adapt the unit of property to a new or different use (see paragraph (l) of this section). (e)Determining the unit of prop- erty—(1)In general. The unit of prop- erty rules in this paragraph (e) apply only for purposes of section 263(a) and §§1.263(a)–1, 1.263(a)–2, 1.263(a)–3, and 1.162–3. Unless otherwise specified, the unit of property determination is based upon the functional interdependence stan- dard provided in paragraph (e)(3)(i) of this section. However, special rules are pro- vided for buildings (see paragraph (e)(2) of this section), plant property (see paragraph (e)(3)(ii) of this section), network assets (see paragraph (e)(3)(iii) of this section), October 21, 20133662013–43 I.R.B. leased property (see paragraph (e)(2)(v) of this section for leased buildings and paragraph (e)(3)(iv) of this section for leased property other than buildings), and improvements to property (see paragraph (e)(4) of this section). Additional rules are provided if a taxpayer has assigned different MACRS classes or depreciation methods to components of property or subsequently changes the class or depreci- ation method of a component or other item of property (see paragraph (e)(5) of this section). Property that is aggregated or subject to a general asset account election or accounted for in a multiple asset ac- count (that is, pooled) may not be treated asasingleunitofproperty. (2)Building—(i)In general. Except as otherwise provided in paragraphs (e)(4), and (e)(5)(ii) of this section, in the case of a building (as defined in §1.48–1(e)(1)), each building and its structural compo- nents (as defined in §1.48–1(e)(2)) is a single unit of property (“building”). See paragraph (e)(2)(iii) of this section for condominiums, paragraph (e)(2)(iv) of this section for cooperatives, and para- graph (e)(2)(v) of this section for leased buildings. (ii)Application of improvement rules to a building.Anamountispaidtoimprove a building under paragraph (d) of this sec- tion if the amount is paid for an improve- ment under paragraphs (j), (k), or para- graph (l) of this section to any of the fol- lowing: (A)Building structure.A building structure consists of the building (as de- fined in §1.48–1(e)(1)), and its structural components (as defined in §1.48–1(e)(2)), other than the structural components des- ignated as buildings systems in paragraph (e)(2)(ii)(B) of this section. (B)Building system.Each of the fol- lowing structural components (as defined in §1.48–1(e)(2)), including the com- ponents thereof, constitutes a building system that is separate from the building structure, and to which the improvement rules must be applied— (1) Heating, ventilation, and air con- ditioning (“HVAC”) systems (including motors, compressors, boilers, furnace, chillers, pipes, ducts, radiators); (2) Plumbing systems (including pipes, drains, valves, sinks, bathtubs, toilets, wa- ter and sanitary sewer collection equip- ment, and site utility equipment used to distribute water and waste to and from the property line and between buildings and other permanent structures); (3) Electrical systems (including wiring, outlets, junction boxes, lighting fixtures and associated connectors, and site utility equipment used to distribute electricity from the property line to and between buildings and other permanent structures); (4) All escalators; (5) All elevators; (6) Fire-protection and alarm systems (including sensing devices, computer con- trols, sprinkler heads, sprinkler mains, as- sociated piping or plumbing, pumps, vi- sual and audible alarms, alarm control pan- els, heat and smoke detection devices, fire escapes, fire doors, emergency exit light- ing and signage, and fire fighting equip- ment, such as extinguishers, and hoses); (7) Security systems for the protection of the building and its occupants (includ- ing window and door locks, security cam- eras, recorders, monitors, motion detec- tors, security lighting, alarm systems, en- try and access systems, related junction boxes, associated wiring and conduit); (8) Gas distribution system (including associated pipes and equipment used to distribute gas to and from the property line and between buildings or permanent struc- tures); and (9) Other structural components iden- tified in published guidance in theFed- eral Registeror in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b)ofthis chapter) that are excepted from the build- ing structure under paragraph (e)(2)(ii)(A) of this section and are specifically desig- nated as building systems under this sec- tion. (iii)Condominium—(A)In general.In the case of a taxpayer that is the owner of an individual unit in a building with multiple units (such as a condominium), the unit of property (“condominium”) is the individual unit owned by the taxpayer and the structural components (as defined in §1.48–1(e)(2)) that are part of the unit. (B)Application of improvement rules to a condominium.Anamountispaid to improve a condominium under para- graph (d) of this section if the amount is paid for an improvement under paragraphs (j), (k), or paragraph (l) of this section to the building structure (as defined in para- graph (e)(2)(ii)(A) of this section) that is part of the condominium or to the por- tion of any building system (as defined in paragraph (e)(2)(ii)(B) of this section) that is part of the condominium. In the case of the condominium management associ- ation, the association must apply the im- provement rules to the building structure or to any building system described under paragraphs (e)(2)(ii)(A) and (e)(2)(ii)(B) of this section. (iv)Cooperative—(A)In general.In the case of a taxpayer that has an own- ership interest in a cooperative housing corporation, the unit of property (“coop- erative”) is the portion of the building in which the taxpayer has possessory rights and the structural components (as defined in §1.48–1(e)(2)) that are part of the por- tion of the building subject to the tax- payer’s possessory rights (cooperative). (B)Application of improvement rules to a cooperative. Anamountispaidtoim- prove a cooperative under paragraph (d) of this section if the amount is paid for an improvement under paragraphs (j), (k), or(l)ofthissectiontotheportionofthe building structure (as defined in paragraph (e)(2)(ii)(A) of this section) in which the taxpayer has possessory rights or to the portion of any building system (as defined in paragraph (e)(2)(ii)(B) of this section) that is part of the portion of the building structure subject to the taxpayer’s posses- sory rights. In the case of a cooperative housing corporation, the corporation must apply the improvement rules to the build- ing structure or to any building system as described under paragraphs (e)(2)(ii)(A) and (e)(2)(ii)(B) of this section. (v)Leased building—(A)In general.In the case of a taxpayer that is a lessee of all or a portion of a building (such as an office, floor, or certain square footage), the unit of property (“leased building property”) is each building and its structural compo- nents or the portion of each building sub- ject to the lease and the structural compo- nents associated with the leased portion. (B)Application of improvement rules to aleasedbuilding. An amount is paid to improve a leased building property under paragraphs (d) and (f)(2) of this section if the amount is paid for an improvement, un- der paragraphs (j), (k), or (l) of this section, to any of the following: (1)Entire building. In the case of a tax- payer that is a lessee of an entire build- ing, the building structure (as defined un- 2013–43 I.R.B.367October 21, 2013 der paragraph (e)(2)(ii)(A) of this section) or any building system (as defined under paragraph (e)(2)(ii)(B) of this section) that is part of the leased building. (2)Portion of a building. In the case of a taxpayer that is a lessee of a portion of a building (such as an office, floor, or certain square footage), the portion of the build- ing structure (as defined under paragraph (e)(2)(ii)(A) of this section) subject to the lease or the portion of any building system (as defined under paragraph (e)(2)(ii)(B) of this section) subject to the lease. (3)Property other than building—(i) In general. Except as otherwise provided in paragraphs (e)(3), (e)(4), (e)(5), and (f)(1) of this section, in the case of real or personal property other than property described in paragraph (e)(2) of this sec- tion, all the components that are function- ally interdependent comprise a single unit of property. Components of property are functionally interdependent if the placing in service of one component by the tax- payer is dependent on the placing in ser- vice of the other component by the tax- payer. (ii)Plant property—(A)Definition.For purposes of this paragraph (e), the term plant propertymeans functionally inter- dependent machinery or equipment, other than network assets, used to perform an industrial process, such as manufacturing, generation, warehousing, distribution, au- tomated materials handling in service in- dustries, or other similar activities. (B)Unit of property for plant property. In the case of plant property, the unit of property determined under the general rule of paragraph (e)(3)(i) of this section is fur- ther divided into smaller units comprised of each component (or group of compo- nents) that performs a discrete and major function or operation within the function- ally interdependent machinery or equip- ment. (iii)Network assets—(A)Definition. For purposes of this paragraph (e), the termnetwork assetsmeans railroad track, oil and gas pipelines, water and sewage pipelines, power transmission and distri- bution lines, and telephone and cable lines that are owned or leased by taxpayers in each of those respective industries. The term includes, for example, trunk and feeder lines, pole lines, and buried conduit. It does not include property that would be included as building structure or building systems under paragraphs (e)(2)(ii)(A) and (e)(2)(ii)(B) of this section, nor does it include separate property that is adjacent to, but not part of a network asset, such as bridges, culverts, or tunnels. (B)Unit of property for network as- sets.In the case of network assets, the unit of property is determined by the taxpayer’s particular facts and circum- stances except as otherwise provided in published guidance in theFederal Reg- isteror in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b)ofthischapter). For these purposes, the functional interde- pendence standard provided in paragraph (e)(3)(i) of this section is not determina- tive. (iv)Leased property other than build- ings. In the case of a taxpayer that is a lessee of real or personal property other than property described in paragraph (e)(2) of this section, the unit of property for the leased property is determined under para- graphs (e)(3)(i),(ii), (iii), and (e)(5) of this section except that, after applying the ap- plicable rules under those paragraphs, the unit of property may not be larger than the property subject to the lease. (4)Improvements to property.Anim- provement to a unit of property generally is not a unit of property separate from the unit of property improved. For the unit of property for lessee improvements, see also paragraph (f)(2)(ii)) of this section. If a taxpayer elects to treat as a capital expen- diture under §1.162–3(d) the amount paid for a rotable spare part, temporary spare part, or standby emergency spare part, and such part is used in an improvement to a unit of property, then for purposes of ap- plying paragraph (d) of this section to the unit of property improved, the part is not a unit of property separate from the unit of property improved. (5)Additional rules—(i)Year placed in service. Notwithstanding the unit of prop- erty determination under paragraph (e)(3) of this section, a component (or a group of components) of a unit property must be treated as a separate unit of property if, at the time the unit of property is ini- tially placed in service by the taxpayer, the taxpayer has properly treated the com- ponent as being within a different class of property under section 168(e) (MACRS classes) than the class of the unit of prop- erty of which the component is a part, or the taxpayer has properly depreciated the component using a different depreciation method than the depreciation method of the unit of property of which the compo- nent is a part. (ii)Change in subsequent taxable year. Notwithstanding the unit of property deter- mination under paragraphs (e)(2), (3), (4), or (5)(i) of this section, in any taxable year after the unit of property is initially placed in service by the taxpayer, if the taxpayer or the Internal Revenue Service changes the treatment of that property (or any por- tion thereof) to a proper MACRS class or a proper depreciation method (for example, as a result of a cost segregation study or a change in the use of the property), then the taxpayer must change the unit of property determination for that property (or the por- tion thereof) under this section to be con- sistent with the change in treatment for de- preciation purposes. Thus, for example, if a portion of a unit of property is prop- erly reclassified to a MACRS class differ- ent from the MACRS class of the unit of property of which it was previously treated as a part, then the reclassified portion of the property shouldbe treated as a sepa- rate unit of property for purposes of this section. (6)Examples.The following examples illustrate the application of this paragraph (e) and assume that the taxpayer has not made a general asset account election with regard to propertyor accounted for prop- erty in a multiple asset account. In addi- tion, unless the facts specifically indicate otherwise, assume that the additional rules in paragraph (e)(5) of this section do not apply: Example 1.Building systems. A owns an office building that contains a HVAC system. The HVAC system incorporates ten roof-mounted units that ser- vice different parts of the building. The roof-mounted units are not connected and have separate controls and duct work that distribute the heated or cooled air to different spaces in the building’s interior. A pays an amount for labor and materials for work performed on the roof-mounted units. Under paragraph (e)(2)(i) of this section, A must treat the building and its struc- tural components as a single unit of property. As pro- vided under paragraph (e)(2)(ii) of this section, an amount is paid to improve a building if it is for an im- provement to the building structure or any designated building system. Under paragraph (e)(2)(ii)(B)( 1)of this section, the entire HVAC system, including all of the roof-mounted units and their components, com- prise a building system. Therefore, under paragraph (e)(2)(ii) of this section, if an amount paid by A for work on the roof-mountedunits is an improvement (for example, a betterment) to the HVAC system, October 21, 20133682013–43 I.R.B. A must treat this amount as an improvement to the building. Example 2.Building systems. B owns a building that it uses in its retail business. The building contains two elevator banks in different locations in its build- ing. Each elevator bank contains three elevators. B pays an amount for labor and materials for work per- formed on the elevators. Under paragraph (e)(2)(i) of this section, B must treat the building and its struc- tural components as a single unit of property. As pro- vided under paragraph (e)(2)(ii) of this section, an amountispaidtoimproveabuildingifitisforanim- provement to the building structure or any designated building system. Under paragraph (e)(2)(ii)(B)( 5)of this section, all six elevators, including all their com- ponents, comprise a building system. Therefore, un- der paragraph (e)(2)(ii) of this section, if an amount paid by B for work on the elevators is an improve- ment (for example, a betterment) to the elevator sys- tem, B must treat this amount as an improvement to the building. Example 3.Building structure and systems; condominium . C owns a condominium unit in a con- dominium office building. C uses the condominium unit in its business of providing medical services. The condominium unit contains two restrooms, each of which contains a sink, a toilet, water and drainage pipes and other bathroom fixtures. C pays an amount for labor and materials to perform work on the pipes, sinks, toilets, and plumbing fixtures that are part of the condominium. Under paragraph (e)(2)(iii) of this section, C must treat the individual unit that it owns, including the structural components that are part of that unit, as a single unit of property. As pro- vided under paragraph (e)(2)(iii)(B) of this section, an amount is paid to improve the condominium if it is for an improvement to the building structure that is part of the condominium or to a portion of any designated building system that is part of the condominium. Under paragraph (e)(2)(ii)(B)( 2)of this section, the pipes, sinks, toilets, and plumbing fixtures that are part of C’s condominium comprise the plumbing system for the condominium. There- fore, under paragraph (e)(2)(iii) of this section, if an amountpaidbyCforworkonpipes,sinks,toilets, and plumbing fixtures is an improvement (for ex- ample, a betterment) to the portion of the plumbing system that is part of C’s condominium, C must treat this amount as an improvement to the condominium. Example 4.Building structure and systems; prop- erty other than buildings . D, a manufacturer, owns a building adjacent to its manufacturing facility that contains office space and related facilities for D’s employees that manage and administer D’s manu- facturing operations. The office building contains equipment, such as desks, chairs, computers, tele- phones, and bookshelves that are not building struc- ture or building systems. D pays an amount to add an extension to the office building. Under paragraph (e)(2)(i) of this section, D must treat the building and its structural components as a single unit of property. As provided under paragraph (e)(2)(ii) of this sec- tion, an amount is paid to improve a building if it is for an improvement to the building structure or any designated building system. Therefore, under para- graph (e)(2)(ii) of this section, if an amount paid by D for the addition of an extension to the office build- ing is an improvement (forexample, a betterment) to the building structure or any of the building sys- tems, D must treat this amount as an improvement to the building. In addition, because the equipment con- tained within the office building constitutes property other than the building, the units of property for the office equipment are initially determined under para- graph (e)(3)(i) of this section and are comprised of all the components that are functionally interdependent (for example, each desk, each chair, and each book shelf). Example 5. Plant property; discrete and major function . E is an electric utility company that oper- ates a power plant to generate electricity. The power plant includes a structure that is not a building un- der §1.48–1(e)(1), and, among other things, one pul- verizer that grinds coal, a single boiler that produces steam, one turbine that converts the steam into me- chanical energy, and one generator that converts me- chanical energy into electrical energy. In addition, the turbine contains a series of blades that cause the tur- bine to rotate when affected by the steam. Because the plant is composed of real and personal tangible property other than a building, the unit of property for the generating equipment is initially determined under the general rule in paragraph (e)(3)(i) of this section and is comprised of all the components that are functionally interdependent. Under this rule, the initial unit of property is the entire plant because the components of the plant are functionally interdepen- dent. However, because the power plant is plant prop- erty under paragraph (e)(3)(ii) of this section, the ini- tial unit of property is further divided into smaller units of property by determining the components (or groups of components) that perform discrete and ma- jor functions within the plant. Under this paragraph, E must treat the structure, the boiler, the turbine, the generator, and the pulverizer each as a separate unit of property because each of these components per- forms a discrete and major function within the power plant. E may not treat components, such as the tur- bine blades, as separate units of property because each of these components does not perform a discrete and major function within the plant. Example 6.Plant property; discrete and major function . F is engaged in a uniform and linen rental business. F owns and operates a plant that utilizes many different machines and equipment in an as- sembly line-like process to treat, launder, and pre- pare rental items for its customers. F utilizes two laundering lines in its plant, each of which can op- erate independently. One line is used for uniforms and another line is used for linens. Both lines incor- porate a sorter, boiler, washer, dryer, ironer, folder, and waste water treatment system. Because the laun- dering equipment contained within the plant is prop- erty other than a building, the unit of property for the laundering equipment is initially determined un- der the general rule in paragraph (e)(3)(i) of this sec- tion and is comprised of all the components that are functionally interdependent. Under this rule, the ini- tial units of property are each laundering line be- cause each line is functionally independent and is comprised of components that are functionally inter- dependent. However, because each line is comprised of plant property under paragraph (e)(3)(ii) of this section, F must further divide these initial units of property into smaller units of property by determin- ing the components (or groups of components) that perform discrete and major functions within the line. Under paragraph (e)(3)(ii) of this section, F must treat each sorter, boiler, washer, dryer, ironer, folder, and waste water treatment system in each line as a sep- arate unit of property because each of these compo- nents performs a discrete and major function within the line. Example 7.Plant property; industrial process. G operates a restaurant that prepares and serves food to retail customers. Within its restaurant, G has a large piece of equipment that uses an assembly line-like process to prepare and cook tortillas that G serves only to its restaurant customers. Because the tortilla-making equipment is property other than a building, the unit of property for the equipment is initially determined under the general rule in para- graph (e)(3)(i) of this section and is comprised of all the components that are functionally interdependent. Under this rule, the initial unit of property is the entire tortilla-making equipment because the vari- ous components of the equipment are functionally interdependent. The equipment is not plant property under paragraph (e)(3)(ii) of this section because the equipment is not used in an industrial process, as it performs a small-scale function in G’s restaurant operations. Thus, G is not required to further divide the equipment into separate units of property based on the components that perform discrete and major functions. Example 8.Personal property.Hownslocomo- tives that it uses in its railroad business. Each loco- motive consists of various components, such as an engine, generators, batteries, and trucks. H acquired a locomotive with all its components. Because H’s locomotive is property other than a building, the ini- tial unit of property is determined under the general rule in paragraph (e)(3)(i) of this section and is com- prised of the components that are functionally inter- dependent. Under paragraph (e)(3)(i) of this section, the locomotive is a single unit of property because it consists entirely of components that are functionally interdependent. Example 9.Personal property. J provides le- gal services to its clients. J purchased a laptop com- puter and a printer for its employees to use in provid- ing legal services. Because the computer and printer are property other than a building, the initial units of property are determined under the general rule in paragraph (e)(3)(i) of this section and are comprised of the components that are functionally interdepen- dent. Under paragraph (e)(3)(i) of this section, the computer and the printer are separate units of prop- erty because the computer and the printer are not components that are functionally interdependent (that is, the placing in service of the computer is not depen- dent on the placing in service of the printer). Example 10.Building structure and systems; leased building . K is a retailer of consumer products. K conducts its retail sales in a building that it leases from L. The leased building consists of the build- ing structure (including the floor, walls, and roof) and various building systems, including a plumbing system, an electrical system, an HVAC system, a security system, and a fire protection and prevention system. K pays an amount for labor and materials to perform work on the HVAC system of the leased building. Under paragraph (e)(2)(v)(A) of this sec- tion, because K leases the entire building, K must treat the leased building and its structural compo- nents as a single unit of property. As provided under paragraph (e)(2)(v)(B) of this section, an amount 2013–43 I.R.B.369October 21, 2013 is paid to improve a leased building property if it is for an improvement (for example, a betterment) to the leased building structure or to any building system within the leased building. Therefore, un- der paragraphs (e)(2)(v)(B)( 1) and (e)(2)(ii)(B)(1) of this section, if an amount paid by K for work on the HVAC system is for an improvement to the HVAC system in the leased building, K must treat this amount as an improvement to the entire leased building property. Example 11.Production of real property related to leased property . Assume the same facts as in Example 10, except that K receives a construction allowance from L, and K uses the construction al- lowance to build a driveway adjacent to the leased building. Assume that under the terms of the lease, K, the lessee, is treated as the owner of any property that it constructs on or nearby the leased building. Also assume that section 110 does not apply to the construction allowance. Finally, assume that the driveway is not plant property or a network asset. Because the construction of the driveway consists of the production of real property other than a building, all the components of thedriveway are functionally interdependent and are a single unit of property under paragraphs (e)(3)(i) and (e)(3)(iv) of this section. Example 12.Leasehold improvements; construc- tion allowance used for lessor-owned improvements . Assume the same facts as Example 11, except that, under the terms of the lease, L, the lessor, is treated as the owner of any property constructed on the leased premises. Because L, the lessor, is the owner of the driveway and the driveway is real property other than a building, all the components of the driveway are functionally interdependent and are a single unit of property under paragraph (e)(3)(i) of this section. Example 13.Buildings and structural compo- nents; leased office space . M provides consulting ser- vices to its clients. M conducts its consulting services business in two office spaces in the same building, each of which it leases from N under separate lease agreements. Each office space contains a separate HVAC system, which is part of the leased property. Both lease agreements provide that M is responsible for maintaining, repairing, and replacing the HVAC system that is part of the leased property. M pays amounts to perform work on the HVAC system in each office space. Because M leases two separate of- fice spaces subject to two leases, M must treat the portion of the building structure and the structural components subject to each lease as a separate unit of property under paragraph (e)(2)(v)(A) of this section. As provided under paragraph (e)(2)(v)(B) of this sec- tion,anamountispaidtoimprove a leased building property, if it is for an improvement to the leased por- tion of the building structure or the portion of any designated building system subject to each lease. Un- der paragraphs (e)(2)(v)(B)( 1) and (e)(2)(ii)(B)(1)of this section, M must treat the HVAC system associ- ated with each leased office space as a building sys- tem of that leased building property. Thus, M must treat the HVAC system associated with the first leased office space as a building system of the first leased office space and the HVAC system associated with the second leased office space as a building system of the second leased office space. Under paragraph (e)(2)(v)(B) of this section, if the amount paid by M for work on the HVAC system in one leased office space is for an improvement (for example, a better- ment) to the HVAC system that is part of that leased space, then M must treat the amount as an improve- ment to that individual leased property. Example 14.Leased property; personal prop- erty . N is engaged in the business of transporting pas- sengers on private jet aircraft. To conduct its busi- ness, N leases several aircraft from O. Under para- graph (e)(3)(iv) of this section (referencing paragraph (e)(3)(i) of this section), N must treat all of the com- ponents of each leased aircraft that are functionally interdependent as a single unit of property. Thus, N must treat each leased aircraft as a single unit of prop- erty. Example 15.Improvement property.(i)Pisare- tailer of consumer products. In Year 1, P purchases a building from Q, which P intends to use as a retail sales facility. Under paragraph (e)(2)(i) of this sec- tion, P must treat the building and its structural com- ponents as a single unit of property. As provided un- der paragraph (e)(2)(ii) of this section, an amount is paid to improve a building if it is for an improvement to the building structure or any designated building system. (ii) In Year 2, P pays an amount to construct an ex- tension to the building to be used for additional ware- house space. Assume that the extension involves the addition of walls, floors, roof, and doors, but does not include the addition or extension of any building systems described in paragraph (e)(2)(ii)(B) of this section. Also assume that the amount paid to build the extension is a betterment to the building structure under paragraph (j) of this section, and is therefore treated as an amount paid for an improvement to the entire building under paragraph (e)(2)(ii) of this sec- tion. Accordingly, P capitalizes the amount paid as an improvement to the building under paragraph (d) of this section. Under paragraph (e)(4) of this section, the extension is not a unit of property separate from the building, the unit of property improved. Thus, to determine whether any future expenditure consti- tutes an improvement to the building under paragraph (e)(2)(ii) of this section, P must determine whether the expenditure constitutes an improvement to the building structure, including the building extension, or to any of the designated building systems. Example 16.Additional rules; year placed in ser- vice . R is engaged in the business of transporting freight throughout the United States. To conduct its business, R owns a fleet of truck tractors and trailers. Each tractor and trailer is comprised of various com- ponents, including tires. R purchased a truck tractor with all of its components, including tires. The trac- tor tires have an average useful life to R of more than one year. At the time R placed the tractor in service, it treated the tractor tires as a separate asset for depreci- ation purposes under section 168. R properly treated the tractor (excluding the cost of the tires) as 3-year property and the tractor tires as 5-year property under section 168(e). Because R’s tractor is property other than a building, the initial units of property for the tractor are determined under the general rule in para- graph (e)(3)(i) of this section and are comprised of all the components that are functionally interdependent. Under this rule, R must treat the tractor, including its tires, as a single unit of property because the tractor and the tires are functionally interdependent (that is, the placing in service of the tires is dependent upon the placing in service of the tractor). However, under paragraph (e)(5)(i) of this section, R must treat the tractor and tires as separate units of property because R properly treated the tires as being within a different class of property under section 168(e). Example 17. Additional rules; change in subse- quent year . S is engaged in the business of leasing nonresidential real property to retailers. In Year 1, S acquired and placed in service a building for use in its retail leasing operation. In Year 5, to accom- modate the needs of a new lessee, S incurred costs to improve the building structure. S capitalized the costs of the improvement under paragraph (d) of this sec- tion and depreciated the improvement in accordance with section 168(i)(6) as nonresidential real property under section 168(e). In Year 7, S determined that the structural improvement made in Year 5 qualified un- der section 168(e)(8) as qualified retail improvement property and, therefore, was 15-year property under section 168(e). In Year 7, S changed its method of accounting to use a 15-year recovery period for the improvement. Under paragraph (e)(5)(ii) of this sec- tion, in Year 7, S must treat the improvement as a unit of property separate from the building. Example 18.Additional rules; change in sub- sequent year . In Year 1, T acquired and placed in service a building and parking lot for use in its re- tail operations. Under §1.263(a)–2 of the regulations, T capitalized the cost of the building and the park- ing lot and began depreciating the building and the parking lot as nonresidential real property under sec- tion 168(e). In Year 3, T completed a cost segrega- tion study under which it properly determined that the parking lot qualified as 15-year property under sec- tion 168(e). In Year 3, T changed its method of ac- counting for the parking lot to use a 15-year recovery period and the 150-percent declining balance method of depreciation. Under paragraph (e)(5)(ii) of this section, beginning in Year 3, T must treat the parking lot as a unit of property separate from the building. Example 19.Additional rules; change in sub- sequent year . In Year 1, U acquired and placed in service a building for use in its manufacturing busi- ness. U capitalized the costs allocable to the build- ing’s wiring separately from the building and depre- ciated the wiring as 7-year property under section 168(e). U capitalized the cost of the building and all other structural components of the building and be- gan depreciating them as nonresidential real property under section 168(e). In Year 3, U completed a cost segregation study under which it properly determined that the wiring is a structural component of the build- ing and, therefore, shouldhave been depreciated as nonresidential real property. In Year 3, U changed its method of accounting to treat the wiring as non- residential real property. Under paragraph (e)(5)(ii) of this section, U must change the unit of property for the wiring in a manner that is consistent with the change in treatment for depreciation purposes. Therefore, U must change the unit of property for the wiring to treat it as a structural component of the building, and as part of the building unit of property, in accordance with paragraph (e)(2)(i) of this section. (f)Improvements to leased prop- erty—(1)In general. Except as provided in paragraph (h) of this section (safe harbor for small taxpayers) and under §1.263(a)–1(f) (de minimissafe harbor), this paragraph (f) provides the exclusive rules for determining whether amounts October 21, 20133702013–43 I.R.B. paid by a taxpayer are for an improvement to a leased property and must be capital- ized. In the case of a leased building or a leased portion of a building, an amount is paid to improve a leased property if the amount is paid for an improvement to any of the properties specified in paragraph (e)(2)(ii) of this section (for lessor im- provements) or in paragraph (e)(2)(v)(B) of this section (for lessee improvements, except as provided in paragraph (f)(2)(ii) of this section). Section 1.263(a)–4 does not apply to amounts paid for improve- ments to leased property or to amounts paid for the acquisition or production of leasehold improvement property. (2)Lessee improvements—(i)Require- ment to capitalize. A taxpayer lessee must capitalize the related amounts (see para- graph (g)(3) of this section) that it pays to improve (as defined under paragraph (d) of this section) a leased property except to the extent that section 110 applies to a construction allowance received by the lessee for the purpose of such improve- ment or when the improvement constitutes a substitute for rent. See §1.61–8(c) for the treatment of lesseeexpenditures that constitute a substitute for rent. A tax- payer lessee must also capitalize the re- lated amounts that a lessor pays to im- prove (as defined under paragraph (d) of this section) a leased property if the lessee is the owner of the improvement, except to the extent that section 110 applies to a construction allowance received by the lessee for the purpose of such improve- ment. An amount paid for a lessee im- provement under this paragraph (f)(2)(i) is treated as an amount paid to acquire or pro- duce a unit of real or personal property un- der §1.263(a)–2(d)(1) of the regulations. (ii)Unit of property for lessee im- provements. For purposes of determining whether an amount paid by a lessee con- stitutes a lessee improvement to a leased property under paragraph (f)(2)(i) of this section, the unit of property and the im- provement rules are applied to the leased property in accordance with paragraph (e)(2)(v) (leased buildings) or paragraph (e)(3)(iv) (leased property other than buildings) of this section and include pre- vious lessee improvements. However, if a lessee improvement is comprised of an entire building erected on leased property, then the unit of property for the building and the application of the improvement rules to the building are determined under paragraphs (e)(2)(i) and (e)(2)(ii) of this section. (3)Lessor improvements—(i)Require- ment to capitalize. A taxpayer lessor must capitalize the related amounts (see para- graph (g)(3) of this section) that it pays directly, or indirectly through a construc- tion allowance to the lessee, to improve (as defined in paragraph (d) of this section) a leased property when the lessor is the owner of the improvement or to the extent that section 110 applies to the construc- tion allowance. A lessor must also capital- ize the related amounts that the lessee pays to improve a leased property (as defined in paragraph (e) of this section) when the lessee’s improvement constitutes a substi- tute for rent. See §1.61–8(c) for treatment of expenditures by lessees that constitute a substitute for rent.Amounts capitalized by the lessor under this paragraph (f)(3)(i) may not be capitalized by the lessee. If a lessor improvement is comprised of an entire building erected on leased property, then the amount paid for the building is treated as an amount paid by the lessor to acquire or produce a unit of property under §1.263(a)–2(d)(1). See paragraphs (e)(2) of this section for the unit of property for a building and paragraph (e)(3) of this sec- tion for the unit of property for real or per- sonal property other than a building. (ii)Unit of property for lessor improve- ments. In general, an amount capitalized as a lessor improvement under paragraph (f)(3)(i) of this section is not a unit of prop- erty separate from the unit of property im- proved. See paragraph (e)(4) of this sec- tion. However, if a lessor improvement is comprised of an entire building erected on leased property, then the unit of prop- erty for the building and the application of the improvement rules to the building are determined under paragraphs (e)(2)(i) and (e)(2)(ii) of this section. (4)Examples. The following examples illustrate the application of this paragraph (f) and do not address whether capitaliza- tion is required under another provision of the Code (for example, section 263A). For purposes of the following examples, as- sume that section 110 does not apply to the lessee and the amounts paid by the lessee are not a substitute for rent. Example 1.Lessee improvements; additions to building . (i) T is a retailer of consumer products. In Year 1, T leases a building from L, which T in- tends to use as a retail sales facility. The leased build- ing consists of the building structure under paragraph (e)(2)(ii)(A) of this section and various building sys- tems under paragraph (e)(2)(ii)(B) of this section, in- cluding a plumbing system, an electrical system, and an HVAC system. Under the terms of the lease, T is permitted to improve the building at its own ex- pense. Under paragraph (e)(2)(v)(A) of this section, because T leases the entirebuilding, T must treat the leased building and its structural components as a sin- gle unit of property. As provided under paragraph (e)(2)(v)(B)( 1) of this section, an amount is paid to improve a leased building property if the amount is paid for an improvement to the leased building struc- ture or to any building system within the leased build- ing. Therefore, under paragraphs (e)(2)(v)(B)( 1)and (e)(2)(ii) of this section, if T pays an amount that im- proves the building structure, the plumbing system, the electrical system, or the HVAC system, then T must treat this amount as an improvement to the en- tire leased building property. (ii) In Year 2, T pays an amount to construct an ex- tension to the building to be used for additional ware- house space. Assume that this amount is for a better- ment (as defined under paragraph (j) of this section) to T’s leased building structure and does not affect any building systems. Accordingly, the amount that T pays for the building extension is for a betterment to the leased building structure, and thus, under para- graph (e)(2)(v)(B)( 1) of this section, is treated as an improvement to the entire leased building under para- graph (d) of this section. Because T, the lessee, paid an amount to improve a leased building property, T is required to capitalize the amount paid for the build- ing extension as a leasehold improvement under para- graph (f)(2)(i) of this section. In addition, paragraph (f)(2)(i) of this section requires T to treat the amount paid for the improvement as the acquisition or pro- duction of a unit of property (leasehold improvement property) under §1.263(a)–2(d)(1). (iii) In Year 5, T pays an amount to add a large overhead door to the building extension that it con- structed in Year 2 to accommodate the loading of larger products into the warehouse space. Under paragraph (f)(2)(ii) of this section, to determine whether the amount paid by T is for a leasehold improvement, the unit of property and the improve- ment rules are applied in accordance with paragraph (e)(2)(v) of this section and include T’s previous improvements to the leased property. Therefore, under paragraph (e)(2)(v)(A) of this section, the unit of property is the entire leased building, including the extension built in Year 2. In addition, under paragraph (e)(2)(v)(B) of this section, the leased building property is improved if the amount is paid for an improvement to the building structure or any building system. Assume that the amount paid to add the overhead door is for a betterment, under paragraph (j) of this section, to the building structure, which includes the extension. Accordingly, T must capitalize the amounts paid to add the overhead door as a leasehold improvement to the leased building property. In addition, paragraph (f)(2)(i) of this section requires T to treat the amount paid for the improvement as the acquisition or production of a unit of property (leasehold improvement property) under §1.263(a)–2(d)(1). However, to determine whetherafutureamountpaidbyTisforaleasehold improvement to the leased building, the unit of prop- 2013–43 I.R.B.371October 21, 2013 erty and the improvement rules are again applied in accordance with paragraph (e)(2)(v) of this section and include the new overhead door. Example 2.Lessee improvements; additions to certain structural components of buildings .(i)As- sume the same facts as Example 1except that in Year 2, T also pays an amount to construct an extension of the HVAC system into the building extension. As- sume that the extension is a betterment, under para- graph (j) of this section, to the leased HVAC system (a building system under paragraph (e)(2)(ii)(B)( 1)of this section). Accordingly, the amount that T pays for the extension of the HVAC system is for a better- ment to the leased building system, the HVAC sys- tem, and thus, under paragraph (e)(2)(v)(B)( 1)ofthis section, is treated as an improvement to the entire leased building property under paragraph (d) of this section. Because T, the lessee, pays an amount to im- prove a leased building property, T is required to cap- italize the amount paid as a leasehold improvement under paragraph (f)(2)(i) of this section. Under para- graph (f)(2)(i) of this section, T must treat the amount paid for the HVAC extension as the acquisition and production of a unit of property (leasehold improve- ment property) under §1.263(a)–2(d)(1). (ii) In Year 5, T pays an amount to add an ad- ditional chiller to the portion of the HVAC system that it constructed in Year 2 to accommodate the cli- mate control requirements for new product offerings. Under paragraph (f)(2)(ii) of this section, to deter- mine whether the amount paid by T is for a leasehold improvement, the unit of property and the improve- ment rules are applied inaccordance with paragraph (e)(2)(v) of this section and include T’s previous im- provements to the leased building property. There- fore, under paragraph (e)(2)(v)(B) of this section, the leased building property is improved if the amount is paid for an improvement to the building structure or any building system. Assume that the amount paid to add the chiller is for a betterment, under paragraph (j) of this section, to the HVAC system, which in- cludes the extension of the system in Year 2. Ac- cordingly, T must capitalize the amounts paid to add the chiller as a leasehold improvement to the leased building property. In addition, paragraph (f)(2)(i) of this section requires T to treat the amount paid for the chiller as the acquisition or production of a unit of property (leasehold improvement property) under §1.263(a)–2(d)(1). However, to determine whether a future amount paid by T is for a leasehold improve- ment to the leased building, the unit of property and the improvement rules are again applied in accor- dance with paragraph (e)(2)(v) of this section and in- clude the new chiller. Example 3.Lessor Improvements; additions to building . (i) T is a retailer of consumer products. In Year 1, T leases a building from L, which T intends to use as a retail sales facility. Pursuant to the lease, L provides a construction allowance to T, which T intends to use to construct an extension to the retail sales facility for additional warehouse space. As- sume that the amount paid for any improvement to the building does not exceed the construction allowance and that L is treated as the owner of any improvement to the building. Under paragraph (e)(2)(i) of this sec- tion, L must treat the building and its structural com- ponents as a single unit of property. As provided un- der paragraph (e)(2)(ii) of this section, an amount is paid to improve a building if it is paid for an improve- ment to the building structure or to any building sys- tem. (ii) In Year 2, T uses L’s construction allowance to construct an extension to the leased building to pro- vide additional warehouse space in the building. As- sume that the extension is a betterment (as defined under paragraph (j) of this section) to the building structure, and therefore, the amount paid for the ex- tension results in an improvement to the building un- der paragraph (d) of this section. Under paragraph (f)(3)(i) of this section, L, the lessor and owner of the improvement, must capitalize the amounts paid to T to construct the extension to the retail sales facility. T is not permitted to capitalize the amounts paid for the lessor-owned improvement. Finally, under paragraph (f)(3)(ii) of this section, the extension to L’s building is not a unit of property separate from the building and its structural components. Example 4.Lessee property; personal property added to leased building . T is a retailer of consumer products. T leases a building from L, which T intends to use as a retail sales facility. Pursuant to the lease, L provides a construction allowance to T, which T uses to acquire and construct partitions for fitting rooms, counters, and shelving. Assume that each partition, counter, and shelving unit is a unit of property under paragraph (e)(3) of this section. Assume that for Fed- eral income tax purposes T is treated as the owner of the partitions, counters, and shelving. T’s expendi- tures for the partitions, counters, and shelving are not improvements to the leased property under paragraph (d) of this section, but rather constitute amounts paid to acquire or produce separate units of personal prop- erty under §1.263(a)–2(d)(1). Example 5. Lessor property; buildings on leased property . L is the owner of a parcel of unimproved real property that L leases to T. Pursuant to the lease, L provides a construction allowance to T of $500,000, which T agrees to use to construct a building costing not more than $500,000 on the leased real property and to lease the building from L after it is constructed. Assume that for Federal income tax purposes, L is treated as the owner of the building that T will con- struct. T uses the $500,000 to construct the building as required under the lease. The building consists of the building structure and the following building sys- tems: (1) a plumbing system; (2) an electrical sys- tem; and (3) an HVAC system. Because L provides a construction allowance to T to construct a build- ing and L is treated as the owner of the building, L must capitalize the amounts that it pays indirectly to T to construct the building as a lessor improvement under paragraph (f)(3)(i) of this section. In addition, the amounts paid by L for the construction allowance are treated as amounts paid by L to acquire and pro- duce the building under §1.263(a)–2(d)(1). Further, under paragraph (e)(2)(i) of this section, L must treat the building and its structural components as a sin- gle unit of property. Under paragraph (f)(3)(i) of this section, T, the lessee, may not capitalize the amounts paid (with the construction allowance received from L) for construction of the building. Example 6.Lessee contribution to construction costs . Assume the same facts as inExample 5, except T spends $600,000 to construct the building. T uses the $500,000 construction allowance provided by L plus $100,000 of its own funds to construct the build- ing that L will own pursuant to the lease. Also assume that the additional $100,000 that T pays is not a sub- stitute for rent. For the reasons discussed in Example 5 , L must capitalize the $500,000 it paid T to con- struct the building under §1.263(a)–2(d)(1). In addi- tion, because T spends its own funds to complete the building, T has a depreciable interest of $100,000 in the building and must capitalize the $100,000 it paid to construct the building as a leasehold improvement under §1.263(a)–2(d)(1) of the regulations. Under paragraph (e)(2)(i) of this section, L must treat the building as a single unit of property to the extent of its depreciable interest of $500,000 In addition, un- der paragraphs (f)(2)(ii) and (e)(2)(i) of this section, T must also treat the building as a single unit of property to the extent of its depreciable interest of $100,000. (g)Special rules for determining im- provement costs—(1)Certain costs in- curred during an improvement—(i)In general. A taxpayer must capitalize all the direct costs of an improvement and all the indirect costs (including, for example, otherwise deductible repair costs) that di- rectly benefit or areincurred by reason of an improvement. Indirect costs arising from activities that do not directly bene- fit and are not incurred by reason of an improvement are not required to be capi- talized under section 263(a), regardless of whether the activitiesare performed at the same time as an improvement. (ii)Exception for individuals’ resi- dences. A taxpayer who is an individual may capitalize amounts paid for repairs and maintenance that are made at the same time as capital improvements to units of property not used in the taxpayer’s trade or business or for the production of in- come if the amounts are paid as part of an improvement (for example, a remodeling) of the taxpayer’s residence. (2)Removal Costs—(i)In general.If a taxpayer disposes of a depreciable asset, including a partial disposition under Prop. Reg. §1.168(i)–1(e)(2)(ix) (September 19, 2013), or Prop. Reg. §1.168(i)–8(d) (September 19, 2013), for Federal income tax purposes and has taken into account the adjusted basis of the asset or com- ponent of the asset inrealizing gain or loss, then the costs of removing the as- set or component are not required to be capitalized under this section. If a de- preciable asset is included in a general asset account under section 168(i)(4), and neither the regulations under section 168(i)(4) and §1.168(i)–1T(e)(3) nor Prop. Reg. §1.168(i)–1(e)(3) (September 19, 2013), apply to a disposition of such as- set, or a portion of such asset under Prop. Reg. §1.168(i)–1(e)(2)(ix) (September 19, 2013), a loss is treated as being realized October 21, 20133722013–43 I.R.B. in the amount of zero upon the disposition of the asset solely for purposes of this paragraph (g)(2)(i). If a taxpayer disposes of a component of a unit of property, but the disposal of the component is not a disposition for Federal tax purposes, then the taxpayer must deduct or capitalize the costs of removing the component based on whether the removal costs directly benefit or are incurred by reason of a repair to the unit of property or an improvement to the unit of property. But see §1.280B–1 for the rules applicable to demolition of structures. (ii)Examples. The following exam- ples illustrate the application of paragraph (g)(2)(i) of this section and, unless other- wise stated, do not address whether cap- italization is required under another pro- vision of this section or another provision of the Code (for example, section 263A). For purposes of the following examples, assume that Prop. Reg. §1.168(i)–1(e) (September 19, 2013), or Prop. Reg. §1.168(i)–8 (September 19, 2013), applies and that §1.280B–1 does not apply. Example 1.Component removed during improve- ment; no disposition . X owns a factory building with a storage area on the second floor. X pays an amount to remove the original columns and girders supporting the second floor and replace them with new columns and girders to permit storage of sup- plies with a gross weight 50 percent greater than the previous load-carrying capacity of the storage area. Assume that the replacement of the columns and girders constitutes a betterment to the building structure and is therefore an improvement to the building unit of property under paragraphs (d)(1) and (j) of this section. Assume that X disposes of the original columns and girders and the disposal of these structural components is not a disposition under Prop. Reg. §1.168(i)–1(e) (September 19, 2013), or Prop. Reg. §1.168(i)–8 (September 19, 2013). Under paragraphs (g)(2)(i) and (j) of this section, the amount paid to remove the columns and girders must be capitalized as a cost of the improvement, because it directly benefits and is incurred by reason of the improvement to the building. Example 2.Component removed during improve- ment; disposition .AssumethesamefactsasEx- ample 1 , except X disposes of the original columns and girders and elects to treat the disposal of these structural components as a partial disposition of the factory building under Prop. Reg. §1.168(i)–8(d) (September 19, 2013), taking into account the ad- justed basis of the components in realizing loss on the disposition. Under paragraph (g)(2)(i) of this section, the amount paid to remove the columns and girders is not required to be capitalized as part of the cost of the improvement regardless of their relation to the im- provement. However, all the remaining costs of re- placing the columns and girders must be capitalized as improvements to the building unit of property un- der paragraphs (d)(1), (j), and (g)(1) of this section. Example 3.Component removed during repair or maintenance; no disposition . Y owns a building in which it conducts its retail business. The roof over Y’s building is covered with shingles. Over time, the shingles begin to wear and Y begins to experience leaks into its retail premises. However, the build- ing still functions in Y’s business. To eliminate the problems, a contractor recommends that Y remove the original shingles and replace them with new shin- gles. Accordingly, Y pays the contractor to replace the old shingles with new but comparable shingles. The new shingles are comparable to original shin- gles but correct the leakage problems. Assume that Y disposes of the original shingles, and the disposal of these shingles is not a disposition under Prop. Reg. §1.168(i)–1(e) (September 19, 2013), or Prop. Reg. §1.168(i)–8 (September 19, 2013). Assume that re- placement of old shingles with new shingles to cor- rect the leakage is not a betterment or a restoration of the building structure or systems under paragraph (j) or (k) of this section and does not adapt the building structure or systems to a new or different use under paragraph (l) of this section. Thus, the amounts paid by Y to replace the shingles are not improvements to the building unit of property under paragraph (d) of this section. Under paragraph (g)(2)(i) of this section, the amounts paid to remove the shingles are not re- quired to be capitalized because they directly benefit and are incurred by reason of repair or maintenance to the building structure. Example 4.Component removed with disposition and restoration . Assume the same facts asExample 3 except Y disposes of the original shingles, and Y elects to treat the disposal of these components as a partial disposition of the building under Prop. Reg. §1.168(i)–8(d) (September 19, 2013), and deducts the adjusted basis of the components as a loss on the dis- position. Under paragraph (k)(1)(i) of this section, amounts paid for replacement of the shingles con- stitute a restoration of thebuilding structure because the amounts are paid for the replacement of a com- ponent of the structure and the taxpayer has properly deducted a loss for that component. Thus, under para- graphs (d)(2) and (k) of this section, Y is required to capitalize the amounts paid for the replacement of the shingles as an improvement to the building unit of property. However, under paragraph (g)(2)(i) of this section, the amounts paid by Y to remove the original shingles are not required to be capitalized as part of the costs of the improvement, regardless of their re- lation to the improvement. (3)Related amounts. For purposes of paragraph (d) of this section, amounts paid to improve a unit of property include amounts paid over a period of more than one taxable year. Whether amounts are related to the same improvement depends on the facts and circumstances of the ac- tivities being performed. (4)Compliance with regulatory re- quirements. For purposes of this section, a Federal, state, or local regulator’s re- quirement that a taxpayer perform certain repairs or maintenance on a unit of prop- erty to continue operating the property is not relevant in determining whether the amount paid improves the unit of property. (h)Safe harbor for small taxpay- ers—(1)In general. A qualifying taxpayer (as defined in paragraph (h)(3) of this section) may elect to not apply paragraph (d)orparagraph(f)ofthissectiontoan eligible building property (as defined in paragraph (h)(4) of this section) if the total amount paid during the taxable year for repairs, maintenance, improvements, and similar activities performed on the eligi- ble building property does not exceed the lesser of— (i) 2 percent of the unadjusted basis (as defined under paragraph (h)(5) of this sec- tion) of the eligible building property; or (ii) $10,000. (2)Application with other safe harbor provisions. For purposes of paragraph (h)(1) of this section, amounts paid for repairs, maintenance, improvements, and similar activities performed on eligible building property include those amounts not capitalized under thede minimissafe harbor election under §1.263(a)–1(f) and those amounts deemed not to improve property under the safe harbor for routine maintenance under paragraph (i) of this section. (3)Qualifying taxpayer—(i)In general. For purposes of this paragraph (h), the termqualifying taxpayermeans a taxpayer whose average annual gross receipts as de- termined under this paragraph (h)(3) for the three preceding taxable years is less than or equal to $10,000,000. (ii)Application to new taxpayers.If a taxpayer has been in existence for less than three taxable years, the taxpayer de- termines its average annual gross receipts for the number of taxable years (including short taxable years) that the taxpayer (or its predecessor) has been in existence. (iii)Treatment of short taxable year.In the case of any taxable year of less than 12 months (a short taxable year), the gross receipts shall be annualized by— (A) Multiplying the gross receipts for the short period by 12; and (B) Dividing the product determined in paragraph (h)(3)(iii)(A) of this section by the number of months in the short period. (iv)Definition of gross receipts.For purposes of applying paragraph (h)(3)(i) of this section, the termgross receiptsmeans the taxpayer’s receipts for the taxable year that are properly recognized under the tax- 2013–43 I.R.B.373October 21, 2013 payer’s methods of accounting used for Federal income tax purposes for the tax- able year. For this purpose, gross receipts include total sales (net of returns and al- lowances) and all amounts received for services. In addition, gross receipts in- clude any income from investments and from incidental or outside sources. For ex- ample, gross receipts include interest (in- cluding original issue discount and tax-ex- empt interest within the meaning of section 103), dividends, rents, royalties, and annu- ities, regardless of whether such amounts are derived in the ordinary course of the taxpayer’s trade of business. Gross re- ceipts are not reduced by cost of goods sold or by the cost of property sold if such property is describedin section 1221(a)(1), (3), (4), or (5). With respect to sales of capital assets as defined in section 1221, or sales of property described in section 1221(a)(2) (relating to property used in a trade or business), gross receipts shall be reduced by the taxpayer’s adjusted basis in such property. Gross receipts do not include the repayment of a loan or simi- lar instrument (for example, a repayment of the principal amount of a loan held by a commercial lender) and, except to the extent of gain recognized, do not include gross receipts derived from a non-recog- nition transaction, such as a section 1031 exchange. Finally, gross receipts do not include amounts received by the taxpayer with respect to sales tax or other similar state and local taxes if, under the applica- ble state or local law, the tax is legally im- posed on the purchaser of the good or ser- vice, and the taxpayer merely collects and remits the tax to the taxing authority. If, in contrast, the tax is imposed on the tax- payer under the applicable law, then gross receipts include the amounts received that are allocable to the payment of such tax. (4)Eligible building property. For pur- poses of this section, the term,eligible building propertyrefers to each unit of property defined in paragraph (e)(2)(i) (building), paragraph (e)(2)(iii)(A) (con- dominium), paragraph (e)(2)(iv)(A) (co- operative), or paragraph (e)(2)(v)(A) (leased building or portion of building) of this section, as applicable, that has an unadjusted basis of $1,000,000 or less. (5)Unadjusted basis—(i)Eligible building property owned by taxpayer.For purposes of this section, the unadjusted basis of eligible building property owned by the taxpayer means the basis as de- termined under section 1012, or other applicable sections ofChapter 1, including subchapters O (relating to gain or loss on dispositions of property), C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses). Unadjusted basis is determined without regard to any adjustments described in section 1016(a)(2) or (3) or to amounts for which the taxpayer has elected to treat as an expense (for example, under sections 179, 179B, or 179C). (ii)Eligible building property leased to the taxpayer. For purposes of this sec- tion, the unadjusted basis of eligible build- ing property leased to the taxpayer is the total amount of (undiscounted) rent paid or expected to be paid by the lessee under the lease for the entire term of the lease, including renewal periods if all the facts and circumstances in existence during the taxable year in which the lease is entered indicate a reasonable expectancy of re- newal. See §1.263(a)–4(f)(5)(ii) for the factors significant in determining whether there exists a reasonable expectancy of re- newal. (6)Time and manner of election.A taxpayer makes the election described in paragraph (h)(1) of this section by attach- ing a statement to the taxpayer’s timely filed original Federaltaxreturn(including extensions) for the taxable year in which amounts are paid for repairs, maintenance, improvements, and similar activities per- formed on the eligible building property providing that such amounts qualify un- der the safe harbor provided in paragraph (h)(1) of this section. See §§301.9100–1 through 301.9100–3 of this chapter for the provisions governing extensions of time to make regulatory elections. The statement must be titled, “Section 1.263(a)–3(h) Safe Harbor Election for Small Taxpayers” and include the taxpayer’s name, address, tax- payer identification number, and a descrip- tion of each eligible building property to which the taxpayer is applying the elec- tion. In the case of an S corporation or a partnership,theelectionismadebytheS corporation or by the partnership, and not by the shareholders or partners. An elec- tion may not be made through the filing of an application for change in account- ing method or, before obtaining the Com- missioner’s consent to make a late elec- tion, by filing an amended Federal tax re- turn. A taxpayer may not revoke an elec- tion made under this paragraph (h). The time and manner of making the election under this paragraph (h) may be modified through guidance of general applicability (see §§601.601(d)(2) and 601.602 of this chapter). (7)Treatment of safe harbor amounts. Amounts paid by the taxpayer for repairs, maintenance, improvements, and similar activities to which the taxpayer properly applies the safe harbor under paragraph (h)(1) of this section and for which the taxpayer properly makes the election un- der paragraph (h)(6) of this section are not treated as improvements under paragraph (d) or (f) of this section and may be de- ducted under §1.162–1 or §1.212–1, as ap- plicable, in the taxable year these amounts are paid, provided the amounts otherwise qualify for a deduction under these sec- tions. (8)Safe harbor exceeded.Iftotal amounts paid by a qualifying taxpayer during the taxable year for repairs, main- tenance, improvements, and similar ac- tivities performed on an eligible building property exceed the safe harbor limita- tions specified in paragraph (h)(1) of this section, then the safe harbor election is not available for that eligible building property and the taxpayer must apply the general improvement rules under this sec- tion to determine whether amounts are for improvements to the unit of property, including the safe harbor for routine main- tenance under paragraph (i) of this section. The taxpayer may also elect to apply thede minimissafe harbor under §1.263(a)–1(f) to amounts qualifying under that safe har- bor irrespective of the application of this paragraph (h). (9)Modification of safe harbor amounts. The amount limitations pro- vided in paragraphs (h)(1)(i), (h)(1)(ii), and (h)(3) of this section may be modified through published guidance in theFed- eral Registeror in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b)ofthis chapter). (10)Examples. The following exam- ples illustrate the rules of this paragraph (h). Assume that §1.212–1 does not apply to the amounts paid. Example 1.Safe harbor for small taxpayers ap- plicable . A is a qualifying taxpayer under paragraph (h)(3) of this section. A owns an office building October 21, 20133742013–43 I.R.B. in which A provides consulting services. In Year 1, A’s building has an unadjusted basis of $750,000 as determined under paragraph (h)(5)(i) of this sec- tion. In Year 1, A pays $5,500 for repairs, main- tenance, improvements and similar activities to the office building. Because A’s building unit of prop- erty has an unadjusted basis of $1,000,000 or less, A’s building constitutes eligible building property un- der paragraph (h)(4) of this section. The aggregate amountpaidbyAduringYear1forrepairs,main- tenance, improvements and similar activities on this eligible building property does not exceed the lesser of $15,000 (2 percent of the building’s unadjusted ba- sis of $750,000) or $10,000. Therefore, under para- graph (h)(1) of this section, A may elect to not apply the capitalization rule of paragraph (d) of this sec- tion to the amounts paid for repair, maintenance, im- provements, or similar activities on the office build- inginYear1.IfAproperlymakestheelectionunder paragraph (h)(6) of this section for the office build- ing and the amounts otherwise constitute deductible ordinary and necessary expenses incurredin carrying on a trade or business, A may deduct these amounts under §1.162–1 in Year 1. Example 2.Safe harbor for small taxpayers in- applicable . Assume the same facts as inExample 1, except that A pays $10,500 for repairs, maintenance, improvements, and similar activities performed on its office building in Year 1. Because this amount exceeds $10,000, the lesser of the two limitations provided in paragraph (h)(1) of this section, A may not apply the safe harbor for small taxpayers under paragraph (h)(1) of this section to the total amounts paid for repairs, maintenance, improvements, and similar activities performed on the building. There- fore, A must apply the general improvement rules under this section to determine which of the aggre- gate amounts paid are for improvements and must be capitalized under paragraph (d) of this section and which of the amounts are for repair and maintenance under §1.162–4. Example 3.Safe harbor applied build- ing-by-building . (i) B is a qualifying taxpayer under paragraph (h)(3) of this section. B owns two rental properties, Building M and Building N. Building M and Building N are both multi-family residential buildings. In Year 1, each property has an unad- justed basis of $300,000 under paragraph (h)(5) of this section. Because Building M and Building N each have an unadjusted basis of $1,000,000 or less, Building M and Building N each constitute eligible building property in Year 1 under paragraph (h)(4) of this section. In Year 1, B pays $5,000 for repairs, maintenance, improvements, and similar activities performedonBuildingM.InYear1,Balsopays $7,000 for repairs, maintenance, improvements, and similar activities performed on Building N. (ii) The total amount paid by B during Year 1 for repairs, maintenance, improvements and similar ac- tivities on Building M ($5,000) does not exceed the lesser of $6,000 (2 percent of the building’s unad- justed basis of $300,000) or $10,000. Therefore, un- der paragraph (h)(1) of this section, for Year 1, B may elect to not apply the capitalization rule under para- graph (d) of this section to the amounts it paid for re- pairs, maintenance, improvements, and similar activ- ities on Building M. If B properly makes the election under paragraph (h)(6) of this section for Building M and the amounts otherwise constitute deductible ordi- nary and necessary expenses incurred in carrying on B’s trade or business, B may deduct these amounts under §1.162–1. (iii) The total amount paid by B during Year 1 for repairs, maintenance, improvements and similar activities on Building N ($7,000) exceeds $6,000 (2 percent of the building’s unadjusted basis of $300,000), the lesser of the two limitations provided under paragraph (h)(1) of this section. Therefore, B may not apply the safe harbor under paragraph (h)(1) of this section to the total amounts paid for repairs, maintenance, improvements, and similar activities performed on Building N. Instead, B must apply the general improvement rules under this section to determine which of the total amounts paid for work performed on Building N are for improvements and must be capitalized under paragraph (d) of this section and which amounts are for repair and main- tenance under §1.162–4. Example 4.Safe harbor applied to leased build- ing property . C is a qualifying taxpayer under para- graph (h)(3) of this section. C is the lessee of a build- ing in which C operates a retail store. The lease is a triple-net lease, and the lease term is 20 years, in- cluding reasonably expected renewals. C pays $4,000 per month in rent. In Year 1, C pays $7,000 for re- pairs, maintenance, improvements, and similar ac- tivities performed on the building. Under paragraph (h)(5)(ii) of this section, the unadjusted basis of C’s leased unit of property is $960,000 ($4,000 monthly rent x 12 months x 20 years). Because C’s leased building has an unadjusted basis of $1,000,000 or less, the building is eligible building property for Year 1 under paragraph (h)(4) of this section. The total amountpaidbyCduringYear1forrepairs,main- tenance, improvements, and similar activities on the leased building ($7,000) does not exceed the lesser of $19,200 (2 percent of the building’s unadjusted ba- sis of $960,000) or $10,000. Therefore, under para- graph (h)(1) of this section, for Year 1, C may elect to not apply the capitalization rule under paragraph (d) of this section to the amounts it paid for repairs, maintenance, improvements, and similar activities on the leased building. If C properly makes the elec- tionunderparagraph(h)(6)ofthissectionforthe leased building and the amounts otherwise constitute deductible ordinary and necessary expenses incurred in carrying on C’s trade or business, C may deduct these amounts under §1.162–1. (i)Safe harbor for routine mainte- nance on property—(1)In general.An amount paid for routine maintenance (as defined in paragraph (i)(1)(i) or (i)(1)(ii) of this section, as applicable) on a unit of tangible property, orin the case of a build- ing, on any of the properties designated in paragraphs (e)(2)(ii), (e)(2)(iii)(B), (e)(2)(iv)(B), or paragraph (e)(2)(v)(B) of this section, is deemed not to improve that unit of property. (i)Routine maintenance for buildings. Routine maintenance for a building unit of property is the recurring activities that a taxpayer expects to perform as a result of the taxpayer’s use of any of the prop- erties designated in paragraphs (e)(2)(ii), (e)(2)(iii)(B), (e)(2)(iv)(B), or (e)(2)(v)(B) of this section to keep the building struc- ture or each building system in its or- dinarily efficient operating condition. Routine maintenance activities include, for example, the inspection, cleaning, and testing of the building structure or each building system, and the replacement of damaged or worn parts with comparable and commercially available replacement parts. Routine maintenance may be per- formed any time during the useful life of the building structure or building sys- tems. However, the activities are routine only if the taxpayer reasonably expects to perform the activities more than once during the 10-year period beginning at the time the building structure or the building system upon which the routine mainte- nance is performed is placed in service by the taxpayer. A taxpayer’s expectation will not be deemed unreasonable merely because the taxpayer does not actually perform the maintenance a second time during the 10-year period, provided that the taxpayer can otherwise substantiate that its expectation was reasonable at the time the property was placed in service. Factors to be considered in determin- ing whether maintenance is routine and whether a taxpayer’s expectation is rea- sonable include the recurring nature of the activity, industry practice, manufacturers’ recommendations, and the taxpayer’s ex- perience with similar or identical property. With respect to a taxpayer that is a lessor of a building or a part of the building, the taxpayer’s use of the building unit of property includes the lessee’s use of its unit of property. (ii)Routine maintenance for property other than buildings. Routine maintenance for property other than buildings is the recurring activities that a taxpayer expects to perform as a result of the taxpayer’s use of the unit of property to keep the unit of property in its ordinarily efficient operating condition. Routine maintenance activities include, for example, the inspec- tion, cleaning, and testing of the unit of property, and the replacement of damaged or worn parts of the unit of property with comparable and commercially available replacement parts. Routine maintenance may be performed any time during the use- ful life of the unit of property. However, the activities are routine only if, at the time the unit of property is placed in service 2013–43 I.R.B.375October 21, 2013 by the taxpayer, the taxpayer reasonably expects to perform the activities more than once during the class life (as defined in paragraph (i)(4) of this section) of the unit of property. A taxpayer’s expectation will not be deemed unreasonable merely because the taxpayer does not actually perform the maintenance a second time during the class life of the unit of property, provided that the taxpayer can otherwise substantiate that its expectation was rea- sonable at the time the property was placed in service. Factors to be considered in de- termining whether maintenance is routine and whether the taxpayer’s expectation is reasonable include the recurring nature of the activity, industry practice, manufactur- ers’ recommendations, and the taxpayer’s experience with similaroridenticalprop- erty. With respect to a taxpayer that is a lessor of a unit of property, the taxpayer’s use of the unit of property includes the lessee’s use of the unit of property. (2)Rotable and temporary spare parts. Except as provided in paragraph (i)(3) of this section, for purposes of paragraph (i)(1)(ii) of this section, amounts paid for routine maintenanceinclude routine main- tenance performed on (and with regard to) rotable and temporary spare parts. (3)Exceptions. Routine maintenance does not include the following: (i) Amounts paid for a betterment to a unit of property under paragraph (j) of this section; (ii) Amounts paid for the replacement of a component of a unit of property for which the taxpayer has properly deducted a loss for that component (other than a ca- sualty loss under §1.165–7) (see paragraph (k)(1)(i) of this section); (iii) Amounts paid for the replacement of a component of a unit of property for which the taxpayer has properly taken into account the adjusted basis of the compo- nent in realizing gain or loss resulting from the sale or exchange of the component (see paragraph (k)(1)(ii) of this section); (iv) Amounts paid for the restoration of damage to a unit of property for which the taxpayer is required to take a basis adjust- ment as a result of a casualty loss under section 165, or relating to a casualty event described in section 165,subject to the lim- itation in paragraph (k)(4) of this section (see paragraph (k)(1)(iii) of this section); (v) Amounts paid to return a unit of property to its ordinarily efficient operat- ing condition, if the property has deterio- rated to a state of disrepair and is no longer functional for its intended use (see para- graph (k)(1)(iv) of this section); (vi) Amounts paid to adapt a unit of property to a new or different use under paragraph (l) of this section; (vii) Amounts paid for repairs, mainte- nance, or improvement of network assets (as defined in paragraph (e)(3)(iii)(A) of this section); or (viii) Amounts paid for repairs, mainte- nance, or improvement of rotable and tem- porary spare parts to which the taxpayer applies the optional method of accounting for rotable and temporary spare parts un- der §1.162–3(e). (4)Class life. The class life of a unit of property is the recovery period pre- scribed for the property under sections 168(g)(2) and (3) for purposes of the alter- native depreciation system, regardless of whether the property is depreciated under section 168(g). For purposes of determin- ing class life under this section, section 168(g)(3)(A) (relating to tax-exempt use property subject to lease) does not ap- ply. If the unit of property is comprised of components with different class lives, then the class life of the unit of property is deemed to be the same as the component with the longest class life. (5)Coordination with section 263A. Amounts paid for routine maintenance under this paragraph (i) may be subject to capitalization under section 263A if these amounts comprise the direct or al- locable indirect costs of other property produced by the taxpayer or property acquired for resale. See, for example, §1.263A–1(e)(3)(ii)(O) requiring tax- payers to capitalize the cost of repairing equipment or facilities allocable to prop- erty produced or property acquired for resale. (6)Examples. The following examples illustrate the application of this paragraph (i) and, unless otherwise stated, do not ad- dress the treatment under other provisions of the Code (for example, section 263A). In addition, unless otherwise stated, as- sume that the taxpayer has not applied the optional method of accounting for rotable and temporary spare parts under §1.162–3(e). Example 1.Routine maintenance on component. (i) A is a commercial airline engaged in the business of transporting passengers and freight throughout the United States and abroad. To conduct its business, A owns or leases various types of aircraft. As a con- dition of maintaining its airworthiness certification for these aircraft, A is required by the Federal Avia- tion Administration (FAA) to establish and adhere to a continuous maintenance program for each aircraft within its fleet. These programs, which are designed by A and the aircraft’s manufacturer and approved by the FAA, are incorporated into each aircraft’s main- tenance manual. The maintenance manuals require a variety of periodic maintenance visits at various in- tervals. One type of maintenance visit is an engine shop visit (ESV), which A expects to perform on its aircraft engines approximately every 4 years to keep its aircraft in its ordinarily efficient operating condi- tion. In Year 1, A purchased a new aircraft, which included four new engines attached to the airframe. The four aircraft engines acquired with the aircraft are not materials or supplies under §1.162–3(c)(1)(i) because they are acquired as part of a single unit of property, the aircraft. In Year 5, A performs its first ESV on the aircraft engines. The ESV includes disas- sembly, cleaning, inspection, repair, replacement, re- assembly, and testing of the engine and its component parts. During the ESV, the engine is removed from the aircraft and shipped to an outside vendor who per- forms the ESV. If inspection or testing discloses a dis- crepancy in a part’s conformity to the specifications in A’s maintenance program,the part is repaired, or if necessary, replaced with a comparable and commer- cially available replacement part. After the ESVs, the engines are returned to A to be reinstalled on another aircraft or stored for laterinstallation. Assume that the class life for A’s aircraft, including the engines, is 12 years. Assume that none of the exceptions set out in paragraph (i)(3) of this section apply to the costs of performing the ESVs. (ii) Because the ESVs involve the recurring ac- tivities that A expects to perform as a result of its use of the aircraft to keep the aircraft in ordinarily effi- cient operating condition and consist of maintenance activities that A expects to perform more than once during the 12 year class life of the aircraft, A’s ESVs are within the routine maintenance safe harbor under paragraph (i)(1)(ii) of this section. Accordingly, the amounts paid for the ESVs are deemed not to improve the aircraft and are not required to be capitalized un- der paragraph (d) of this section. Example 2.Routine maintenance after class life. Assume the same facts as in Example 1,exceptthat in year 15 A pays amounts to perform an ESV on one of the original aircraft engines after the end of the class life of the aircraft. Because this ESV in- volves the same routine maintenance activities that were performed on aircraft engines in Example 1,this ESV also is within the routine maintenance safe har- bor under paragraph (i)(1)(ii) of this section. Accord- ingly, the amounts paid for this ESV, even though per- formed after the class life of the aircraft, are deemed not to improve the aircraft and are not required to be capitalized under paragraph (d) of this section. Example 3.Routine maintenance on rotable spare parts . (i) Assume the same facts as inExample 1 , except that in addition to the four engines pur- chased as part of the aircraft, A separately purchases four additional new engines that A intends to use in its aircraft fleet to avoid operational downtime when ESVs are required to be performed on the engines previously installed on an aircraft. Later in Year October 21, 20133762013–43 I.R.B. 1, A installs these four engines on an aircraft in its fleet. In Year 5, A performs the first ESVs on these four engines. Assume that these ESVs involve the same routine maintenance activities that were per- formed on the engines in Example 1, and that none of the exceptions set out in paragraph (i)(3) of this section apply to these ESVs. After the ESVs were performed, these engines were reinstalled on other aircraft or stored for later installation. (ii) The additional aircraft engines are rotable spare parts because they were acquired separately from the aircraft, they are removable from the air- craft, and are repaired and reinstalled on other aircraft or stored for later installation. See §1.162–3(c)(2) (definition of rotable and temporary spare parts). Assume the class life of an engine is the same as the airframe, 12 years. Because the ESVs involve the recurring activities that A expects to perform as a result of its use of the engines to keep the engines in ordinarily efficient operating condition, and consist of maintenance activities that A expects to perform more than once during the 12 year class life of the engine, the ESVs fall within the routine maintenance safe harbor under paragraph (i)(1)(ii) of this section. Accordingly, the amounts paid for the ESVs for the four additional engines are deemed not to improve these engines and are not required to be capitalized under paragraph (d) of this section. For the treat- ment of amounts paid to acquire the engines, see §1.162–3(a). Example 4.Routine maintenance resulting from prior owner’s use . (i) In January, Year 1, B purchases a used machine for use in its manufacturing opera- tions. Assume that the machine is the unit of property and has a class life of 10 years. B places the machine in service in January, Year 1, and at that time, B ex- pects to perform manufacturer recommended sched- uled maintenance on the machine approximately ev- ery three years. The scheduled maintenance includes the cleaning and oiling of the machine, the inspec- tion of parts for defects, and the replacement of mi- nor items such as springs, bearings, and seals with comparable and commercially available replacement parts. At the time B purchased the machine, the ma- chine was approaching the end of a three-year sched- uled maintenance period. As a result, in February, Year 1, B pays amounts to perform the manufacturer recommended scheduled maintenance. Assume that none of the exceptions set out in paragraph (i)(3) of this section apply to the amounts paid for the sched- uled maintenance. (ii) The majority of B’s costs do not qualify un- der the routine maintenance safe harbor in paragraph (i)(1)(ii) of this section because the costs were in- curred primarily as a result of the prior owner’s use of the property and not B’s use. B acquired the ma- chine just before it had received its three-year sched- uled maintenance. Accordingly, the amounts paid for the scheduled maintenance resulted from the prior owner’s, and not B’s, use of the property and must be capitalized if those amounts result in a betterment un- der paragraph (i) of this section, including the amelio- ration of a material condition or defect, or otherwise result in an improvement under paragraph (d) of this section. Example 5.Routine maintenance resulting from new owner’s use . Assume the same facts as inEx- ample 4 , except that after B pays amounts for the maintenance in Year 1, B continues to operate the ma- chine in its manufacturing business. In Year 4, B pays amounts to perform the next scheduled manufacturer recommended maintenance on the machine. Assume that the scheduled maintenance activities performed are the same as those performed in Example 4and that none of the exceptions set out in paragraph (i)(3) of this section apply to the amounts paid for the sched- uled maintenance. Because the scheduled mainte- nance performed in Year 4 involves the recurring ac- tivities that B performs as a result of its use of the machine, keeps the machine in an ordinarily efficient operating condition, and consists of maintenance ac- tivities that B expects to perform more than once dur- ing the 10-year class life of the machine, B’s sched- uled maintenance costs are within the routine main- tenance safe harbor under paragraph (i)(1)(ii) of this section. Accordingly, the amounts paid for the sched- uled maintenance in Year 4 are deemed not to im- prove the machine and are not required to be capi- talized under paragraph (d) of this section. Example 6.Routine maintenance; replacement of substantial structural part; coordination with section 263A . C is in the business of producing commercial products for sale. As part of the production process, C places raw materials into lined containers in which a chemical reaction is used to convert raw materials into the finished product. The lining, which com- prises 60 percent of the total physical structure of the container, is a substantial structural part of the con- tainer. Assume that each container, including its lin- ing, is the unit of property and that a container has a class life of 12 years. At the time that C placed the container into service, C was aware that approx- imately every three years, the container lining would need to be replaced with comparable and commer- cially available replacement materials. At the end of three years, the container will continue to function, but will become less efficient and the replacement of the lining will be necessary to keep the container in an ordinarily efficient operating condition. In Year 1, C acquired 10 new containers and placed them into service. In Year 4, Year 7, Year 9, and Year 12, C pays amounts to replace the containers’ linings with comparable and commercially available replacement parts. Assume that none of the exceptions set out in paragraph(i)(3)ofthissectionapplytotheamounts paid for the replacement linings. Because the replace- ment of the linings involves recurring activities that C expects to perform as a result of its use of the contain- ers to keep the containers in their ordinarily efficient operating condition and consists of maintenance ac- tivities that C expects to perform more than once dur- ing the 12-year class life of the containers, C’s lining replacement costs are withinthe routine maintenance safe harbor under paragraph (i)(1)(ii) of this section. Accordingly, the amounts that C paid for the replace- ment of the container linings are deemed not to im- prove the containers and are not required to be capi- talized under paragraph (d) of this section. However, the amounts paid to replace the lining may be subject to capitalization under section 263A if the amounts paid for this maintenance comprise the direct or al- locable indirect costs of the property produced by C. See §1.263A–1(e)(3)(ii)(O). Example 7.Routine maintenance once during class life . D is a Class I railroad that owns a fleet of freight cars. Assume that a freight car, including all its components, is a unit of property and has a class life of 14 years. At the time that D places a freight car into service, D expects to perform cyclical recon- ditioning to the car every 8 to 10 years to keep the freight car in ordinarily efficient operating condition. During this reconditioning, D pays amounts to dis- assemble, inspect, and recondition or replace com- ponents of the freight car with comparable and com- mercially available replacement parts. Ten years af- ter D places the freight car in service, D pays amounts to perform a cyclical reconditioning on the car. Be- cause D expects to perform the reconditioning only once during the 14 year class life of the freight car, the amounts D pays for the reconditioning do not qualify for the routine maintenance safe harbor under para- graph (i)(1)(ii) of this section. Accordingly, D must capitalize the amounts paid for the reconditioning of thefreightcariftheseamountsresultinanimprove- ment under paragraph (d) of this section. Example 8.Routine maintenance; reasonable ex- pectation .AssumethesamefactsasExample 7,ex- cept in Year 1, D acquires and places in service sev- eral refrigerated freight cars, which also have a class life of 14 years. Because of the special requirements of these cars, at the time they are placed in service, D expects to perform a reconditioning of the refrig- eration components of the freight car every 6 years to keep the freight car in an ordinarily efficient op- erating condition. During the reconditioning, D pays amounts to disassemble, inspect, and recondition or replace the refrigeration components of the freight car with comparable and commercially available re- placement parts. Assume that none of the exceptions set out in paragraph (i)(3) of this section apply to the amounts paid for the reconditioning of these freight cars. In Year 6, D pays amounts to perform a recondi- tioning on the refrigeration components on one of the freight cars. However, because of changes in the fre- quency that D utilizes this freight car, D does not per- form the second reconditioning on the same freight car until Year 15, after the end of the 14-year class life of the car. Under paragraph (i)(1)(ii) of this section, D’s reasonable expectation that it would perform the reconditioning every 6 years will not be deemed un- reasonable merely because D did not actually perform the reconditioning a second time during the 14-year class life, provided that D can substantiate that its ex- pectation was reasonable at the time the property was placed in service. If D can demonstrate that its ex- pectation was reasonable in Year 1 using the factors provided in paragraph (i)(1)(ii) of this section, then the amounts paid by D to recondition the refriger- ated freight car components in Year 6 and in Year 15 are within the routine maintenance safe harbor under paragraph (i)(1)(ii) of this section. Example 9.Routine maintenance on non-rotable part . E is a towboat operator that owns and leases a fleet of towboats. Each towboat is equipped with two diesel-powered engines. Assume that each towboat, including its engines, is the unit of property and that a towboat has a class life of 18 years. At the time that E places its towboats into service, E is aware that approximately every three to four years E will need to perform scheduled maintenance on the two towboat engines to keep the engines in their ordinar- ily efficient operating condition. This maintenance is completed while the engines are attached to the towboat and involves the cleaning and inspecting of the engines to determine which parts are within acceptable operating tolerances and can continue to be used, which parts must be reconditioned to be 2013–43 I.R.B.377October 21, 2013 brought back to acceptable tolerances, and which parts must be replaced. Engine parts replaced during these procedures are replaced with comparable and commercially available replacement parts. Assume the towboat engines are not rotable spare parts under §1.162–3(c)(2). In Year 1, E acquired a new towboat, including its two engines, and placed the towboat into service. In Year 5, E pays amounts to perform scheduled maintenance on both engines in the tow- boat. Assume that none of the exceptions set out in paragraph (i)(3) of this section apply to the scheduled maintenance costs. Because the scheduled mainte- nance involves recurring activities that E expects to perform more than once during the 18-year class life of the towboat, the maintenance results from E’s use of the towboat, and the maintenance is performed to keep the towboat in an ordinarily efficient operating condition, the scheduled maintenance on E’s towboat is within the routine maintenance safe harbor under paragraph (i)(1)(ii) of this section. Accordingly, the amounts paid for the scheduled maintenance to its towboat engines in Year 5 are deemed not to improve the towboat and are not required to be capitalized under paragraph (d) of this section. Example 10.Routine maintenance with related betterments . Assume the same facts asExample 9, except that in Year 9 E’s towboat engines are due for another scheduled maintenance visit. At this time, E decides to upgrade the engines to increase their horse- power and propulsion, which would permit the tow- boats to tow heavier loads. Accordingly, in Year 9, E pays amounts to perform many of the same activ- ities that it would perform during the typical sched- uled maintenance activities such as cleaning, inspect- ing, reconditioning, and replacing minor parts, but at the same time, E incurs costs to upgrade certain en- gine parts to increase the towing capacity of the boats in excess of the capacity of the boats when E placed them in service. In combination with the replace- ment of parts with new and upgraded parts, the sched- uled maintenance must be completed to perform the horsepower and propulsion upgrade. Thus, the work done on the engines encompasses more than the re- curring activities that E expected to perform as a re- sult of its use of the towboats and did more than keep the towboat in its ordinarily efficient operating con- dition. Rather under paragraph (j) of this section, the amounts paid to increase the horsepower and propul- sion of the engines are for a betterment to the tow- boat, and such amounts are excepted from the routine maintenance safe harbor under paragraph (i)(3)(i) of this section. In addition, under paragraph (g)(1)(i) of this section, the scheduled maintenance procedures directly benefit the upgrades. Therefore, the amounts that E paid in Year 9 for the maintenance and upgrade of the engines do not qualify for the routine mainte- nance safe harbor described under paragraph (i)(1)(ii) of this section. Rather, E must capitalize the amounts paid for maintenance and upgrades of the engines as an improvement to the towboats under paragraph (d) of this section. Example 11.Routine maintenance with unrelated improvements . Assume the same facts asExample 9, except in Year 5, in addition to paying amounts to perform the scheduled engine maintenance on both engines, E also incurs costs to upgrade the communi- cations and navigation systems in the pilot house of the towboat with new state-of-the-art systems. As- sume the amounts paid to upgrade the communica- tions and navigation systems are for betterments un- der paragraph (j) of this section, and therefore result in an improvement to the towboat under paragraph (d) of this section. In contrast with Example 9,the amounts paid for the scheduled maintenance on E’s towboat engines are not otherwise related to the up- grades to the navigation systems. Because the sched- uled maintenance on the towboat engines does not di- rectly benefit and is not incurred by reason of the up- grades to the communication and navigation systems, the amounts paid for the scheduled engine mainte- nance are not a direct or indirect cost of the improve- ment under paragraph (g)(1)(i) of this section. Ac- cordingly, the amounts paid for the scheduled main- tenance to its towboat engines in Year 5 are routine maintenance deemed not toimprove the towboat and are not required to be capitalized under paragraph (d) of this section. Example 12.Exceptions to routine maintenance. F owns and operates a farming and cattle ranch with an irrigation system that provides water for crops. Assume that each canal in the irrigation system is a single unit of property and has a class life of 20 years. At the time F placed the canals into service, F ex- pected to have to perform major maintenance on the canals every three years to keep the canals in their ordinarily efficient operating condition. This mainte- nance includes draining the canals, and then cleaning, inspecting, repairing, and reconditioning or replacing parts of the canal with comparable and commercially available replacement parts. F placed the canals into service in Year 1 and did not perform any mainte- nance on the canals until Year 6. At that time, the canals had fallen into a state of disrepair and no longer functioned for irrigation. In Year 6, F pays amounts to drain the canals and do extensive cleaning, repairing, reconditioning, and replacing parts of the canals with comparable and commercially available replacement parts. Although the work performed on F’s canals was similar to the activities that F expected to per- form, but did not perform, every three years, the costs of these activities do not fall within the routine main- tenance safe harbor. Specifically, under paragraph (i)(3)(v) of this section, routine maintenance does not include activities that return a unit of property to its former ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use. Accord- ingly, amounts that F pays for work performed on the canals in Year 6 must be capitalized if they result in improvements under paragraph (d) of this section (for example, restorations under paragraph (k) of this sec- tion). Example 13.Routine maintenance on a building; escalator system . In Year 1, G acquires a large retail mall in which it leases space to retailers. The mall contains an escalator system with 40 escalators, which includes landing platforms, trusses, tracks, steps, handrails, and safety brushes. In Year 1, when G placed its building into service, G reasonably ex- pected that it would need toreplace the handrails on the escalators approximately every four years to keep the escalator system in its ordinarily efficient operat- ing condition. After a routine inspection and test of the escalator system in Year 4, G determines that the handrails need to be replaced and pays an amount to replace the handrails with comparable and com- mercially available handrails. The escalator system, including the handrails, is a building system under paragraph (e)(2)(ii)(B)( 4)ofthissection. Assume that none of the exceptions in paragraph (i)(3) of this section apply to the scheduled maintenance costs. Because the replacement of the handrails involves recurring activities that Gexpects to perform as a result of its use of the escalator system to keep the escalator system in an ordinarily efficient operating condition, and G reasonably expects to perform these activities more than once during the 10-year period beginning at the time building system was placed in service, the amounts paid by G for the handrail replacements are withinthe routine maintenance safe harbor under paragraph (i)(1)(i) of this section. Accordingly, the amounts paid for the replacement of the handrails in Year 4 are deemed not to improve the building unit of property and are not required to be capitalized under paragraph (d) of this section. Example 14.Not routine maintenance; escala- tor system . Assume the same facts as inExample 13, except that in Year 9, G pays amounts to replace the steps of the escalators. In Year 1, when G placed its building into service, G reasonably expected that ap- proximately every 18 to 20 years G would need to re- place the steps to keep the escalator system in its ordi- narily efficient operating condition. Because the re- placement does not involve recurring activities that G expects to perform more than once during the 10-year period beginning at the time the building structure or the building system was placed in service, the costs of these activities do not fall within the routine main- tenance safe harbor. Accordingly, amounts that G pays to replace the steps in Year 9 must be capitalized if they result in improvements under paragraph (d) of this section (for example, restorations under para- graph (k) of this section). Example 15.Routine maintenance on building; reasonable expectation . In Year 1, H acquires a new office building, which it uses to provide services. The building contains an HVAC system, which is a building system under paragraph (e)(2)(ii)(B)( 1)of this section. In Year 1, when H placed its building into service, H reasonably expected that every four years H would need to pay an outside contractor to perform detailed testing, monitoring, and preventa- tive maintenance on its HVAC system to keep the HVAC system in its ordinarily efficient operating condition. This scheduled maintenance includes dis- assembly, cleaning, inspection, repair, replacement, reassembly, and testing of the HVAC system and many of its component parts. If inspection or testing discloses a problem with any component, the part is repaired, or if necessary, replaced with a comparable and commercially available replacement part. The scheduled maintenance at these intervals is recom- mended by the manufacturer of the HVAC system and is routinely performed on similar systems in sim- ilar buildings. Assume that none of the exceptions in paragraph (i)(3) of this section apply to the amounts paid for the maintenance on the HVAC system. In Year 4, H pays amounts to a contractor to perform the scheduled maintenance. However, H does not perform this scheduled maintenance on its building again until Year 11. Under paragraph (i)(1)(i) of this section, H’s reasonable expectation that it would perform the maintenance every 4 years will not be deemed unreasonable merely because H did not ac- tually perform the maintenance a second time during the 10-year period, provided that H can substantiate that its expectation was reasonable at the time the October 21, 20133782013–43 I.R.B. property was placed in service. If H can demonstrate that its expectation was reasonable in Year 1 using the other factors considered in paragraph (i)(1)(i), then the amounts H paid for the maintenance of the HVAC system in Year 4 and in Year 11 are within the routine maintenance safe harbor under paragraph (i)(1)(i) of this section. (j)Capitalization of betterments—(1) In general.A taxpayer must capitalize as an improvement an amount paid for a bet- terment to a unit of property. An amount is paid for a betterment to a unit of property only if it— (i) Ameliorates a material condition or defect that either existed prior to the tax- payer’s acquisition of the unit of property or arose during the production of the unit of property, whether or not the taxpayer was aware of the condition or defect at the time of acquisition or production; (ii) Is for a material addition, includ- ing a physical enlargement, expansion, ex- tension, or addition of a major component (as defined in paragraph (k)(6) of this sec- tion) to the unit of property or a material in- crease in the capacity, including additional cubic or linear space,of the unit of prop- erty; or (iii) Is reasonably expected to materi- ally increase the productivity, efficiency, strength, quality, or output of the unit of property. (2)Application of betterment rules—(i) In general. The applicability of each quan- titative and qualitative factor provided in paragraphs (j)(1)(ii) and (j)(1)(iii) of this section to a particular unit of property de- pends on the nature of the unit of property. For example, if an addition or an increase in a particular factor cannot be measured in the context of a specific type of property, this factor is not relevant in the determina- tion of whether an amount has been paid for a betterment to the unit of property. (ii)Application of betterment rules to buildings. Anamountispaidtoimprove a building if it is paid for a betterment, as defined under paragraph (j)(1) of this section, to a property specified under paragraph (e)(2)(ii) (building), paragraph (e)(2)(iii)(B) (condominium), paragraph (e)(2)(iv)(B) (cooperative), or paragraph (e)(2)(v)(B) (leased building or leased portion of building) of this section. For example, an amount is paid to improve a building if it is paid for an increase in the efficiency of the building structure or any one of its building systems (for example, the HVAC system). (iii)Unavailability of replacement parts. If a taxpayer replaces a part of a unit of property that cannot reasonably be replaced with the same type of part (for example, because of technological advancements or product enhancements), the replacement of the part with an im- proved, but comparable, part does not, by itself, result in a betterment to the unit of property. (iv)Appropriate comparison—(A)In general. In cases in which an expenditure is necessitated by normal wear and tear or damage to the unit of property that oc- curred during the taxpayer’s use of the unit of property, the determination of whether an expenditure is for the betterment of the unit of property is made by comparing the condition of the property immediately after the expenditure with the condition of the property immediately prior to the cir- cumstances necessitating the expenditure. (B)Normal wear and tear.Iftheex- penditure is made to correct the effects of normal wear and tear to the unit of prop- erty that occurred during the taxpayer’s use of the unit of property, the condition of the property immediately prior to the circumstances necessitating the expendi- ture is the condition of the property af- ter the last time the taxpayer corrected the effects of normal wear and tear (whether the amounts paid were for maintenance or improvements) or, if the taxpayer has not previously corrected the effects of normal wear and tear, the condition of the property when placed in service by the taxpayer. (C)Damage to property. If the expen- diture is made to correct damage to a unit of property that occurred during the tax- payer’s use of the unit of property, the con- dition of the property immediately prior to the circumstances necessitating the expen- diture is the condition of the property im- mediately prior to damage. (3)Examples. The following examples illustrate the application of this paragraph (j) only and do not address whether capi- talization is required under another provi- sion of this section or another provision of the Internal Revenue Code (for example, section 263A). Unless otherwise provided, assume that the appropriate comparison in paragraph (j)(2)(iv) of this section is not applicable under the facts. Example 1.Amelioration of pre-existing material condition or defect . In Year 1, A purchases a store located on a parcel of land that contains underground gasoline storage tanks left by prior occupants. As- sume that the parcel of land is the unit of property. The tanks had leaked prior to A’s purchase, causing soil contamination. A is not aware of the contamina- tion at the time of purchase. In Year 2, A discovers the contamination and incurs costs to remediate the soil. The remediation costs are for a betterment to the land under paragraph (j)(1)(i) of this section because A in- curred the costs to ameliorate a material condition or defect that existed prior to A’s acquisition of the land. Example 2.Not amelioration of pre-existing con- dition or defect . B owns an office building that was constructed with insulation that contained asbestos. The health dangers of asbestos were not widely known when the building was constructed. Several years after B places the building into service, B determines that certain areas of asbestos-containing insulation have begun to deteriorate and could even- tually pose a health risk to employees. Therefore, B pays an amount to remove the asbestos-containing insulation from the building structure and replace it with new insulation that is safer to employees, but no more efficient or effective than the asbestos insu- lation. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a building unit of property if the amount is paid for a betterment to the building structure or any building system. Although the asbestos is determined to be unsafe under certain circumstances, the presence of asbestos insulation in a building, by itself, is not a preexisting material condition or defect of the building structure under paragraph (j)(1)(i) of this section. In addition, the removal and replacement of the asbestos is not for a material addition to the building structure or a material increase in the capacity of the building structure under paragraphs (j)(1)(ii) and (j)(2)(iv) of this section as compared to the condition of the property prior to the deterioration of the insulation. Similarly, the removal and replacement of asbestos is not reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of the building structure under paragraphs (j)(1)(iii) and (j)(2)(iv) of this section as compared to the con- dition of the property prior to the deterioration of the insulation. Therefore, theamountpaidtoremoveand replace the asbestos insulation is not for a betterment to the building structure or an improvement to the building under paragraph (j) of this section. Example 3.Not amelioration of pre-existing ma- terial condition or defect . (i) In January, Year 1, C purchased a used machine for use in its manu- facturing operations. Assume that the machine is a unit of property and has a class life of 10 years. C placed the machine in service in January, Year 1 and at that time expected to perform manufacturer recom- mended scheduled maintenance on the machine ev- ery three years. The scheduled maintenance includes cleaning and oiling the machine, inspecting parts for defects, and replacing minor items, such as springs, bearings, and seals, with comparable and commer- cially available replacement parts. The scheduled maintenance does not include any material additions or materially increase the capacity, productivity, effi- ciency, strength, quality, or output of the machine. At the time C purchased the machine, it was approaching the end of a three-year scheduled maintenance period. As a result, in February, Year 1, C pays an amount to perform the manufacturer recommended scheduled 2013–43 I.R.B.379October 21, 2013 maintenance to keep the machine in its ordinarily ef- ficient operating condition. (ii) The amount that C pays does not qualify un- der the routine maintenance safe harbor in paragraph (i) of this section, because the cost primarily results from the prior owner’s use of the property and not the taxpayer’s use. C acquired the machine just be- fore it had received its three-year scheduled mainte- nance. Accordingly, the amount that C pays for the scheduled maintenance results from the prior owner’s use of the property and ameliorates conditions or de- fects that existed prior to C’s ownership of the ma- chine. Nevertheless, considering the purpose and mi- nor nature of the work performed, this amount does not ameliorate a material condition or defect in the machine under paragraph (j)(1)(i) of this section, is not for a material addition to or increase in capacity of the machine under paragraph (j)(1)(ii) of this section, and is not reasonably expected to materially increase the productivity, efficiency, strength, quality, or out- put of the machine under paragraph (j)(1)(iii) of this section. Therefore, C is not required to capitalize the amount paid for the scheduled maintenance as a bet- terment to the unit of property under this paragraph (j). Example 4.Not amelioration of pre-existing ma- terial condition or defect . D purchases a used ice resurfacing machine for use in the operation of its ice skating rink. To comply with local regulations, D is required to routinely monitor the air quality in the ice skating rink. One week after D places the ma- chine into service, during a routine air quality check, D discovers that the operation of the machine is ad- versely affecting the air quality in the skating rink. As a result, D pays an amount to inspect and retune the machine, which includes replacing minor com- ponents of the engine that had worn out prior to D’s acquisition of the machine. Assume the resurfacing machine, including the engine, is the unit of property. The routine maintenance safe harbor in paragraph (i) of this section does not apply to the amounts paid, be- cause the activities performed do not relate solely to the taxpayer’s use of the machine. The amount that D pays to inspect, retune, and replace minor com- ponents of the ice resurfacing machine ameliorates a condition or defect that existed prior to D’s acquisi- tion of the equipment. Nevertheless, considering the purpose and minor nature of the work performed, this amount does not ameliorate a material condition or defect in the machine under paragraph (j)(1)(i) of this section. In addition, the amount is not paid for a ma- terial addition to the machine or a material increase in the capacity of the machineunder paragraph (j)(1)(ii) of this section. Also, the activities are not reasonably expected to materially increase the productivity, ef- ficiency, strength, quality, or output of the machine under paragraph (j)(1)(iii) of this section. Therefore, D is not required to capitalize the amount paid to in- spect, retune, and replace minor components of the machine as a betterment under this paragraph (j). Example 5.Amelioration of material condition or defect . (i) E acquires a building for use in its business of providing assisted living services. Be- fore and after the purchase, the building functions as an assisted living facility. However, at the time of the purchase, E is aware that the building is in a condition that is below the standards that E requires for facilities used in its business. Immediately after the acquisition and during the following two years, while E continues to use the building as an assisted living facility, E pays amounts for extensive repairs and maintenance, and the acquisition of new prop- erty to bring the facility into the high-quality condi- tion for which E’s facilities are known. The work on E’s building includes repairing damaged drywall, repainting, re-wallpapering, replacing windows, re- pairing and replacing doors, replacing and regrout- ing tile, repairing millwork, and repairing and replac- ing roofing materials. The work also involves the re- placement of section 1245 property, including win- dow treatments, furniture, and cabinets. The work that E performs affects only the building structure un- der paragraph (e)(2)(ii)(A) of this section and does not affect any of the building systems described in paragraph (e)(2)(ii)(B) of this section. Assume that each section 1245 property is a separate unit of prop- erty. (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a build- ing unit of property if the amount is paid for a bet- terment to the building structure or any building sys- tem. Considering the purpose of the expenditure and the effect of the expenditures on the building struc- ture, the amounts that E paid for repairs and mainte- nance to the building structure comprise a betterment to the building structure under paragraph (j)(1)(i) of this section because the amounts ameliorate mate- rial conditions that existed prior to E’s acquisition of the building. Therefore, E must treat the amounts paid for the betterment to the building structure as an improvement to the building and must capitalize the amounts under paragraphs (j) and (d)(1) of this section. Moreover, E is required to capitalize the amounts paid to acquire and install each section 1245 property, including each window treatment, each item of furniture, and each cabinet, in accordance with §1.263(a)–2(d)(1). Example 6.Not a betterment; building refresh. (i) F owns a nationwide chain of retail stores that sell a wide variety of items. To maintain the appearance and functionality of its store buildings after several years of wear, F periodically pays amounts to refresh the look and layout of its stores. The work that F per- forms during a refresh consists of cosmetic and lay- out changes to the store’s interiors and general repairs and maintenance to the store building to modernize the store buildings and reorganize the merchandise displays. The work to each store consists of replac- ing and reconfiguring display tables and racks to pro- vide better exposure of the merchandise, making cor- responding lighting relocations and flooring repairs, moving one wall to accommodate the reconfiguration of tables and racks, patching holes in walls, repainting the interior structure with a new color scheme to coor- dinate with new signage, replacing damaged ceiling tiles, cleaning and repairing wood flooring through- out the store building, and power washing building exteriors. The display tables and the racks all consti- tute section 1245 property. F pays amounts to refresh 50 stores during the taxable year. Assume that each section 1245 property within each store is a separate unit of property. Finally, assume that the work does not ameliorate any material conditions or defects that existed when F acquired the store buildings or result in any material additions to the store buildings. (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a build- ing unit of property if the amount is paid for a bet- terment to the building structure or any building sys- tem. Considering the facts and circumstances includ- ing the purpose of the expenditure, the physical na- ture of the work performed, and the effect of the ex- penditure on the buildings’ structure and systems, the amounts paid for the refresh of each building are not for any material additionsto, or material increases in the capacity of, the buildings’ structure or sys- tems as compared with the condition of the structure or systems after the previous refresh. Moreover, the amounts paid are not reasonably expected to mate- rially increase the productivity, efficiency, strength, quality, or output of any building structure or sys- tem under as compared to the condition of the struc- tures or systems after the previous refresh. Rather, the work performed keeps F’s store buildings’ structures and buildings’ systems in their ordinarily efficient op- erating condition. Therefore, F is not required to treat the amounts paid for the refresh of its store buildings’ structures and buildings’ systems as betterments un- der paragraphs (j)(1)(ii), (j)(1)(iii), and (j)(2)(iv) of this section. However, F is required to capitalize the amounts paid to acquire and install each section 1245 property in accordance with §1.263(a)–2(d)(1). Example 7. Building refresh; limited improve- ment . (i) Assume the same facts asExample 6except, in the course of the refresh to one of its store build- ings, F also pays amounts to increase the building’s storage space, add a second loading dock, and add a second overhead door. Specifically, at the same time F pays amounts to perform the refresh, F pays addi- tional amounts to construct an addition to the back of the store building, including adding a new over- head door and loading dock to the building. The work also involves upgrades to the electrical system of the building, including the addition of a second service box with increased amperage and new wiring from the service box to provide lighting and power throughout the new space. Although it is performed at the same time, the construction of the additions does not affect, and is not otherwise related to, the refresh of the retail space. (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a build- ingunitofpropertyiftheamountispaidforabet- terment to the building structure or any building sys- tem. Under paragraph (j)(1)(ii) of this section, the amounts paid by F to add the storage space, loading dock, overhead door, and expand the electrical sys- tem are for betterments to F’s building structure and to the electrical system because they are for mate- rial additions to, and a material increase in capacity of, the structure and the electrical system of F’s store building. Accordingly, F must treat the amounts paid for these betterments as improvements to the building unit of property and capitalize these amounts under paragraphs (d)(1) and (j) of this section. However, for the reasons discussed in Example 6,Fisnotre- quired to treat the amounts paid for the refresh of its store building structure and systems as a betterments under paragraph (j)(1) of this section. In addition, F is not required under paragraph (g)(1) of this section to capitalize the refresh costs described in Example 6 because these costs do not directly benefit and are not incurred by reason of the additions to the building structure and electrical system. As in Example 6,Fis required to capitalize the amounts paid to acquire and install each section 1245 property in accordance with §1.263(a)–2(d)(1). October 21, 20133802013–43 I.R.B. Example 8.Betterment; building remodel.(i)G owns a large chain of retail stores that sell a variety of items. G determines that due to changes in the re- tail market, it can no longer compete in its current store class and decides to upgrade its stores to offer higher end products to a different type of customer. To offer these products and attract different types of customers, G must substantially remodel its stores. Thus, G pays amounts to remodel its stores by per- forming work on the buildings’ structures and sys- tems as defined under paragraphs (e)(2)(ii)(A) and (e)(2)(ii)(B) of this section. This work includes re- placing large parts of the exterior walls with win- dows, replacing the escalators with a monumental staircase, adding a new glass enclosed elevator, re- building the interior and exterior facades, replacing vinyl floors with ceramic flooring, replacing ceiling tiles with acoustical tiles, and removing and rebuild- ing walls to move changing rooms and create spe- cialty departments. The work also includes upgrades to increase the capacity ofthe buildings’ electrical system to accommodate the structural changes and the addition of new section 1245 property, such as new product information kiosks and point of sale sys- tems. The work to the electrical system also involves the installation of new more efficient and mood en- hancing lighting fixtures. In addition, the work in- cludes remodeling all bathrooms by replacing con- tractor-grade plumbing fixtures with designer-grade fixtures that conserve water and energy. Finally, G also pays amounts to clean debris resulting from con- struction during the remodel, patch holes in walls that were made to upgrade the electrical system, repaint existing walls with a new color scheme to match the new interior construction, and to power wash build- ing exteriors to enhance the new exterior facade. (ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a build- ing unit of property if the amount is paid for a bet- terment to the building structure or any building sys- tem. Considering the facts and circumstances, in- cluding the purpose of the expenditure, the physi- cal nature of the work performed, and the effect of the work on the buildings’ structures and buildings’ systems, the amounts that G pays for the remodel- ing of its stores result in betterments to the build- ings’ structures and several of its systems under para- graph (j) of this section. Specifically, the amounts paid to replace large parts of the exterior walls with windows, replace the escalators with a monumen- tal staircase, add a new elevator, rebuild the interior and exterior facades, replace vinyl floors with ce- ramic flooring, replace the ceiling tiles with acous- tical tiles, and to remove and rebuild walls are for material additions, that is the addition of major com- ponents, to the building structure under paragraph (j)(1)(ii) of this section and are reasonably expected to increase the quality of the building structure un- der paragraph (j)(1)(iii) of this section. Similarly, the amounts paid to upgrade the electrical system are to materially increase the capacity of the electri- cal system under paragraph (j)(1)(ii) of this section and are reasonably expected to increase the quality of this system under paragraph (j)(1)(iii) of this sec- tion. In addition, the amounts paid to remodel the bathrooms with higher grade and more resource-ef- ficient materials are reasonably expected to increase the efficiency and quality of the plumbing system un- der paragraph (j)(1)(iii) of this section. Finally, the amounts paid to clean debris, patch and repaint exist- ing walls with a new color scheme, and to power wash building exteriors, while not betterments by them- selves, directly benefitted and were incurred by rea- son of the improvements to G’s store buildings’ struc- tures and electrical systems under paragraph (g)(1) of this section. Therefore, G must treat the amounts paid for betterments to the store buildings’ structures and systems, including the costs of cleaning, patch- ing, repairing, and power washing the building, as improvements to G’s buildings and must capitalize these amounts under paragraphs (d)(1) and (j) of this section. Moreover, G is required to capitalize the amounts paid to acquire and install each section 1245 property in accordance with §1.263(a)–2(d)(1). For the treatment of amounts paid to remove components of property, see paragraph (g)(2) of this section. Example 9.Not betterment; relocation and re- installation of personal property. In Year 1, H pur- chases new cash registers for use in its retail store located in leased space in a shopping mall. Assume that each cash register is a unit of property as deter- mined under paragraph (e)(3) of this section. In Year 1, H capitalizes the costs of acquiring and installing the new cash registers under §1.263(a)–2(d)(1). In Year 3, H’s lease expires, and H decides to relocate its retail store to a different building. In addition to various other costs, H pays $5,000 to move the cash registers and $1,000 to reinstall them in the new store. Thecashregistersareusedforthesamepurposeand in the same manner that they were used in the former location. The amounts that H pays to move and rein- stall the cash registers into its new store do not result in a betterment to the cash registers under paragraph (j)ofthissection. Example 10.Betterment; relocation and reinstal- lation of equipment . J operates a manufacturing facil- ity in Building A, which contains various machines that J uses in its manufacturing business. J decides to expand part of its operations by relocating a ma- chine to Building B to reconfigure the machine with additional components. Assume that the machine is a single unit of property under paragraph (e)(3) of this section. J pays amounts to disassemble the machine, to move the machine to the new location, and to re- install the machine in a new configuration with addi- tional components. Assume that the reinstallation, in- cluding the reconfiguration and the addition of com- ponents, is for an increase in capacity of the machine, and therefore is for a betterment to the machine un- der paragraph (j)(1)(ii) of this section. Accordingly, J must capitalize the costs of reinstalling the machine as an improvement to the machine under paragraphs (j) and (d)(1) of this section. J is also required to cap- italize the costs of disassembling and moving the ma- chine to Building B because these costs directly ben- efit and are incurred by reason of the improvement to the machine under paragraph (g)(1) of this section. Example 11. Betterment; regulatory requirement. K owns a building that it uses in its business. In Year 1, City C passes an ordinance setting higher safety standards for buildingsbecause of the hazardous conditions caused by earthquakes. To comply with the ordinance, K pays an amount to add expansion bolts to its building structure. These bolts anchor the wooden framing of K’s building to its cement foundation, providing additional structural support and resistance to seismic forces, making the building more resistant to damage from lateral movement. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this sec- tion, an amount is paid to improve a building unit of property if the amount is paid for a betterment to the building structure or any building system. The framing and foundation are part of the building structure as defined in paragraph(e)(2)(ii)(A)ofthis section. Prior to the ordinance, the old building was in good condition but did not meet City C’s new requirements for earthquake resistance. The amount paid by K for the addition of the expansion bolts met City C’s new requirement, but also materially increased the strength of the building structure under paragraph (j)(1)(iii) of this section. Therefore, K must treat the amount paid to add the expansion bolts as a betterment to the building structure and must capitalize this amount as an improvement to building under paragraphs (d)(1) and (j) of this section. City C’s new requirement that K’s building meet certain safety standards to continue to operate is not relevant in determining whether the amount paid improved the building. See paragraph (g)(4) of this section. Example 12. Not a betterment; regulatory re- quirement. L owns a meat processing plant. After operating the plant for many years, L discovers that oil is seeping through the concrete walls of the plant. Federal inspectors advise L that it must correct the seepage problem or shutdown its plant. To correct the problem, L pays an amount to add a concrete lin- ing to the walls from the floor to a height of about four feet and also to add concrete to the floor of the plant. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this sec- tion, an amount is paid to improve a building unit of property if the amount is paid for a betterment to the building structure or any building system. The walls are part of the building structure as defined in para- graph (e)(2)(ii)(A) of this section. The condition ne- cessitating the expenditure was the seepage of the oil into the plant. Prior to the seepage, the walls did not leak and were functioning for their intended use. L is not required to treat the amount paid as a betterment under paragraphs (j)(1)(ii) and (j)(2)(iv) of this sec- tion because it is not paid for a material addition to, or a material increase in the capacity of, the building’s structure as compared to the condition of the structure prior to the seepage of oil. Moreover, the amount paid is not reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of the building structure under paragraphs (j)(1)(iii) and (j)(2)(iv) as compared to the condition of the structure prior to the seepage of the oil. Therefore, L is not re- quired to treat the amount paid to correct the seepage as a betterment to the building under paragraph (d)(1) or (j) of this section. The federal inspectors’ require- ment that L correct the seepage to continue operating the plant is not relevant in determining whether the amount paid improves the plant. Example 13.Not a betterment; new roof mem- brane . M owns a building that it uses for its retail business. Over time, the waterproof membrane (top layer) on the roof of M’s building begins to wear, and M began to experience water seepage and leaks throughout its retail premises. To eliminate the prob- lems, a contractor recommends that M put a new rub- ber membrane on the worn membrane. Accordingly, M pays the contractor to add the new membrane. The new membrane is comparable to the worn membrane when it was originally placed in service by the tax- payer. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a building 2013–43 I.R.B.381October 21, 2013 unit of property if the amount is paid for a betterment to the building structure or any building system. The roof is part of the building structure under paragraph (e)(2)(ii)(A) of this section. The condition necessitat- ing the expenditure was the normal wear of M’s roof. Under paragraph (j)(2)(iv) of this section, to deter- mine whether the amounts are for a betterment, the condition of the building structure after the expendi- ture must be compared to the condition of the struc- ture when M placed the building into service because M has not previously corrected the effects of normal wear and tear. Under these facts, the amount paid to add the new membrane to the roof is not for a ma- terial addition or a material increase in the capacity of the building structure under paragraph (j)(1)(ii) of this section as compared to the condition of the struc- ture when it was placed in service. Moreover, the new membrane is not reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of the building structure under paragraph (j)(1)(iii) of this section as compared to the condition of the building structure when it was placed in ser- vice. Therefore, M is not required to treat the amount paid to add the new membrane as a betterment to the building under paragraph (d)(1) or (j) of this section. Example 14.Material increase in capacity; building . N owns a factory building with a stor- age area on the second floor. N pays an amount to reinforce the columns and girders supporting the second floor to permit storage of supplies with a gross weight 50 percent greater than the previous load-carrying capacity ofthe storage area. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a building unit of property if the amount is paid for a betterment to the building structure or any building system. The columns and girders are part of the building structure defined under paragraph (e)(2)(ii)(A) of this section. N must treat the amount paid to reinforce the columns and girders as a betterment under paragraphs (j)(1)(ii) and (j)(1)(iii) of this section because it materially in- creases the load-carrying capacity and the strength of the building structure. Therefore, N must capitalize this amount as an improvement to the building under paragraphs (d)(1) and (j) of this section. Example 15.Material increase in capacity; chan- nel. O owns harbor facilities consisting of a slip for the loading and unloading of barges and a channel leading from the slip to the river. At the time of purchase, the channel was 150 feet wide, 1,000 feet long, and 10 feet deep. Several years after purchasing the harbor facilities, to allow for ingress and egress and for the unloading of larger barges, O decides to deepen the channel to a depth of 20 feet. O pays a contractor to dredge the channel to 20 feet. Assume the channel is the unit of property. O must capitalize the amounts paid for the dredging as an improvement to the channel because they are for a material increase in the capacity of the unit of property under paragraph (j)(1)(ii) of this section. Example 16. Not a material increase in capac- ity; channel . Assume the same facts as inExample 15 , except that the channel was susceptible to silta- tion and, after dredging to 20 feet, the channel depth had been reduced to 18 feet. O pays a contractor to redredge the channel to a depth of 20 feet. The expen- diture was necessitated by the siltation of the channel. Both prior to the siltation and after the redredging, the depth of the channel was 20 feet. Applying the com- parison rule under paragraph (j)(2)(iv) of this section, the amounts paid by O to redredge the channel are not for a betterment under paragraph (j)(1)(ii) of this sec- tion because they are not for amaterial addition to, or a material increase in the capacity of, the unit of prop- erty as compared to the condition of the property prior to the siltation. Similarly, these amounts are not for a betterment under paragraph (j)(1)(iii) of this section because the amounts are not reasonably expected to increase the productivity, efficiency, strength, quality, or output of the unit of property as compared to the condition of the property before the siltation. There- fore, O is not required to capitalize these amounts as improvement under paragraphs (d)(1) and (j) of this section. Example 17.Material increase in capacity; chan- nel . Assume the same facts as inExample 16except that after the redredging, there is more siltation, and the channel depth is reduced back to 18 feet. In ad- dition, to allow for additional ingress and egress and for the unloading of even larger barges, O decides to deepen the channel to a depth of 25 feet. O pays a contractor to redredge the channel to 25 feet. O must capitalize the amounts paid for the dredging as an im- provement to the channel because the amounts are for a material increase in the capacity of the unit of prop- erty under paragraph (j)(1)(ii) of this section as com- pared to condition of the unit of property before the siltation. As part of this improvement, O is also re- quired to capitalize the portion of the redredge costs allocable to restoring the depth lost to the siltation be- cause, under paragraph (g)(1)(i) of this section, these amounts directly benefit and are incurred by reason of the improvement to the unit of property. Example 18.Not a material increase in capac- ity; building . P owns a building used in its trade or business. The first floor has a drop-ceiling. To fully expose windows on the first floor, P pays an amount to remove the drop-ceiling and repaint the original ceiling. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a build- ing unit of property if the amount is paid for a bet- terment to the building structure or any building sys- tem. The ceiling is part of the building structure as defined under paragraph (e)(2)(ii)(A) of this section. P is not required to treat the amount paid to remove the drop-ceiling as a betterment to the building be- cause it was not for a material addition or material increase in the capacity of the building structure un- der paragraph (j)(1)(ii) of this section and it was not reasonably expected to materially increase to the ef- ficiency, strength, or quality of the building structure under paragraph (j)(1)(iii) of this section. In addi- tion, under paragraph (j)(2)(i) of this section, because the effect on productivity and output of the building structure cannot be measured in this context, these factors are not relevant in determining whether there is a betterment to the building structure. Example 19. Material increase in capacity; building . Q owns a building that it uses in its retail business. The building contains one floor of retail space with very high ceilings. Q pays an amount to add a stairway and a mezzanine for the purposes of adding additional selling space within its building. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this sec- tion, an amount is paid to improve a building unit of property if the amount is paid for a betterment to the building structure or any building system. The stairway and the mezzanine are part of the building structure as defined under paragraph (e)(2)(ii)(A) of this section. Q is required to treat the amount paid to add the stairway and mezzanine as a bet- terment because it is for a material addition to, and an increase in the capacity of, the building structure under paragraph (j)(1)(ii) of this section. Therefore, Q must capitalize this amount as an improvement to the building unit of property under paragraphs (d)(1) and (j) of this section. Example 20.Not material increase in efficiency; HVAC system . R owns an office building that it uses to provide services to customers. The build- ing contains an HVAC system that incorporates 10 roof-mounted units that provide heating and air conditioning for different parts of the building. The HVAC system also consists of controls for the entire system and duct work that distributes the heated or cooled air to the various spaces in the building’s in- terior. After many years of use of the HVAC system, R begins to experience climate control problems in various offices throughout the office building and consults with a contractor to determine the cause. The contractor recommends that R replace two of the roof-mounted units. R pays an amount to re- place the two specified units. The two new units are expected to eliminate the climate control problems and to be 10 percent more energy efficient than the replaced units in their original condition. No work is performed on the other roof-mounted heating/cool- ing units, the duct work, or the controls. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a building unit of property if the amount is paid for a betterment to the building structure or any building system. The HVAC system, including the two-roof mounted units, is a building system under paragraph (e)(2)(ii)(B)( 1)ofthissec- tion. The replacement of the two roof-mounted units is not a material addition to or a material increase in the capacity of the HVAC system under paragraphs (j)(1)(ii) and (j)(3)(ii) of this section as compared to the condition of the system prior to the climate control problems. In addition, given the 10 percent efficiency increase in two units of the entire HVAC system, the replacement is not expected to materially increase the productivity, efficiency, strength, qual- ity, or output of the HVAC system under paragraphs (j)(1)(iii) and (j)(2)(iv) of this section as compared to the condition of the system prior to the climate control problems. Therefore, R is not required to capitalize the amounts paid for these replacements as betterments to the building unit of property under paragraphs (d)(1) and (j) of this section. Example 21.Material increase in efficiency; building . S owns a building that it uses in its ser- vice business. S conducts an energy assessment and determines that it could significantly reduce its energy costs by adding insulation to its building. S pays an insulation contractor to apply a combination of loose-fill, spray foam, and blanket insulation throughout S’s building structure, including within the attic, walls, and crawl spaces. S reasonably ex- pects the new insulation to make the building more energy efficient because the contractor indicated that the new insulation would reduce its annual energy and power costs by approximately 50 percent of its annual costs during the last five years. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a building if the amount is paid for a betterment to the building structure or any October 21, 20133822013–43 I.R.B. building system. Therefore, under paragraphs (d)(1) and (j) of this section, S must capitalize as a better- ment the amount paid to add the insulation because the insulation is reasonably expected to materially increase the efficiency of the building structure under paragraph (j)(1)(iii) of this section. Example 22.Material addition; building.Towns and operates a restaurant, which provides a variety of prepared foods to its customers. To better accom- modate its customers and increase customer traffic, T decides to add a drive-through service area. As a result, T pays amounts to partition an area within its restaurant for a drive-through service counter, to construct a service window with necessary security features, to build an overhang for vehicles, and to construct a drive-up menu board. Assume that the drive-up menu board is section 1245 property that is a separate unit of property under paragraph (e)(3) of this section. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a build- ing unit of property if the amount is paid for a better- ment to the building structure or any building system. The amounts paid for the partition, service window and overhang are betterments to the building struc- ture because they comprise a material addition (that is, a physical expansion, extension, and addition of a major component) to the building structure under paragraph (j)(1)(ii) of this section. Accordingly, T must capitalize as an improvement the amounts paid to add the partition, drive-through window, and over- hang under paragraphs (d)(1) and (j) of this section. T is also required to capitalize the amounts paid to acquire and install each section 1245 property in ac- cordance with §1.263(a)–2(d)(1). Example 23.Costs incurred during betterment.U owns a building that it uses in its service business. To accommodate new employees and equipment, U pays amounts to increase the load capacity of its electrical system by adding a second electrical panel with addi- tional circuits and adding wiring and outlets through- out the electrical system of its building. To com- plete the upgrades to the electrical system, the con- tractor makes several holes in walls. As a result, U also incurs costs to patch the holes and repaint sev- eral walls. Under paragraphs (e)(2)(ii) and (j)(2)(ii) of this section, an amount is paid to improve a build- ing unit of property if the amount is paid for a better- ment to the building structure or any building system. The amounts paid to upgrade the panel and wiring are for betterments to U’s electrical system because they increase the capacity of the electrical system un- der paragraph (j)(1)(ii) of this section and increase the strength and output ofthe electrical system un- der paragraph (j)(1)(iii) of this section. Accordingly, U is required to capitalize the costs of the upgrade to the electrical system as an improvement to the build- ing unit of property under paragraphs (d)(1) and (j) of this section. Moreover, under paragraph (g)(1) of this section, U is required to capitalize the amounts paid to patch holes and repaint several walls in its building because these costs directly benefit and are incurred by reason of the improvement to U’s building unit of property. (k)Capitalization of restorations—(1) In general. A taxpayer must capitalize as an improvement an amount paid to restore a unit of property, including an amount paid to make good the exhaustion for which an allowance is or has been made. An amount restores a unit of property only if it— (i) Is for the replacement of a compo- nent of a unit of property for which the tax- payer has properly deducted a loss for that component, other thana casualty loss un- der §1.165–7; (ii) Is for the replacement of a compo- nent of a unit of property for which the tax- payer has properly taken into account the adjusted basis of the component in realiz- ing gain or loss resulting from the sale or exchange of the component; (iii) Is for the restoration of damage to a unit of property for which the taxpayer is required to take a basis adjustment as a result of a casualty loss under section 165, or relating to a casualty event described in section 165, subject to the limitation in paragraph (k)(4) of this section; (iv) Returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use; (v) Results in the rebuilding of the unit of property to a like-new condition after the end of its class life as defined in para- graph (i)(4) of this section (see paragraph (k)(5) of this section); or (vi) Is for the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of a unit of property (see paragraph (k)(6) of this section). (2)Application of restorations to buildings. An amount is paid to im- proveabuildingifitispaidtorestore (as defined under paragraph (k)(1) of this section) a property specified under paragraph (e)(2)(ii) (building), paragraph (e)(2)(iii)(B) (condominium), paragraph (e)(2)(iv)(B) (cooperative), or paragraph (e)(2)(v)(B) (leased building or portion of building) of this section. For example, an amount is paid to improve a building if it is paid for the replacement of a part or combination of parts that comprise a major component or substantial structural part of the building structure or any one of its building systems (for example, the HVAC system). See paragraph (k)(6) of this section. (3)Exception for losses based on sal- vage value. A taxpayer is not required to treat as a restoration amounts paid under paragraph (k)(1)(i) or paragraph (k)(1)(ii) of this section if the unit of property has been fully depreciated and the loss is at- tributable only to remaining salvage value as computed for federal income tax pur- poses. (4)Restoration of damage from casu- alty—(i)Limitation. For purposes of para- graph (k)(1)(iii) of this section, the amount paid for restoration of damage to the unit of property that mustbe capitalized under this paragraph (k) is limited to the excess (ifany)of— (A) The amount prescribed by §1.1011–1 as the adjusted basis of the single, identifiable property (under §1.167–7(b)(2)(i)) for determining the loss allowable on account of the casualty, over (B) The amount paid for restoration of damage to the unit of property under paragraph (k)(1)(iii) of this section that also constitutes an improvement under any other provision of paragraph (k)(1) of this section. (ii)Amounts in excess of limitation.The amounts paid for restoration of damage to a unit of property as described in para- graph (k)(1)(iii) of this section, but that ex- ceed the limitation provided in paragraph (k)(4)(i) of this section, must be treated in accordance with the provisions of the In- ternal Revenue Code and regulations that are otherwise applicable. See, for exam- ple, §1.162–4 (repairs and maintenance); §1.263(a)–2 (costs to acquire and produce units of property); and §1.263(a)–3 (costs to improve units of property). (5)Rebuild to like-new condition.For purposes of paragraph (k)(1)(v) of this section, a unit of property is rebuilt to a like-new condition if it is brought to the status of new, rebuilt, remanufactured, or a similar status under the terms of any fed- eral regulatory guideline or the manufac- turer’s original specifications. Generally, a comprehensive maintenance program, even though substantial, does not return a unit of property to a like-new condition. (6)Replacement of a major component or a substantial structural part—(i)In general. To determine whether an amount is for the replacement of a part or a com- bination of parts that comprise a major component or a substantial structural part of the unit of property under paragraph (k)(1)(vi) of this section, it is appropriate to consider all the facts and circumstances. These facts and circumstances include the quantitative and qualitative significance of 2013–43 I.R.B.383October 21, 2013 the part or combination of parts in relation to the unit of property. (A)Major component.Amajorcom- ponent is a part or combination of parts that performs a discrete and critical func- tion in the operation of the unit of prop- erty. An incidental component of the unit of property, even though such component performs a discrete and critical function in the operation of the unit of property, gen- erally will not, by itself, constitute a major component. (B)Substantial structural part.Asub- stantial structural part is a part or combina- tion of parts that comprises a large portion of the physical structure of the unit of prop- erty. (ii)Major components and substantial structural parts of buildings. In the case of a building, an amount is for the replace- ment of a major component or a substantial structural part of the building unit of prop- erty if— (A) The replacement includes a part or combination of parts that comprise a major component (as defined in para- graph(k)(6)(i)(A)ofthissection),ora significant portion of a major component, of any of the properties designated in paragraph (e)(2)(ii) (building), paragraph (e)(2)(iii)(B) (condominium), paragraph (e)(2)(iv)(B) (cooperative), or paragraph (e)(2)(v)(B) (leased building or leased portion of a building) of this section; or (B) The replacement includes a part or combination of parts that comprises a large portion of the physical structure of any of the properties designated in paragraph (e)(2)(ii) (building), paragraph (e)(2)(iii)(B) (condominium), paragraph (e)(2)(iv)(B) (cooperative), or paragraph (e)(2)(v)(B) (leased building or portion of building) of this section. (7)Examples. The following examples illustrate the application of this paragraph (k) only and do not address whether capi- talization is required under another provi- sion of this section or another provision of the Code (for example, section 263A). Un- less otherwise stated, assume that the tax- payer has not properly deducted a loss for, nor taken into account the adjusted basis on a sale or exchange of, any unit of prop- erty, asset, or component of a unit of prop- erty that is replaced. Example 1.Replacement of loss component.A owns a manufacturing building containing various types of manufacturing equipment. A does a cost segregation study of the manufacturing building and properly determines that a walk-in freezer in the man- ufacturing building is section 1245 property as de- fined in section 1245(a)(3). The freezer is not part of the building structure or the HVAC system under paragraph (e)(2)(i) or (e)(2)(ii)(B)( 1) of this section. Several components of the walk-in freezer cease to function, and A decides to replace them. A abandons the old freezer components and properly recognizes a loss from the abandonment of the components. A replaces the abandoned freezer components with new components and incurs costs to acquire and install the new components. Under paragraph (k)(1)(i) of this section, A must capitalize the amounts paid to ac- quire and install the new freezer components because A replaced components for which it had properly de- ducted a loss. Example 2.Replacement of sold component.As- sume the same facts as in Example 1, except that A did not abandon the components but instead sold them to another party and properly recognized a loss on the sale. Under paragraph (k)(1)(ii) of this sec- tion, A must capitalize the amounts paid to acquire and install the new freezer components because A re- placed components for which it had properly taken into account the adjusted basis of the components in realizing a loss from the sale of the components. Example 3.Restoration after casualty loss.B owns an office building that it uses in its trade or busi- ness. A storm damages the office building at a time when the building has an adjusted basis of $500,000. B deducts under section 165 a casualty loss in the amount of $50,000, and properly reduces its basis in the office building to $450,000. B hires a contractor to repair the damage to the building, including the re- pair of the building roof and the removal of debris from the building premises. B pays the contractor $50,000 for the work. Under paragraph (k)(1)(iii) of this section, B must treat the $50,000 amount paid to the contractor as a restoration of the building structure because B properly adjusted its basis in that amount as a result of a casualty loss under section 165, and the amount does not exceed the limit in paragraph (k)(4) of this section. Therefore, B must treat the amount paid as an improvement to the building unit of prop- erty and, under paragraph (d)(2) of this section, must capitalize the amount paid. Example 4.Restoration after casualty event.As- sume the same facts as in Example 3,exceptthatB receives insurance proceeds of $50,000 after the ca- sualty to compensate for its loss. B cannot deduct a casualty loss under section 165 because its loss was compensated by insurance. However, B properly re- duces its basis in the property by the amount of the in- surance proceeds. Under paragraph (k)(1)(iii) of this section, B must treat the $50,000 amount paid to the contractor as a restoration of the building structure because B has properly taken a basis adjustment re- lating to a casualty event described in section 165, and the amount does not exceed the limit in para- graph (k)(4) of this section. Therefore, B must treat the amount paid as an improvement to the building unit of property and, under paragraph (d)(2) of this section, must capitalize the amount paid. Example 5.Restoration after casualty loss; lim- itation . (i) C owns a building that it uses in its trade or business. A storm damages the building at a time when the building has an adjusted basis of $500,000. C determines that the cost of restoring its property is $750,000, deducts a casualty loss under section 165 in the amount of $500,000, and properly reduces its basis in the building to $0. C hires a contractor to repair the damage to the building and pays the con- tractor $750,000 for the work. The work involves re- placing the entire roof structure of the building at a cost of $350,000 and pumping water from the build- ing, cleaning debris from the interior and exterior, and replacing areas of damaged dry wall and flooring at a cost of $400,000. Although resulting from the casu- alty event, the pumping, cleaning, and replacing dam- aged drywall and flooring, does not directly benefit and is not incurred by reason of the roof replacement. (ii) Under paragraph (k)(1)(vi) of this section, C must capitalize as an improvement the $350,000 amount paid to the contractor to replace the roof structure because the roof structure constitutes a major component and a substantial structural part of the building unit of property. In addition, under paragraphs (k)(1)(iii) and (k)(4)(i), C must treat as a restoration the remaining costs, limited to the excess of the adjusted basis of the building over the amounts paid for the improvement under paragraph (k)(1)(vi). Accordingly, C must treat as a restoration $150,000 ($500,000 - $350,000) of the $400,000 paid for the portion of the costs related to repairing and cleaning the building structure under paragraph (k)(1)(iii) of this section. Thus, in addition to the $350,000 to replace the roof structure, C must also capitalize the $150,000 as an improvement to the building unit of property under paragraph (d)(2) of this section. C is not required to capitalize the remaining $250,000 repair and cleaning costs under paragraph (k)(1)(iii) of this section. Example 6.Restoration of property in a state of disrepair . D owns and operates a farm with several barns and outbuildings. D did not use or maintain one of the outbuildings on a regular basis, and the out- building fell into a state of disrepair. The outbuild- ing previously was used for storage but can no longer be used for that purpose because the building is not structurally sound. D decides to restore the outbuild- ing and pays an amount to shore up the walls and replace the siding. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount is paid to restore the build- ing structure or any building system. The walls and siding are part of the building structure under para- graph (e)(2)(ii)(A) of this section. Under paragraph (k)(1)(iv) of this section, D must treat the amount paid to shore up the walls and replace the siding as a restoration of the building structure because the amounts return the building structure to its ordinarily efficient operating condition after it had deteriorated to a state of disrepair and was no longer functional for its intended use. Therefore, D must treat the amount paid to shore up the walls and replace the siding as an improvement to the building unit of property and, under paragraph (d)(2) of this section, must capitalize the amount paid. Example 7.Rebuild of property to like-new con- dition before end of class life . E is a Class I rail- road that owns a fleet of freight cars. Assume the freight cars have a recovery period of 7 years un- dersection168(c)andaclasslifeof14years. Ev- ery 8 to 10 years, E rebuilds its freight cars. Ten years after E places the freight car in service, E per- forms a rebuild to the manufacturer’s original speci- fication, which includes a complete disassembly, in- October 21, 20133842013–43 I.R.B. spection, and reconditioning or replacement of com- ponents of the suspension and draft systems, trailer hitches, and other specialequipment. E also modi- fies the car to upgrade various components to the lat- est engineering standards. The freight car is stripped to the frame, with all of its substantial components either reconditioned or replaced. The frame itself is the longest-lasting part of the car and is recondi- tioned. The walls of the freight car are replaced or are sandblasted and repainted. New wheels are in- stalled on the car. All the remaining components of the car are restored before they are reassembled. At the end of the rebuild, the freight car has been restored to like-new condition under the manufacturer’s spec- ifications. Assume the freight car is the unit of prop- erty. E is not required to treat as an improvement and capitalize the amounts paid to rebuild the freight car under paragraph (k)(1)(v) of this section because, although the amounts paid restore the freight car to like-new condition, the amounts were not paid after the end of the class life of the freight car. However, see paragraphs (k)(1)(vi) and (k)(6) of this section to determine whether any amounts must be capitalized because they are paid for the replacement of a major component or a substantial structural part of the unit of property. Example 8.Rebuild of property to like-new con- dition after end of class life . Assume the same facts as in Example 7, except that E rebuilds the freight car 15 years after E places it in service. Under para- graph (k)(1)(v) of this section, E must treat as an im- provement and capitalize the amounts paid to rebuild the freight car because the amounts paid restore the freight car to like-new condition after the end of the class life of the freight car. Example 9.Not a rebuild to a like-new condi- tion . F is a commercial airline engaged in the busi- ness of transporting freight and passengers. To con- duct its business, F owns several aircraft. As a con- dition of maintaining its airworthiness certificates, F is required by the FAA to establish and adhere to a continuous maintenance program for each aircraft in its fleet. F performs heavy maintenance on its air- frames every 8 to 10 years. In Year 1, F purchased an aircraft for $15 million. In Year 16, F paid $2 mil- lion for the labor and materials necessary to perform the second heavy maintenance visit on the airframe of an aircraft. To perform the heavy maintenance visit, F extensively disassembles the airframe, remov- ing items such as engines, landing gear, cabin and passenger compartment seats, side and ceiling pan- els, baggage stowage bins, galleys, lavatories, floor boards, cargo loading systems, and flight control sur- faces. As specified by F’s maintenance manual for the aircraft, F then performs certain tasks on the dis- assembled airframe for the purpose of preventing de- terioration of the inherent safety and reliability lev- els of the airframe. These tasks include lubrication and service, operational and visual checks, inspection and functional checks, reconditioning of minor parts and components, and removal, discard, and replace- ment of certain life-limited single cell parts, such as cartridges, canisters, cylinders, and disks. Recondi- tioning of parts includes burnishing corrosion, repair- ing cracks, dents, gouges, punctures, tightening or replacing loose or missing fasteners, replacing dam- aged seals, gaskets, or valves, and similar activities. In addition to the tasks described above, to comply with certain FAA airworthiness directives, F inspects specific skin locations, applies doublers over small areas where cracks were found, adds structural rein- forcements, and replaces skin panels on a small sec- tion of the fuselage. However, the heavy maintenance does not include the replacement of any major com- ponents or substantial structural parts of the aircraft with new components. In addition, the heavy main- tenance visit does not bring the aircraft to the status of new, rebuilt, remanufactured, or a similar status under FAA guidelines or the manufacturer’s original spec- ifications. After the heavy maintenance, the aircraft was reassembled. Assume the aircraft, including the engines, is a unit of property and has a class life of 12 years under section 168(c). Although the heavy maintenance is performed after the end of the class life of the aircraft, F is not required to treat the heavy maintenance as a restoration and improvement of the unit of property under paragraph (k)(1)(v) of this sec- tion because, although extensive, the amounts paid do not restore the aircraft to like-new condition. See also paragraph (i)(1)(iii) of this section for the application of the safe harbor for routine maintenance. Example 10.Replacement of major component or substantial structural part; personal property .Gisa common carrier that owns a fleet of petroleum haul- ing trucks. G pays amounts to replace the existing engine, cab, and petroleum tank with a new engine, cab, and tank. Assume the tractor of the truck (which includes the cab and the engine) is a single unit of property and that the trailer (which contains the pe- troleum tank) is a separate unit of property. The new engine and the cab each constitute a part or combi- nation of parts that comprise a major component of G’s tractor, because they perform a discrete and crit- ical function in the operation of the tractor. In ad- dition, the cab constitutes a part or combination of parts that comprise a substantial structural part of G’s tractor. Therefore, the amounts paid for the replace- ment of the engine and the cab must be capitalized under paragraph (k)(1)(vi) of this section. Moreover, the new petroleum tank constitutes a part or combina- tion of parts that comprise a major component and a substantial structural part of the trailer. Accordingly, the amounts paid for the replacement of the tank also must be capitalized under paragraph (k)(1)(vi) of this section. Example 11.Repair performed during restora- tion . Assume the same facts as inExample 10, except that, at the same time the engine and cab of the tractor are replaced, G pays amounts to paint the cab of the tractor with its company logo and to fix a broken tail- light on the tractor. The repair of the broken taillight and the painting of the cab generally are deductible expenses under §1.162–4. However, under paragraph (g)(1)(i) of this section, a taxpayer must capitalize all the direct costs of an improvement and all the indirect costs that directly benefit or are incurred by reason of an improvement. Repairs and maintenance that do not directly benefit or are not incurred by reason of an improvement are not required to be capitalized under section 263(a), regardless of whether they are made at the same time as an improvement. For the amounts paid to paint the logo on the cab, G’s need to paint the logo arose from the replacement of the cab with a new cab. Therefore, under paragraph (g)(1)(i) of this sec- tion, G must capitalize the amounts paid to paint the cab as part of the improvement to the tractor because these amounts directly benefit and are incurred by reason of the restoration of the tractor. The amounts paid to repair the broken taillight are not for the re- placement of a major component, do not directly ben- efit, and are not incurred by reason of the replacement of the cab or the engine under paragraph (g)(1)(i) of this section, even thoughthe repair was performed at the same time as these replacements. Thus, G is not required to capitalize the amounts paid to repair the broken taillight. Example 12.Related amounts to replace major component or substantial structural part; personal property . (i) H owns a retail gasoline station, consist- ing of a paved area used for automobile access to the pumps and parking areas, a building used to market gasoline, and a canopy covering the gasoline pumps. The premises also consist of underground storage tanks (USTs) that are connected by piping to the pumps and are part of the gasoline pumping system used in the immediate retail sale of gas. The USTs are components of the gasoline pumping system. To comply with regulations issued by the Environmen- tal Protection Agency, H is required to remove and replace leaking USTs. In Year 1, H hires a contrac- tor to perform the removal and replacement, which consists of removing the old tanks and installing new tanks with leak detection systems. The removal of the old tanks includes removing the paving material covering the tanks, excavating a hole large enough to gain access to the old tanks, disconnecting any strapping and pipe connections to the old tanks, and lifting the old tanks out of the hole. Installation of the new tanks includes placement of a liner in the excavated hole, placement of the new tanks, instal- lation of a leak detection system, installation of an overfill system, connection of the tanks to the pipes leading to the pumps, backfilling of the hole, and replacement of the paving. H also is required to pay a permit fee to the county to undertake the installation of the new tanks. (ii) H pays the permit fee to the county on October 15, Year 1. On December 15, Year 1, the contractor completes the removal of the old USTs and bills H for the costs of removal. On January 15, Year 2, the contractor completes the installation of the new USTs and bills H for the remainder of the work. Assume that H computes its taxes on a calendar year basis and H’s gasoline pumping system is the unit of prop- erty. Under paragraph (k)(1)(vi) of this section, H must capitalize the amounts paid to replace the USTs as a restoration to the gasoline pumping system be- cause the USTs are parts or combinations of parts that comprise a major component and substantial struc- tural part of the gasoline pumping system. Moreover, under paragraph (g)(2) of this section, H must capi- talize the costs of removing the old USTs because H has not taken a loss on the disposition of the USTs, and the amounts to remove the USTs directly benefit and are incurred by reasonof the restoration of, and improvement to, the gasoline pumping system. In ad- dition, under paragraph (g)(1) of this section, H must capitalize the permit fees because they directly ben- efit and are incurred by reason of the improvement to the gasoline pumping system. Finally, under para- graph (g)(3) of this section, H must capitalize the re- lated amounts paid to improve the gasoline pumping system, including the permit fees, the amount paid to remove the old USTs, and the amount paid to install the new USTs, even though the amounts were sepa- rately invoiced, paid to different parties, and incurred in different tax years. 2013–43 I.R.B.385October 21, 2013 Example 13.Not replacement of major compo- nent; incidental . J owns a machine shop in which it makes dies used by manufacturers. In Year 1, J pur- chased a drill press for use in its production process. In Year 3, J discovers that the power switch assem- bly, which controls the supply of electric power to the drill press, has become damaged and cannot op- erate. To correct this problem, J pays amounts to replace the power switch assembly with comparable and commercially available replacement parts. As- sume that the drill press is a unit of property under paragraph (e) of this section and the power switch as- sembly is a small component of the drill press that may be removed and installed with relative ease. The power switch assembly is not a major component of the unit of property under paragraph (k)(6)(i)(A) of this section because, although the power assembly may affect the function of J’s drill press by control- ling the supply of electric power, the power assembly is an incidental component of the drill press. In addi- tion, the power assembly is not a substantial structural part of J’s drill press under paragraph (k)(6)(i)(B) of this section. Therefore, J is not required to capitalize the costs to replace the power switch assembly under paragraph (k)(1)(vi) of this section. Example 14.Replacement of major component or substantial structural part; roof . K owns a man- ufacturing building. K discovers several leaks in the roof of the building and hires a contractor to inspect and fix the roof. The contractor discovers that a ma- jorportionofthedeckinghasrottedandrecommends the replacement of the entire roof. K pays the con- tractor to replace the entire roof, including the deck- ing, insulation, asphalt, and various coatings. Un- der paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount is paid to restore the building structure or any building system. The roof is part of the building structure as defined under paragraph (e)(2)(ii)(A) of this section. Because the entire roof performs a discrete and criti- cal function in the building structure, the roof com- prises a major component of the building structure under paragraph (k)(6)(ii)(A) of this section. In addi- tion, because the roof comprises a large portion of the physical structure of the building structure, the roof comprises a substantial structural part of the build- ing structure under paragraph (k)(6)(ii)(B) of this sec- tion. Therefore, under either analysis, K must treat the amount paid to replace the roof as a restoration of thebuildingunderparagraphs(k)(1)(vi)and(k)(2)of this section and must capitalize the amount paid as an improvement under paragraph (d)(2) of this section. Example 15.Not replacement of major compo- nent or substantial structural part; roof membrane . L owns a building in which it conducts its retail busi- ness. The roof decking over L’s building is covered with a waterproof rubber membrane. Over time, the rubber membrane begins to wear, and L begins to ex- perience leaks into its retail premises. However, the building is still functioning in L’s business. To elim- inate the problems, a contractor recommends that L replace the membrane on the roof with a new rub- ber membrane. Accordingly, L pays the contractor to strip the original membrane and replace it with a new rubber membrane. The new membrane is compara- ble to the original membrane but corrects the leakage problems. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a build- ing if the amount is paid to restore the building struc- ture or any building system. The roof, including the membrane, is part of the building structure as defined under paragraph (e)(2)(ii)(A) of this section. Be- cause the entire roof performs a discrete and critical function in the building structure, the roof comprises a major component of the building structure under paragraph (k)(6)(ii)(A) of this section. Although the replacement membrane may aid in the function of the building structure, it does not, by itself, comprise a significant portion of the roof major component un- der paragraph (k)(6)(ii)(A) of this section. In addi- tion, the replacement membrane does not comprise a substantial structural part of L’s building structure un- der paragraph (k)(6)(ii)(B) of this section. Therefore, L is not required to capitalize the amount paid to re- place the membrane as a restoration of the building under paragraph (k)(1)(vi) of this section. Example 16. Not a replacement of major com- ponent or substantial structural part ;HVAC system. M owns a building in which it operates an office that provides medical services. The building con- tains one HVAC system, which is comprised of three furnaces, three air conditioning units, and duct work that runs throughout the building to distribute the hot or cold air throughout the building. One furnace in M’s building breaks down, and M pays an amount to replace it with a new furnace. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount is paid to restore the building structure or any building system. The HVAC system, including the furnaces, is a building system under paragraph (e)(2)(ii)(B)( 1)ofthissec- tion. As the parts that provide the heating function in the system, the three furnaces, together, perform a discrete and critical function in the operation of the HVAC system and are therefore a major component of the HVAC system under paragraph (k)(6)(i)(A) of this section. However, the single furnace is not a sig- nificant portion of this major component of the HVAC system under paragraph (k)(6)(ii)(A) of this section, or a substantial structural part of the HVAC system under paragraph (k)(6)(ii)(B) of this section. There- fore, M is not required to treat the amount paid to re- place the furnace as a restoration of the building under paragraph (k)(1)(vi) of this section. Example 17.Replacement of major component or substantial structural part; HVAC system . N owns a large office building in which it provides consulting services. The building contains one HVAC system, which is comprised of one chiller unit, one boiler, pumps, duct work, diffusers, air handlers, outside air intake, and a cooling tower. The chiller unit includes the compressor, evaporator, condenser, and expan- sion valve, and it functions to cool the water used to generate air conditioning throughout the building. N pays an amount to replace the chiller with a compa- rable unit. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount is paid to restore the building structure or any building system. The HVAC system, includ- ing the chiller unit, is a building system under para- graph (e)(2)(ii)(B)( 1) of this section. The chiller unit performs a discrete and critical function in the opera- tion of the HVAC system because it provides the cool- ing mechanism for the entire system. Therefore, the chiller unit is a major component of the HVAC sys- tem under paragraph (k)(6)(ii)(A) of this section. Be- cause the chiller unit comprises a major component of a building system, N must treat the amount paid to replace the chiller unit as a restoration to the building under paragraphs (k)(1)(vi) and (k)(2) of this section and must capitalize the amount paid as an improve- ment to the building under paragraph (d)(2) of this section. Example 18.Not replacement of major compo- nent or substantial structural part; HVAC system .O owns an office building that it uses to provide ser- vices to customers. The building contains a HVAC system that incorporates ten roof-mounted units that provide heating and air conditioning for the building. The HVAC system also consists of controls for the en- tire system and duct work that distributes the heated or cooled air to the various spaces in the building’s interior. O begins to experience climate control prob- lems in various offices throughout the office building and consults with a contractor to determine the cause. The contractor recommends that O replace three of the roof-mounted heating and cooling units. O pays an amount to replace the three specified units. No work is performed on the other roof-mounted heating and cooling units, the duct work, or the controls. Un- der paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount re- stores the building structure or any building system. The HVAC system, including the 10 roof-mounted heating and cooling units, is a building system un- der paragraph (e)(2)(ii)(B)( 1) of this section. As the components that generate the heat and the air con- ditioning in the HVAC system, the 10 roof-mounted units, together, perform a discrete and critical func- tionintheoperationoftheHVACsystemand,there- fore, are a major component of the HVAC system un- der paragraph (k)(6)(ii)(A) of this section. The three roof-mounted heating and cooling units are not a sig- nificant portion of a major component of the HVAC system under (k)(6)(ii)(A) of this section, or a sub- stantial structural part of the HVAC system, under paragraph (k)(6)(ii)(B) of this section. Accordingly, O is not required to treat the amount paid to replace the three roof-mounted heating and cooling units as a restoration of the building under paragraph (k)(1)(iv) of this section. Example 19.Replacement of major component or substantial structural part; fire protection system .P owns a building that it uses to operate its business. P pays an amount to replace the sprinkler system in the building with a new sprinkler system. Under para- graphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The fire protection and alarm system, including the sprin- kler system, is a building system under paragraph (e)(2)(ii)(B)( 6) of this section. As the component that provides the fire suppression mechanism in the sys- tem, the sprinkler system performs a discrete and crit- ical function in the operation of the fire protection and alarm system and is therefore a major compo- nent of the system under paragraph (k)(6)(ii)(A) of this section. Because the sprinkler system comprises a major component of a building system, P must treat the amount paid to replace the sprinkler system as restoration to the building unit of property under para- graphs (k)(1)(vi) and (k)(2) of this section and must capitalize the amount paid as an improvement to the building under paragraph (d)(2) of this section. Example 20.Replacement of major component or substantial structural part ;electrical system.Q owns a building that it uses to operate its business. Q October 21, 20133862013–43 I.R.B. pays an amount to replace the wiring throughout the building with new wiring that meets building code re- quirements. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a build- ing if the amount restores the building structure or any building system. The electrical system, includ- ing the wiring, is a building system under paragraph (e)(2)(ii)(B)( 3) of this section. As the component that distributes the electricity throughout the system, the wiring performs a discrete and critical function in the operation of the electrical system under para- graph (k)(6)(ii)(A) of this section. The wiring also comprises a large portion of the physical structure of the electrical system under paragraph (k)(6)(ii)(B) of this section. Because the wiring comprises a major component and a substantial structural part of a build- ing system, Q must treat the amount paid to replace the wiring as a restoration to the building under para- graphs (k)(1)(vi) and (k)(2) of this section and must capitalize the amount paid as an improvement to the building under paragraph (d)(2) of this section. Example 21.Not a replacement of major com- ponent or substantial structural part; electrical sys- tem . R owns a building that it uses to operate its business. R pays an amount to replace 30 percent of the wiring throughout the building with new wiring that meets building code requirements. Under para- graphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The electrical system, including the wiring, is a building system under paragraph (e)(2)(ii)(B)( 3)ofthissec- tion. All the wiring in the building comprises a major component because it performs a discrete and criti- cal function in the operation of the electrical system. However, the portion of the wiring that was replaced is not a significant portion of the wiring major com- ponent under paragraph (k)(6)(ii)(A) of this section, nor does it comprise a substantial structural part of the electrical system under paragraph (k)(6)(ii)(B) of this section. Therefore, under paragraph (k)(6) of this section, the replacement of 30 percent of the wiring is not the replacement of a major component or sub- stantial structural part of the building, and R is not re- quired to treat the amount paid to replace 30 percent of the wiring as a restoration to the building under paragraph (k)(1)(iv) of this section. Example 22.Replacement of major component or substantial structural part ;plumbing system.S owns a building in which it conducts a retail busi- ness. The retail building has three floors. The re- tail building has men’s and women’s restrooms on two of the three floors. S decides to update the re- strooms by paying an amount to replace the plumb- ing fixtures in all of the restrooms, including all the toilets and sinks, with modern style plumbing fixtures of similar quality and function. S does not replace the pipes connecting the fixtures to the building’s plumb- ing system. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The plumbing system, including the plumbing fixtures, is a building system under para- graph (e)(2)(ii)(B)( 2) of this section. All the toilets together perform a discrete and critical function in the operation of the plumbing system, and all the sinks, together, also perform a discrete and critical function in the operation of the plumbing system. Therefore, under paragraph (k)(6)(ii)(A) of this section, all the toilets comprise a major component of the plumbing system, and all the sinks comprise a major component of the plumbing system. Accordingly, S must treat the amount paid to replace all of the toilets and all of the sinks as a restoration of the building under para- graphs (k)(1)(vi) and (k)(2) of this section and must capitalize the amount paid as an improvement to the building under paragraph (d)(2) of this section. Example 23.Not replacement of major compo- nent or substantial structural part; plumbing system . Assume the same facts as Example 22except that S does not update all the bathroom fixtures. Instead, Sonlypaysanamounttoreplace8ofthetotalof 20 sinks located in the various restrooms. The 8 re- placed sinks, by themselves, do not comprise a sig- nificant portion of a major component (the 20 sinks) of the plumbing system under paragraph (k)(6)(ii)(A) of this section nor do they comprise a large portion of the physical structure of the plumbing system under paragraph (k)(6)(ii)(B) of this section. Therefore, un- der paragraph (k)(6) of thissection, the replacement of the eight sinks does notconstitute the replacement of a major component or substantial structural part of the building, and S is not required to treat the amount paid to replace the eight sinks as a restoration of a building under paragraph (k)(1)(iv) of this section. Example 24.Replacement of major component or substantial structural part; plumbing system .(i)T owns and operates a hotel building. T decides that, to attract customers and to remain competitive, it needs to update the guest rooms in its facility. Accordingly, T pays amounts to replace the bathtubs, toilets, and sinks, and to repair, repaint, and retile the bathroom walls and floors, which is necessitated by the installa- tion of the new plumbing components. The replace- ment bathtubs, toilets, sinks, and tile are new and in a different style, but are similar in function and quality to the replaced items. T also pays amounts to replace certain section 1245 property, such as the guest room furniture, carpeting, drapes, table lamps, and parti- tion walls separating the bathroom area. T completes this work on two floors at a time, closing those floors and leaving the rest of the hotel open for business. In Year 1, T pays amounts to perform the updates for 4 of the 20 hotel room floors and expects to complete the renovation of the remaining rooms over the next two years. (ii) Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The plumbing system, including the bathtubs, toilets, and sinks, is a building system under paragraph (e)(2)(ii)(B)( 2)ofthissection. All the bathtubs, together, all the toilets, together, and all the sinks together in the hotel building perform discrete and critical functions in the operation of the plumbing system under paragraph (k)(6)(ii)(A) of this section and comprise a large portion of the physical structure of the plumbing system under para- graph (k)(6)(ii)(B) of this section. Therefore, under paragraph (k)(6)(ii) of this section, these plumbing components comprise major components and sub- stantial structural parts of the plumbing system, and T must treat the amount paid to replace these plumbing components as a restoration of, and improvement to, the building under paragraphs (k)(1)(vi) and (k)(2) of this section. In addition, under paragraph (g)(1)(i) of this section, T must treat the costs of repairing, repainting, and retiling the bathroom walls and floors as improvement costs because these costs directly benefit and are incurred by reason of the improve- ment to the building. Further, under paragraph (g)(3) of this section, T must treat the costs incurred in Years 1, 2, and 3 for the bathroom remodeling as improvement costs, even though they are incurred over a period of several taxable years, because they are related amounts paid to improve the building unit of property. Accordingly, under paragraph (d)(2) of this section, T must treat all the amounts it incurs to update its hotel restrooms as an improvement to the hotel building and capitalize these amounts. In addition, under §1.263(a)–2 of the regulations, T must capitalize the amounts paid to acquire and install each section 1245 property. Example 25.Not replacement of major compo- nent or substantial structural part; windows .Uowns a large office building that it uses to provide office space for employees that manage U’s operations. The building has 300 exterior windows that represent 25 percent of the total surface area of the building. In Year 1, U pays an amount to replace 100 of the ex- terior windows that had become damaged. At the time of these replacements, U has no plans to replace any other windows in the near future. Under para- graphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The exterior windows are part of the building structure as defined under paragraph (e)(2)(ii)(A) of this section. The 300 exterior windows perform a discrete and crit- ical function in the operation of the building structure and are, therefore, a major component of the building structure under paragraph (k)(6)(i)(A) of this section. However, the 100 windows do not comprise a signif- icant portion of this major component of the build- ing structure under paragraph (k)(6)(ii)(A) of this sec- tion or a substantial structural part of the building structure under paragraph (k)(6)(ii)(B) of this section. Therefore, under paragraph (k)(6) of this section, the replacement of the 100 windows does not constitute the replacement of a majorcomponent or substantial structural part of the building, and U is not required to treat the amount paid to replace the 100 windows as restoration of the building under paragraph (k)(1)(iv) of this section. Example 26.Replacement of major component; windows . Assume the same facts asExample 25, except that that U replaces 200 of the 300 windows on the building. The 300 exterior windows perform a discrete and critical function in the operation of the building structure and are, therefore, a major component of the building structure under paragraph (k)(6)(i)(A) of this section. The 200 windows com- prise a significant portion of this major component of the building structure under paragraph (k)(6)(ii)(A) of this section. Therefore, under paragraph (k)(6) of this section, the replacement of the 200 windows comprise the replacement of a major component of the building structure. Accordingly, U must treat the amount paid to replace the 200 windows as a restora- tion of the building under paragraphs (k)(1)(vi) and (k)(2) of this section and must capitalize the amount paid as an improvement to the building under para- graph (d)(2) of this section. Example 27.Replacement of substantial struc- tural part; windows . Assume the same facts asEx- ample 25, except that the building is a modern de- sign and the 300 windows represent 90 percent of the 2013–43 I.R.B.387October 21, 2013 total surface area of the building. U replaces 100 of the 300 windows on the building. The 300 ex- terior windows perform a discrete and critical func- tion in the operation of the building structure and are, therefore, a major component of the building struc- ture under paragraph (k)(6)(i)(A) of this section. The 100 windows do not comprise a significant portion of this major component of the building structure under paragraph (k)(6)(ii)(A) of this section, however, they do comprise a substantial structural part of the build- ing structure under paragraph (k)(6)(ii)(B) of this sec- tion. Therefore, under paragraph (k)(6) of this sec- tion, the replacement of the 100 windows comprise the replacement of a substantial structural part of the building structure. Accordingly, U must treat the amount paid to replace the 100 windows as a restora- tion of the building unit of property under paragraphs (k)(1)(vi) and (k)(2) of this section and must capital- ize the amount paid as an improvement to the building under paragraph (d)(2) of this section. Example 28.Not replacement of major compo- nent or substantial structural part; floors .Vowns and operates a hotel building. V decides to refresh the appearance of the hotel lobby by replacing the floors in the lobby. The hotel lobby comprises less than 10 percent of the square footage of the entire hotel build- ing. V pays an amount to replace the wood flooring in the lobby with new wood flooring of a similar qual- ity. V did not replace any other flooring in the build- ing. Assume that the wood flooring constitutes sec- tion 1250 property. Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The wood flooring is part of the building structure under paragraph (e)(2)(ii)(A) of this section. All the floors in the hotel building com- prise a major component of the building structure be- cause they perform a discrete and critical function in the operation of the building structure. However, the lobby floors are not a significant portion of a major component (that is, all the floors) under paragraph (k)(6)(ii)(A) of this section, nor do the lobby floors comprise a substantial structural part of the building structure under paragraph (k)(6)(ii)(B) of this section. Therefore, under paragraph (k)(6) of this section, the replacement of the lobby floors is not the replacement of a major component or substantial structural part of the building unit of property, and V is not required to treat the amount paid for the replacement of the lobby floors as a restoration to the building under paragraph (k)(1)(iv) of this section. Example 29.Replacement of major component or substantial structural part ;floors. Assume the same facts as Example 28, except that V decides to refresh the appearance of all the public areas of the hotel building by replacing all the floors in the pub- lic areas. To that end, V pays an amount to replace all the wood floors in all the public areas of the ho- tel building with new wood floors. The public areas include the lobby, the hallways, the meeting rooms, the ballrooms, and other public rooms throughout the hotel interiors. The public areas comprise approxi- mately 40 percent of the square footage of the entire hotel building. All the floors in the hotel building comprise a major component of the building struc- ture because they perform a discrete and critical func- tion in the operation of the building structure. The floors in all the public areas of the hotel comprise a significant portion of a major component (that is, all the building floors) of the building structure. There- fore, under paragraph (k)(6)(ii)(A) of this section, the replacement of all the public area floors constitutes the replacement of a major component of the build- ing structure. Accordingly, V must treat the amount paid to replace the public area floors as a restora- tion of the building unit of property under paragraphs (k)(1)(vi) and (k)(2) of this section and must capital- ize the amounts as an improvement to the building under paragraph (d)(2) of this section. Example 30.Replacement with no disposition.(i) X owns an office building with four elevators serv- ing all floors in the building. X replaces one of the elevators. The elevator is astructural component of the office building. X chooses to apply Prop. Reg. §1.168(i)–8 to taxable years beginning on or after January 1, 2012, and before the applicability date of the final regulations. In accordance with Prop. Reg. §1.168(i)–8(c)(4)(ii)(A) (September 19, 2013), the office building (including its structural components) is the asset for tax disposition purposes. X does not treat the structural components of the office build- ing as assets under Prop. Reg. §1.168(i)–8(c)(4)(iii) (September 19, 2013). X also does not make the par- tial disposition election provided under Prop. Reg. §1.168(i)–8(d)(2) (September 19, 2013), for the ele- vator. Thus, the retirement of the replaced elevator is not a disposition under section 168, and no loss is taken into account for purposes of paragraph (k)(1)(i) of this section. (ii) Under paragraphs (e)(2)(ii) and (k)(2) of this section, an amount is paid to improve a building if the amount restores the building structure or any building system. The elevator system, including all four elevators, is a building system under paragraph (e)(2)(ii)(B)( 5) of this section. The replacement elevator does not perform a discrete and critical function in the operation of elevator system under paragraph (k)(6)(ii)(A) of this section nor does it comprise a large portion of the physical structure of the elevator system under paragraph (k)(6)(ii)(B) of this section. Therefore, under paragraph (k)(6) of this section, the replacement elevator does not constitute the replacement of a major component or substantial structural part of the elevator system. Accordingly, X is not required to treat the amount paid to replace the elevator as a restoration to the building under either paragraph (k)(1)(i) or paragraph (k)(1)(vi) of this section. Example 31.Replacement with disposition.The facts are the same as in Example 30,exceptXmakes the partial disposition election provided under para- graph Prop. Reg. §1.168(i)–8(d)(2) (September 19, 2013), for the elevator. Although the office building (including its structural components) is the asset for disposition purposes, the result of X making the partial disposition election for the elevator is that the retirement of the replaced elevator is a disposition. Thus, depreciation for the retired elevator ceases at the time of its retirement (taking into account the applicable convention), and X recognizes a loss upon this retirement. Accordingly, X must treat the amount paid to replace the elevator as a restoration of the building under paragraphs (k)(1)(i) and (k)(2) of this section and must capitalize the amount paid as an im- provement to the building under paragraph (d)(2) of this section. In addition, the replacement elevator is treated as a separate asset for tax disposition purposes pursuant to Prop. Reg. §1.168(i)–8(c)(4)(ii)(D) (September 19, 2013), and for depreciation purposes pursuant to section 168(i)(6). (l)Capitalization of amounts to adapt property to a new or different use—(1)In general. A taxpayer must capitalize as an improvement an amount paid to adapt a unit of property to a new or different use. In general, an amount is paid to adapt a unit of property to a new or different use if the adaptation is not consistent with the tax- payer’s ordinary use of the unit of property at the time originally placed in service by the taxpayer. (2)Application of adaption rule to buildings. In the case of a building, an amount is paid to improve a building if it is paid to adapt to a new or dif- ferent use a property specified under paragraph (e)(2)(ii) (building), paragraph (e)(2)(iii)(B) (condominium), paragraph (e)(2)(iv)(B) (cooperative), or paragraph (e)(2)(v)(B) (leased building or leased portion of building) of this section. For example, an amount is paid to improve a building if it is paid to adapt the building structure or any one of its buildings sys- tems to a new or different use. (3)Examples. The following examples illustrate the application of this paragraph (l) only and do not address whether capital- ization is required under another provision of this section or under another provision of the Code (for example, section 263A). Unless otherwise stated, assume that the taxpayer has not properly deducted a loss for any unit of property, asset, or compo- nent of a unit of property that is removed and replaced. Example 1.New or different use; change in build- ing use . A is a manufacturer and owns a manufactur- ing building that it has used for manufacturing since Year 1, when A placed it in service. In Year 30, A pays an amount to convert its manufacturing building into a showroom for its business. To convert the fa- cility, A removes and replaces various structural com- ponents to provide a better layout for the showroom and its offices. A also repaints the building interi- ors as part of the conversion. When building ma- terials are removed and replaced, A uses compara- ble and commercially available replacement materi- als. Under paragraphs (l)(2) and (e)(2)(ii) of this sec- tion, an amount is paid to improve A’s manufactur- ing building if the amount adapts the building struc- ture or any designated building system to a new or different use. Under paragraph (l)(1) of this section, the amount paid to convert the manufacturing build- ing into a showroom adapts the building structure to a new or different use because the conversion to a showroom is not consistent with A’s ordinary use of the building structure at the time it was placed in ser- vice. Therefore, A must capitalize the amount paid to convert the building into a showroom as an improve- October 21, 20133882013–43 I.R.B. ment to the building under paragraphs (d)(3) and (l) of this section. Example 2.Not a new or different use; leased building. B owns and leases out space in a building consisting of twenty retail spaces. The space was de- signed to be reconfigured; that is, adjoining spaces could be combined into one space. One of the tenants expands its occupancy by leasing two adjoining retail spaces. To facilitate the new lease, B pays an amount to remove the walls between the three retail spaces. Assume that the walls between spaces are part of the building and its structural components. Under para- graphs (l)(2) and (e)(2)(ii) of this section, an amount is paid to improve B’s building if it adapts the build- ing structure or any of the building systems to a new or different use. Under paragraph (l)(1) of this sec- tion, the amount paid to convert three retail spaces into one larger space for an existing tenant does not adapt B’s building structure to a new or different use because the combination of retail spaces is consistent with B’s intended, ordinary use of the building struc- ture. Therefore, the amount paid by B to remove the walls does not improve the building under paragraph (l) of this section and is not required to be capitalized under paragraph (d)(3) of this section. Example 3.Not a new or different use; prepar- ing building for sale . C owns a building consisting of twenty retail spaces. C decides to sell the building. In anticipation of selling the building, C pays an amount to repaint the interior walls and to refinish the hard- wood floors. Under paragraphs (l)(2) and (e)(2)(ii) of this section, an amount is paid to improve C’s build- ing to a new or different use if it adapts the build- ing structure or any of the building systems to a new or different use. Preparing the building for sale does not constitute a new or different use for the build- ing structure under paragraph (l)(1) of this section. Therefore, the amount paid by C to prepare the build- ing structure for sale does not improve the building under paragraph (l) of this section and is not required to be capitalized under paragraph (d)(3) of this sec- tion. Example 4.New or different use; land.Downsa parcel of land on which it previously operated a man- ufacturing facility. Assume that the land is the unit of property. During the course of D’s operation of the manufacturing facility, the land became contami- nated with wastes from its manufacturing processes. D discontinues manufacturing operations at the site and decides to develop the property for residential housing. In anticipation of building residential prop- erty, D pays an amount to remediate the contamina- tion caused by D’s manufacturing process. In addi- tion, D pays an amount to regrade the land so that it can be used for residential purposes. Amounts that D pays to clean up wastes do not adapt the land to a new or different use, regardless of the extent to which the land was cleaned, because this cleanup merely returns the land to the condition it was in before the land was contaminated in D’s operations. Therefore, D is not required to capitalize the amount paid for the cleanup under paragraph (l)(1) of this section. However, the amount paid to regrade the land so that it can be used for residential purposes adapts the land to a new or different use that is inconsistent with D’s intended or- dinary use of the property at the time it was placed in service. Accordingly, the amounts paid to regrade the land must be capitalized as improvements to the land under paragraphs (d)(3) and (l) of this section. Example 5.New or different use; part of build- ing . (i) E owns a building in which it operates a re- tail drug store. The store consists of a pharmacy for filling medication prescriptions and various depart- ments where customers can purchase food, toiletries, home goods, school supplies, cards, over-the-counter medications, and other similar items. E decides to create a walk-in medical clinic where nurse practi- tioners and physicians’ assistants diagnose, treat, and write prescriptions for common illnesses and injuries, administer common vaccinations, conduct physicals and wellness screenings, and provide routine lab tests and services for common chronic conditions. To cre- ate the clinic, E pays amounts to reconfigure the phar- macy building. E incurs costs to build new walls creating an examination room, lab room, reception area, and waiting area. E installs additional plumb- ing, electrical wiring, and outlets to support the lab. E also acquires section 1245 property, such as comput- ers, furniture, and equipment necessary for the new clinic. E treats the amounts paid for those units of property as costs of acquiring new units of property under §1.263(a)–2. (ii) Under paragraphs (l)(2) and (e)(2)(ii) of this section, an amount is paid to improve E’s building if it adapts the building structure or any of the building systems to a new or different use. Under paragraph (l)(1) of this section, the amount paid to convert part of the retail drug store building structure into a med- ical clinic adapts the building structure to a new and different use, because the useof the building structure to provide clinical medical services is not consistent with E’s intended ordinary use of the building struc- ture at the time it was placed in service. Similarly, the amounts paid to add to the plumbing system and the electrical systems to support the new medical ser- vices is not consistent withE’s intended ordinary use of these systems when the systems were placed in ser- vice. Therefore, E must treat the amount paid for the conversion of the building structure, plumbing sys- tem, and electrical system as an improvement to the building and capitalize the amount under paragraphs (d)(3) and (l) of this section. Example 6.Not a new or different use; part of building. (i) F owns a building in which it operates a grocery store. The grocery store includes various departments for fresh produce, frozen foods, fresh meats, dairy products, toiletries, and over-the-counter medicines. The grocery store also includes separate counters for deli meats, prepared foods, and baked goods, often made to order. To better accommodate its customers’ shopping needs, F decides to add a sushi bar where customers can order freshly prepared sushi from the counter for take-home or to eat at the counter. To create the sushi bar, F pays amounts to add a sushi counter and chairs, add additional wiring and outlets to support the counter, and install addi- tional pipes and a sink, to provide for the safe han- dling of the food. F also pays amounts to replace flooring and wall coverings in the sushi bar area with decorative coverings to reflect more appropriate dé- cor. Assume the sushi counter and chairs are section 1245 property, and F treats the amounts paid for those units of property as costs of acquiring new units of property under §1.263(a)–2. (ii) Under paragraphs (l)(2) and (e)(2)(ii) of this section, an amount is paid to improve F’s building if it adapts the building structure or any of the building systems to a new or different use. Under paragraph (l)(1) of this section, the amount paid to convert a part of F’s retail grocery into a sushi bar area does not adapt F’s building structure, plumbing system, or electrical system to a new or different use, because the sale of sushi is consistent with F’s intended, ordi- nary use of the building structure and these systems in its grocery sales business, which includes selling food to its customers at various specialized counters. Accordingly, the amount paid by F to replace the wall and floor finishes, add wiring, and add plumbing to create the sushi bar space does not improve the build- ing unit of property under paragraph (l) of this section and is not required to be capitalized under paragraph (d)(3) of this section. Example 7.Not a new or different use; part of building . (i) G owns a hospital with various depart- ments dedicated to the provision of clinical medical care. To better accommodate its patients’ needs, G decides to modify the emergency room space to pro- vide both emergency care and outpatient surgery. To modify the space, G pays amounts to move interior walls, add additional wiring and outlets, replace floor tiles and doors, and repaint the walls. To complete the outpatient surgery center, G also pays amounts to in- stall miscellaneous medical equipment necessary for the provision of surgicalservices. Assume the med- ical equipment is section 1245 property, and G treats the amounts paid for those units of property as costs of acquiring new units of property under §1.263(a)–2. (ii) Under paragraphs (l)(2) and (e)(2)(ii) of this section, an amount is paid to improve G’s building if it adapts the building structure or any of the build- ing systems to a new or different use. Under para- graph (l)(1) of this section, the amount paid to con- vert part of G’s emergency room into an outpatient surgery center does not adapt G’s building structure or electrical system to a new or different use, because the provision of outpatient surgery is consistent with G’s intended, ordinary use of the building structure and these systems in its clinical medical care busi- ness. Accordingly, the amounts paid by G to relocate interior walls, add additional wiring and outlets, re- place floor tiles and doors, and repaint the walls to create outpatient surgery space do not improve the building under paragraph (l) of this section and are not required to be capitalized under paragraph (d)(3) of this section. (m)Optional regulatory accounting method—(1)In general. This para- graph (m) provides an optional simpli- fied method (the regulatory accounting method) for regulated taxpayers to de- termine whether amounts paid to repair, maintain, or improve tangible property are to be treated as deductible expenses or capital expenditures. A taxpayer that uses the regulatory accounting method de- scribed in paragraph (m)(3) of this section must use that method for property subject to regulatory accounting instead of deter- mining whether amounts paid to repair, maintain, or improve property are capi- tal expenditures or deductible expenses under the general principles of sections 162(a), 212, and 263(a). Thus, the capi- 2013–43 I.R.B.389October 21, 2013 talization rules in paragraph (d) (and the routine maintenancesafe harbor described in paragraph (i)) of this section do not apply to amounts paid to repair, maintain, or improve property subject to regula- tory accounting by taxpayers that use the regulatory accounting method under this paragraph (m). (2)Eligibility for regulatory account- ing method. A taxpayer that is engaged in a trade or business in a regulated in- dustry is a regulated taxpayer and may use the regulatory accounting method un- der this paragraph (m). For purposes of this paragraph (m), a taxpayer is in a reg- ulated industry only if the taxpayer is sub- ject to the regulatory accounting rules of the Federal Energy Regulatory Commis- sion (FERC), the Federal Communications Commission (FCC), or the Surface Trans- portation Board (STB). (3)Description of regulatory account- ing method. Under the regulatory ac- counting method, a taxpayer must follow the method of accounting for regulatory accounting purposes that it is required to follow for FERC, FCC, or STB (whichever is applicable) in determining whether an amount paid repairs, maintains, or im- proves property under this section. There- fore, a taxpayer must capitalize for Federal income tax purposes an amount paid that is capitalized as an improvement for reg- ulatory accounting purposes. A taxpayer may not capitalize for Federal income tax purposes under this section an amount paid that is not capitalized as an improve- ment for regulatory accounting purposes. A taxpayer that uses the regulatory ac- counting method must use that method for all of its tangible property that is subject to regulatory accounting rules. The method does not apply to tangible property that is not subject to regulatory accounting rules. The method also does not apply to property for the taxable years in which the taxpayer elected to apply the repair allowance under §1.167(a)–11(d)(2). The regulatory accounting method is a method of accounting under section 446(a). (4)Examples. The following examples illustrate the application of this paragraph (m): Example 1.Taxpayer subject to regulatory ac- counting rules of FERC . W is an electric utility com- pany that operates a power plant that generates elec- tricity and that owns and operates network assets to transmit and distribute the electricity to its customers. W is subject to the regulatory accounting rules of FERC, and W uses the regulatory accounting method under paragraph (m) of this section. W does not capi- talize on its books and records for regulatory account- ing purposes the cost of repairs and maintenance per- formed on its turbines or its network assets. Under the regulatory accounting method, W may not capi- talize for Federal income tax purposes amounts paid for repairs performed on its turbines or its network assets. Example 2.Taxpayer not subject to regulatory ac- counting rules of FERC . X is an electric utility com- pany that operates a power plant to generate electric- ity. X previously was subject to the regulatory ac- counting rules of FERC, but currently X is not re- quired to use FERC’s regulatory accounting rules. X cannot use the regulatoryaccountingmethodpro- vided in this paragraph (m). Example 3.Taxpayer subject to regulatory ac- counting rules of FCC . Y is a telecommunications company that is subject to the regulatory accounting rules of the FCC. Y uses the regulatory accounting method under this paragraph (m). Y’s assets include a telephone central office switching center, which contains numerous switches and various switching equipment. Y capitalizes on its books and records for regulatory accounting purposes the cost of replac- ing each switch. Under the regulatory accounting method, Y is required to capitalize for Federal in- come tax purposes amounts paid to replace each switch. Example 4.Taxpayer subject to regulatory ac- counting rules of STB . Z is a Class I railroad that is subject to the regulatory accounting rules of the STB. Z uses the regulatory accounting method un- der this paragraph (m). Z capitalizes on its books and records for regulatory accounting purposes the cost of locomotive rebuilds. Under the regulatory account- ing method, Z is required to capitalize for Federal in- come tax purposes amounts paid to rebuild its loco- motives. (n)Election to capitalize repair and maintenance costs—(1)In general.A taxpayer may elect to treat amounts paid during the taxable year for repair and maintenance (as defined under §1.162–4) to tangible property as amounts paid to improve that property under this section and as an asset subject to the allowance for depreciation if the taxpayer incurs these amounts in carrying on the taxpayer’s trade or business and if the taxpayer treats these amounts as capital expenditures on its books and records regularly used in computing income (“books and records”). A taxpayer that elects to apply this para- graph (n) in a taxable year must apply this paragraph to all amounts paid for re- pair and maintenance to tangible property that it treats as capital expenditures on its books and records in that taxable year. Any amounts for which this election is made shall not be treated as amounts paid for repair or maintenance under §1.162–4. (2)Time and manner of election.A taxpayer makes this election under this paragraph (n) by attaching a statement to the taxpayer’s timely filed original Federal tax return (including extensions) for the taxable year in which the taxpayer pays amounts described under paragraph (n)(1) of this paragraph. See §§301.9100–1 through 301.9100–3 of this chapter for the provisions governing extensions of time to make regulatory elections. The state- ment must be titled “Section 1.263(a)–3(n) Election” and include the taxpayer’s name, address, taxpayer identification number, and a statement that the taxpayer is making the election to capitalize repair and main- tenance costs under §1.263(a)–3(n). In the case of a consolidated group filing a con- solidated income tax return, the election is made for each member of the consoli- dated group by the common parent, and the statement must also include the names and taxpayer identification numbers of each member for which the election is made. In the case of an S corporation or a partnership, the election is made by the S corporation or partnership and not by the shareholders or partners. A taxpayer mak- ing this election for a taxable year must treat any amounts paid for repairs and maintenance during the taxable year that are capitalized on the taxpayer’s books and records as improvements to tangible property. The taxpayer must begin to de- preciate the cost of such improvements amounts when they are placed in service by the taxpayer under the applicable pro- visions of the Code and regulations. An election may not be made through the filing of an application for change in ac- counting method or, before obtaining the Commissioner’s consent to make a late election, by filing an amended Federal tax return. The time and manner of electing to capitalize repair and maintenance costs under this paragraph (n) may be modified through guidance of general applicability (see §§601.601(d)(2) and 601.602 of this chapter). (3)Exception. This paragraph (n) does not apply to amounts paid for repairs or maintenance of rotable or temporary spare parts to which the taxpayer applies the optional method of accounting for rotable and temporary spare parts under §1.162–3(e). October 21, 20133902013–43 I.R.B. (4)Examples. The following examples illustrate the application of this paragraph (n): Example 1.Election to capitalize routine main- tenance on non-rotable part .(i)Qisatowboatop- erator that owns a fleet of towboats that it uses in its trade or business. Each towboat is equipped with two diesel-powered engines. Assume that each tow- boat, including its engines, is the unit of property and that a towboat has a class life of 18 years. Assume the towboat engines are not rotable spare parts under §1.162–3(c)(2). In Year 1, Q acquired a new towboat, including its two engines, and placed the towboat into service. In Year 4, Q pays amounts to perform sched- uled maintenance on both engines in the towboat. As- sume that none of the exceptions set out in paragraph (i)(3) of this section apply to the scheduled mainte- nance costs and that the scheduled maintenance on Q’s towboat is within the routine maintenance safe harbor under paragraph (i)(1)(ii) of this section. Ac- cordingly, the amounts paid for the scheduled main- tenance to its towboat engines in Year 4 are deemed not to improve the towboat and are not required to be capitalized under paragraph (d) of this section. (ii) On its books and records, Q treats amounts paid for scheduled maintenance on its towboat en- gines as capital expenditures. For administrative con- venience, Q decides to account for these costs in the same way for Federal income tax purposes. Under paragraph (n) of this section, in Year 4, Q may elect to capitalize the amounts paid for the scheduled main- tenance on its towboat engines. If Q elects to capital- ize such amounts, Q must capitalize all amounts paid for repair and maintenance to tangible property that Q treats as capital expenditures on its books and records in Year 4. Example 2.No election to capitalize routine maintenance . Assume the same facts asExample 1 , except in Year 8, Q pays amounts to perform scheduled maintenance for a second time on the towboat engines. On its books and records, Q treats the amounts paid for this scheduled maintenance as capital expenditures. However, in Year 8, Q decides not to make the election to capitalize the amounts paid for scheduled maintenance under paragraph (n) of this section. Because Q does not make the election under paragraph (n) for Year 8, Q may apply the routine maintenance safe harbor under paragraph (i)(1)(ii) of this section to the amounts paid in Year 8, and not treat these amounts as capital expenditures. Because the election is made for each taxable year, there is no effect on the scheduled maintenance costs capitalized by Q on its Federal tax return for Year 4. Example 3.Election to capitalize replacement of building component . (i) R owns an office building that it uses to provide services to customers. The building contains a HVAC system that incorporates ten roof-mounted units that provide heating and air conditioning for different parts of the building. In Year 1, R pays an amount to replace 2 of the 10 units to address climate control problems in various offices throughout the office building. Assume that the re- placement of the two units does not constitute an im- provement to the HVAC system, and, accordingly, to the building unit of property under paragraph (d) of this section, and that R may deduct these amounts as repairs and maintenance under §1.162–4. (ii) On its books and records, R treats amounts paid for the two HVAC components as capital expen- ditures. R determines that it would prefer to account for these amounts in the same way for Federal in- come tax purposes. Under this paragraph (n), in Year 1, R may elect to capitalize the amounts paid for the new HVAC components. If R elects to capitalize such amounts, R must capitalize all amounts paid for repair and maintenance to tangible property that R treats as capital expenditures on its books and records in Year 1. (o)Treatment of capital expenditures. Amounts required to be capitalized un- der this section are capital expenditures and must be taken into account through a charge to capital account or basis, or in the case of property that is inventory in the hands of a taxpayer, through inclusion in inventory costs. (p)Recovery of capitalized amounts. Amounts that are capitalized under this section are recovered through deprecia- tion, cost of goods sold, or by an adjust- ment to basis at the time the property is placed in service, sold, used, or otherwise disposed of by the taxpayer. Cost recovery is determined by the applicable Code and regulation provisions relating to the use, sale, or disposition of property. (q)Accounting method changes.Ex- cept as otherwise provided in this section, a change to comply with this section is a change in method ofaccounting to which the provisions of sections 446 and 481 and the accompanying regulations apply. A taxpayer seeking to change to a method of accounting permitted in this section must secure the consent of the Commissioner in accordance with §1.446–1(e) and follow the administrative procedures issued under §1.446–1(e)(3)(ii) for obtaining the Com- missioner’s consent to change its account- ing method. (r)Effective/applicability date—(1)In general. Except for paragraphs (h), (m), and (n) of this section, this section ap- plies to taxable years beginning on or af- ter January 1, 2014. Paragraphs (h), (m), and(n)ofthissectionapplytoamounts paid in taxable years beginning on or af- ter January 1, 2014. Except as provided in paragraphs (r)(2) and (r)(3) of this section, §1.263(a)–3 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of this sec- tion—(i)In general. Except for para- graphs (h), (m), and (n) of this section, a taxpayer may choose to apply this section to taxable years beginning on or after Jan- uary 1, 2012. A taxpayer may choose to apply paragraphs (h), (m), and (n) of this section to amounts paid in taxable years beginning on or after January 1, 2012. (ii)Transition rule for certain elections on 2012 or 2013 returns.Ifunderpara- graph (r)(2)(i) of this section, a taxpayer chooses to make the election to apply the safe harbor for small taxpayers under para- graph (h) of this section or the election to capitalize repair and maintenance costs under paragraph (n) of this section for amounts paid in its taxable year beginning on or after January 1, 2012, and ending on or before September 19, 2013 (applicable taxable year), and the taxpayer did not make the election specified in paragraph (h)(6) or paragraph (n)(2) of this section on its timely filed original Federal tax return for the applicable taxable year, the taxpayer must make the election specified in paragraph (h)(6) or paragraph (n)(2) of this section for the applicable taxable year by filing an amended Federal tax return (including the required statements) for the applicable taxable year on or before 180 days from the due date including exten- sions of the taxpayer’s Federal tax return for the applicable taxable year, notwith- standing that the taxpayer may not have extended the due date. (3)Optional application of TD 9564. A taxpayer may choose to apply §1.263(a)–3T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014. §1.263(a)–3T [Removed] Par. 25. Section 1.263(a)–3T is re- moved. Par. 26. Section 1.263(a)–6 is added to read as follows: §1.263(a)–6 Election to deduct or capitalize certain expenditures. (a)In general. Under certain provisions of the Internal Revenue Code (Code), tax- payers may elect to treat capital expendi- tures as deductible expenses or as deferred expenses, or to treat deductible expenses as capital expenditures. (b)Election provisions. The sections referred to in paragraph (a) of this section include: (1) Section 173 (circulation expendi- tures); 2013–43 I.R.B.391October 21, 2013 (2) Section 174 (research and experi- mental expenditures); (3) Section 175 (soil and water conser- vation expenditures; endangered species recovery expenditures); (4) Section 179 (election to expense certain depreciable business assets); (5) Section 179A (deduction for clean- fuel vehicles and certain refueling prop- erty); (6) Section 179B (deduction for capi- tal costs incurred in complying with envi- ronmental protection agency sulfur regula- tions); (7) Section 179C (election to expense certain refineries); (8) Section 179D (energy efficient com- mercial buildings deduction); (9) Section 179E (election to expense advanced mine safety equipment); (10) Section 180 (expenditures by farm- ers for fertilizer); (11) Section 181 (treatment of certain qualified film and television productions); (12) Section 190 (expenditures to re- move architectural and transportation bar- riers to the handicapped and elderly); (13) Section 193 (tertiary injectants); (14) Section 194 (treatment of refor- estation expenditures); (15) Section 195 (start-up expendi- tures); (16) Section 198 (expensing of environ- mental remediation costs); (17) Section 198A (expensing of quali- fied disaster expenses); (18) Section 248 (organization expendi- tures of a corporation); (19) Section 266 (carrying charges); (20) Section 616 (development expen- ditures); and (21) Section 709 (organization and syn- dication fees of a partnership). (c)Effective/applicability date—(1) In general. This section applies to tax- able years beginning on or after January 1, 2014. Except as provided in para- graphs (c)(2) and (c)(3) of this section, §1.263(a)–3 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. For the effective dates of the enumerated election provisions, see those Code sections and the regulations under those sections. (2)Early application of this section.A taxpayer may choose to apply this section to taxable years beginning on or after Jan- uary 1, 2012. (3)Optional application of TD 9564. A taxpayer may choose to apply §1.263(a)–6T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014. §1.263(a)–6T [Removed] Par. 27. Section 1.263(a)–6T is re- moved. Par. 28. Section 1.263A–0 is amended by adding new entries in the outline for §1.263A–1(k) and (l) to read as follows: §1.263A–0 Outline of the Regulations under Section 263A. ***** §1.263A–1 Uniform Capitalization of Costs. ***** (k) Change in method of accounting. (1) In general. (2) Scope limitations. (3) Audit protection. (4) Section 481(a) adjustment. (5) Time for requesting change. (l) Effective/applicability date. (1) In general. (2) Mixed service costs; self-con- structed tangible personal property pro- duced on a routine and repetitive basis. (3) Materials and supplies. (i) In general (ii) Early application of this section. (iii) Optional application of TD 9564. ***** Par. 29. Section 1.263A–1 is amended by: 1. Removing paragraphs (b)(14) and (m). 2.Revising paragraphs (c)(4), (e)(2)(i)(A), (e)(3)(ii)(E) and (l). The revisions read as follows: §1.263A–1 Uniform capitalization of costs. ***** (c) * * * (4)Recovery of capitalized costs.Costs that are capitalized under section 263A are recovered through depreciation, amortiza- tion, cost of goods sold, or by an adjust- ment to basis at the time the property is used, sold, placed in service, or otherwise disposed of by the taxpayer. Cost recov- ery is determined by the applicable Inter- nal Revenue Code and regulation provi- sions relating to use, sale, or disposition of property. ***** (e) * * * (2) * * * (i) * * * (A)Direct material costs.Direct mate- rials costsinclude the cost of those materi- als that become an integral part of specific property produced and those materials that are consumed in the ordinary course of production and that can be identified or as- sociated with particular units or groups of units of property produced. For example, a cost described in §1.162–3, relating to the cost of a material or supply, may be a di- rect material cost. ***** (3) * * * (ii) * * * (E)Indirect material costs.Indirect material costsinclude the cost of mate- rials that are not an integral part of spe- cific property produced and the cost of materials that are consumed in the ordi- nary course of performing production or resale activities that cannot be identified or associated with particular units of prop- erty. Thus, for example, a cost described in §1.162–3, relating to the cost of a mate- rial or supply, may be an indirect cost. ***** (l)Effective/applicability dates—(1)In general. Except as provided in paragraphs (l)(2) and (l)(3) of this section, the effec- tive dates for this section are provided in paragraph (a)(2) of this section. (2)Mixed service costs; self-con- structed tangible personal property pro- duced on a routine and repetitive basis. Paragraphs (h)(2)(i)(D), (k), and (l)(2) of this section apply for taxable years ending on or after August 2, 2005. (3)Materials and supplies—(i)In gen- eral. The last sentence of paragraphs (e)(2)(i)(A) and (e)(2)(ii)(E) of this sec- tion, and paragraph (l)(3) of this section apply to amounts paid (to acquire or pro- duce property) in taxable years beginning on or after January 1, 2014. Except as October 21, 20133922013–43 I.R.B. provided in paragraph (l)(3)(ii) or para- graph (l)(3)(iii) of this section, section 1.263A–1 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (ii)Early application of this section. A taxpayer may choose to apply the last sentence of paragraphs (e)(2)(i)(A) and (e)(2)(ii)(E) of this section, and paragraph (l)(3) of this section to amounts paid (to acquire or produce property) in taxable years beginning on or after January 1, 2012. (iii)Optional application of TD 9564. A taxpayer may choose to ap- ply §1.263A–1T(b)(14), the introductory phrase of §1.263A–1T(c)(4), the last sentence of §1.263A–1T(e)(2)(i)(A), the last sentence of §1.263A–1T(e)(2)(ii)(E), §1.263A–1T(l), and §1.263A–1T(m)(2), as these provisions are contained in TD 9564 (76 FR 81060) December 27, 2011, to amounts paid (to acquire or produce property) in taxableyears beginning on or after January 1, 2012, and before January 1, 2014. §1.263A–1T [Removed] Par. 30. Section 1.263A–1T is re- moved. Par. 31. Section 1.1016–3 is amended by revising paragraphs (a)(1)(ii), (j)(1), and (j)(3) to read as follows: §1.1016–3 Exhaustion, wear and tear, obsolescence, amortization, and depletion for periods since February 13, 1913. (a)*** (1)* * * (ii) The determination of the amount properly allowable for exhaustion, wear and tear, obsolescence, amortization, and depletion must be made on the basis of facts reasonably known to exist at the end of the taxable year. A taxpayer is not permitted to take advantage in a later year of the taxpayer’s prior failure to take any such allowance or the taxpayer’s taking an allowance plainly inadequate under the known facts in prior years. In the case of depreciation, if in prior years the taxpayer has consistently taken proper deductions under one method, the amount allowable for such prior years may not be increased, even though a greater amount would have been allowable under another proper method. For rules governing losses on retirement or disposition of depreciable property, including rules for determining basis, see §1.167(a)–8, §1.168(i)–1T(e), §1.168(i)–8T, Prop. Reg. §1.168(i)–1(e) (September 19, 2013), or Prop. Reg. §1.168(i)–8 (September 19, 2013), as ap- plicable. The application of this paragraph is illustrated by the following example (for purposes of this example, assume section 167(f)(1) as in effect on September 19, 2013, applies to taxable years beginning on or after January 1, 2014): Example. On July 1, 2014, A, a calendar-year tax- payer, purchased and placedin service “off-the-shelf” computer software at a cost of $36,000. This com- puter software is not an amortizable section 197 intangible. Pursuant to section 167(f)(1), the useful life of the computer software is 36 months. It has no salvage value. Computer software placed in service in 2014 is not eligible for the additional first year depreciation deduction provided by section 168(k). A did not deduct any depreciation for the computer software for 2014 and deducted depreciation of $12,000 for the computer software for 2015. As a result, the total amount of depreciation allowed for the computer software as of December 31, 2015, was $12,000. However, the total amount of depreciation allowable for the computer software as of December 31, 2015, is $18,000 ($6,000 for 2014 + $12,000 for 2015). As a result, the unrecovered cost of the com- puter software as of December 31, 2015, is $18,000 (cost of $36,000 less the depreciation allowable of $18,000 as of December 31, 2015). Accordingly, depreciation for 2016 for the computer software is $12,000 (unrecovered cost of $18,000 divided by the remaining useful life of 18 months as of January 1, 2016, multiplied by 12 full months in 2016). ***** (j)Effective/applicability dates—(1)In general. Except as provided in paragraphs (j)(2) and (j)(3) of this section, this section applies on or after December 30, 2003. For the applicability of regulations before De- cember 30, 2003, see §1.1016–3 in effect prior to December 30,2003 (§1.1016–3 as contained in 26 CFR part 1 edition revised as of April 1, 2003). ***** (3)Applicationof §1.1016–3T(a)(1)(ii)—(i)In general. Paragraph (a)(1)(ii) of this section applies to taxable years beginning on or after January 1, 2014. Except as provided in paragraphs (j)(3)(ii) and (j)(3)(iii) of this section, §1.1016–3(a)(1)(ii) as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (ii)Earlyapplicationof §1.1016–3(a)(1)(ii). A taxpayer may choose to apply paragraph (a)(1)(ii) of this section to taxable years beginning on or after January 1, 2012. (iii)Optional application of TD 9564. A taxpayer may choose to apply §1.1016–3T(a)(1)(ii) as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after Jan- uary 1, 2012, and before January 1, 2014. §1.1016–3T [Removed] Par. 32. Section 1.1016–3T is removed. PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT Par. 33. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 34. In §602.101, paragraph (b) is amended by adding the following entries to the table in numerical order to read as follows: §602.101 OMB Control numbers. ***** (b) * * * CFR part or section where Identified and described Current OMB control No. ***** 1.263(a)–1........................................................... 1545–2248 1.263(a)–3........................................................... 1545 –2248 ***** 2013–43 I.R.B.393October 21, 2013 Beth Tucker, Deputy Commissioner for Operations Support. Approved August 15, 2013. Mark J. Mazur, Assistant Secretary oftheTreasury(TaxPolicy). (Filed by the Office of the Federal Register on September 13, 2013, 11:15 a.m., and published in the issue of the Federal Register for September 19, 2013, 78 F.R. 57686) Section 280G.—Golden Parachute Payments Federal short-term, mid-term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 382.—Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change The adjusted applicable federal long-term rate is set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 412.—Minimum Funding Standards The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 467.—Certain Payments for the Use of Property or Services The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 468.—Special Rules for Mining and Solid Waste Reclamation and Closing Costs The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 482.—Allocation of Income and Deductions Among Taxpayers Federal short-term, mid-term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 483.—Interest on Certain Deferred Payments The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 642.—Special Rules for Credits and Deductions Federal short-term, mid-term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 807.—Rules for Certain Reserves The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 846.—Discounted Unpaid Losses Defined The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 1274.—Determi- nation of Issue Price in the Case of Certain Debt Instru- ments Issued for Property (Also Sections 42, 280G, 382, 412, 467, 468, 482, 483, 642, 807, 846, 1288, 7520, 7872.) Federal rates; adjusted federal rates; ad- justed federal long-term rate and the long- term exempt rate. For purposes of sections 382, 642, 1274, 1288, and other sections of the Code, tables set forth the rates for Oc- tober 2013. Rev. Rul. 2013–21 This revenue ruling provides various prescribed rates for federal income tax purposes for October 2013 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable fed- eral rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the ap- propriate percentages for determining the low-income housingcredit described in section 42(b)(1) for buildings placed in service during the current month. How- ever, under section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service after July 30, 2008, with respect to housing credit dollar amount allocations made before January 1, 2014, shall not be less than 9%. Finally, Table 5 contains the federal rate for determining the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520. October 21, 20133942013–43 I.R.B. REV. RUL. 2013–21 TABLE 1 Applicable Federal Rates (AFR) for October 2013 Period for Compounding AnnualSemiannualQuarterlyMonthly Short-term AFR.32%.32%.32%.32% 110% AFR .35%.35%.35%.35% 120% AFR.38%.38%.38%.38% 130% AFR.42%.42%.42%.42% Mid-term AFR1.93%1.92%1.92%1.91% 110% AFR2.12%2.11%2.10%2.10% 120% AFR2.31%2.30%2.29%2.29% 130% AFR 2.52%2.50% 2.49%2.49% 150% AFR 2.90%2.88%2.87%2.86% 175% AFR 3.39%3.36% 3.35% 3.34% Long-term AFR 3.50% 3.47%3.46% 3.45% 110% AFR3.86%3.82%3.80%3.79% 120% AFR4.20%4.16%4.14%4.12% 130% AFR 4.56%4.51% 4.48%4.47% REV. RUL. 2013–21 TABLE 2 Adjusted AFR for October 2013 Period for Compounding AnnualSemiannualQuarterlyMonthly Short-term adjusted AFR .32%.32%.32%.32% Mid-term adjusted AFR1.78%1.77%1.77%1.76% Long-term adjusted AFR 3.50% 3.47%3.46% 3.45% REV. RUL. 2013–21 TABLE 3 Rates Under Section 382 for October 2013 Adjusted federal long-term rate for the current month 3.50% Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.)3.50% REV. RUL. 2013–21 TABLE 4 Appropriate Percentages Under Section 42(b)(1) for October 2013 Note: Under section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service after July 30, 2008, with respect to housing credit dollar amount allocations made before January 1, 2014, shall not be less than 9%. Appropriate percentage for the 70% present value low-income housing credit7.63% Appropriate percentage for the 30% present value low-income housing credit3.27% 2013–43 I.R.B.395October 21, 2013 REV. RUL. 2013–21 TABLE 5 Rate Under Section 7520 for October 2013 Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest2.4% Section 1288.—Treatment of Original Issue Discount on Tax-Exempt Obligations The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 7520.—Valuation Tables The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. Section 7872.—Treatment of Loans With Below-Market Interest Rates The adjusted applicable federal short-term, mid- term, and long-term rates are set forth for the month of October 2013. See Rev. Rul. 2013-21, page 394. October 21, 20133962013–43 I.R.B. Part III. Administrative, Procedural, and Miscellaneous 26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement; determination of correct liability. (Also: sections 66, 6015) Rev. Proc. 2013–34 SECTION 1. PURPOSE AND SCOPE .01Purpose. This revenue procedure provides guidance for a taxpayer seeking equitable relief from income tax liability under section 66(c) or section 6015(f) of the Internal Revenue Code (a “requesting spouse”). Section 4.01 of this revenue procedure provides the threshold require- ments for any request for equitable relief. Section 4.02 of this revenue procedure sets forth the conditions under which the In- ternal Revenue Service will make stream- lined relief determinations granting equi- table relief under section 6015(f) from an understatement of income tax or an un- derpayment of income tax reported on a joint return, or the operation of community property law under section 66(c). Section 4.03 of this revenue procedure provides a nonexclusive list of factors for considera- tion in determining whether relief should be granted under section 6015(f) because it would be inequitable to hold a requesting spouse jointly and severally liable when the conditions of section 4.02 are not met. The factors in section 4.03 also will apply in determining whether to relieve a spouse from income tax liability resulting from the operation of community property law under the equitable relief provision of sec- tion 66(c). .02Scope. This revenue procedure ap- plies to spouses who request either equi- table relief from jointand several liability under section 6015(f), or equitable relief under section 66(c) from income tax lia- bility resulting from the operation of com- munity property law. SECTION 2. BACKGROUND .01 Section 6013(d)(3) provides that married taxpayers who file a joint return under section 6013 will be jointly and severally liable for the income tax arising from that joint return. For purposes of section 6013(d)(3) and this revenue pro- cedure, the term “tax” includes penalties, additions to tax, and interest. See sections 6601(e)(1) and 6665(a)(2). .02 Section 3201(a) of the Internal Rev- enue Service Restructuring and Reform Act of 1998, Pub. L. No. 105–206, 112 Stat. 685, 734 (RRA), enacted section 6015, which provides relief in certain circumstances from the joint and several liability imposed by section 6013(d)(3). Section 6015(b) and (c) specify two sets of circumstances under which relief from joint and several liability is available in cases involving understatements of tax. Section 6015(b) is modeled after former section 6013(e), the prior innocent spouse statute, and section 6015(c) provides for separation of liability for taxpayers who are no longer married to, are legally sepa- rated from, or not living together with the person with whom they filed a joint re- turn. If relief is not available under section 6015(b) or (c), section 6015(f) authorizes the Secretary to grant equitable relief if, taking into account all the facts and cir- cumstances, the Secretary determines that it is inequitable to hold a requesting spouse liable for any unpaid tax or any deficiency (or any portion of either). Section 66(c) provides relief from in- come tax liability resulting from the op- eration of community property law to tax- payers domiciled in a community property state who do not file a joint return. Sec- tion 3201(b) of the RRA amended section 66(c) to add an equitable relief provision similar to section 6015(f). .03 Section 6015 provides relief only from joint and several liability arising from a joint return. If an individual signs a joint return under duress, the election to file jointly is not valid and there is no valid re- turn with respect to the requesting spouse. The individual is not jointly and severally liable for any income tax liabilities aris- ing from that return. In that case, section 6015 does not apply and is not necessary for obtaining relief. If an individual files a claim for relief under section 6015, but also maintains that there is no valid joint return due to duress, the Service will first make a determination as to the validity of the joint return and may accordingly deny the request for section 6015 relief based on the fact that no joint return was filed (and thus, relief is not necessary). If it is ulti- mately determined that a valid joint return was filed, the Service will then consider whether the individual would be entitled to relief from joint and several liability on the merits. .04 Under section 6015(b) and (c), re- lief is available only from an understate- ment or a deficiency. Section 6015(b) and (c) do not authorize relief from an under- payment of income tax reported on a joint return. Section 66(c)and section 6015(f) permit equitable relief from an underpay- ment of income tax or from a deficiency. The legislative history of section 6015 pro- vides that Congress intended for the Secre- tary to exercise discretion in granting eq- uitable relief from an underpayment of in- come tax if a requesting spouse “does not know, and had no reason to know, that funds intended for the payment of tax were instead taken by the other spouse for such other spouse’s benefit.” H.R. Conf. Rep. No. 105–599, at 254 (1998). Congress also intended for the Secretary to exercise the equitable relief authority under section 6015(f) in other situations if, “taking into account all the facts and circumstances, it is inequitable to hold an individual liable for all or part of any unpaid tax or defi- ciency arising from a joint return.”Id. SECTION 3. SIGNIFICANT CHANGES On January 5, 2012,the Department of Treasury and the Service released No- tice 2012–8, 2012–4 I.R.B. 309, which set forth a proposed revenue procedure to update and revise Rev. Proc. 2003–61, 2003–2 C.B. 296. Notice 2012–8 also modified and clarified the criteria for equi- table relief, and it eliminated the two-year rule for filing a claim for relief as set forth in Notice 2011–70, 2011–32 I.R.B. 135. Notice 2012–8 invited public comment re- garding the proposed revenue procedure. A total of 54 comments were received, 45 of which were generalcomments either in support of the revisions, asking for assis- tance in specific cases, or totally unrelated to innocent spouse relief. The nine sub- stantive comments ranged from discussing one or two discrete issues to commenting on all aspects of the proposed revenue pro- cedure and innocent spouse relief in gen- eral. Treasury and the Service considered all comments received, and the proposed revenue procedure has been modified to 2013–43 I.R.B.397October 21, 2013 take into account many of the concerns raised. This revenue procedure supersedes Rev. Proc. 2003–61. The structure and format of this revenue procedure generally follows that of Rev. Proc. 2003–61 with the following significant changes: .01 This revenue procedure gives greater deference to the presence of abuse than Rev. Proc. 2003–61. The Service recognizes that the issue of abuse can be relevant with respect to the analysis of other factors and can negate the presence of certain factors. This change is intended to give greater weight to the presence of abuse when its presence impacts the anal- ysis of other factors. .02 The timeliness threshold condition in section 4.01(3) of this revenue proce- dure provides that a request for equitable relief under section 6015(f) or section 66(c) must be filed before the expiration of the period of limitation for collection un- der section 6502 to the extent the taxpayer seeks relief from an outstanding liability, or before the expiration of the period of limitation for credit or refund under sec- tion 6511 to the extent the taxpayer seeks a refund of taxes paid. This is a significant change to the requirement in Rev. Proc. 2003–61, section 4.01(3), and Treas. Reg. § 1.6015–5(b)(1) (TD 9003), that the re- questing spouse’s claim for equitable relief must be filed no later than two years after the date of the Service’s first collection activity.SeeNotice 2011–70. In response to a comment received with respect to Notice 2012–8, section 4.01(3)(a) refers to the period of limitation for collection as its commonly used IRS term — Collection Statute Expiration Date or CSED. .03 The attribution threshold condition in section 4.01(7) of this revenue proce- dure adds a new exception in paragraph (e) to the requirement that the income tax li- ability must be attributable to an item of the nonrequesting spouse. Under section 4.01(7)(e) of the revenue procedure, relief would not be precluded for an item attrib- utable to the requesting spouse if the non- requesting spouse’s fraud gave rise to the understatement of tax or deficiency. .04 Streamlined determinations under section 4.02 of this revenue procedure now apply to understatements of income tax in- stead of only underpayments as under Rev. Proc. 2003–61. Section 4.02 also now ap- plies to claims for equitable relief under section 66(c). .05 Section 4.03(2) of this revenue pro- cedure clarifies that no one factor or a ma- jority of factors necessarily controls the determination. Therefore, depending on the facts and circumstances of the case, re- lief may still be appropriate if the number of factors weighing against relief exceeds the number of factors weighing in favor of relief, or a denial of relief may still be ap- propriate if the number of factors weigh- ing in favor of relief exceeds the number of factors weighing against relief. .06 The economic hardship factor in section 4.03(2)(b) of this revenue proce- dure now provides minimum standards based on income, expenses, and assets, for determining whether the requesting spouse would suffer economic hardship if relief is not granted. Section 4.03(2)(b) also now provides that the lack of a find- ing of economic hardship does not weigh against relief, as it did under Rev. Proc. 2003–61, and instead will be neutral. .07 The knowledge factor for under- statement cases in section 4.03(2)(c)(i) of this revenue procedure clarifies how the factor works in cases involving equi- table relief under section 66(c), in addition to cases involving equitable relief under section 6015(f). Section 4.03(2)(c)(i)(A) provides that actualknowledge of the item giving rise to an understatement or defi- ciency will no longer be weighed more heavily than other factors, as it did under Rev. Proc. 2003–61. Further, section 4.03(2)(c)(i)(A) clarifies that, for purposes of this factor, if the nonrequesting spouse abused the requesting spouse or main- tained control over the household finances by restricting the requesting spouse’s ac- cess to financial information, and because of the abuse or financial control, the re- questing spouse was not able to challenge the treatment of any items on the joint re- turn for fear of the nonrequesting spouse’s retaliation, then that abuse or financial control will result in this factor weighing in favor of relief even if the requesting spouse knew or had reason to know of the items giving rise to the understatement or deficiency. .08 The knowledge factor for under- payment cases in section 4.03(2)(c)(ii) of this revenue procedure now provides that, in determining whether the requesting spouse knew or had reason to know that the nonrequesting spouse would not pay the tax reported as due on the return, the Service will consider whether the request- ing spouse reasonably expected that the nonrequesting spouse would pay the tax liability at the time the return was filed or within a reasonable period of time after the filing of the return. In response to comments received with respect to Notice 2012–8, section 4.03(2)(c)(ii) provides that a requesting spouse may be presumed to have reasonably expected that the non- requesting spouse would pay the liability if a request for an installment agreement topaythetaxwasfiledbythelaterof 90 days after the due date for payment of the tax, or 90 days after the return was filed. Further, section 4.03(2)(c)(ii) clarifies that for purposes of this factor, if the nonrequesting spouse abused the requesting spouse or maintained control over the household finances by restricting the requesting spouse’s access to financial information, and because of the abuse or financial control, the requesting spouse was not able to question the payment of the taxes reported as due on the return or challenge the nonrequesting spouse’s as- surance regarding payment of the taxes for fear of the nonrequesting spouse’s retali- ation, then that abuse or financial control will result in this factor weighing in fa- vor of relief even if the requesting spouse knew or had reason to know that the non- requesting spouse would not pay the tax liability. Finally, section 4.03(2)(c)(ii) provides that if the requesting spouse did not reasonably expect that the nonrequest- ing spouse would pay the tax liability reported on an amended return that was based on items not properly reported on the original return, the Service will also consider whether the requesting spouse knew or had reason to know of the under- statement on the original return. .09 The legal obligation factor in sec- tion 4.03(2)(d) of this revenue procedure clarifies that a requesting spouse’s legal obligation to pay outstanding tax liabili- ties is a factor to consider in determining whether equitable relief should be granted, in addition to whether the nonrequesting spouse has a legal obligation to pay the tax liabilities. .10 The significant benefit factor in sec- tion 4.03(2)(e) of this revenue procedure provides that any significant benefit a re- questing spouse may have received from October 21, 20133982013–43 I.R.B. the unpaid tax or understatement will not weigh against relief (will be neutral) if the nonrequesting spouse abused the request- ing spouse or maintained financial control and made the decisions regarding living a more lavish lifestyle. Further, section 4.03(2)(e) provides that if only the non- requesting spouse significantly benefitted from the unpaid tax or understatement, and the requesting spouse had little or no ben- efit, or the nonrequesting spouse enjoyed the benefit to the requesting spouse’s detri- ment, this factor will weigh in favor of relief. Section 4.03(2)(e) also provides that if the amount of unpaid tax or under- statement of tax was small such that nei- ther spouse received a significant benefit, then this factor is neutral. In response to comments received with respect to Notice 2012–8, section 4.03(2)(e) provides that the determination that the tax liability was small such that neither spouse received a significant benefit will vary depending on the facts and circumstances of each case. .11 The compliance with the income tax laws factor in section 4.03(2)(f) of this rev- enue procedure now provides that a re- questing spouse’s subsequent compliance with all Federal income tax laws is a factor that may weigh in favor of relief, instead of always being neutral under Rev. Proc. 2003–61. .12 Section 4.04 of this revenue proce- dure broadens the availability of refunds in cases involving deficiencies by eliminat- ing the rule in section 4.04(1) of Rev. Proc. 2003–61 that limited refunds in cases in- volving deficiencies to payments made by the requesting spouse pursuant to an in- stallment agreement. SECTION 4. GENERAL CONDITIONS FOR RELIEF .01Eligibility for equitable relief.A requesting spouse must satisfy all of the following threshold conditions to be eli- gible to submit a request for equitable re- lief under section 6015(f). With the excep- tion of conditions (1) and (2), a request- ing spouse must satisfy all of the follow- ing threshold conditions to be eligible to submit a request for equitable relief under section 66(c). The Service may relieve a requesting spouse who satisfies all the ap- plicable threshold conditions set forth be- low of all or part of the income tax liabil- ity under section 66(c) or section 6015(f) if, taking into accountall the facts and cir- cumstances, the Service determines that it would be inequitable to hold the requesting spouse liable for the income tax liability. The threshold conditions are as follows: (1) The requesting spouse filed a joint return for the taxable year for which he or she seeks relief. (2) Relief is not available to the request- ing spouse under section 6015(b) or (c). (3) The claim for relief is timely filed: (a) If the requesting spouse is applying for relief from a liability or a portion of a li- ability that remains unpaid, the request for relief must be made on or before the Col- lection Statute Expiration Date (CSED). The CSED is the date the period of limi- tation on collection of the income tax lia- bility expires, as provided in section 6502. Generally, that period expires 10 years af- ter the assessment of tax, but it may be ex- tended by other provisions of the Internal Revenue Code. (b) Claims for credit or refund of amounts paid must be made before the expiration of the period of limitation on credit or refund, as provided in section 6511. Generally, that period expires three years from the time the return was filed or two years from the time the tax was paid, whichever is later. (4) No assets were transferred between the spouses as part of a fraudulent scheme by the spouses. (5) The nonrequesting spouse did not transfer disqualified assets to the request- ing spouse. For this purpose, the term “dis- qualified asset” has the meaning given the term by section 6015(c)(4)(B). If the non- requesting spouse transferred disqualified assets to the requesting spouse, relief will be available only to the extent that the in- come tax liability exceeds the value of the disqualified assets. Even if there was a transfer of disqualified assets, the request- ing spouse may be eligible for relief if the nonrequesting spouse abused the request- ing spouse or maintained control over the household finances by restricting the re- questing spouse’s access to financial in- formation, or the requesting spouse did not have actual knowledge that disquali- fied assets were transferred. (6) The requesting spouse did not knowingly participate in the filing of a fraudulent joint return. (7) The income tax liability from which the requesting spouse seeks relief is attrib- utable (either in full or in part) to an item of the nonrequesting spouse or an under- payment resulting from the nonrequesting spouse’s income. If the liability is partially attributable to the requesting spouse, then relief can only be considered for the por- tion of the liability attributable to the non- requesting spouse. Nonetheless, the Ser- vice will consider granting relief regard- less of whether the understatement, defi- ciency, or underpayment is attributable (in full or in part) to the requesting spouse if any of the following exceptions applies: (a)Attribution solely due to the oper- ation of community property law.Ifan item is attributable or partially attribut- able to the requesting spouse solely due to the operation of community property law, then for purposes of this revenue proce- dure, that item (or portion thereof) will be considered to be attributable to the nonre- questing spouse. (b)Nominal ownership.Iftheitemis titled in the name of the requesting spouse, the item is presumptively attributable to the requesting spouse. This presumption is rebuttable. For example, H opens an in- dividual retirement account (IRA) in W’s name and forges W’s signature on the IRA in 2006. Thereafter, H makes contribu- tions to the IRA and in 2008 takes a tax- able distribution from the IRA. H and W file a joint return for the 2008 taxable year, but do not report the taxable distribution on their joint return. The Service later de- termines a deficiency relating to the tax- able IRA distribution. W requests relief from joint and several liability under sec- tion 6015. W establishes that W did not contribute to the IRA, sign paperwork re- lating to the IRA, or otherwise act as if W were the owner of the IRA. W, thereby, re- buts the presumption that the IRA is attrib- utable to W. (c)Misappropriation of funds.Ifthe requesting spouse did not know, and had no reason to know, that funds intended for the payment of tax were misappropriated by the nonrequesting spouse for the nonre- questing spouse’s benefit, the Service will consider granting equitable relief although the underpayment may be attributable in part or in full to an item of the requesting spouse. The Service will consider granting relief in this case only to the extent that the funds intended for the payment of tax were taken by the nonrequesting spouse. 2013–43 I.R.B.399October 21, 2013 (d)Abuse. If the requesting spouse es- tablishes that he or she was the victim of abuse prior to the time the return was filed, and that, as a result of the prior abuse, the requesting spouse was not able to chal- lenge the treatment of any items on the re- turn, or was not able to question the pay- ment of any balance due reported on the re- turn, for fear of the nonrequesting spouse’s retaliation, the Service will consider grant- ing equitable relief even though the defi- ciency or underpayment may be attribut- able in part or in full to an item of the re- questing spouse. (e)Fraud committed by nonrequesting spouse. The Service will consider granting relief notwithstanding that the item giving rise to the understatement or deficiency is attributable to the requesting spouse, if the requesting spouse establishes that the non- requesting spouse’s fraud is the reason for the erroneous item. For example, W fraud- ulently accesses H’s brokerage account to sell stock that H had separately received from an inheritance. W deposits the funds from the sale in a separate bank account to which H does not have access. H and W file a joint Federal income tax return for the year, which does not report the in- come from the sale of the stock. The Ser- vice determines a deficiency based on the omission of the income from the sale of the stock. H requests relief from the defi- ciency under section6015(f). The income from the sale of the stock normally would be attributable to H. Because W commit- ted fraud with respect to H, however, and because this fraud was the reason for the erroneous item, the liability is properly at- tributable to W. .02.Circumstances under which the Service will make streamlined determina- tions granting equitable relief under sec- tions 66(c) and 6015(f). If a requesting spouse who filed a joint return, or a requesting spouse who did not file a joint return in a community prop- erty state, satisfies the threshold condi- tions of section 4.01, the Service will con- sider whether the requesting spouse is en- titled to a streamlined determination of eq- uitable relief under section 66(c) or section 6015(f) under this section 4.02. If a re- questing spouse is not entitled to a stream- lined determination because the requesting spouse does not satisfy all the elements in this section 4.02, the requesting spouse is still entitled to be considered for relief un- der the equitable factors in section 4.03. The Service will make streamlined deter- minations granting equitable relief under section 66(c) or section 6015(f), in cases in which the requesting spouse establishes that the requesting spouse: (1)Marital status. Is no longer married to the nonrequesting spouse as set forth in section 4.03(2)(a); (2)Economic hardship.Wouldsuf- fer economic hardship if relief were not granted as set forth in section 4.03(2)(b); and (3)Knowledge or reason to know. (a)Section 6015(f) cases.Didnot know or have reason to know that there was an understatement or deficiency on the joint income tax return, as set forth in section 4.03(2)(c)(i), or did not know or have reason to know that the nonrequest- ing spouse would not or could not pay the underpayment of tax reported on the joint income tax return, as set forth in section 4.03(2)(c)(ii). If the nonrequesting spouse abused the requesting spouse or main- tained control over the household finances by restricting the requesting spouse’s ac- cess to financial information, and because of the abuse or financial control, the re- questing spouse was not able to challenge the treatment of any items on the joint return, or to question the payment of the taxes reported as due on the joint return or challenge the nonrequesting spouse’s assurance regarding payment of the taxes, for fear of the nonrequesting spouse’s retaliation, then the abuse or financial con- trol will result in this factor being satisfied even if the requesting spouse knew or had reason to know of the items giving rise to the understatement or deficiency or knew or had reason to know that the nonrequest- ing spouse would not pay the tax liability. (b)Section 66(c) cases. Did not know or have reason to know of an item of community income properly includible in gross income, which, under the rules con- tained in section 879(a), would be treated as the income of the nonrequesting spouse. .03.Factors for determining whether to grant equitable relief. (1)Applicability. This section 4.03 applies to a requesting spouse who re- quests relief under section 66(c) or section 6015(f), and who satisfies the threshold conditions of section 4.01, but does not qualify for streamlined determinations granting relief under section 4.02. (2)Factors. In determining whether it is inequitable to hold the requesting spouse liable for all or part of the unpaid income tax liability or deficiency, and whether full or partial equitable relief under section 66(c) or section 6015(f) should be granted, all the facts and circumstances of the case are to be taken into account. The factors listed below are designed as guides and not intended to comprise an exclusive list. Other factors relevant to a specific claim for relief may also be taken into account in making the determination. In evaluating a claim for relief, no one factor or a majority of factors necessarily determines the out- come. The degree of importance of each factor varies depending on the requesting spouse’s facts and circumstances. Abuse or the exercise of financial control by the nonrequesting spouse is a factor that may impact the other factors, as described below. Factors to consider include the following: (a)Marital status. Whether the request- ing spouse is no longer married to the non- requesting spouse as of the date the Service makes its determination. If the requesting spouse is still married to the nonrequesting spouse, this factor is neutral. If the request- ing spouse is no longer married to the non- requesting spouse, this factor will weigh in favor of relief. For purposes of this sec- tion, a requesting spouse will be treated as being no longer married to the nonrequest- ing spouse only in the following situations: (i) The requesting spouse is divorced from the nonrequesting spouse, (ii) The requesting spouse is legally separated from the nonrequesting spouse under applicable state law, (iii) The requesting spouse is a widow or widower and is not an heir to the non- requesting spouse’s estate that would have sufficient assets to pay the tax liability, or (iv) The requesting spouse has not been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date the Service makes its determination. For these purposes, a temporary absence (e.g., due to incarceration, illness, business, mil- itary service, or education) is not consid- ered separation if the absent spouse is ex- pected to return to the household. See Treas. Reg. § 1.6015–3(b)(3)(i). A re- questing spouse is a member of the same household as the nonrequesting spouse for October 21, 20134002013–43 I.R.B. any period in which the spouses maintain the same residence. (b)Economic hardship.Whetherthe requesting spouse will suffer economic hardship if relief is not granted. For pur- poses of this factor, an economic hardship exists if satisfaction of the tax liabil- ity in whole or in part will cause the requesting spouse to be unable to pay rea- sonable basic living expenses. Whether the requesting spouse will suffer eco- nomic hardship is determined based on rules similar to those provided in Treas. Reg. § 301.6343–1(b)(4), and the Service will take into consideration a requesting spouse’s current income and expenses and the requesting spouse’s assets. In deter- mining the requesting spouse’s reasonable basic living expenses, the Service will consider whether the requesting spouse shares expenses or has expenses paid by another individual (such as a family member, including a current spouse). If denying relief from the joint and several liability will cause the requesting spouse to suffer economic hardship, this factor will weigh in favor of relief. If denying relief from the joint and several liability will not cause the requesting spouse to suffer economic hardship, this factor will be neutral. In determining whether the requesting spouse would suffer economic hardship if relief is not granted, the Service will com- pare the requesting spouse’s income to the Federal poverty guidelines (as updated periodically in the Federal Register by the U.S. Department of Health and Human Services under the authority of 42 U.S.C. § 9902(2)) for the requesting spouse’s family size and will determine by how much, if at all, the requesting spouse’s monthly income exceeds the spouse’s rea- sonable basic monthly living expenses. This factor will weigh in favor of relief if the requesting spouse’s income is below 250% of the Federal poverty guidelines, unless the requesting spouse has assets out of which the requesting spouse can make payments towards the tax liability and still adequately meet the requesting spouse’s reasonable basic living expenses. If the requesting spouse’s income exceeds 250% of the Federal poverty guidelines, this factor will still weigh in favor of relief if the requesting spouse’s monthly income exceeds the requesting spouse’s reason- able basic monthly living expenses by $300 or less, unless the requesting spouse has assets out of which the requesting spouse can make payments towards the tax liability and still adequately meet the re- questing spouse’s reasonable basic living expenses. If the requesting spouse’s in- come exceeds 250% of the Federal poverty guidelines and monthly income exceeds monthly expenses by more than $300, or if the requesting spouse qualifies under either standard but has sufficient assets to make payments towards the tax liability and still adequatelymeet the requesting spouse’s reasonable basic living expenses, the Service will consider all facts and circumstances (including the size of the requesting spouse’s household) in deter- mining whether the requesting spouse would suffer economic hardship if relief is not granted. If the requesting spouse is deceased, this factor is neutral. (c)Knowledge or reason to know. (i)Understatement cases. (A)Section 6015(f) cases.Whetherthe requesting spouse knew or had reason to know of the item giving rise to the un- derstatement or deficiency as of the date the joint return (including a joint amended return) was filed, or the date the request- ing spouse reasonably believed the joint return was filed. If the requesting spouse did not know and had no reason to know of the item giving rise to the understate- ment, this factor will weigh in favor of relief. If the requesting spouse knew or had reason to know of the item giving rise to the understatement, this factor will weigh against relief. Actual knowledge of the item giving rise to the understate- ment or deficiency will not be weighed more heavily than any other factor. De- pending on the facts and circumstances, if the requesting spouse was abused by the nonrequesting spouse (as described in sec- tion 4.03(2)(c)(iv)), or the nonrequesting spouse maintained control of the house- hold finances by restricting the requesting spouse’s access to financial information, and because of the abuse or financial con- trol, the requesting spouse was not able to challenge the treatment of any items on the joint return for fear of the nonrequesting spouse’s retaliation, this factor will weigh in favor of relief even if the requesting spouse knew or had reason to know of the items giving rise to the understatement or deficiency. (B)Section 66(c) cases.Whetherthe requesting spouse knew or had reason to know of an item of community in- come properly includible in gross income, which, under the rules contained in section 879(a), would be treated as the income of the nonrequesting spouse. (ii)Underpayment cases. In the case of an income tax liability that was prop- erly reported but not paid, whether, as of thedatethereturnwasfiledorthedate the requesting spouse reasonably believed the return was filed, the requesting spouse knew or had reason to know that the non- requesting spouse would not or could not pay the tax liability at that time or within a reasonable period of time after the filing of the return. This factor will weigh in favor of relief if the requesting spouse reason- ably expected the nonrequesting spouse to pay the tax liability reported on the return. A reasonable expectation of payment will be presumed if the spouses submitted a re- quest for an installment agreement to pay the tax reported as due on the return. To benefit from the presumption, the request for an installment agreement must be filed by the later of 90 days after the due date for payment of the tax, or 90 days after the return was filed. The request must detail the plan for paying the tax, interest, and penalties, satisfy the liability within a rea- sonable time, and it must not be unreason- able for the requesting spouse to believe that the nonrequesting spouse will be able to make the payments contemplated in the requested installment agreement. This factor will weigh against relief if, based on the facts and circumstances of the case, it was not reasonable for the re- questing spouse to believe that the non- requesting spouse would or could pay the tax liability shown on the return. For ex- ample, if prior to the return being filed, or the date the requesting spouse reason- ably believed the return was filed, the re- questing spouse knew of the nonrequesting spouse’s prior bankruptcies, financial dif- ficulties, or other issues with the Service or other creditors, or was otherwise aware of difficulties in timely paying bills, then this factor will generally weigh against relief. Depending on the facts and circum- stances, if the requesting spouse was abused by the nonrequesting spouse (as described in section 4.03(2)(c)(iv)), or the nonrequesting spouse maintained control of the household finances by restricting 2013–43 I.R.B.401October 21, 2013 the requesting spouse’s access to financial information, and because of the abuse or financial control, the requesting spouse was not able to question the payment of the taxes reported as due on the return or challenge the nonrequesting spouse’s assurance regarding payment of the taxes for fear of the nonrequesting spouse’s re- taliation, this factor will weigh in favor of relief even if the requesting spouse knew or had reason to know about the nonre- questing spouse’s intent or ability to pay the taxes due. With respect to an underpayment of tax on an amended return that reports a liabil- ity based on items not properly reported on the original return, the initial inquiry is whether, as of the date the amended re- turn was filed, or the date the requesting spouse reasonably believed the amended return was filed, the requesting spouse rea- sonably expected that the nonrequesting spouse would pay the tax within a rea- sonable period of time. If so, this fac- tor will weigh in favor of relief. How- ever, if it was not reasonable for the re- questing spouse to expect that the nonre- questing spouse would pay the tax, the re- questing spouse’s knowledge or reason to know of the understatement on the origi- nal return will also be considered. If the requesting spouse knew or had reason to know of the item giving rise to the under- statement on the original return, then this factor will weigh against relief. If the re- questing spouse did not know or have rea- son to know of the item, then this factor will weigh in favor of relief. (iii)Reason to know. The facts and cir- cumstances that are considered in deter- mining whether the requesting spouse had reason to know of an understatement, or reason to know whether the nonrequesting spouse could or would pay the reported tax liability, include, but are not limited to, the requesting spouse’s level of education, any deceit or evasiveness of the nonrequest- ing spouse, the requesting spouse’s de- gree of involvement in the activity gener- ating the income tax liability, the request- ing spouse’s involvement in business or household financialmatters, the request- ing spouse’s business or financial exper- tise, and any lavish or unusual expendi- tures compared with past spending levels. (iv)Abuse by the nonrequesting spouse. For purposes of this revenue procedure, if the requesting spouse establishes that he or she was the victim of abuse (not amounting to duress, see Treas. Reg. § 1.6015–1(b)), then depending on the facts and circum- stances of the requesting spouse’s situa- tion, the abuse may result in certain fac- tors weighing in favor of relief when other- wise the factor may have weighed against relief. Abuse comes in many forms and can include physical, psychological, sex- ual, or emotional abuse, including efforts to control, isolate, humiliate, and intim- idate the requesting spouse, or to under- mine the requesting spouse’s ability to rea- son independently and be able to do what is required under the tax laws. All the facts and circumstances are considered in determining whether a requesting spouse was abused. The impact of a nonrequest- ing spouse’s alcohol or drug abuse is also considered in determining whether a re- questing spouse was abused. Depending on the facts and circumstances, abuse of the requesting spouse’s child or other fam- ily member living in the household may constitute abuse of the requesting spouse. (d)Legal obligation.Whetherthe requesting spouse or the nonrequesting spouse has a legal obligation to pay the outstanding Federal income tax liability. For purposes of this factor, a legal obliga- tion is an obligation arising from a divorce decree or other legally binding agreement. This factor will weigh in favor of relief if the nonrequesting spouse has the sole legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement. This factor, however, will be neutral if the requesting spouse knew or had reason to know, when entering into the divorce decree or agreement, that the nonrequesting spouse would not pay the income tax liability. This factor will weigh against relief if the requesting spouse has the sole legal obligation. The fact that the nonrequesting spouse has been relieved of liability for the taxes at issue as a result of a discharge in bankruptcy is disregarded in determining whether the requesting spouse has the sole legal obligation. This factor will be neutral if, based on an agreement or consent order, both spouses have a legal obligation to pay the outstanding income tax liability, the spouses are not sepa- rated or divorced, or the divorce decree or agreement is silent as to any obligation to pay the outstanding income tax liability. (e)Significant benefit.Whetherthe requesting spouse significantly benefit- ted from the unpaid income tax liabil- ity or understatement. See Treas. Reg. § 1.6015–2(d). A significant benefit is any benefit in excess of normal support. For example, if the requesting spouse en- joyed the benefits of a lavish lifestyle, such as owning luxury assets and taking expensive vacations, this factor will weigh against relief. If, however, the nonrequest- ing spouse controlled the household and business finances or there was abuse (as described in section 4.03(2)(c)(iv)) such that the nonrequesting spouse made the decision on spending funds for a lavish lifestyle, then this mitigates this factor so that it is neutral. If only the nonrequesting spouse significantly benefitted from the unpaid tax or understatement, and the re- questing spouse had little or no benefit, or the nonrequesting spouse enjoyed the ben- efit to the requesting spouse’s detriment, this factor will weigh in favor of relief. If the amount of unpaid tax or understate- ment was small such that neither spouse received a significant benefit, then this factor is neutral. Whether the amount of unpaid tax or understatement is small such that neither spouse received a significant benefit will vary depending on the facts and circumstances of each case. (f)Compliance with income tax laws. Whether the requesting spouse has made a good faith effort to comply with the in- come tax laws in the taxable years follow- ing the taxable year or years to which the request for relief relates. (i) If the requesting spouse is compliant for taxable years after being divorced from the nonrequesting spouse, then this factor will weigh in favor of relief. If the re- questing spouse is not compliant, then this factor will weigh against relief. If the re- questing spouse made a good faith effort to comply with the tax laws but was unable to fully comply, then this factor will be neu- tral. For example, if the requesting spouse timely filed an income tax return but was unable to fully pay the tax liability due to the requesting spouse’s poor financial or economic situation after the divorce, then this factor will be neutral. (ii) If the requesting spouse remains married to the nonrequesting spouse, whether or not legally separated or living apart, and continues to file joint returns with the nonrequesting spouse after re- questing relief, then this factor will be neutral if the joint returns are compliant October 21, 20134022013–43 I.R.B. with the tax laws, but will weigh against relief if the returns are not compliant. (iii) If the requesting spouse remains married to the nonrequesting spouse but files separate returns, this factor will weigh infavorofreliefiftherequestingspouseis compliant with the taxlaws and will weigh against relief if the requesting spouse is not compliant with the tax laws. If the request- ing spouse made a good faith effort to com- ply with the tax laws but was unable to fully comply, then this factor will be neu- tral. For example, if the requesting spouse timely filed an income tax return but was unable to fully pay the tax liability due to the requesting spouse’s poor financial or economic situation as a result of being sep- arated or living apart from the nonrequest- ing spouse, then this factor will be neutral. (g)Mental or physical health.Whether the requesting spouse was in poor physical or mental health. This factor will weigh infavorofreliefiftherequestingspouse was in poor mental or physical health at the time the return or returns for which the re- quest for relief relates were filed (or at the time the requesting spouse reasonably be- lieved the return or returns were filed), or at the time the requesting spouse requested relief. The Service will consider the na- ture, extent, and duration of the condition, including the ongoing economic impact of the illness. If the requesting spouse was in neither poor physical nor poor mental health, this factor is neutral. .04.Refunds. In both understatement and underpayment cases, a requesting spouse is eligible for a refund of sepa- rate payments made by the requesting spouse after July 22, 1998, if the request- ing spouse establishes that the funds used to make the payment for which a refund is sought were provided by the requesting spouse. A requesting spouse is not eligible for refunds of payments made with the joint return, joint payments, or payments that the nonrequesting spouse made. A re- questing spouse, however, may be eligible for a refund of the requesting spouse’s por- tion of the requesting and nonrequesting spouse’s joint overpayment from another tax year that was applied to the joint in- come tax liability to the extent that the requesting spouse can establish that the requesting spouse provided the funds for the overpayment. The availability of re- funds is subject to the refund limitations of section 6511. SECTION 5. PROCEDURE A requesting spouse seeking equi- table relief under section 66(c) or section 6015(f) must file Form 8857,Request for Innocent Spouse Relief (and Separation of Liability, and Equitable Relief),orother similar statement signed under penalties of perjury, within the applicable period of limitation as set forth in section 4.01(3) of this revenue procedure. SECTION 6. EFFECT ON OTHER DOCUMENTS Rev. Proc. 2003–61, 2003–2 C.B. 296, is modified and superseded. SECTION 7. EFFECTIVE DATE This revenue procedure is effective for requests for relief filed on or after Septem- ber 16, 2013. In addition, this revenue pro- cedure is effective for requests for equi- table relief pending on September 16, 2013 whether with the Service, the Office of Ap- peals, or in a case docketed with a Federal court. SECTION 8. DRAFTING INFORMATION The principal authors of this rev- enue procedure are Nancy Rose and Sheida Lahabi of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this revenue procedure contact Branches 1 or 2 of Procedure and Administration on (202) 622–4910 or (202) 622–4940 (not a toll free call). 2013–43 I.R.B.403October 21, 2013 Part IV. Items o fGeneralInterest Notice of Prop osed Rulemaking an dNoticeof Public Hearin g Guidance Rega rding Disposition s of Tangible Depreciable Property REG–110732–13 AGENCY:Internal Revenue Service (IRS), Treasury. ACTION:No tice of proposed rulemak- ing, notic e of public hearing, and partial withdrawa l of previously proposed regula- tions. SUMMARY:This document contains proposed regulations regarding disposi- tions of property subject to depreciation under section 168 of the Internal Rev- enue Code (Code) (Modified Accelerated Cost Recovery System (MACRS) prop- erty). The proposedregulations also amend the general asset account regula- tions under §1.168(i)–1 and the accounting for MACRS property regulations under §1.168(i)–7. The proposed regulations will affect all taxpayers that dispose of MACRS property. This document also provides notice of a public hearing on these proposed regulations and partially withdraws the proposed regulations pub- lished in theFederal Registeron Decem- ber 27, 2011 (76 FR 81128). DATES:Written and/or electronic com- ments must be received by November 18, 2013. Requests to speak and outlines of topics to be discussed at the public hear- ing scheduled for December 19, 2013, at 10 a.m. must be received by November 18, 2013. ADD RESSES:Send submissions to: CC: PA:LPD:PR (REG–110732–13), room 520 5, Internal Revenue Service, P.O. Box 760 4, Ben Franklin Station, Washington, DC 2 0044. Submissions may be hand-de- liv ered Monday through Friday between th e hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG–110732–13), Co urier’s Desk, Internal Revenue Ser- vi ce, 1111 Constitution Avenue, NW., Washington, D C 20224, or sent elec- tronically, v ia the Federal eRulemak- ing Portal atw ww.regulations.gov(IRS REG–110732–1 3). The public hearing will be held in the IRS Auditorium, Internal Rev enue Building, 1111 Constitutio n Avenue, NW., Washington, DC. FOR FURTHER INFORMATION CONTACT:Concerning the pro- posed regulations, Kathleen Reed and Patrick Clinton, Office of Associate Chief Counsel (Income Tax and Accounting) (202) 622–4930; and concerning submission of comments, the hearing, and/or to be placed on the building access list to attend the hearing, Oluwafunmilayo (Funmi) Taylor, (202) 622–7180 (not toll-free numbers). SUPPLEME NTARY INFORMATION: Background On Decembe r 27, 2011, the IRS and the Treas ury Department published in the Federal R egister(76 FR 81060) tem- porary re gulations (TD 9564) regarding the accou nting for, and dispositions of, propert y subject to depreciation under section 168 (MACRS property). The tempora ry regulations also amended the general asset account regulations under §1.168( i)–1. On the same date, the IRS publis hed in theFederal Register(76 FR 81128) a notice of proposed rulemaking (REG–1 68745–03) cross-referencing the tempor ary regulations (2011 proposed regula tions). The IRS and the Treasury Depar tment received numerous written comme nts responding to the notice of propo sed rulemaking and held a public heari ng on May 9, 2012. The te mporary regulations generally apply to taxable years beginning on or after Janua ry 1, 2012. In response to the com- ment s received and the statements made at the p ublic hearing, the IRS and the Trea- sury Department releasedNotice 2012–73, 2012 –51 I.R.B. 713, on November 20, 2012 , announcing that, to help taxpayers tran sition to the final regulations, the IRS and the Treasury Department will change the applicability date of the temporary reg ulations to taxable years beginning on or after Janua ry 1, 2014, while permitting taxpayers to c hoose to apply the temporary regulations t o taxable years beginning on or after Janua ry 1, 2012, and before the applicabilit y date of the final regulations. Notice 2012– 73 also alerts taxpayers that the IRS and th e Treasury Department in- tend to publi sh final regulations in 2013 and expect th e final regulations to apply to taxable y ears beginning on or after Jan- uary 1, 2014 , but that the final regulations would permi t taxpayers to apply the pro- visions of t he final regulations to taxable years begi nning on or after January 1, 2012. On De cember 17, 2012, the IRS and the Tre asury Department published in theFede ral Register(77 FR 74583) a technical amendment to TD 9564, which amended t he applicability date of the temporar y regulations to taxable years be- ginning o n or after January 1, 2014, while permitti ng taxpayers to choose to apply the temp orary regulations to taxable years beginni ng on or after January 1, 2012, and before t he applicability date of the final regulat ions. Notice 2 012–73 also alerts taxpayers that the IRS and the Treasury Department intend t o revise the disposition rules in the tempor ary regulations. After considering the com ment letters and the statements made at the public hearing, the IRS and the Tre asury Department decided to with- draw th e 2011 proposed regulations under §§1.1 68(i)–1 and 1.168(i)–8 and to pro- pose n ew regulations. This document conta ins the new proposed regulations under §§1.168(i)–1 and 1.168(i)–8 as well a s new proposed regulations under §1.1 68(i)–7. The temporary regulations unde r §§1.168(i)–1T and 1.168(i)–8T are not r evised and taxpayers continue to have the o ption of applying those temporary regu lations to taxable years beginning on or af ter January 1, 2012, and before the app licability date of the final regulations. Sum mary of Comments and Exp lanation of Provisions I.O verview The se proposed regulations under §§1 .168(i)–1 and 1.168(i)–8 include many of t he provisions contained in the 2011 pro posed regulations and the temporary October 21, 20134042013–43 I.R.B. regulations under §§1.168(i)–1T and 1.168(i)–8T. However, these proposed regulations provide significant changes to the rules relating to the determination of the asset disposed of and a qualify- ing disposition of an asset in a general asset account, and the proposed regu- lations under §§1.168(i)–1, 1.168(i)–7, and 1.168(i)–8 provide new rules for par- tial dispositions of assets. The IRS and the Treasury Department intend to pub- lish final regulations under §§1.168(i)–1, 1.168(i)–7, and 1.168(i)–8 later this year. Accordingly, these proposed regulations generally are proposed to apply to taxable years beginning on or after January 1, 2014. II.Disposition Rules for MACRS Property The IRS and the Treasury Department received several comments on the dis- position rules under §§1.168(i)–1T and 1.168(i)–8T. Most of the comments related to dispositions of structural components of a building, dispositions of assets in a general asset account, and determination of the unadjusted depreciable basis of a disposed asset in a multiple asset account or a general asset account. A.Determination of Asset Disposed Of and Partial Dispositions 1. The temporary regulations The temporary regulations under §1.168(i)–8T provide rules for determin- ing gain or loss upon the disposition of MACRS property that are generally con- sistent with the disposition rules under §1.168–6 of the proposed regulations on the Accelerated Cost Recovery System of former section 168 (ACRS) (which have been generally applied to MACRS prop- erty). However, if anabandoned asset is subject to nonrecourseindebtedness, the temporary regulations clarify that the asset is treated in the same manner as an asset disposed of by sale. Section 1.168–2(l)(1) of the proposed ACRS regulations provides that a dispo- sition does not include the retirement of a structural component of a building and, consequently, §1.168–6(b) of the proposed ACRS regulations provides that no loss is recognized upon the retirement of a struc- tural component of a building. The tem- porary regulations expand the definition of disposition for MACRS property to in- clude the retirement of a structural com- ponent of a building and, accordingly, the temporary regulations allow the recogni- tion of a loss upon such a retirement. The temporary regulations under §1.168(i)–1T provide rules for establish- ing general asset accounts, for computing depreciation for general asset accounts, and for determining gain or loss upon the disposition of assets in general as- set accounts. Section 1.168(i)–1T(e)(2) provides that, in general, no loss is rec- ognized upon the disposition of an asset from a general asset account. However, §1.168–1T(e)(3)(iii) provides that a tax- payer may elect to recognize gain or loss upon the disposition of an asset in a gen- eral asset account if there is a qualifying disposition. The temporary regulations define the term “disposition” to include the retirement of a structural component of a building and define the term “quali- fying disposition” to allow the recognition of gain or loss upon most dispositions of assets in general asset accounts. Thus, a taxpayer has the option of recognizing a loss on most dispositions of assets in gen- eral asset accounts under the temporary regulations. The temporary regulations under §§1.168(i)–1T and 1.168(i)–8T also pro- vide rules for determining the disposed asset. Those sections of the temporary regulations provide that the facts and circumstances of each disposition are considered in determining the appro- priate disposed asset. In general, the asset for disposition purposes cannot be larger than the unit of property as deter- mined under §1.263(a)–3(e)(2), (e)(3), and (e)(5) or as otherwise provided in published guidance in theFederal Reg- isteror in the Internal Revenue Bul- letin. However, under §§1.168(i)–1T and 1.168(i)–8T, each building is the asset for disposition purposes, unless more than one building is treated as the asset un- der §1.1250–1(a)(2)(ii). If the building includes two or more condominium or cooperative units, then each condominium or cooperative unit (instead of the build- ing) is the asset for disposition purposes. Consistent with including a retirement of a structural component of a building as a disposition, the temporary regulations provide that each structural component of a building, condominium unit, or co- operative unit is the asset for disposition purposes. Further, if a taxpayer prop- erly includes an item in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87–56 (1987–2 C.B. 674), (see 26 CFR 601.601(d)(2)(ii)(b)) or classifies an item in one of the categories under section 168(e)(3) (other than a category that in- cludes buildings or structural components; for example, retail motor fuels outlet and qualified leasehold improvement prop- erty), each item is the asset provided it is not larger than the unit of property as determined under §1.263(a)–3(e)(3) or (e)(5). Consistent with section 168(i)(6), the temporary regulations also provide that if the taxpayer places in service an improvement or addition to an asset after the taxpayer placed the asset in service, the improvement or addition is a sepa- rate asset for depreciation purposes. The temporary regulations also provide that a taxpayer generally may use any reason- able, consistent method to treat each of an asset’s components as the asset for dispo- sition purposes. 2. Comments on the temporary regulations Several commenters stated that requir- ing taxpayers to treat the structural compo- nents of a building as assets separate from the underlying building increases admin- istrative burdens for taxpayers because of the necessity to track the components. Fur- ther, while the temporary regulations per- mit taxpayers to define the asset for dis- position purposes at the smallest compo- nent level, effectively allowing taxpayers the ability to recognize a loss on the par- tial retirement of a larger item, some com- menters indicated that such an approach is unduly complicated and will pose sig- nificant administrative burdens for taxpay- ers. Other commenters suggested that the ability to use any reasonable, consistent method to treat each of an asset’s compo- nents as the asset for disposition purposes be expanded to assets classified in asset classes 00.11 through 00.4 of Rev. Proc. 87–56, which accounts for the property that a taxpayer typically uses in its busi- ness (for example, office furniture, com- puters, cars, corporate jets, and land im- provements (other than a building and its structural components)). Several commenters suggested that the use of general asset accounts be the default 2013–43 I.R.B.405October 21, 2013 rule to eliminate traps for taxpayers. Com- menters stated that requiring taxpayers to make a general asset account election when structural components are placed in service to forgo the loss on dispositions of structural components occurring years later was a trap for taxpayers. For exam- ple, because a taxpayer that did not elect general asset account treatment cannot forgo a mandatory loss on a disposition of a structural component, the taxpayer would be required to capitalize the re- placement of the structural component under §1.263(a)–3(k)(1)(i) even if the replacement of the structural component does not constitute the replacement of a major component, a significant portion of a major component, or a substantial structural part of the building unit of prop- erty under §§1.263(a)–3(k)(1)(vi) and 1.263(a)–3(k)(6)(ii). Further, because some structural components are defined in §1.48–1(e)(2) at a diminutive level (for example, one window in a building), com- menters stated that absent including all structural components in a general asset account, taxpayers run the risk of failing to identify every disposition in a given taxable year. The IRS and the Treasury Department do not think that the use of general asset accounts should be the default rule. How- ever, the IRS and the Treasury Department agree that taxpayers that do not elect gen- eral asset account treatment should have the same flexibility to forgo a loss upon the disposition of a structural component as taxpayers that elect general asset account treatment. As discussed in this preamble, these proposed regulations make signifi- cant modifications to the disposition rules to allow this flexibility. 3. Structural components These proposed regulations change the rule in the temporary regulations under §§1.168(i)–1T and 1.168(i)–8T that each structural component of a building, condo- minium, or cooperative is the asset for tax disposition purposes. The proposed regu- lations provide that a building (including its structural components), a condominium (including its structural components), or a cooperative (including its structural com- ponents) is the asset for disposition pur- poses. This rule allows taxpayers to forgo a loss upon the disposition of a structural component of a building without making a general asset account election. 4. Partial dispositions A. Assets not included in general asset accounts The proposed regulations under §1.168(i)–8 also provide that the disposi- tion rules apply to a partial disposition of an asset (for example, the disposition of a roof (or a portion of the roof)). This rule allows taxpayers to claim a loss upon the disposition of a structural component (or a portion thereof) of a building or upon the disposition of a component (or a portion thereof) of any other asset without iden- tifying the component as an asset before the disposition event. The partial dispo- sition rule also minimizes circumstances in which an original part and any subse- quent replacements of the same part are required to be capitalized and depreciated simultaneously. These proposed regula- tions provide examples demonstrating the application of the partial disposition rule. In many cases, the partial disposition rule is elective (“partial disposition elec- tion”). However, consistent with the oper- ation of sections 165, 168(i)(7), 1031, and 1033, and because sales of a portion of an asset are common, the partial disposition rule is required to be applied to a disposi- tion of a portion of an asset as a result of a casualty event described in section 165, to a disposition of a portion of an asset for which gain (determined without regard to section 1245 or 1250) is not recognized inwholeorinpartundersection1031or 1033, to a transfer of a portion of an as- set in a step-in-the-shoes transaction de- scribed in section 168(i)(7)(B), or to a sale of a portion of an asset. Consequently, a disposition includes a disposition of a por- tion of an asset under these circumstances, even if the taxpayer does not make the par- tial disposition election for that disposed portion. For other transactions, a disposi- tion includes a disposition of a portion of an asset only if the taxpayer makes the par- tial disposition election for that disposed portion. A taxpayer may make the partial dispo- sition election for the disposition of a por- tion of any type of MACRS property, in- cluding an asset that is properly included in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87–56. However, con- sistent with section 168(i)(6), a taxpayer making the partial disposition election for the disposition of a portion of an asset that is properly included in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87–56 must classify the replacement por- tion of the asset under the same asset class as the disposed portion of the asset. The partial disposition election is made on the taxpayer’s timely filed original Fed- eral tax return, including extensions, for the taxable year in which the portion of the asset is disposed of by the taxpayer. This election may not be made or revoked by the filing of an application for a change in method of accounting. A taxpayer may re- voke a partial disposition election by fil- ing a request for a letter ruling and ob- taining the consent of the Commissioner of Internal Revenue to revoke this elec- tion. The Commissioner may grant a re- quest to revoke this election if the taxpayer acted reasonably and in good faith, and the revocation will not prejudice the interests of the Government. In deciding whether to grant such a request, the Commissioner anticipates applying standards similar to the standards under 26 CFR 301.9100–3 for granting extensions of time for mak- ing regulatory elections. If a taxpayer chooses to apply these proposed regula- tions to its taxable year beginning in 2012 or 2013, these proposed regulations also provide rules for making the partial dispo- sition election for the portion of an asset disposed of by the taxpayer during those taxable years. These proposed regulations also pro- vide a special partial disposition rule to ad- dress commenters’ concerns about the ef- fect of an IRS disallowance of a taxpayer’s characterization of the replacement of a portion of an asset as a repair. When the IRS disallows a taxpayer’s repair deduc- tion for the amount paid or incurred for the replacement of a portion of an asset and capitalizes such amount under §1.263(a)–2 or §1.263(a)–3, the taxpayer may make the partial disposition election for the disposi- tion of the portion of the asset to which the IRS’s adjustment pertains by filing an ap- plication for change in accounting method, provided the asset of which the disposed portion was a part is owned by the taxpayer at the beginning of the year of change (as defined for purposes of section 446(e)). October 21, 20134062013–43 I.R.B. B. Assets included in general asset accounts Similarly, the proposed regulations un- der §1.168(i)–1 also provide that the dis- position rules apply to a partial disposi- tion of an asset included in a general as- set account. Consequently, a disposition includes a disposition of a portion of an as- set as a result of a casualty event described in section 165, a disposition of a portion of an asset for which gain (determined with- out regard to section 1245 or 1250) is not recognized in whole or in part under sec- tion 1031 or 1033, a transfer of a portion of an asset in a transaction described in sec- tion 168(i)(7)(B), a sale of a portion of an asset, or a disposition of a portion of an asset in a transaction described under the anti-abuse rules applicable to general as- set accounts. For other transactions, a dis- position includes a disposition of a portion of an asset only if the taxpayer makes the election to terminate the general asset ac- count upon the disposition of all assets, in- cluding that disposed portion, in that gen- eral asset account or makes the qualifying disposition election for that disposed por- tion. A separate partial disposition elec- tion is not provided for assets in a general asset account because a taxpayer can claim a loss upon the disposition of an asset (or a portion thereof) in a general asset account only when the taxpayer makes these two elections. 5. Components of an asset Because the partial disposition rule under these proposed regulations allows taxpayers to treat the disposition of an as- set’s component as a disposition, the IRS and the Treasury Department believe that the rule in §§1.168(i)–1T and 1.168(i)–8T allowing taxpayers to use any reason- able, consistent method to treat an asset’s components as the asset for disposition purposes is no longer needed. Accord- ingly, these proposed regulations do not include that temporary regulations rule. The IRS and the Treasury Department request comments addressing whether the rule in §§1.168(i)–1T and 1.168(i)–8T allowing taxpayers to use any reason- able, consistent method to treat an asset’s components as the asset for disposition purposes is still needed. 6. Disposition definition Consistent with these changes, these proposed regulations modify the tempo- rary regulations’ definition of a disposition under §§1.168(i)–1T and 1.168(i)–8T to provide that a disposition includes the disposition of a structural component (or a portion thereof) of a building only if the partial disposition rule applies to such structural component (or a portion thereof). 7. General asset accounts Finally, these proposed regulations change the temporary regulation defi- nition of a qualifying disposition under §1.168(i)–1T(e)(3)(iii). The purpose of a general asset account is to reduce the ad- ministrative burden of tracking deprecia- ble assets. This purpose was accomplished in the final regulations for general asset accounts under §1.168(i)–1 (as in effect before the temporary regulations under §1.168(i)–1T) by allowing a taxpayer to group assets in one or more general asset accounts and by allowing a taxpayer to elect to terminate general asset account treatment only when the taxpayer disposes of all of the assets, or the last asset, in the account, or disposes of an asset in a qual- ifying disposition, which generally was a casualty or other extraordinary event. The temporary regulations under §1.168(i)–1T expand a qualifying disposition to include generally any disposition and, as a result, increased the administrative burden of tracking depreciable assets. To reduce this burden, the IRS and the Treasury Depart- ment have decided to change the definition of a qualifying disposition so that it is the same as it was under the final regu- lations for general asset accounts under §1.168(i)–1 (as in effect before the tem- porary regulations under §1.168(i)–1T). Accordingly, these proposed regulations provide that a qualifying disposition is a disposition that does not involve all the assets, the last asset, or the remaining portion of the last asset, remaining in a general asset account and that is: (1) a direct result of a fire,storm, shipwreck, or other casualty, or from theft; (2) a chari- table contribution for which a deduction is allowable under section 170; (3) a di- rect result of a cessation, termination, or disposition of a business, manufacturing, or other income producing process, oper- ation, facility, plant, or other unit (other than by transfer to a supplies, scrap, or similar account); or (4) generally a trans- action to which a nonrecognition section of the Code applies. B.Determination of Basis and Identification of Disposed or Converted Asset The temporary regulations under §§1.168(i)–1T and 1.168(i)–8T provide that if the disposed asset is in a general as- set account, is in a multiple asset account, or is a component of a larger asset, and it is impracticable from the taxpayer’s records to determine the unadjusted depreciable basis of the disposed asset, the taxpayer may use any reasonable method that is consistently applied to the taxpayer’s general asset accounts, multiple asset ac- counts, or larger assets, as applicable. Several commenters requested that one or more specific methodologies be pro- vided. They suggested using replacement cost adjusted for inflation using an objec- tive index, using third-party construction estimating and valuation services, or using relative fair market value of acquired com- ponents. In response, these proposed regulations provide nonexclusive examples of reason- able methods. Such examples include: (1) discounting the cost ofthe replacement as- set to its placed-in-service year cost using the Consumer Price Index; (2) apro rata allocation of the unadjusted depreciable basis of the general asset account or mul- tiple asset account, as applicable, based on the replacement cost of the disposed asset and the replacement cost of all of the as- sets in the general asset account or multi- ple asset account, as applicable; and (3) a study allocating the cost of the asset to its individual components. The IRS and the Treasury Department expect that reason- able methods are available that use infor- mation readily available or known to the taxpayer and do not necessitate undertak- ing expensive studies. As previously mentioned, these pro- posed regulations do not include the tem- porary regulation rule in §§1.168(i)–1T and 1.168(i)–8T that allows taxpayers to use any reasonable, consistent method to treat an asset’s components as the asset for tax disposition purposes. Consistent with 2013–43 I.R.B.407October 21, 2013 this change, these proposed regulations do not include the temporary regulation rules in §§1.168(i)–1T and 1.168(i)–8T regard- ing the determination of the unadjusted depreciable basis, and identification, of the disposed component of a larger as- set. However, these proposed regulations provide rules regarding the determination of the unadjusted depreciable basis, and identification, of the disposed portion of an asset when the partial disposition rule applies. If the partial disposition rule applies, these proposed regulations provide that a taxpayer may use any reasonable method for determining the unadjusted deprecia- ble basis of the disposed portion of the asset. Also, if a taxpayer disposes of more than one portion of the same asset, the tax- payer may use any reasonable method that is consistently applied to all portions of the same asset for purposes of determining the unadjusted depreciable basis of each disposed portion of the asset. These pro- posed regulations provide nonexclusive examples of reasonable methods. If a taxpayer disposes of a portion of the asset and the partial disposition rule applies to that disposition, these proposed regulations provide rules regarding the identification of the asset. When it is im- practicable from the taxpayer’s records to determine the particular taxable year in which the asset was placed in service by the taxpayer, the taxpayer must identify the asset by using the methods allowed when the asset is in a general asset account or a multiple asset account: the first-in, first-out (FIFO) method, the modified FIFO method, a mortality dispersion table if the asset is a mass asset, or any other method designated by the Secretary in published guidance. A last-in, first-out (LIFO) method is not permitted. C.Other Changes The proposed regulations under §1.168(i)–8 provide that if a taxpayer disposes of a portion of an asset and the partial disposition rule applies to that dis- position, the taxpayer must account for the disposed portion in a single asset account beginning in the taxable year in which the disposition occurs. This new rule also is provided in the proposed regulations under §1.168(i)–7. The proposed regulations under §§1.168(i)–1 and 1.168(i)–8 also provide examples demonstrating the interaction between the disposition rules and the cap- italization of tangible property rules under §1.263(a)–3. Proposed Effective Date These regulations are proposed to ap- ply to taxable years beginning on or after January 1, 2014. The regulations also per- mit taxpayers to rely on the provisions of the proposed regulations for taxable years beginning on or after January 1, 2012, and before the applicability date of the final regulations. The proposed regula- tions provide that taxpayers may apply the provisions of the final regulations to tax- able years beginning on or after January 1, 2012. The temporary regulations under §§1.168(i)–1T and 1.168(i)–8T allow tax- payers to apply the temporary regulations to taxable years beginning on or after Jan- uary 1, 2012, but the final regulations will provide that taxpayers may not apply the temporary regulations to taxable years be- ginning on or after January 1, 2014. Special Analyses It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Execu- tive Order 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Ad- ministrative Procedure Act (5 U.S.C. chap- ter 5) does not apply to these regulations, and because these regulations do not im- pose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this regula- tion has been submitted to the Chief Coun- sel for Advocacy of the Small Business Administration for comment on its impact on small business. Comments and Public Hearing Before the proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the “Addresses” heading. The IRS and the Treasury De- partment request comments on all aspects of these proposed rules. All comments will be available for public inspection and copying atwww.regulations.govor upon request. A public hearing has been scheduled for December 19, 2013, beginning at 10 a.m. in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, DC. Due to building security procedures, visitors must enter at the Con- stitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediateentrance area more than 30 minutes beforethe hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER IN- FORMATION CONTACT” section of this preamble. The rules of 26 CFR 601.601(a)(3) ap- ply to the hearing. Persons who wish to present oral comments at the hearing must submit electronic or written comments, an outline of the topics to be discussed, and the time to be devoted to each topic (signed original and eight (8) copies) by Novem- ber 18, 2013. A period of 10 minutes will be allotted to each person for making com- ments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receivingoutlines has passed. Copies of the agenda will be available free of charge at the hearing. Statement of Availability for IRS Document For copies of recently issued Revenue Procedures, Revenue Rulings, notices and other guidance published in the In- ternal Revenue Bulletin or Cumulative Bulletin please visit the IRS website at http://www.irs.gov. Drafting Information The principal author of these regula- tions is Kathleen Reed, Office of the Asso- ciate Chief Counsel (Income Tax and Ac- counting). However, other personnel from the IRS and the Treasury Department par- ticipated in their development. ***** October 21, 20134082013–43 I.R.B. Partial Withdrawal of Proposed Amendments to the Regulations Accordingly, under the authority of 26 U.S.C. 7805, §§1.168(i)–1 and 1.168(i)–8 of the notice of proposed rulemaking (REG–168745–03) that was published in theFederal Registeron December 27, 2011 (76 FR 81128), are withdrawn. Proposed Amendment to the Regulations Accordingly, 26 CFR part 1 is proposed to be amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read in part as follows: Authority: 26 U.S.C. 7805 * * * Section 1.168(i)–1 also issued under 26 U.S.C. 168(i)(4). * * * Par. 2. In §1.168(i)–0, the entries under §1.168(i)–1 are amended by: 1. Redesignating the entries for para- graphs (b)(4), (b)(5), and (b)(6) as newly- designated entries for paragraphs (b)(5), (b)(6), and (b)(7). 2. Adding entries for paragraphs (b)(4), (b)(8), and (b)(9). 3. Revising the entries for newly-des- ignated paragraphs (b)(6) and (b)(7). 4. Revising entries for paragraphs (c)(3), (d)(2), (d)(3), (e), (e)(2)(v) through (viii), (e)(3)(vi), (h)(1), (i), and (m). 5. Removing the entry for paragraph (h)(2). 6. Redesignating the entries for para- graph (h)(3) as newly-designated entries for paragraph (h)(2). The additions and revisions read as fol- lows: §1.168(i)–0 Table of contents for the general asset account rules. ***** §1.168(i)–1 General asset accounts. ***** (b) * * * (4) Building. *** (6) Mass assets. (7) Portion of an asset. (8) Remaining adjusted depreciable ba- sis of the general asset account. (9) Structural component. (c) * * * (3) Examples. ***** (d) * * * (2) Assets in general asset account are eligible for additional first year deprecia- tion deduction. (3) No assets in general asset account are eligible for additional first year depre- ciation deduction. ***** (e) Dispositions from a general asset ac- count. ***** (2) * * * (v) Manner of disposition. (vi) Disposition by transfer to a supplies account. (vii) Leasehold improvements. (viii) Determination of asset disposed of. ***** (3) * * * (vi) Technical termination of a partner- ship. ***** (h) * * * (1) Conversion to any personal use. ***** (i) Redetermination of basis. ***** (m) Effective/applicability date. Par. 3. Section1.168(i)–1isamended by revising paragraphs (a) through (l)(1), and paragraph (m), to read as follows: §1.168(i)–1 General asset accounts. (a)Scope. This section provides rules for general asset accounts under section 168(i)(4). The provisions of this section applyonlytoassetsforwhichanelection has been made under paragraph (l) of this section. (b)Definitions. For purposes of this section, the following definitions apply: (1)Unadjusted depreciable basishas the same meaning given such term in §1.168(b)–1(a)(3). (2)Unadjusted depreciable basis of the general asset accountis the sum of the unadjusted depreciable bases of all assets included in the general asset account. (3)Adjusted depreciable basis of the general asset accountis the unadjusted de- preciable basis of the general asset account less the adjustments to basis described in section 1016(a)(2) and (3). (4)Buildinghas the same meaning as that term is defined in §1.48–1(e)(1). (5)Expensed cost is the amount of any allowable credit or deduction treated as a deduction allowable for depreciation or amortization for purposes of section 1245 (for example, a creditallowable under sec- tion 30 or a deduction allowable under sec- tion 179, 179A, or 190). Expensed cost does not include any additional first year depreciation deduction. (6)Mass assetsis a mass or group of individual items of depreciable assets— (i) That are not necessarily homoge- nous; (ii) Each of which is minor in value relative to the total value of the mass or group; (iii) Numerous in quantity; (iv) Usually accounted for only on a total dollar or quantity basis; (v) With respect to which separate iden- tification is impracticable; and (vi) Placed in service in the same tax- able year. (7)Portionofanassetis any part of an asset that is less than the entire asset as determined under paragraph (e)(2)(viii) of this section. (8)Remaining adjusted depreciable ba- sisofthegeneralassetaccountis the un- adjusted depreciable basis of the general asset account less the amount of the addi- tional first year depreciation deduction al- lowed or allowable, whichever is greater, for the general asset account. (9)Structural componenthas the same meaning as that term is defined in §1.48–1(e)(2). (c)Establishment of general asset ac- counts—(1)Assets eligible for general as- set accounts—(i)General rules. Assets that are subject to either the general de- preciation system of section 168(a) or the alternative depreciation system of section 168(g) may be accounted for in one or more general asset accounts. An asset is included in a general asset account only to the extent of the asset’s unadjusted depre- ciable basis. However, an asset is not to be included in a general asset account if the asset is used both in a trade or business (or for the production of income) and in a per- sonal activity at any time during the tax- able year in which the asset is placed in ser- vice by the taxpayer or if the asset is placed 2013–43 I.R.B.409October 21, 2013 in service and disposed of during the same taxable year. (ii)Special rules for assets generat- ing foreign source income. (A) Assets that generate foreign source income, both United States and foreign source income, or combined gross income of a foreign sales corporation (FSC) (as defined in for- mer section 922), domestic international sales corporation (DISC) (as defined in section 992(a)), or possessions corpora- tion (as defined in section 936) and its related supplier may be included in a gen- eral asset account if the requirements of paragraph (c)(2)(i) of this section are sat- isfied. If, however, the inclusion of these assets in a general asset account results in a substantial distortion of income, the Commissioner may disregard the general asset account election and make any real- locations of income or expense necessary to clearly reflect income. (B) A general asset account shall be treated as a single asset for purposes of applying the rules in §1.861–9T(g)(3) (relating to allocation and apportion- ment of interest expense under the asset method). A general asset account that generates income in more than one group- ing of income (statutory and residual) is a multiple category asset (as defined in §1.861–9T(g)(3)(ii)), and the income yield from the general asset account must be determined by applying the rules for multiple category assets as if the general asset account were a single asset. (2)Grouping assets in general asset ac- counts—(i)General rules. If a taxpayer makes the election under paragraph (l) of this section, assets that are subject to the election are grouped into one or more gen- eral asset accounts. Assets that are eligible to be grouped into a single general asset ac- count may be divided into more than one general asset account. Each general asset account must include only assets that— (A) Have the same applicable deprecia- tion method; (B) Have the same applicable recovery period; (C) Have the same applicable conven- tion; and (D) Are placed in service by the tax- payer in the same taxable year. (ii)Special rules.Inadditiontothegen- eral rules in paragraph (c)(2)(i) of this sec- tion, the following rules apply when estab- lishing general asset accounts— (A) Assets subject to the mid-quarter convention may only be grouped into a general asset account with assets that are placed in service in the same quarter of the taxable year; (B) Assets subject to the mid-month convention may only be grouped into a general asset account with assets that are placed in service in the same month of the taxable year; (C) Passenger automobiles for which the depreciation allowance is limited un- der section 280F(a) must be grouped into a separate general asset account; (D) Assets not eligible for any addi- tional first year depreciation deduction (including assets for which the taxpayer elected not to deduct the additional first year depreciation) provided by, for ex- ample, section 168(k), 168(l), 168(m), 168(n), 1400L(b), or 1400N(d), must be grouped into a separate general asset ac- count; (E) Assets eligible for the additional first year depreciation deduction may only be grouped into a general asset account with assets for which the taxpayer claimed the same percentage of the additional first year depreciation (for example, 30 percent, 50 percent, or 100 percent); (F) Except for passenger automobiles described in paragraph (c)(2)(ii)(C) of this section, listed property (as defined in sec- tion 280F(d)(4)) must be grouped into a separate general asset account; (G) Assets for which the depreciation allowance for the placed-in-service year is not determined by using an optional depre- ciation table (for further guidance, see sec- tion 8 of Rev. Proc. 87–57, 1987–2 C.B. 687, 693 (see §601.601(d)(2) of this chap- ter)) must be grouped into a separate gen- eral asset account; (H) Mass assets that are or will be sub- ject to paragraph (j)(2)(i)(D) of this sec- tion (disposed of or converted mass asset is identified by a mortality dispersion ta- ble) must be grouped into a separate gen- eral asset account; and (I) Assets subject to paragraph (h)(2)(iii)(A) of this section (change in use results in a shorter recovery period or a more accelerated depreciation method) for which the depreciation allowance for the year of change (as defined in §1.168(i)–4(a)) is not determined by us- ing an optional depreciation table must be grouped into a separate general asset account. (3)Examples. The following exam- ples illustrate the application of this para- graph (c). For purposes of these exam- ples, assume that section 168 as in effect on September 19, 2013, applies to tax- able years beginning on or after January 1, 2014. Example 1. In 2014, J, a proprietorship with a cal- endar year-end, purchases and places in service one item of equipment that costs $550,000. This equip- ment is section 179 property and also is 5-year prop- erty under section 168(e). On its Federal tax return for 2014, J makes an election under section 179 to ex- pense $25,000 of the equipment’s cost and makes an election under paragraph (l) of this section to include the equipment in a generalasset account. As a result, the unadjusted depreciable basis of the equipment is $525,000. In accordance with paragraph (c)(1) of this section, J must include only $525,000 of the equip- ment’s cost in the general asset account. Example 2. In 2014, K, a proprietorship with a calendar year-end, purchases and places in service 100 items of equipment. All of these items are 5-year property under section 168(e), are not listed property, and are not eligible for any additional first year depre- ciation deduction. On its Federal tax return for 2014, K does not make an election under section 179 to ex- pense the cost of any of the 100 items of equipment and does make an election under paragraph (l) of this section to include the 100 items of equipment in a general asset account. K depreciates its 5-year prop- erty placed in service in 2014 using the optional de- preciation table that corresponds with the general de- preciation system, the 200-percent declining balance method, a 5-year recovery period, and the half-year convention. In accordance with paragraph (c)(2) of this section, K includes all of the 100 items of equip- ment in one general asset account. Example 3. The facts are the same as inExample 2 , except that K decides not to include all of the 100 items of equipment in one general asset account. In- stead and in accordance with paragraph (c)(2) of this section, K establishes 100 general asset accounts and includes one item of equipment in each general asset account. Example 4. L, a calendar-year corporation, is a wholesale distributer. In 2014, L places in service the following properties for use in its wholesale distribu- tion business: computers, automobiles, and forklifts. On its Federal tax return for 2014, L does not make an election under section 179 to expense the cost of any of these items of equipment and does make an election under paragraph (l) of this section to include all of these items of equipment in a general asset ac- count. All of these items are 5-year property under section 168(e) and are not eligible for any additional first year depreciation deduction. The computers are listed property, and the automobiles are listed prop- erty and are subject to section 280F(a). L depreciates its 5-year property placed in service in 2014 using the optional depreciation table that corresponds with the general depreciation system, the 200-percent declin- ing balance method, a 5-year recovery period, and the half-year convention. Although the computers, auto- mobiles, and forklifts are 5-year property, L cannot October 21, 20134102013–43 I.R.B. include all of them in one general asset account be- cause the computers and automobiles are listed prop- erty. Further, even though the computers and automo- biles are listed property, L cannot include them in one general asset account because the automobiles also are subject to section 280F(a). In accordance with paragraph (c)(2) of this section, L establishes three general asset accounts: one for the computers, one for the automobiles, and one for the forklifts. Example 5. M, a fiscal-year corporation with a taxable year ending June 30, purchases and places in service ten items of new equipment in October 2014, and purchases and places in service five other items of new equipment in February 2015. On its Federal tax return for the taxable year ending June 30, 2015, M does not make an election under sec- tion 179 to expense the cost of any of these items of equipment and does make an election under para- graph (l) of this section to include all of these items of equipment in a general asset account. All of these items of equipment are 7-year property under section 168(e), are not listed property, and are property de- scribed in section 168(k)(2)(B). All of the ten items of equipment placed in service in October 2014 are eligible for the 50-percent additional first year de- preciation deduction provided by section 168(k)(1). All of the five items of equipment placed in service in February 2015 are not eligible for any additional first year depreciation deduction. M depreciates its 7-year property placed in service for the taxable year ending June 30, 2015, using the optional depreciation table that corresponds with the general depreciation system, the 200-percent declining balance method, a 7-year recovery period, and the half-year convention. Although the 15 items of equipment are depreciated using the same depreciation method, recovery period, and convention, M cannot include all of them in one general asset account because some of items of equip- ment are not eligible for any additional first year de- preciation deduction. In accordance with paragraph (c)(2) of this section, M establishes two general asset accounts: one for the ten items of equipment eligible for the 50-percent additional first year depreciation deduction and one for the five items of equipment not eligible for any additional first year depreciation de- duction. (d)Determination of depreciation al- lowance—(1)In general. Depreciation allowances are determined for each gen- eral asset account. The depreciation al- lowances must be recorded in a deprecia- tion reserve account for each general as- set account. The allowance for depre- ciation under this section constitutes the amount of depreciation allowable under section 167(a). (2)Assets in general asset account are eligible for additional first year deprecia- tion deduction. If all the assets in a gen- eral asset account are eligible for the ad- ditional first year depreciation deduction, the taxpayer first must determine the al- lowable additional first year depreciation deduction for the general asset account for the placed-in-service year and then must determine the amount otherwise allowable as a depreciation deduction for the gen- eral asset account for the placed-in-service year and any subsequent taxable year. The allowable additional first year depreciation deduction for the general asset account for the placed-in-serviceyear is determined by multiplying the unadjusted depreciable ba- sis of the general asset account by the ad- ditional first year depreciation deduction percentage applicable to the assets in the account (for example, 30 percent, 50 per- cent, or 100 percent). The remaining ad- justed depreciable basis of the general as- set account then is depreciated using the applicable depreciation method, recovery period, and convention for the assets in the account. (3)No assets in general asset account are eligible for additional first year depre- ciation deduction. If none of the assets in a general asset account are eligible for the additional first year depreciation de- duction, the taxpayer must determine the allowable depreciation deduction for the general asset account for the placed-in- service year and any subsequent taxable year by using the applicable depreciation method, recovery period, and convention for the assets in the account. (4)Special rule for passenger automo- biles. For purposes of applying section 280F(a), the depreciation allowance for a general asset account established for passenger automobiles is limited for each taxable year to the amount prescribed in section 280F(a) multiplied by the excess of the number of automobiles originally included in the account over the number of automobiles disposed of during the taxable year or in any prior taxable year in a trans- action described in paragraphs (e)(3)(iii) (disposition of an asset in a qualifying dis- position), (e)(3)(iv) (transactions subject to section 168(i)(7)), (e)(3)(v) (transac- tions subject to section 1031 or section 1033), (e)(3)(vi) (technical termination of a partnership), (e)(3)(vii) (anti-abuse rule), (g) (assets subject to recapture), (h)(1) (conversion topersonal use), or (h)(2) (business or income-producing use percentage changes) of this section. (e)Dispositions from a general asset account—(1)Scope and Definition—(i) In general. This paragraph (e) provides rules applicable to dispositions of assets included in a general asset account. For purposes of this paragraph (e), an asset in a general asset account is disposed of when ownership of the asset is transferred or when the asset is permanently withdrawn from use either in the taxpayer’s trade or business or in the production of income. A disposition includes the sale, exchange, retirement, physical abandonment, or de- struction of an asset. A disposition also occurs when an asset is transferred to a supplies, scrap, or similar account, or when a portion of an asset is disposed of as described in paragraph (e)(1)(ii) of this section. If a structural component (or a portion thereof) of a building is disposed of in a disposition described in paragraph (e)(1)(ii) of this section, a disposition also includes the disposition of such structural component (or such portion thereof). (ii)Disposition of a portion of an asset. For purposes of applying paragraph (e) of this section, a disposition includes a dispo- sition of a portion of an asset in a general asset account as a resultof a casualty event described in section 165, a disposition of a portion of an asset in a general asset ac- count for which gain (determined without regard to section 1245 or section 1250) is not recognized in whole or in part under section 1031 or section 1033, a transfer of a portion of an asset in a general asset ac- count in a transaction described in section 168(i)(7)(B), a sale of a portion of an as- set in a general asset account, or a dispo- sition of a portion of an asset in a gen- eral asset account in a transaction is de- scribed in paragraph (e)(3)(vii)(B) of this section. For other transactions, a dispo- sition includes a disposition of a portion of an asset in a general asset account only if the taxpayer makes the election under paragraph (e)(3)(ii) of this section to ter- minate the general asset account in which that disposed portion is included or makes the election under paragraph (e)(3)(iii) of this section for that disposed portion. (2)General rules for a disposition—(i) No immediate recovery of basis. Except as provided in paragraph (e)(3) of this sec- tion, immediately before a disposition of any asset in a general asset account or a disposition of a portion of such asset as de- scribed in paragraph (e)(1)(ii) of this sec- tion, the asset or the portion of the as- set, as applicable, is treated as having an adjusted depreciable basis (as defined in §1.168(b)–1(a)(4)) of zero for purposes of section 1011. Therefore, no loss is realized upon the disposition of an asset from the 2013–43 I.R.B.411October 21, 2013 general asset account or upon the disposi- tion of a portion of such asset as described in paragraph (e)(1)(ii) of this section. Sim- ilarly, where an asset or a portion of an as- set, as applicable, is disposed of by transfer to a supplies, scrap, or similar account, the basis of the asset or the portion of the as- set, as applicable, in the supplies, scrap, or similar account will be zero. (ii)Treatment of amount realized.Any amount realized on a disposition is recog- nized as ordinary income (notwithstand- ing any other provision of subtitle A of the Internal Revenue Code) to the extent the sum of the unadjusted depreciable ba- sis of the general asset account and any ex- pensed cost (as defined in paragraph (b)(5) of this section) for assets in the account ex- ceeds any amounts previously recognized as ordinary income upon the disposition of other assets in the account or upon the dis- position of portions of such assets as de- scribed in paragraph (e)(1)(ii) of this sec- tion. The recognition and character of any excess amount realized are determined un- der other applicable provisions of the In- ternal Revenue Code (other than sections 1245 and 1250 or provisions of the Internal Revenue Code that treat gain on a disposi- tion as subject to section 1245 or 1250). (iii)Effect of disposition on a general asset account. Except as provided in para- graph (e)(3) of this section, the unadjusted depreciable basis and the depreciation re- serve of the general asset account are not affected as a result of a disposition of an asset from the general asset account or of a disposition of a portion of such asset as de- scribed in paragraph (e)(1)(ii) of this sec- tion. (iv)Coordination with nonrecognition provisions. For purposes of determining the basis of an asset or a portion of an asset, as applicable, acquired in a trans- action, other than a transaction described in paragraphs (e)(3)(iv) (pertaining to transactions subjectto section 168(i)(7)), (e)(3)(v) (pertaining to transactions sub- ject to section 1031 or section 1033), and (e)(3)(vi) (pertaining to technical termi- nations of partnerships) of this section, to which a nonrecognition section of the In- ternal Revenue Code applies (determined without regard to this section), the amount of ordinary income recognized under this paragraph (e)(2) is treated as the amount of gain recognized on the disposition. (v)Manner of disposition. The man- ner of disposition (for example, normal retirement, abnormal retirement, ordinary retirement, or extraordinary retirement) is not taken into account in determining whether a disposition occurs or gain or loss is recognized. (vi)Disposition by transfer to a sup- plies account. If a taxpayer made an election under §1.162–3(d) to treat the cost of any rotable spare part, temporary spare part, or standby emergency spare part (as defined in §1.162–3(c)) as a cap- ital expenditure subject to the allowance for depreciation and also made an election under paragraph (l) of this section to in- clude that rotable, temporary, or standby emergency spare part in a general as- set account, the taxpayer can dispose of the rotable, temporary, or standby emer- gency spare part by transferring it to a supplies account only if the taxpayer has obtained the consent of the Commissioner to revoke the §1.162–3(d) election. See §1.162–3(d)(3) for the procedures for re- voking a §1.162–3(d) election. (vii)Leasehold improvements.The rules of paragraph (e) of this section also apply to— (A) A lessor of leased property that made an improvement to that property for the lessee of the property, has a depreciable basis in the improvement, made an elec- tion under paragraph (l) of this section to include the improvement in a general asset account, and disposesof the improvement (or disposes of a portion of the improve- ment as described in paragraph (e)(1)(ii) of this section) before orupon the termination of the lease with the lessee. See section 168(i)(8)(B); and (B) A lessee of leased property that made an improvement to that property, has a depreciable basis in the improvement, made an election under paragraph (l) of this section to include the improvement in a general asset account, and disposes of the improvement (or disposes of a portion of the improvement as described in paragraph (e)(1)(ii) of this section) before or upon the termination of the lease. (viii)Determination of asset disposed of—(A)General rules. For purposes of ap- plying paragraph (e) of this section to the disposition of an asset in a general asset account (instead of the disposition of the general asset account), the facts and cir- cumstances of each disposition are consid- ered in determining what is the appropri- ate asset disposed of. The asset for dis- position purposes may not consist of items placed in service by the taxpayer on dif- ferent dates. For purposes of determin- ing what is the appropriate asset disposed of, the unit of property determination un- der §1.263(a)–3(e) or in published guid- ance in the Internal Revenue Bulletin un- der section 263(a) (see §601.601(d)(2) of this chapter) does not apply. (B)Special rules. In addition to the general rules in paragraph (e)(2)(viii)(A) of this section, the following rules apply for purposes of applying paragraph (e) of this section to the disposition of an asset in a general asset account (instead of the disposition of the general asset account): (1) Each building (including its struc- tural components) is the asset except as provided in §1.1250–1(a)(2)(ii) or in paragraph (e)(2)(viii)(B)(2) or paragraph (e)(2)(viii) (B)(4)ofthissection. (2) If a building has two or more con- dominium or cooperative units, each con- dominium or cooperative unit (including its structural components) is the asset ex- cept as provided in §1.1250–1(a)(2)(ii) or in paragraph (e)(2)(viii)(B)(4) of this sec- tion. (3) If a taxpayer properly includes an item in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87–56 (1987–2 C.B. 674) (see §601.601(d)(2) of this chap- ter) or properly classifies an item in one of the categories under section 168(e)(3) (ex- cept for a category that includes buildings or structural components; for example, retail motor fuels outlet, qualified lease- hold improvement property, qualified restaurant property, and qualified retail improvement property), each item is the asset provided paragraph (e)(2)(viii)(B)(4) of this section does not apply to the item. For example, each desk is the asset, each computer is the asset, and each qualified smart electric meter is the asset. (4) If the taxpayer places in service an improvement or addition to an asset after the taxpayer placed the asset in service, the improvement or addition is a separate asset. (ix)Examples. The following exam- ples illustrate the application of this para- graph (e)(2). For purposes of these ex- amples, assume that section 168 as in ef- fect on September 19, 2013, applies to tax- October 21, 20134122013–43 I.R.B. able years beginning on or after January 1, 2014. Example 1. A, a calendar-year partnership, main- tains one general asset account for one office build- ing that cost $10 million. A discovers a leak in the roof of the building and decides to replace the entire roof. The roof is a structural component of the build- ing. In accordance with paragraph (e)(2)(viii)(B)( 1) of this section, the office building (including its struc- tural components) is the asset for disposition pur- poses. The retirement of the replaced roof is not a dis- position of a portion of an asset as described in para- graph (e)(1)(ii) of this section. Thus, the retirement of the replaced roof is not a disposition under para- graph (e)(1) of this section. As a result, A continues to depreciate the $10 million cost of the general as- set account. If A must capitalize the amount paid for the replacement roof pursuant to §1.263(a)–3, the re- placement roof is a separate asset for disposition pur- poses pursuant to paragraph (e)(2)(viii)(B)( 4)ofthis section and for depreciation purposes pursuant to sec- tion 168(i)(6). Example 2. B, a calendar-year commercial air- line company, maintains one general asset account for five aircraft that cost a total of $500 million. These aircraft are described in asset class 45.0 of Rev. Proc. 87–56. B replaces the existing engines on one of the aircraft with new engines. Assume each aircraft is a unit of property as determined under §1.263(a)–3(e)(3) and each engine of an aircraft is a major component or substantial structural part of the aircraft as determined under §1.263(a)–3(k)(6). Assume also that B treats each aircraft as the asset for disposition purposes in accordance with paragraph (e)(2)(viii) of this section. The retirement of the replaced engines is not a disposition of a portion of an asset as described in paragraph (e)(1)(ii) of this section. Thus, the retirement of the replaced engines is not a disposition under paragraph (e)(1) of this section. As a result, B continues to depreciate the $500 million cost of the general asset account. If B must capitalize the amount paid for the replacement engines pursuant to §1.263(a)–3, the replacement engines are a separate asset for disposition purposes pursuant to paragraph (e)(2)(viii)(B)( 4)ofthissec- tion and for depreciation purposes pursuant to section 168(i)(6). Example 3. (i) R, a calendar-year corporation, maintains one general asset account for ten machines. The machines cost a total of $10,000 and are placed in service in June 2014. Of the ten machines, one machine costs $8,200 and nine machines cost a to- tal of $1,800. Assume R depreciates this general as- set account using the optional depreciation table that corresponds with the general depreciation system, the 200-percent declining balance method, a 5-year re- covery period, and a half-year convention. R does not make a section 179 election for any of the ma- chines, and all of the machines are not eligible for any additional first year depreciation deduction. As of January 1, 2015, the depreciation reserve of the ac- count is $2,000 ($10,000 x 20%). (ii) On February 8, 2015, R sells the machine that cost $8,200 to an unrelated party for $9,000. Under paragraph (e)(2)(i) of this section, this machine has an adjusted depreciable basis of zero. (iii) On its 2015 tax return, R recognizes the amount realized of $9,000 as ordinary income because such amount does not exceed the unad- justed depreciable basis of the general asset account ($10,000), plus any expensed cost for assets in the account ($0), less amounts previously recognized as ordinary income ($0). Moreover, the unadjusted depreciable basis and depreciation reserve of the account are not affected by the disposition of the machine. Thus, the depreciation allowance for the account in 2015 is $3,200 ($10,000 x 32%). Example 4. (i) The facts are the same as inEx- ample 3 . In addition, on June 4, 2016, R sells seven machines to an unrelated party for a total of $1,100. In accordance with paragraph (e)(2)(i) of this section, these machines have an adjusted depreciable basis of zero. (ii) On its 2016 tax return, R recognizes $1,000 as ordinary income (the unadjusted depreciable ba- sis of $10,000, plus the expensed cost of $0, less the amount of $9,000 previously recognized as ordi- nary income). The recognition and character of the excess amount realized of $100 ($1,100-$1,000) are determined under applicable provisions of the Inter- nal Revenue Code other than section 1245 (such as section 1231). Moreover, the unadjusted depreciable basis and depreciation reserve of the account are not affected by the disposition of the machines. Thus, the depreciation allowance for the account in 2016 is $1,920 ($10,000 x 19.2%). (3)Special rules—(i)In general.This paragraph (e)(3) provides the rules for ter- minating general asset account treatment upon certain dispositions. While the rules under paragraphs (e)(3)(ii) and (iii) of this section are optional rules, the rules under paragraphs (e)(3)(iv), (v), (vi), and (vii) of this section are mandatory rules. A tax- payer elects to apply paragraph (e)(3)(ii) or paragraph (e)(3)(iii) of this section by reporting the gain, loss, or other deduction on the taxpayer’s timely filed original Fed- eral tax return (including extensions) for the taxable year in which the disposition occurs. A taxpayer may revoke the elec- tion to apply paragraph (e)(3)(ii) or para- graph (e)(3)(iii) of this section only by fil- ing a request for a private letter ruling and obtaining the Commissioner’s consent to revoke the election. The Commissioner may grant a request to revoke this elec- tion if the taxpayer acted reasonably and in good faith, and the revocation will not prejudice the interests of the Government. See generally §301.9100–3 of this chapter. The election to apply paragraph (e)(3)(ii) or (iii) of this section may not be made or revoked through the filing of an applica- tion for change in accounting method. For purposes of applying paragraph (e)(3)(iii) through (vii) of this section, see paragraph (j) of this section for identifying an as- set disposed of and its unadjusted depre- ciable basis. Solely for purposes of ap- plying paragraphs (e)(3)(iii), (e)(3)(iv)(C), (e)(3)(v)(B), and (e)(3)(vii) of this section, the termassetis: (A) The asset as determined under para- graph (e)(2)(viii) of this section, or (B) The portion of such asset that is disposed of in a disposition described in paragraph (e)(1)(ii) of this section. (ii)Disposition of all assets remain- ing in a general asset account—(A)Op- tional termination of a general asset ac- count. Upon the disposition of all of the assets, the last asset, or the remaining por- tion of the last asset, in a general asset account, a taxpayer may apply this para- graph (e)(3)(ii) to recover the adjusted de- preciable basis of the general asset ac- count (rather than having paragraph (e)(2) of this section apply). Under this para- graph (e)(3)(ii), the general asset account terminates and the amount of gain or loss for the general asset account is determined under section 1001(a) by taking into ac- count the adjusted depreciable basis of the general asset account at the time of the dis- position (as determined under the appli- cable convention for the general asset ac- count). The recognition and character of the gain or loss are determined under other applicable provisions of the Internal Rev- enue Code, except that the amount of gain subject to section 1245 (or section 1250) is limited to the excess of the depreciation allowed or allowable for the general asset account, including any expensed cost (or the excess of the additional depreciation allowed or allowable for the general as- set account), over any amounts previously recognized as ordinary income under para- graph (e)(2) of this section. (B)Examples. The following exam- ples illustrate the application of this para- graph (e)(3)(ii). For purposes of these ex- amples, assume that section 168 as in ef- fect on September 19, 2013, applies to tax- able years beginning on or after January 1, 2014. Example 1. (i) T, a calendar-year corporation, maintains a general asset account for 1,000 calcula- tors. The calculators cost a total of $60,000 and are placed in service in 2014. Assume T depreciates this general asset account using the optional depreciation table that corresponds with the general depreciation system, the 200-percent declining balance method, a 5-year recovery period, and a half-year convention. T does not make a section 179 election for any of the calculators, and all of the calculators are not eligible for any additional first year depreciation deduction. In 2015, T sells 200 of the calculators to an unre- lated party for a total of $10,000 and recognizes the 2013–43 I.R.B.413October 21, 2013 $10,000 as ordinary income in accordance with para- graph (e)(2) of this section. (ii) On March 26, 2016, T sells the remaining calculators in the general asset account to an unre- lated party for $35,000. T elects to apply paragraph (e)(3)(ii) of this section. As a result, the account ter- minates and gain or loss is determined for the account. (iii) On the date of disposition, the adjusted de- preciable basis of the account is $23,040 (unadjusted depreciable basis of $60,000 less the depreciation al- lowed or allowable of $36,960). Thus, in 2016, T rec- ognizes gain of $11,960 (amount realized of $35,000 less the adjusted depreciable basis of $23,040). The gain of $11,960 is subject to section 1245 to the ex- tent of the depreciation allowed or allowable for the account (plus the expensed cost for assets in the ac- count) less the amounts previously recognized as or- dinary income ($36,960 + $0 - $10,000 = $26,960). As a result, the entire gain of $11,960 is subject to section 1245. Example 2. (i) J, a calendar-year corporation, maintains a general asset account for one item of equipment. This equipment costs $2,000 and is placed in service in 2014. Assume J depreciates this general asset account using the optional depreciation table that corresponds with the general depreciation system, the 200-percent declining balance method, a 5-year recovery period, and a half-year conven- tion. J does not make a section 179 election for the equipment, and it is not eligible for any additional first year depreciation deduction. In June 2016, J sells the equipment to an unrelated party for $1,000. J elects to apply paragraph (e)(3)(ii) of this section. As a result, the account terminates and gain or loss is determined for the account. (ii) On the date of disposition, the adjusted depre- ciable basis of the account is $768 (unadjusted depre- ciable basis of $2,000 less the depreciation allowed or allowable of $1,232). Thus, in 2016, J recognizes gain of $232 (amount realized of $1,000 less the ad- justed depreciable basis of $768). The gain of $232 is subject to section 1245 to the extent of the deprecia- tion allowed or allowable for the account (plus the ex- pensed cost for assets in the account) less the amounts previously recognized as ordinary income ($1,232 + $0 - $0 = $1,232). As a result, the entire gain of $232 is subject to section 1245. (iii)Disposition of an asset in a qual- ifying disposition—(A)Optional deter- mination of the amount of gain, loss, or other deduction. In the case of a quali- fying disposition (described in paragraph (e)(3)(iii)(B) of this section) of an as- set, a taxpayer may elect to apply this paragraph (e)(3)(iii) (rather than having paragraph (e)(2) of this section apply). Under this paragraph (e)(3)(iii), general asset account treatment for the asset ter- minates as of the first day of the taxable year in which the qualifying disposition occurs, and the amount of gain, loss, or other deduction for the asset is determined under §1.168(i)–8 or §1.168(i)–8T, as ap- plicable, by taking into account the asset’s adjusted depreciable basis at the time of the disposition. The adjusted depreciable basis of the asset at the time of the dispo- sition (as determined under the applicable convention for the general asset account in which the asset was included) equals the unadjusted depreciable basis of the asset less the depreciation allowed or allowable for the asset, computed by using the de- preciation method, recovery period, and convention applicable to the general asset account in which the asset was included and by including the portion of the ad- ditional first year depreciation deduction claimed for the general asset account that is attributable to the asset disposed of. The recognition and character of the gain, loss, or other deduction are determined under other applicable provisions of the Internal Revenue Code, except that the amount of gain subject to section 1245 (or section 1250) is limited to the lesser of— (1) The depreciation allowed or allow- able for the asset, including any expensed cost (or the additional depreciation al- lowed or allowable) for the asset; or (2) The excess of— (i) The original unadjusted depreciable basis of the general asset account plus, in the case of section 1245 property origi- nally included in the general asset account, any expensed cost; over (ii) The cumulative amounts of gain previously recognized as ordinary income under either paragraph (e)(2) of this sec- tion or section 1245 (or section 1250). (B)Qualifying dispositions.Aquali- fying dispositionis a disposition that does not involve all the assets, or the last asset, remaining in a general asset account and that is— (1) A direct result of a fire, storm, ship- wreck, or other casualty, or from theft; (2) A charitable contribution for which a deduction is allowable under section 170; (3) A direct result of a cessation, ter- mination, or disposition of a business, manufacturing or other income producing process, operation, facility, plant, or other unit (other than by transfer to a supplies, scrap, or similar account); or (4) A transaction, other than a transac- tion described in paragraph (e)(3)(iv) (per- taining to transactions subject to section 168(i)(7)), (v) (pertaining to transactions subject to section 1031 or section 1033), (vi) (pertaining to technical terminations of partnerships), or (vii) (anti-abuse rule) of this section, to which a nonrecognition section of the Internal Revenue Code ap- plies (determined without regard to this section). (C)Effect of a qualifying disposition on a general asset account. If the taxpayer elects to apply this paragraph (e)(3)(iii) to a qualifying disposition of an asset, then— (1) The asset is removed from the gen- eral asset account as of the first day of the taxable year in which the qualifying dis- position occurs. For that taxable year, the taxpayer accounts for the asset in a single asset account in accordance with the rules under §1.168(i)–7(b) or §1.168(i)–7T(b), as applicable; (2) The unadjusted depreciable basis of the general asset account is reduced by the unadjusted depreciable basis of the asset as of the first day of the taxable year in which the disposition occurs; (3) The depreciation reserve of the gen- eral asset account is reduced by the de- preciation allowed or allowable for the as- set as of the end of the taxable year im- mediately preceding the year of disposi- tion, computed by using the depreciation method, recovery period, and convention applicable to the general asset account in which the asset was included and by in- cluding the portion of the additional first year depreciation deduction claimed for the general asset accountthat is attribut- able to the asset disposed of; and (4) For purposes of determining the amount of gain realized on subsequent dis- positions that is subject to ordinary income treatment under paragraph (e)(2)(ii) of this section, the amount of any expensed cost with respect to the asset is disregarded. (D)Examples. The following exam- ples illustrate the application of this para- graph (e)(3)(iii). For purposes of these ex- amples, assume that section 168 as in ef- fect on September 19, 2013, applies to tax- able years beginning on or after January 1, 2014. Example 1. (i) Z, a calendar-year corporation, maintains one general asset account for 12 machines. Each machine costs $15,000 and is placed in service in 2014. Of the 12 machines, nine machines that cost a total of $135,000 are used in Z’s Kentucky plant, and three machines that cost a total of $45,000 are used in Z’s Ohio plant. Assume Z depreciates this general asset account using the optional depreciation table that corresponds with the general depreciation system, the 200-percent declining balance method, a 5-year recovery period, and the half-year convention. Z does not make a section 179 election for any of the machines, and all of the machines are not eligible for any additional first year depreciation deduction. As October 21, 20134142013–43 I.R.B. of December 31, 2015, the depreciation reserve for the account is $93,600. (ii) On May 27, 2016, Z sells its entire manufac- turing plant in Ohio to an unrelated party. The sales proceeds allocated to each of the three machines at the Ohio plant is $5,000. This transaction is a quali- fying disposition under paragraph (e)(3)(iii)(B)( 3)of this section and Z elects to apply paragraph (e)(3)(iii) of this section. (iii) For Z’s 2016 return, the depreciation al- lowance for the account is computed as follows. As of December 31, 2015, the depreciation allowed or allowable for the three machines at the Ohio plant is $23,400. Thus, as of January 1, 2016, the unadjusted depreciable basis of the account is reduced from $180,000 to $135,000 ($180,000 less the unadjusted depreciable basis of $45,000 for the three machines), and, as of December 31, 2015, the depreciation reserve of the account is decreased from $93,600 to $70,200 ($93,600 less the depreciation allowed or allowable of $23,400 for the three machines as of December 31, 2015). Consequently, the deprecia- tion allowance for the account in 2016 is $25,920 ($135,000 x 19.2%). (iv) For Z’s 2016 return, gain or loss for each of the three machines at the Ohio plant is determined as follows. The depreciation allowed or allowable in 2016 for each machine is $1,440 (($15,000 x 19.2%)/ 2). Thus, the adjusted depreciable basis of each ma- chine under section 1011 is $5,760 (the adjusted de- preciable basis of $7,200 removed from the account less the depreciation allowed or allowable of $1,440 in 2016). As a result, the loss recognized in 2016 for each machine is $760 ($5,000 - $5,760), which is sub- ject to section 1231. Example 2. (i) A, a calendar-year partnership, maintains one general asset account for one office building that cost $20 million and was placed in service in July 2011. A depreciates this general asset account using the optional depreciation table that corresponds with the general depreciation system, the straight-line method, a 39-year recovery period, and the mid-month convention. As of January 1, 2014, the depreciation reserve for the account is $1,261,000. (ii) In May 2014, a tornado occurs where the building is located and damages the roof of the building. A decides to replace the entire roof. The roof is replaced in June 2014. The roof is a structural component of the building. Because the roof was damaged as a result of a casualty event described in section 165, the partial disposition rule provided under paragraph (e)(1)(ii) of this section applies to the roof. Although the office building (including its structural components) is the asset for disposition purposes, the partial disposition rule provides that the retirement of the replaced roof is a disposition under paragraph (e)(1) of this section. This retire- ment is a qualifying disposition under paragraph (e)(3)(iii)(B)( 1) of this section and A elects to apply paragraph (e)(3)(iii) of this section for the retirement of the damaged roof. (iii) Of the $20 million cost of the office building, assume $1 million is the cost of the retired roof. (iv) For A’s 2014 return, the depreciation al- lowance for the account is computed as follows. As of December 31, 2013, the depreciation allowed or allowable for the retired roof is $63,050. Thus, as of January 1, 2014, the unadjusted depreciable basis of the account is reduced from $20,000,000 to $19,000,000 ($20,000,000 less the unadjusted depre- ciable basis of $1,000,000 for the retired roof), and the depreciation reserveof the account is decreased from $1,261,000 to $1,197,950 ($1,261,000 less the depreciation allowed or allowable of $63,050 for the retired roof as of December 31, 2013). Consequently, the depreciation allowance for the account in 2014 is $487,160 ($19,000,000 x 2.564%). (v) For A’s 2014 return, gain or loss for the re- tired roof is determined as follows. The deprecia- tion allowed or allowable in 2014 for the retired roof is $11,752 (($1,000,000 x 2.564%) x 5.5/12). Thus, the adjusted depreciable basis of the retired roof un- der section 1011 is $925,198 (the adjusted deprecia- ble basis of $936,950 removed from the account less the depreciation allowed or allowable of $11,752 in 2014). As a result, the loss recognized in 2014 for the retired roof is $925,198, which is subject to sec- tion 1231. (vi) If A must capitalize the amount paid for the replacement roof under §1.263(a)–3, the replacement roof is a separate asset for depreciation purposes pur- suant to section 168(i)(6). If A includes the replace- ment roof in a general asset account, the replacement roof is a separate asset for disposition purposes pur- suant to paragraph (e)(2)(viii)(B)( 4) of this section. If A includes the replacement roof in a single asset ac- count or a multiple asset account under §1.168(i)–7, the replacement roof is a separate asset for disposi- tion purposes pursuant to §1.168(i)–8(c)(4)(ii)(D). (iv)Transactions subject to section 168(i)(7)—(A)In general. If a taxpayer transfers one or more assets in a gen- eral asset account (or a portion of such asset) in a transaction described in sec- tion 168(i)(7)(B) (pertaining to treatment of transferees in certain nonrecognition transactions), the taxpayer (the transferor) and the transferee must apply this para- graph (e)(3)(iv) to the asset (or the portion of such asset) (instead of applying para- graph (e)(2), (e)(3)(ii), or (e)(3)(iii) of this section). The transferee is bound by the transferor’s election under paragraph (l) of this section for the portion of the trans- feree’s basis in the asset (or the portion of such asset) that does not exceed the trans- feror’s adjusted depreciable basis of the general asset account or the asset (or the portion of such asset), as applicable (as de- termined under paragraph (e)(3)(iv)(B)(2) or paragraph (e)(3)(iv)(C)(2) of this sec- tion, as applicable). (B)All assets remaining in general as- set account are transferred. If a taxpayer transfers all the assets, the last asset, or the remaining portion of the last asset, in a general asset account in a transaction de- scribed in section 168(i)(7)(B)— (1) The taxpayer (the transferor) must terminate the general asset account on the date of the transfer. The allowable depre- ciation deduction for the general asset ac- count for the transferor’s taxable year in which the section 168(i)(7)(B) transaction occurs is computed by using the depreci- ation method, recovery period, and con- vention applicable to the general asset ac- count. This allowable depreciation deduc- tion is allocated between the transferor and the transferee on a monthly basis. This allocation is made in accordance with the rules in §1.168(d)–1(b)(7)(ii) for allocat- ing the depreciation deduction between the transferor and the transferee; (2) The transferee must establish a new general asset account for all the assets, the last asset, or the remaining portion of the last asset, in the taxable year in which the section 168(i)(7)(B) transaction occurs for the portion of its basis in the assets that does not exceed the transferor’s adjusted depreciable basis of the general asset account in which all the assets, the last asset, or the remaining portion of the last asset, were included. The transferor’s adjusted depreciable basis of this gen- eral asset account is equal to the adjusted depreciable basis of that account as of the beginning of the transferor’s taxable year in which the transaction occurs, de- creased by the amount of depreciation allocable to the transferor for the year of the transfer (as determined under para- graph (e)(3)(iv)(B)(1) of this section). The transferee is treated as the transferor for purposes of computing the allowable de- preciation deduction for the new general asset account under section 168. The new general asset account must be established in accordance with the rules in paragraph (c) of this section, except that the unad- justed depreciable bases of all the assets, the last asset, or the remaining portion of the last asset, and the greater of the de- preciation allowed or allowable for all the assets, the last asset, or the remaining por- tion of the last asset (including the amount of depreciation for the transferred assets that is allocable to the transferor for the year of the transfer), are included in the newly established general asset account. Consequently, this general asset account in the year of the transfer will have a be- ginning balance for both the unadjusted depreciable basis and the depreciation re- serve of the general asset account; and (3) For purposes of section 168 and this section, the transferee treats the portion of its basis in the assets that exceeds the 2013–43 I.R.B.415October 21, 2013 transferor’s adjusted depreciable basis of the general asset account in which all the assets, the last asset, or the remaining por- tion of the last asset, were included (as de- termined under paragraph (e)(3)(iv)(B)(2) of this section) as a separate asset that the transferee placed in service on the date of the transfer. The transferee ac- counts for this asset under §1.168(i)–7 or §1.168(i)–7T, as applicable, or may make an election under paragraph (l) of this sec- tion to include the asset in a general asset account. (C)Not all assets remaining in general asset account are transferred. If a taxpayer transfers an asset in a general asset ac- count in a transaction described in section 168(i)(7)(B) and if paragraph (e)(3)(iv)(B) of this section does not apply to this as- set— (1) The taxpayer (the transferor) must remove the transferred asset from the gen- eral asset account in which the asset is included, as of the first day of the taxable year in which the section 168(i)(7)(B) transaction occurs. In addition, the ad- justments to the general asset account described in paragraphs (e)(3)(iii)(C)(2) through (4) of this section must be made. The allowable depreciation deduction for the asset for the transferor’s taxable year in which the section 168(i)(7)(B) trans- action occurs is computed by using the depreciation method, recovery period, and convention applicable to the general asset account in which the asset was included. This allowable depreciation deduction is allocated between the transferor and the transferee on a monthly basis. This alloca- tion is made in accordance with the rules in §1.168(d)–1(b)(7)(ii) for allocating the depreciation deduction between the trans- feror and the transferee; (2) The transferee must establish a new general asset account for the asset in the taxable year in which the section 168(i)(7)(B) transaction occurs for the portion of its basis in the asset that does not exceed the transferor’s adjusted depre- ciable basis of the asset. The transferor’s adjusted depreciable basis of this asset is equal to the adjusted depreciable basis of the asset as of the beginning of the trans- feror’s taxable year in which the trans- action occurs, decreased by the amount of depreciation allocable to the transferor for the year of the transfer (as determined under paragraph (e)(3)(iv)(C)(1)ofthis section). The transferee is treated as the transferor for purposes of computing the allowable depreciation deduction for the new general asset account under section 168. The new general asset account must be established in accordance with the rules in paragraph (c) of this section, except that the unadjusted depreciable basis of the asset, and the greater of the depreci- ation allowed or allowable for the asset (including the amount of depreciation for the transferred asset that is allocable to the transferor for the year of the transfer), are included in the newly established general asset account. Consequently, this general asset account in the year of the transfer will have a beginning balance for both the unadjusted depreciable basis and the depreciation reserve of the general asset account; and (3) For purposes of section 168 and this section, the transferee treats the portion of its basis in the asset that exceeds the transferor’s adjusteddepreciable basis of the asset (as determined under paragraph (e)(3)(iv)(C)(2) of this section) as a sep- arate asset that the transferee placed in service on the date of the transfer. The transferee accounts for this asset under §1.168(i)–7 or §1.168(i)–7T, as appli- cable, or may make an election under paragraph (l) of this section to include the asset in a general asset account. (v)Transactions subject to section 1031 or section 1033—(A)Like-kind ex- change or involuntary conversion of all assets remaining in a general asset ac- count. If all the assets, the last asset, or the remaining portion of the last asset, in a general asset account are transferred by a taxpayer in a like-kind exchange (as defined under §1.168–6(b)(11)) or in an involuntary conversion (as defined under §1.168–6(b)(12)), the taxpayer must ap- ply this paragraph (e)(3)(v)(A) (instead of applying paragraph (e)(2), (e)(3)(ii), or (e)(3)(iii) of this section). Under this paragraph (e)(3)(v)(A), the general as- set account terminates as of the first day of the year of disposition (as defined in §1.168(i)–6(b)(5)) and— (1) The amount of gain or loss for the general asset account is determined under section 1001(a) by taking into account the adjusted depreciable basis of the general asset account at the time of disposition (as defined in §1.168(i)–6(b)(3)). The depreciation allowance for the general asset account in the year of disposition is determined in the same manner as the depreciation allowance for the relin- quished MACRS property (as defined in §1.168(i)–6(b)(2)) in the year of dispo- sition is determined under §1.168(i)–6. The recognition and character of gain or loss are determined in accordance with paragraph (e)(3)(ii)(A) of this section (notwithstanding thatparagraph (e)(3)(ii) of this section is an optional rule); and (2) The adjusted depreciable basis of the general asset account at the time of dis- position is treated as the adjusted depre- ciable basis of the relinquished MACRS property. (B)Like-kind exchange or involuntary conversion of less than all assets remain- ing in a general asset account. If an asset in a general asset account is transferred by a taxpayer in a like-kind exchange or in an involuntary conversion and if para- graph (e)(3)(v)(A) of this section does not apply to this asset, the taxpayer must apply this paragraph (e)(3)(v)(B) (instead of applying paragraph (e)(2), (e)(3)(ii), or (e)(3)(iii) of this section). Under this para- graph (e)(3)(v)(B), general asset account treatment for the asset terminates as of the first day of the year of disposition (as defined in §1.168(i)–6(b)(5)), and— (1) The amount of gain or loss for the asset is determined bytaking into account the asset’s adjusted depreciable basis at the time of disposition (as defined in §1.168(i)–6(b)(3)). The adjusted depre- ciable basis of the asset at the time of dis- position equals the unadjusted depreciable basis of the asset less the depreciation allowed or allowable for the asset, com- puted by using the depreciation method, recovery period, and convention applica- ble to the general asset account in which the asset was included and by including the portion of the additional first year depreciation deduction claimed for the general asset account thatis attributable to the relinquished asset. The depreciation allowance for the asset in the year of dis- position is determined in the same manner as the depreciation allowance for the re- linquished MACRS property (as defined in §1.168(i)–6(b)(2)) in the year of dis- position is determined under §1.168(i)–6. The recognition and character of the gain or loss are determined in accordance with paragraph (e)(3)(iii)(A) of this section October 21, 20134162013–43 I.R.B. (notwithstanding thatparagraph (e)(3)(iii) of this section is an optional rule); and (2) As of the first day of the year of dis- position, the taxpayer must remove the re- linquished asset from the general asset ac- count and make the adjustments to the gen- eral asset account described in paragraphs (e)(3)(iii)(C)(2) through (4) of this section. (vi)Technical termination of a part- nership. In the case of a technical ter- mination of a partnership under section 708(b)(1)(B), the terminated partner- ship must apply this paragraph (e)(3)(vi) (instead of applying paragraph (e)(2), (e)(3)(ii), or (e)(3)(iii) of this section). Under this paragraph (e)(3)(vi), all of the terminated partnership’s general asset accounts terminate as of the date of its termination under section 708(b)(1)(B). The terminated partnership computes the allowable depreciation deduction for each of its general asset accounts for the taxable year in which the technical termination occurs by using the depreciation method, recovery period, and convention applica- ble to the general asset account. The new partnership is not bound by the terminated partnership’s election under paragraph (l) of this section. (vii)Anti-abuse rule—(A)In general. If an asset in a general asset account is disposed of by a taxpayer in a transaction described in paragraph (e)(3)(vii)(B) of this section, general asset account treat- ment for the asset terminates as of the first day of the taxable year in which the disposition occurs. Consequently, the taxpayer must determine the amount of gain, loss, or other deduction attribut- able to the disposition in the manner de- scribed in paragraph (e)(3)(iii)(A) of this section (notwithstanding that paragraph (e)(3)(iii)(A) of this section is an optional rule) and must make the adjustments to the general asset account described in para- graphs (e)(3)(iii)(C)(1) through (4)ofthis section. (B)Abusive transactions. A trans- action is described in this paragraph (e)(3)(vii)(B) if the transaction is not de- scribed in paragraph (e)(3)(iv), (e)(3)(v), or (e)(3)(vi) of this section, and if the transaction is entered into, or made, with a principal purpose of achieving a tax benefit or result that would not be avail- able absent an election under this section. Examples of these types of transactions include— (1) A transaction entered into with a principal purpose of shifting income or de- ductions among taxpayers in a manner that would not be possible absent an election under this section to take advantage of dif- fering effective tax rates among the tax- payers; or (2) An election madeunder this section with a principal purpose of disposing of an asset from a general asset account to uti- lize an expiring net operating loss or credit if the transaction is not abona fidedispo- sition. The fact that a taxpayer with a net operating loss carryover or a credit carry- over transfers an asset to a related person or transfers an asset pursuant to an arrange- ment where the asset continues to be used (or is available for use) by the taxpayer pursuant to a lease (or otherwise) indicates, absent strong evidenceto the contrary, that the transaction is described in this para- graph (e)(3)(vii)(B). (f)Assets generating foreign source income—(1)In general. This paragraph (f) provides the rules for determining the source of any income, gain, or loss recog- nized, and the appropriate section 904(d) separate limitation category or categories for any foreign source income, gain, or loss recognized on a disposition (within the meaning of paragraph (e)(1) of this section) of an asset in a general asset ac- count that consists of assets generating both United States and foreign source income. These rules apply only to a dispo- sition to which paragraphs (e)(2) (general disposition rules), (e)(3)(ii) (disposition of all assets remaining in a general asset account), (e)(3)(iii) (disposition of an as- set in a qualifying disposition), (e)(3)(v) (transactions subject to section 1031 or section 1033), or (e)(3)(vii) (anti-abuse rule) of this section applies. Solely for purposes of applying this paragraph (f), the termassetis: (i) The asset as determined under para- graph (e)(2)(viii) of this section, or (ii) The portion of such asset that is dis- posed of in a disposition described in para- graph (e)(1)(ii) of this section. (2)Source of ordinary income, gain, or loss—(i)Source determined by alloca- tion and apportionment of depreciation al- lowed. The amount of any ordinary in- come, gain, or loss that is recognized on the disposition of an asset in a general as- set account must be apportioned between United States and foreign sources based on the allocation and apportionment of the— (A) Depreciation allowed for the gen- eral asset account as of the end of the tax- able year in which the disposition occurs if paragraph (e)(2) of this section applies to the disposition; (B) Depreciation allowed for the gen- eral asset account as of the time of dis- position if the taxpayer applies paragraph (e)(3)(ii) of this section to the disposition of all assets, the last asset, or the remain- ing portion of the last asset, in the general asset account, or if all the assets, the last asset, or the remaining portion of the last asset, in the general asset account are dis- posed of in a transaction described in para- graph (e)(3)(v)(A) of this section; or (C) Depreciation allowed for the asset disposed of for only the taxable year in which the disposition occurs if the tax- payer applies paragraph (e)(3)(iii) of this section to the disposition of the asset in a qualifying disposition, if the asset is dis- posed of in a transaction described in para- graph (e)(3)(v)(B) of this section (like- kind exchange or involuntary conversion), or if the asset is disposed of in a transac- tion described in paragraph (e)(3)(vii) of this section (anti-abuse rule). (ii)Formula for determining foreign source income, gain, or loss. The amount of ordinary income, gain, or loss rec- ognized on the disposition that shall be treated as foreign source income, gain, or loss must be determined under the formula in this paragraph (f)(2)(ii). For purposes of this formula, the allowed depreciation deductions are determined for the appli- cable time period provided in paragraph (f)(2)(i) of this section. The formula is: 2013–43 I.R.B.417October 21, 2013 Foreign Source Income, Gain, or Loss from the Disposition of an Asset = Total Ordinary Income, Gain, or Loss from the Disposition of an Asset X Allowed Depreciation Deductions Allocated and Apportioned to Foreign Source Income/Total Allowed Depreciation Deductions for the General Asset Account or for the Asset Disposed of (as applicable) (3)Section 904(d) separate categories. If the assets in the general asset account generate foreign source income in more than one separate category under section 904(d)(1) or another section of the Inter- nal Revenue Code (for example, income treated as foreign source income under section 904(g)(10)), or under a United States income tax treaty that requires the foreign tax credit limitation to be deter- mined separately for specified types of income, the amount of “foreign source income, gain, or loss from the disposition of an asset” (as determined under the for- mula in paragraph (f)(2)(ii) of this section) must be allocated and apportioned to the applicable separate category or categories under the formula in this paragraph (f)(3). For purposes of this formula, the allowed depreciation deductions are determined for the applicable time period provided in paragraph (f)(2)(i) of this section. The formula is: Foreign Source Income, Gain, or Loss in a Separate Category = Foreign Source Income, Gain, or Loss from The Disposition of an Asset X Allowed Depreciation Deductions Allocated and Apportioned to a Separate Category Total/Allowed Depreciation Deductions and Apportioned to Foreign Source Income (g)Assets subject to recapture.Ifthe basis of an asset in a general asset ac- count is increased as a result of the recap- ture of any allowable credit or deduction (for example, the basis adjustment for the recapture amount under section 30(d)(2), 50(c)(2), 168(l)(7), 168(n)(4), 179(d)(10), 179A(e)(4), or 1400N(d)(5)), general as- set account treatment for the asset termi- nates as of the first day of the taxable year in which the recapture event occurs. Con- sequently, the taxpayer must remove the asset from the general asset account as of that day and must make the adjustments to the general asset account described in paragraphs (e)(3)(iii)(C)(2) through (4)of this section. (h)Changes in use—(1)Conversion to any personal use. An asset in a general asset account becomes ineligible for gen- eral asset account treatment if a taxpayer uses the asset in any personal activity dur- ing a taxable year. Upon a conversion to any personal use, the taxpayer must re- move the asset from the general asset ac- count as of the first day of the taxable year in which the change in use occurs (the year of change) and must make the adjustments to the general asset account described in paragraphs (e)(3)(iii)(C)(2) through (4)of this section. (2)Change in use results in a dif- ferent recovery period or depreciation method—(i)No effect on general asset account election. A change in the use described in §1.168(i)–4(d) (change in use results in a different recovery period or depreciation method) of an asset in a general asset account shall not cause or permit the revocation of the election made under this section. (ii)Asset is removed from the general asset account. Upon a change in the use described in §1.168(i)–4(d), the taxpayer must remove the asset from the general as- set account as of the first day of the year of change (as defined in §1.168(i)–4(a)) and must make the adjustments to the gen- eral asset account described in paragraphs (e)(3)(iii)(C)(2) through (4) of this sec- tion. If, however, the result of the change in use is described in §1.168(i)–4(d)(3) (change in use results in a shorter recovery period or a more accelerated depreciation method) and the taxpayer elects to treat the asset as though the change in use had not occurred pursuant to §1.168(i)–4(d)(3)(ii), no adjustment is made to the general asset account upon the change in use. (iii)New general asset account is es- tablished—(A)Change in use results in a shorter recovery period or a more ac- celerated depreciation method.Ifthere- sult of the change in use is described in §1.168(i)–4(d)(3) (change in use results in a shorter recovery period or a more accelerated depreciation method) and ad- justments to the general asset account are made pursuant to paragraph (h)(2)(ii) of this section, the taxpayer must establish a new general asset account for the asset in the year of change in accordance with the rules in paragraph (c) of this section, ex- cept that the adjusted depreciable basis of the asset as of the first day of the year of change is included in the general asset ac- count. For purposes of paragraph (c)(2) of this section, the applicable depreciation method, recovery period, and convention are determined under §1.168(i)–4(d)(3)(i). (B)Change in use results in a longer recovery period or a slower depreciation method. If the result of the change in use is described in §1.168(i)–4(d)(4) (change in use results in a longer recovery period or a slower depreciation method), the taxpayer must establish a separate general asset ac- count for the asset in the year of change in accordance with the rules in paragraph (c) of this section, except that the unad- justed depreciable basis of the asset, and the greater of the depreciation of the asset allowed or allowable in accordance with section 1016(a)(2), as of the first day of the year of change are included in the newly established general asset account. Conse- quently, this general asset account as of the first day of the year of change will have a beginning balance for both the unadjusted depreciable basis and the depreciation re- serve of the general asset account. For pur- poses of paragraph (c)(2) of this section, October 21, 20134182013–43 I.R.B. the applicable depreciation method, recov- ery period, and convention are determined under §1.168(i)–4(d)(4)(ii). (i)Redetermination of basis.If,af- ter the placed-in-service year, the unad- justed depreciable basis of an asset in a general asset account is redetermined due to a transaction other than that described in paragraph (g) of this section (for exam- ple, due to contingent purchase price or discharge of indebtedness), the taxpayer’s election under paragraph (l) of this section for the asset also applies to the increase or decrease in basis resulting from the rede- termination. For the taxable year in which the increase or decrease in basis occurs, the taxpayer must establish a new general as- set account for the amount of the increase or decrease in basis in accordance with the rules in paragraph (c) of this section. For purposes of paragraph (c)(2) of this sec- tion, the applicable recovery period for the increase or decrease in basis is the recov- ery period of the asset remaining as of the beginning of the taxable year in which the increase or decrease in basis occurs, the ap- plicable depreciation method and applica- ble convention for the increase or decrease in basis are the same depreciation method and convention applicable to the asset that applies for the taxable year in which the increase or decrease in basis occurs, and the increase or decrease in basis is deemed to be placed in service in the same taxable year as the asset. (j)Identification of disposed or con- verted asset—(1)In general.Therules of this paragraph (j) apply when an asset in a general asset account is disposed of or converted in a transaction described in paragraphs (e)(3)(iii) (disposition of an asset in a qualifying disposition), (e)(3)(iv)(B) (transactions subject to sec- tion 168(i)(7)), (e)(3)(v)(B) (transactions subject to section 1031 or section 1033), (e)(3)(vii) (anti-abuse rule), (g) (assets subject to recapture), or (h)(1) (conversion to any personal use) of this section. (2)Identifying which asset is disposed of or converted—(i)In general. For pur- poses of identifying which asset in a gen- eral asset account is disposed of or con- verted, a taxpayer must identify the dis- posed of or converted asset by using— (A) The specific identification method of accounting. Under this method of ac- counting, the taxpayer can determine the particular taxable year in which the dis- posed of or converted asset was placed in service by the taxpayer; (B) A first-in, first-out method of ac- counting if the taxpayer can readily deter- mine from its records the total dispositions of assets with the same recovery period during the taxable year but the taxpayer cannot readily determine from its records the unadjusted depreciable basis of the dis- posed of or converted asset. Under this method of accounting, the taxpayer iden- tifies the general asset account with the earliest placed-in-service year that has the same recovery period as the disposed of or converted asset and that has assets at the beginning of the taxable year of the dis- position or conversion, and the taxpayer treats the disposed of or converted asset as being from that general asset account. To determine which general asset account has assets at the beginning of the taxable year of the disposition or conversion, the tax- payer reduces the number of assets origi- nally included in the account by the num- ber of assets disposed of or converted in any prior taxable year in a transaction to which this paragraph (j) applies; (C) A modified first-in, first-out method of accounting if the taxpayer can readily determine from its records the to- tal dispositions of assets with the same recovery period during the taxable year and the unadjusted depreciable basis of the disposed of or converted asset. Under this method of accounting, the taxpayer identifies the general asset account with the earliest placed-in-service year that has the same recovery period as the disposed of or converted asset and that has assets at the beginning of the taxable year of the disposition or conversion with the same unadjusted depreciable basis as the disposed of or converted asset, and the taxpayer treats the disposed of or con- verted asset as being from that general asset account. To determine which general asset account has assets at the beginning of the taxable year of the disposition or conversion, the taxpayer reduces the num- ber of assets originally included in the account by the number of assets disposed of or converted in any prior taxable year in a transaction to which this paragraph (j) applies; (D) A mortality dispersion table if the asset is a mass asset accounted for in a sep- arate general asset account in accordance with paragraph (c)(2)(ii)(H) of this section and if the taxpayer can readily determine from its records the total dispositions of assets with the same recovery period dur- ing the taxable year. The mortality dis- persion table must be based upon an ac- ceptable sampling of the taxpayer’s actual disposition and conversion experience for mass assets or other acceptable statistical or engineering techniques. To use a mor- tality dispersion table, the taxpayer must adopt recordkeeping practices consistent with the taxpayer’s prior practices and con- sonant with good accounting and engineer- ing practices; or (E) Any other method as the Secretary may designate by publication in theFed- eral Registeror in the Internal Revenue Bulletin (see §601.601(d)(2) of this chap- ter) on or after September 19, 2013. See paragraph (j)(2)(iii) of this section regard- ing the last-in, first-out method of account- ing. (ii)Disposition of a portion of an as- set. If a taxpayer disposes of a portion of an asset and paragraph (e)(1)(ii) of this section applies to that disposition, the tax- payer may identify the asset by using any applicable method provided in paragraph (j)(2)(i) of this section (after taking into ac- count paragraph (j)(2)(iii) of this section). (iii)Last-in, first-out method of ac- counting. For purposes of paragraph (j)(2) of this section, a last-in, first-out method of accounting may not be used. Under a last-in, first-out method of accounting, the taxpayer identifies the general asset ac- count with the most recent placed-in-ser- vice year that has the same recovery period as the disposed of or converted asset and that has assets at the beginning of the tax- able year of the disposition or conversion, and the taxpayer treats the disposed of or converted asset as being from that general asset account. (3)Basis of disposed of or converted as- set. Solely for purposes of this paragraph (j)(3), the termassetis the asset as deter- mined under paragraph (e)(2)(viii) of this section or the portion of such asset that is disposed of in a disposition described in paragraph (e)(1)(ii) of this section. After identifying which asset in a general asset account is disposed of or converted, the taxpayer may use any reasonable method that is consistently applied to all assets in the same general asset account for pur- poses of determining the unadjusted depre- ciable basis of the disposed of or converted 2013–43 I.R.B.419October 21, 2013 asset in that general asset account. Exam- ples of a reasonable method include, but are not limited to, discounting the cost of the replacement asset to its placed-in-ser- vice year cost using the Consumer Price Index, apro rataallocation of the unad- justed depreciable basis of the general as- set account based on the replacement cost of the disposed asset and the replacement cost of all of the assets in the general asset account, and a study allocating the cost of the asset to its individual components. (k)Effect of adjustments on prior dis- positions. The adjustments to a general asset account under paragraphs (e)(3)(iii), (e)(3)(iv), (e)(3)(v), (e)(3)(vii), (g), or (h) of this section have no effect on the recog- nition and character of prior dispositions subject to paragraph (e)(2) of this section. (l)Election—(1)Irrevocable election. If a taxpayer makes an election under this paragraph (l), the taxpayer consents to, and agrees to apply, all of the provisions of this section to the assets included in a gen- eral asset account. Except as provided in paragraphs (c)(1)(ii)(A), (e)(3), (g), or (h) of this section or except as otherwise ex- pressly provided by other guidance pub- lished in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter), an election made under this section is irrevocable and will be binding on the taxpayer for com- puting taxable income for the taxable year for which the election is made and for all subsequent taxable years. An election un- der this paragraph (l) is made separately by each person owning an asset to which this section applies (for example, by each member of a consolidated group, at the partnership level (and not by the partner separately), or at the S corporation level (and not by the shareholder separately)). ***** (m)Effective/applicability date—(1)In general. This section applies to taxable years beginning on or after January 1, 2014. Except as provided in paragraphs (m)(2), (m)(3), and (m)(4) of this section, §1.168(i)–1 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014. (2)Early application of this section.A taxpayer may choose to apply the provi- sions of this section to taxable years begin- ning on or after January 1, 2012. (3)Early application of regulation project REG–110732–13. A taxpayer may rely on the provisions of this section in regulation project REG–110732–13 for taxable years beginning on or after Jan- uary 1, 2012. However, a taxpayer may not rely on the provisions of this section in regulation project REG–110732–13 for taxable years beginning on or after Jan- uary 1, 2014. (4)Optional application of TD 9564. A taxpayer may choose to apply §1.168(i)–1T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012. However, a taxpayer may not apply §1.168(i)–1T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2014. (5)Change in method of accounting. A change to comply with this section for depreciable assets placed in service in a taxable year ending on or after December 30, 2003, is a change in method of ac- counting to which the provisions of sec- tion 446(e) and the regulations under sec- tion 446(e) apply. A taxpayer also may treat a change to comply with this section for depreciable assets placed in service in a taxable year ending before December 30, 2003, as a change in method of accounting to which the provisions of section 446(e) and the regulations under section 446(e) apply. This paragraph (m)(5) does not ap- ply to a change to comply with paragraphs (e)(3)(ii), (e)(3)(iii), or paragraph (l) of this section. Par. 4. Section1.168(i)–7isamended by: 1. Adding a new sentence at end of paragraph (b). 2. Revising paragraph (e). The addition and revision read as fol- lows: §1.168(i)–7 Accounting for MACRS property. ***** (b) * * * If a taxpayer disposes of a por- tion of an asset and §1.168(i)–8(d)(1) ap- plies to that disposition, the taxpayer must account for the disposed portion in a sin- gle asset account beginning in the taxable year in which the disposition occurs. See §1.168(i)–8(h)(3)(i). ***** (e)Effective/applicability date—(1)In general. This section applies to taxable years beginning on or after January 1, 2014. (2)Early application of this section.A taxpayer may choose to apply the provi- sions of this section to taxable years begin- ning on or after January 1, 2012. (3)Early application of regulation project REG–110732–13. A taxpayer may rely on the provisions of this section in regulation project REG–110732–13 for taxable years beginning on or after Jan- uary 1, 2012. However, a taxpayer may not rely on the provisions of this section in regulation project REG–110732–13 for taxable years beginning on or after Jan- uary 1, 2014. (4)Optional application of TD 9564. A taxpayer may choose to apply §1.168(i)–7T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012. However, a taxpayer may not apply §1.168(i)–7T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2014. (5)Change in method of accounting.A change to comply with this section for de- preciable assets placed in service in a tax- able year ending on or after December 30, 2003, is a change in method of accounting to which the provisions of section 446(e) and the regulations under section 446(e) apply. A taxpayer also may treat a change to comply with this section for deprecia- ble assets placed in service in a taxable year ending before December 30, 2003, as a change in method of accounting to which the provisions of section 446(e) and the regulations under section 446(e) apply. Par. 5. Section 1.168(i)–8 is added to read as follows: §1.168(i)–8 Dispositions of MACRS property. (a)Scope. This section provides rules applicable to dispositions of MACRS property (as defined in §1.168(b)–1(a)(2)) or to depreciable property (as defined in §1.168(b)–1(a)(1)) that would be MACRS property but for an election made by the taxpayer either to expense all or some of the property’s cost under section 179, 179A, 179B, 179C, 179D, or 1400I(a)(1), or any similar provision, or to amortize all October 21, 20134202013–43 I.R.B. or some of the property’s cost under sec- tion 1400I(a)(2) or any similar provision. This section also applies to dispositions described in paragraph (d)(1) of this sec- tion of a portion of such property. Except as provided in §1.168(i)–1(e)(iii), this section does not apply to dispositions of assets included in a general asset account. For rules applicable to dispositions of as- sets included in a general asset account, see §1.168(i)–1(e) or §1.168(e)–1T, as applicable. (b)Definitions. For purposes of this section— (1)Buildinghas the same meaning as that term is defined in §1.48–1(e)(1). (2)Dispositionoccurs when ownership of the asset is transferred or when the as- set is permanently withdrawn from use ei- ther in the taxpayer’s trade or business or in the production of income. A dispo- sition includes the sale, exchange, retire- ment, physical abandonment, or destruc- tion of an asset. A disposition also occurs when an asset is transferred to a supplies, scrap, or similar account, or when a portion of an asset is disposed of as described in paragraph (d)(1) of this section. If a struc- tural component (or a portion thereof) of a building is disposed of in a disposition de- scribed in paragraph (d)(1) of this section, a disposition also includes the disposition of such structural component (or such por- tion thereof). (3)Mass assetsis a mass or group of individual items of depreciable assets— (i) That are not necessarily homoge- nous; (ii) Each of which is minor in value relative to the total value of the mass or group; (iii) Numerous in quantity; (iv) Usually accounted for only on a total dollar or quantity basis; (v) With respect to which separate iden- tification is impracticable; and (vi) Placed in service in the same tax- able year. (4)Portionofanassetis any part of an asset that is less than the entire asset as determined under paragraph (c)(4) of this section. (5)Structural componenthas the same meaning as that term is defined in §1.48–1(e)(2). (6)Unadjusted depreciable basis of the multiple asset account or poolis the sum of the unadjusted depreciable bases (as de- fined in §1.168(b)–1(a)(3)) of all assets included in the multiple asset account or pool. (c)Special rules—(1)Manner of dis- position. The manner of disposition (for example, normal retirement, abnormal re- tirement, ordinary retirement, or extraordi- nary retirement) is not taken into account in determining whether a disposition oc- curs or gain or loss is recognized. (2)Disposition by transfer to a supplies account. If a taxpayer made an election under §1.162–3(d) to treat the cost of any rotable spare part, temporary spare part, or standby emergency spare part (as defined in §1.162–3(c)) as a capital expenditure subject tothe allowance for depreciation, the taxpayer can dispose of the rotable, temporary, or standby emer- gency spare part by transferring it to a supplies account only if the taxpayer has obtained the consent of the Commissioner to revoke the §1.162–3(d) election. See §1.162–3(d)(3) for the procedures for re- voking a §1.162–3(d) election. (3)Leasehold improvements. This sec- tion also applies to— (i) A lessor of leased property that made an improvement to that property for the lessee of the property, has a depreciable ba- sis in the improvement, and disposes of the improvement before or upon the termina- tion of the lease with the lessee. See sec- tion 168(i)(8)(B); and (ii) A lessee of leased property that made an improvement to that property, has a depreciable basis in the improvement, and disposes of the improvement before or upon the termination of the lease. (4)Determination of asset disposed of—(i)General rules. For purposes of applying this section, the facts and circum- stances of each disposition are considered in determining what is the appropriate asset disposed of. The asset for dispo- sition purposes may not consist of items placed in service by the taxpayer on dif- ferent dates. For purposes of determining what is the appropriate asset disposed of, the unit of property determination under §1.263(a)–3(e) or in published guidance in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter) under sec- tion 263(a) does not apply. (ii)Special rules. In addition to the gen- eral rules in paragraph(c)(4)(i) of this sec- tion, the following rules apply for purposes of applying this section: (A) Each building (including its struc- tural components) is the asset except as provided in §1.1250–1(a)(2)(ii) or in paragraph (c)(4)(ii)(B) or paragraph (c)(4)(ii)(D) of this section. (B) If a building has two or more con- dominium or cooperative units, each con- dominium or cooperative unit (including its structural components) is the asset ex- cept as provided in §1.1250–1(a)(2)(ii) or in paragraph (c)(4)(ii)(D) of this section. (C) If a taxpayer properly includes an item in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87–56 (1987–2 C.B. 674) (see §601.601(d)(2) of this chapter) or properly classifies an item in one of the categories under section 168(e)(3) (except for a category that in- cludes buildings or structural components; for example, retail motor fuels outlet, qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property), each item is the asset provided paragraph (c)(4)(ii)(D) of this section does not apply to the item. For example, each desk is the asset, each computer is the asset, and each qualified smart electric meter is the asset. (D) If the taxpayer places in service an improvement or addition to an asset after the taxpayer placed the asset in service, the improvement or addition is a separate asset. (d)Disposition of a portion of an as- set—(1)In general. For purposes of ap- plying this section, a disposition includes a disposition of a portion of an asset as a result of a casualty event described in section 165, a disposition of a portion of an asset for which gain (determined with- out regard to section 1245 or section 1250) is not recognized in whole or in part un- der section 1031 or section 1033, a trans- fer of a portion of an asset in a transac- tion described in section 168(i)(7)(B), or a sale of a portion of an asset, even if the taxpayer does not make the election under paragraph (d)(2)(i) of this section for that disposed portion. For other transactions, a disposition includes a disposition of a por- tion of an asset only if the taxpayer makes the election under paragraph (d)(2)(i) of this section for that disposed portion. (2)Partial disposition election—(i)In general. A taxpayer may make an elec- tion under this paragraph (d)(2) to apply this section to a disposition of a portion of an asset. If the asset isproperly included 2013–43 I.R.B.421October 21, 2013 in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87–56 (1987–2 C.B. 674) (see §601.601(d)(2) of this chapter), a taxpayer may make an election under this paragraph (d)(2) to apply this section to a disposition of a portion of such asset only if the taxpayer classifies the replacement portion of the asset under the same asset class as the disposed portion of the asset. (ii)Time and manner for making elec- tion—(A)Time for making election.Ex- cept as provided in paragraph (d)(2)(iii) or paragraph (d)(2)(iv) of this section, a tax- payer must make the election specified in paragraph (d)(2)(i) of this section by the due date (including extensions) of the orig- inal Federal tax return for the taxable year in which the portion of an asset is disposed of by the taxpayer. (B)Manner of making election.Ex- cept as provided in paragraph (d)(2)(iii) or paragraph (d)(2)(iv) of this section, a tax- payer must make the election specified in paragraph (d)(2)(i) of this section by ap- plying the provisions of this section for the taxable year in which the portion of an as- set is disposed of by the taxpayer, by re- porting the gain, loss, or other deduction on the taxpayer’s timely filed (including extensions) original Federal tax return for that taxable year, and, if the asset is prop- erly included in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87–56 (1987–2 C.B. 674) (see §601.601(d)(2) of this chapter), by classifying the replace- ment portion of such asset under the same asset class as the disposed portion of the asset in the taxable year in which the re- placement portion is placed in service by the taxpayer. Except as provided in para- graph (d)(2)(iii) or paragraph (d)(2)(iv)(B) of this section, the election specified in paragraph (d)(2)(i) of this section may not be made through the filing of an applica- tion for change in accounting method. (iii)Special rule for subsequent In- ternal Revenue Service adjustment.This paragraph (d)(2)(iii) applies when a tax- payer deducted the amount paid or in- curred for the replacement of a portion of an asset as a repair under §1.162–4, the taxpayer did not make the election specified in paragraph (d)(2)(i) of this section for the disposed portion of that asset within the time and in the manner under paragraph (d)(2)(ii) or paragraph (d)(2)(iv) of this section, and as a result of an examination of the taxpayer’s Federal tax return, the Internal Revenue Service disallows the taxpayer’s repair deduction for the amount paid or incurred for the replacement of the portion of that asset and instead capitalizes such amount under §1.263(a)–2 or §1.263(a)–3. If this para- graph (d)(2)(iii) applies, the taxpayer may make the election specified in paragraph (d)(2)(i) of this section for the disposition of the portion of the asset to which the Internal Revenue Service’s adjustment pertains by filing an application for change in accounting method, provided the asset of which the disposed portion was a part is owned by the taxpayer at the beginning of the year of change (as defined for purposes of section 446(e)). (iv)Special rules for 2012 or 2013 returns. If, under paragraph (j)(2) or para- graph (j)(3) of this section, a taxpayer chooses to apply the provisions of this section to a taxable year beginning on or after January 1, 2012, and ending on or before September 19, 2013 (applicable taxable year), and the taxpayer did not make the election specified in paragraph (d)(2)(i) of this section on its timely filed original Federal tax return for the applica- ble taxable year, including extensions, the taxpayer must make the election specified in paragraph (d)(2)(i) of this section for the applicable taxable year by filing either— (A) An amended Federal tax return for the applicable taxable year on or be- fore 180 days from the due date including extensions of the taxpayer’s Federal tax return for the applicable taxable year, notwithstanding that the taxpayer may not have extended the due date; or (B) An application for change in ac- counting method with the taxpayer’s timely filed original Federal tax return for the first or second taxable year succeeding the applicable taxable year. (v)Revocation. A taxpayer may re- voke the election specified in paragraph (d)(2)(i) of this section only by filing a re- quest for a private letter ruling and obtain- ing the Commissioner’s consent to revoke the election. The Commissioner may grant a request to revoke this election if the tax- payer acted reasonably and in good faith, and the revocation will not prejudice the interests of the Government. See generally §301.9100–3 of this chapter. The election specified in paragraph (d)(2)(i) of this sec- tion may not be revoked through the filing of an application forchange in accounting method. (e)Gain or loss on dispositions.Solely for purposes of this paragraph (e), the term assetis an asset within the scope of this section or the portion of such asset that is disposed of in a disposition described in paragraph (d)(1) of this section. Except as provided by section 280B and §1.280B–1, the following rules apply when an asset is disposed of during a taxable year: (1) If an asset is disposed of by sale, ex- change, or involuntary conversion, gain or loss must be recognized under the appli- cable provisions of the Internal Revenue Code. (2) If an asset is disposed of by physi- cal abandonment, lossmust be recognized in the amount of the adjusted deprecia- ble basis (as defined in §1.168(b)–1(a)(4)) of the asset at the time of the abandon- ment (taking into account the applicable convention). However, if the abandoned asset is subject to nonrecourse indebted- ness, paragraph (e)(1) of this section ap- plies to the asset (instead of this paragraph (e)(2)). For a loss from physical abandon- ment to qualify for recognition under this paragraph (e)(2), the taxpayer must intend to discard the asset irrevocably so that the taxpayer will neither use the asset again nor retrieve it for sale, exchange, or other disposition. (3) If an asset is disposed of other than by sale, exchange, involuntary conversion, physical abandonment, or conversion to personal use (as, for example, when the as- set is transferred to a supplies or scrap ac- count), gain is not recognized. Loss must be recognized in the amount of the ex- cess of the adjusted depreciable basis of the asset at the time of the disposition (tak- ing into account the applicable conven- tion) over the asset’s fair market value at the time of the disposition (taking into ac- count the applicable convention). (f)Basis of asset disposed of—(1)In general. The adjusted basis of an asset dis- posed of for computing gain or loss is its adjusted depreciable basis at the time of the asset’s disposition (as determined un- der the applicable convention for the as- set). (2)Assets disposed of are in multiple asset accounts. If the taxpayer accounts for the asset disposed of in a multiple as- set account or pool and it is impractica- ble from the taxpayer’s records to deter- October 21, 20134222013–43 I.R.B. mine the unadjusted depreciable basis (as defined in §1.168(b)–1(a)(3)) of the asset disposed of, the taxpayer may use any rea- sonable method that is consistently applied to all assets in the same multiple asset ac- count or pool for purposes of determin- ing the unadjusted depreciable basis of as- sets disposed of. Examples of a reasonable method include, but are not limited to, dis- counting the cost of the replacement asset to its placed-in-service year cost using the Consumer Price Index, apro rataalloca- tion of the unadjusted depreciable basis of the multiple asset account or pool based on the replacement cost of the disposed asset and the replacement cost of all of the assets in the multiple asset account or pool, and a study allocating the cost of the asset to its individual components. To determine the adjusted depreciable basis of an asset dis- posed of in a multiple asset account, the depreciation allowed or allowable for the asset disposed of is computed by using the depreciation method, recovery period, and convention applicable to the multiple asset account or pool in which the asset disposed of was included and by including the ad- ditional first year depreciation deduction claimed for the asset disposed of. (3)Disposition of a portion of an asset. This paragraph (f)(3) applies only when a taxpayer disposes of a portion of an asset and paragraph (d)(1)of this section applies to that disposition. For computing gain or loss, the adjusted basis of the disposed portion of the asset is the adjusted depre- ciable basis of that disposed portion at the time of its disposition (as determined un- der the applicable convention for the as- set). The taxpayer may use any reason- able method for purposes of determining the unadjusted depreciable basis (as de- fined in §1.168(b)–1(a)(3)) of the disposed portion of the asset. If a taxpayer disposes of more than one portion of the same asset and paragraph (d)(1)of this section applies to more than one of those dispositions, the taxpayer may use any reasonable method that is consistently applied to all portions of the same asset for purposes of deter- mining the unadjusted depreciable basis of each disposed portion of the asset. Exam- ples of a reasonable method include, but are not limited to, discounting the cost of the replacement portion of the asset to its placed-in-service year cost using the Con- sumer Price Index, apro rataallocation of the unadjusted depreciable basis of the as- set based on the replacement cost of the disposed portion of the asset and the re- placement cost of the asset, and a study al- locating the cost of the asset to its individ- ual components. To determine the adjusted depreciable basis of the disposed portion of the asset, the depreciation allowed or al- lowable for the disposed portion is com- puted by using the depreciation method, recovery period, and convention applica- ble to the asset in which the disposed por- tion was included and by including the por- tion of the additional first year deprecia- tion deduction claimed for the asset that is attributable to the disposed portion. (g)Identification of asset disposed of—(1)In general. Except as provided in paragraph (g)(2) or paragraph (g)(3) of this section, a taxpayer must use the spe- cific identification method of accounting to identify which asset is disposed of by the taxpayer. Under this method of ac- counting, the taxpayer can determine the particular taxable year in which the asset disposed of was placed in service by the taxpayer. (2)Asset disposed of is in a multiple asset account. If a taxpayer accounts for the asset disposed of in a multiple asset account or pool and the total dispositions of assets with the same recovery period during the taxable year are readily deter- mined from the taxpayer’s records, but it is impracticable from the taxpayer’s records to determine the particular taxable year in which the asset disposed of was placed in service by the taxpayer, the taxpayer must identify the asset disposed of by using— (i) A first-in, first-out method of ac- counting if the unadjusted depreciable basis of the asset disposed of cannot be readily determined from the taxpayer’s records. Under this method of account- ing, the taxpayer identifies the multiple asset account or pool with the earliest placed-in-service year that has the same recovery period as the asset disposed of and that has assets at the beginning of the taxable year of the disposition, and the taxpayer treats the asset disposed of as being from that multiple asset account or pool; (ii) A modified first-in, first-out method of accounting if the unadjusted depreciable basis of the asset disposed of can be readily determined from the taxpayer’s records. Under this method of accounting, the tax- payer identifies the multiple asset account or pool with the earliest placed-in-service year that has the same recovery period as the asset disposed of and that has assets at the beginning of the taxable year of the dis- position with the same unadjusted depre- ciable basis as the asset disposed of, and the taxpayer treats the asset disposed of as being from that multiple asset account or pool; (iii) A mortality dispersion table if the asset disposed of is a mass asset. The mortality dispersion table must be based upon an acceptable sampling of the tax- payer’s actual disposition experience for mass assets or other acceptable statistical or engineering techniques. To use a mor- tality dispersion table, the taxpayer must adopt recordkeeping practices consistent with the taxpayer’s prior practices and con- sonant with good accounting and engineer- ing practices; or (iv) Any other method as the Secretary may designate by publication in theFed- eral Registeror in the Internal Revenue Bulletin (see §601.601(d)(2) of this chap- ter) on or after September 19, 2013. See paragraph (g)(4) of this section regarding the last-in, first-out method of accounting. (3)Disposition of a portion of an asset. If a taxpayer disposes of a portion of an as- set and paragraph (d)(1) of this section ap- plies to that disposition, but it is impracti- cable from the taxpayer’s records to deter- mine the particular taxable year in which the asset was placed in service, the tax- payer must identify the asset by using any applicable method provided in paragraph (g)(2) of this section (after taking into ac- count paragraph (g)(4) of this section). (4)Last-in, first-out method of account- ing. For purposes of paragraph (g)(2) of this section, a last-in,first-out method of accounting may not be used. Under a last- in, first-out methodof accounting, the tax- payer identifies the multiple asset account or pool with the most recent placed-in-ser- vice year that has the same recovery period as the asset disposed of and that has assets at the beginning of the taxable year of the disposition, and the taxpayer treats the as- set disposed of as being from that multiple asset account or pool. (h)Accounting for asset disposed of—(1)Depreciation ends. Depreciation ends for an asset at the time of the asset’s disposition (as determined under the ap- plicable convention for the asset). See §1.167(a)–10(b). If the asset disposed 2013–43 I.R.B.423October 21, 2013 of is in a single asset account initially or as a result of §1.168(i)–8(h)(2)(i) or §1.168(i)–8(h)(3)(i), the single asset ac- count terminates at the time of the asset’s disposition (as determined under the ap- plicable convention for the asset). If a taxpayer disposes of a portion of an asset and paragraph (d)(1)of this section applies to that disposition, depreciation ends for that disposed portion of the asset at the time of the disposition of the disposed por- tion (as determined under the applicable convention for the asset). (2)Asset disposed of in a multiple asset account or pool. If the taxpayer accounts for the asset disposed of in a multiple asset account or pool, then— (i) As of the first day of the taxable year in which the disposition occurs, the asset disposed of is removed from the multiple asset account or pool and is placed into a single asset account. See §1.168(i)–7(b) or §1.168(i)–7T(b), as applicable; (ii) The unadjusted depreciable basis of the multiple asset account or pool must be reduced by the unadjusted depreciable ba- sis of the asset disposed of as of the first day of the taxable year in which the dispo- sition occurs. See paragraph (f)(2) of this section for determining the unadjusted de- preciable basis of the asset disposed of; (iii) The depreciation reserve of the multiple asset accountor pool must be reduced by the depreciation allowed or allowable for the asset disposed of as of the end of the taxable year immediately preceding the year of disposition, com- puted by using the depreciation method, recovery period, and convention applica- ble to the multiple asset account or pool in which the asset disposed of was included and by including the additional first year depreciation deduction claimed for the asset disposed of; and (iv) In determining the adjusted depre- ciable basis of the asset disposed of at the time of disposition (taking into account the applicable convention), the deprecia- tion allowed or allowable for the asset dis- posed of is computed by using the depre- ciation method, recovery period, and con- vention applicable to the multiple asset ac- count or pool in which the asset disposed of was included and by including the ad- ditional first year depreciation deduction claimed for the asset disposed of. (3)Disposition of a portion of an asset. This paragraph (h)(3) applies only when a taxpayer disposes of a portion of an asset and paragraph (d)(1) ofthis section applies to that disposition. In this case— (i) As of the first day of the taxable year in which the disposition occurs, the dis- posed portion is placed into a single asset account. See §1.168(i)–7(b); (ii) The unadjusted depreciable basis of the asset must be reduced by the unad- justed depreciable basis of the disposed portion of the first day of the taxable year in which the disposition occurs. See para- graph (f)(3) of this section for determining the unadjusted depreciable basis of the dis- posed portion; (iii) The depreciation reserve of the as- set must be reduced by the depreciation al- lowed or allowable for the disposed por- tion as of the end of the taxable year im- mediately preceding the year of disposi- tion, computed by using the depreciation method, recovery period, and convention applicable to theasset in which the dis- posed portion was included and by includ- ing the portion of the additional first year depreciation deduction claimed for the as- set that is attributable to the disposed por- tion; and (iv) In determining the adjusted depre- ciable basis of the disposed portion at the time of disposition (taking into account the applicable convention), the depreciation allowed or allowable for the disposed por- tion is computed by using the depreciation method, recovery period, and convention applicable to theasset in which the dis- posed portion was included and by includ- ing the portion of the additional first year depreciation deduction claimed for the as- set that is attributable to the disposed por- tion. (i)Examples. The application of this section is illustratedby the following ex- amples. For purposes of these examples, assume that section 168 as in effect on September 19, 2013, applies to taxable years beginning on or after January 1, 2014. Example 1. A owns an office building with four elevators. A replaces one of the elevators. The ele- vator is a structural component of the office building. In accordance with paragraph (c)(4)(ii)(A) of this sec- tion, the office building (including its structural com- ponents) is the asset for disposition purposes. A does not make the partial disposition election provided un- der paragraph (d)(2) of this section for the elevator. Thus, the retirement of the replaced elevator is not a disposition. As a result, depreciation continues for the cost of the building (including the cost of the re- tired elevator and the building’s other structural com- ponents), and A does not recognize a loss for this re- tired elevator. If A must capitalize the amount paid for the replacement elevator pursuant to §1.263(a)–3, the replacement elevator is a separate asset for dispo- sition purposes pursuant to paragraph (c)(4)(ii)(D) of this section and for depreciation purposes pursuant to section 168(i)(6). Example 2. The facts are the same as inExam- ple 1 , except A accounts for each structural compo- nent of the office building as a separate asset in its fixed asset system. Although A treats each structural component as a separate asset in its records, the of- fice building (including its structural components) is the asset for disposition purposes in accordance with paragraph (c)(4)(ii)(A) of this section. Accordingly, the result is the same as in Example 1. Example 3. The facts are the same as inExample 1 , except A makes the partial disposition election provided under paragraph (d)(2) of this section for the elevator. Although the office building (including its structural components) is the asset for disposi- tion purposes, the result of A making the partial disposition election for the elevator is that the re- tirement of the replaced elevator is a disposition. Thus, depreciation for the retired elevator ceases at the time of its retirement (taking into account the applicable convention), and A recognizes a loss upon this retirement. Further, A must capitalize the amount paid for the replacement elevator pursuant to §1.263(a)–3(k)(1)(i), and the replacement elevator is a separate asset for disposition purposes pursuant to paragraph (c)(4)(ii)(D) of this section and for depreciation purposes pursuant to section 168(i)(6). Example 4. B, a calendar-year commercial air- line company, owns several aircraft that are used in the commercial carrying of passengers and described in asset class 45.0 of Rev. Proc. 87–56. B replaces the existing engines on one of the aircraft with new engines. Assume each aircraft is a unit of property as determined under §1.263(a)–3(e)(3) and each engine of an aircraft is a major component or substantial structural part of the aircraft as determined under §1.263(a)–3(k)(6). Assume also that B treats each aircraft as the asset for disposition purposes in ac- cordance with paragraph (c)(4) of this section. B makes the partial disposition election provided under paragraph (d)(2) of this section for the engines in the aircraft. Although the aircraft is the asset for disposition purposes, the result of B making the partial disposition election for the engines is that the retirement of the replaced engines is a disposition. Thus, depreciation for the retired engines ceases at the time of their retirement (taking into account the applicable convention), and B recognizes a loss upon this retirement. Further, B must capitalize the amount paid for the replacement engines pursuant to §1.263(a)–3(k)(1)(i), and the replacement engines are a separate asset for disposition purposes pursuant to paragraph (c)(4)(ii)(D) of this section and for depreciation purposes pursuant to section 168(i)(6). Example 5. The facts are the same as inExample 4 , except B does not make the partial disposition elec- tion provided under paragraph (d)(2) of this section for the engines. Thus, the retirement of the replaced engines on one of the aircraft is not a disposition. As a result, depreciation continues for the cost of the air- craft (including the cost ofthe retired engines), and B does not recognize a loss for these retired engines. If B must capitalize the amount paid for the replacement October 21, 20134242013–43 I.R.B. engines pursuant to §1.263(a)–3, the replacement en- gines are a separate asset for disposition purposes pur- suant to paragraph (c)(4)(ii)(D) of this section and for depreciation purposes pursuant to section 168(i)(6). Example 6. C, a corporation, owns several trucks that are used in its trade or business and described in asset class 00.241 of Rev. Proc. 87–56. C re- places the engine on one of the trucks with a new engine. Assume each truck is a unit of property as determined under §1.263(a)–3(e)(3) and each engine is a major component or substantial structural part of the truck as determined under §1.263(a)–3(k)(6). Be- cause the trucks are described in asset class 00.241 of Rev. Proc. 87–56, C must treat each truck as the asset for disposition purposes. C does not make the partial disposition election provided under paragraph (d)(2) of this section for the engine. Thus, the retirement of the replaced engine on the truck is not a disposition. As a result, depreciation continues for the cost of the truck (including the cost of the retired engine), and C does not recognize a loss for this retired engine. If C must capitalize the amount paid for the replacement engine pursuant to §1.263(a)–3, the replacement en- gine is a separate asset for disposition purposes pur- suant to paragraph (c)(4)(ii)(D) of this section and for depreciation purposes pursuant to section 168(i)(6). Example 7. D owns a retail building. D replaces 60 percent of the roof of this building. In accordance with paragraph (c)(4)(ii)(A) of this section, the retail building (including its structural components) is the asset for disposition purposes. Assume D must cap- italize the costs incurred for replacing 60 percent of the roof pursuant to §1.263(a)–3(k)(1)(vi). D makes the partial disposition election provided under para- graph (d)(2) of this section for the 60 percent of the replaced roof. Thus, the retirement of 60 percent of the roof is a disposition. As a result, depreciation for 60 percent of the roof ceases at the time of its retire- ment (taking into account the applicable convention), and D recognizes a loss upon this retirement. Further, D must capitalize the amount paid for the 60 percent of the roof pursuant to §1.263(a)–3(k)(1)(i) and (vi) and the replacement 60 percent of the roof is a sep- arate asset for disposition purposes pursuant to para- graph (c)(4)(ii)(D) of this section and for depreciation purposes pursuant to section 168(i)(6). Example 8. (i) The facts are the same as inEx- ample 7 . Ten years after replacing 60 percent of the roof, D replaces 55 percent of the roof of the build- ing. In accordance with paragraph (c)(4)(ii)(A) and (D) of this section, for disposition purposes, the re- tail building (including its structural components ex- cept the replacement 60 percent of the roof) is an as- set and the replacement 60 percent of the roof is a separate asset. Assume D must capitalize the costs incurred for replacing 55 percent of the roof pursuant to §1.263(a)–3(k)(1)(vi). D makes the partial dispo- sition election provided under paragraph (d)(2) of this section for the 55 percent of the replaced roof. Thus, the retirement of 55 percent of the roof is a disposi- tion. (ii) However, D cannot determine from its records whether the replaced 55 percent is part of the 60 per- cent of the roof replaced ten years ago or whether the replaced 55 percent is part of the remaining 40 per- cent of the original roof. Pursuant to paragraph (g)(3) of this section, D identifies which asset it disposed of by using the first-in, first-out method of accounting. As a result, D disposed of the remaining 40 percent of the original roof and 25 percent of the 60 percent of the roof replaced ten years ago. (iii) Thus, depreciation for the remaining 40 per- cent of the original roof ceases at the time of its retire- ment (taking into account theapplicable convention), and D recognizes a loss upon this retirement. Further, depreciation for 25 percent of the 60 percent of the roof replaced ten years ago ceases at the time of its re- tirement (taking into account the applicable conven- tion), and D recognizes a loss upon this retirement. Also, D must capitalize the amount paid for the 55 percent of the roof pursuant to §1.263(a)–3(k)(1)(i) and (vi), and the replacement 55 percent of the roof is a separate asset for disposition purposes pursuant to paragraph (c)(4)(ii)(D) of this section and for de- preciation purposes pursuant to section 168(i)(6). Example 9. (i) On July 1, 2011, E, a calen- dar-year taxpayer, purchased and placed in service a multi-story office building that costs $20,000,000. The cost of each structural component of the build- ing was not separately stated. E accounts for the building in its records as a single asset with a cost of $20,000,000. E depreciates the building as nonresidential real property and uses the optional depreciation table that corresponds with the gen- eral depreciation system, the straight-line method, a 39-year recovery period, and the mid-month conven- tion. As of January 1, 2014, the depreciation reserve for the building is $1,261,000. (ii) On June 30, 2014, E replaces one of the of- fice building’s elevators. E did not dispose of any other structural components of this building in 2014. E makes the partial disposition election provided un- der paragraph (d)(2) of this section for this eleva- tor. Although the office building (including its struc- tural components) is the asset for disposition pur- poses, the result of E making the partial disposition election for the elevator is that the retirement of the replaced elevator is a disposition. Because E cannot identify the cost of the structural components of the office building from its records, E determines the cost of any disposed structural component of this build- ing by discounting the cost of the replacement struc- tural component to its placed-in-service year cost us- ing the Consumer Price Index. Using this reasonable method, E determines the cost of the retired elevator by discounting the cost of the replacement elevator to its cost in 2011 (the placed-in-service year) using the Consumer Price Index, resulting in $150,000 of the $20,000,000 purchase price for the building to be the cost of the retired elevator. Using the optional de- preciation table that corresponds with the general de- preciation system, the straight-line method, a 39-year recovery period, and the mid-month convention, the depreciation allowed or allowable for the retired ele- vator as of December 31, 2013, is $9,457.50. (iii) For E’s 2014 Federal tax return, the loss for the retired elevator is determined as follows. The de- preciation allowed or allowable for 2014 for the re- tired elevator is $1,763 ((unadjusted depreciable basis of $150,000 x depreciation rate of 2.564% for 2014) x 5.5/12 months). Thus, the adjusted depreciable ba- sis of the retired elevator is $138,779.50 (the adjusted depreciable basis of $140,542.50 removed from the building cost less the depreciation allowed or allow- able of $1,763 for 2014). As a result, E recognizes a loss of $138,779.50 for the retired elevator in 2014, which is subject to section 1231. (iv) For E’s 2014 Federal tax return, the de- preciation allowance for the building is computed as follows. As of January 1, 2014, the unad- justed depreciable basis of the building is reduced from $20,000,000 to $19,850,000 ($20,000,000 less the unadjusted depreciable basis of $150,000 for the retired elevator), and the depreciation re- serve of the building is reduced from $1,261,000 to $1,251,542.50 ($1,261,000 less the depreciation allowed or allowable of $9,457.50 for the retired elevator as of December 31, 2013). Consequently, the depreciation allowance for the building for 2014 is $508,954 ($19,850,000 x depreciation rate of 2.564% for 2014). (v) E also must capitalize the amount paid for the replacement elevator pursuant to §1.263(a)–3(k)(1)(i). The replacement elevator is a separate asset for tax disposition purposes pursuant to paragraph (c)(4)(ii)(D) of this section and for depreciation purposes pursuant to section 168(i)(6). Example 10. (i) Since 2005, F, a calendar year taxpayer, has accounted for items of MACRS prop- erty that are mass assets in pools. Each pool includes only the mass assets that have the same depreciation method, recovery period, and convention, and are placed in service by F in the same taxable year. None of the pools are general asset accounts under section 168(i)(4) and the regulations under section 168(i)(4). F identifies any dispositions of these mass assets by specific identification. (ii) During 2014, F sells 10 items of mass assets with a 5-year recovery period each for $100. Under the specific identification method, F identifies these mass assets as being from the pool established by F in 2012 for mass assets with a 5-year recovery period. Assume F depreciates this pool using the optional de- preciation table that corresponds with the general de- preciation system, the 200-percent declining balance method, a 5-year recovery period, and the half-year convention. F elected not to deduct the additional first year depreciation provided by section 168(k) for 5-year property placed in service during 2012. As of January 1, 2014, this pool contains 100 similar items of mass assets with a total cost of $25,000 and a to- tal depreciation reserveof $13,000. Because all the items of mass assets in the pool are similar, F allo- cates the cost and depreciation allowed or allowable for the pool ratably among each item in the pool. Us- ing this reasonable method (because all the items of mass assets in the pool are similar), F allocates a cost of $250 ($25,000 x (1/100)) to each disposed of mass asset and depreciation allowed or allowable of $130 ($13,000 x (1/100)) to each disposed of mass asset. The depreciation allowed or allowable in 2014 for each disposed of mass asset is $24 (($250 x 19.2%) / 2). As a result, the adjusted depreciable basis of each disposed of mass asset under section 1011 is $96 ($250 - $130 - $24). Thus, F recognizes a gain of $4 for each disposed of mass asset in 2014, which is sub- ject to section 1245. (iii) Further, as of January 1, 2014, the unadjusted depreciable basis of the 2012 pool of mass assets with a 5-year recovery period is reduced from $25,000 to $22,500 ($25,000 less the unadjusted depreciable ba- sis of $2,500 for the 10 disposed of items), and the de- preciation reserve of this 2012 pool is reduced from $13,000 to $11,700 ($13,000 less the depreciation al- lowed or allowable of $1,300 for the 10 disposed of items as of December 31, 2013). Consequently, as 2013–43 I.R.B.425October 21, 2013 of January 1, 2014, the 2012 pool of mass assets with a 5-year recovery period has 90 items with a total cost of $22,500 and a depreciation reserve of $11,700. Thus, the depreciation allowance for this pool for 2014 is $4,320 ($22,500 x 19.2%). Example 11. (i) The facts are the same as inEx- ample 10 . Because of changes in F’s recordkeep- ing in 2015, it is impracticable for F to continue to identify disposed of mass assets using specific iden- tification and to determine the unadjusted deprecia- ble basis of the disposed of mass assets. As a re- sult, F files a Form 3115, Application for Change in Accounting Method, to change to a first-in, first-out method beginning with the taxable year beginning on January 1, 2015, on a modified cut-off basis. See §1.446–1(e)(2)(ii)( d)(2)(vii). Under the first-in, first- out method, the mass assets disposed of in a taxable year are deemed to be from the pool with the earliest placed-in-service year that has assets as of the begin- ning of the taxable year of the disposition with the same recovery period as the asset disposed of. The Commissioner of Internal Revenue consents to this change in method of accounting. (ii) During 2015, F sells 20 items of mass assets with a 5-year recovery period each for $50. As of January 1, 2015, the 2008 pool is the pool with the earliest placed-in-service year for mass assets with a 5-year recovery period, and this pool contains 25 items of mass assets with a total cost of $10,000 and a total depreciation reserve of $10,000. Thus, F allo- cates a cost of $400 ($10,000 x (1/25)) to each dis- posed of mass asset and depreciation allowed or al- lowable of $400 to each disposed of mass asset. As a result, the adjusted depreciable basis of each dis- posed of mass asset is $0. Thus, F recognizes a gain of $50 for each disposed of mass asset in 2015, which is subject to section 1245. (iii) Further, as of January 1, 2015, the unadjusted depreciable basis of the 2008 pool of mass assets with a 5-year recovery period is reduced from $10,000 to $2,000 ($10,000 less the unadjusted depreciable ba- sis of $8,000 for the 20 disposed of items ($400 x 20)), and the depreciation reserve of this 2008 pool is reduced from $10,000 to $2,000 ($10,000 less the de- preciation allowed or allowable of $8,000 for the 20 disposed of items as of December 31, 2014). Conse- quently, as of January 1, 2015, the 2008 pool of mass assets with a 5-year recovery period has 5 items with a total cost of $2,000 and a depreciation reserve of $2,000. (j)Effective/applicability date—(1)In general. This section applies to taxable years beginning on or after January 1, 2014. (2)Early application of this section.A taxpayer may choose to apply the provi- sions of this section to taxable years begin- ning on or after January 1, 2012. (3)Early application of regulation project REG–110732–13. A taxpayer may rely on the provisions of this section in regulation project REG–110732–13 for taxable years beginning on or after Jan- uary 1, 2012. However, a taxpayer may not rely on the provisions of this section in regulation project REG–110732–13 for taxable years beginning on or after Jan- uary 1, 2014. (4)Optional application of TD 9564. A taxpayer may choose to apply §1.168(i)–8T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012. However, a taxpayer may not apply §1.168(i)–8T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2014. (5)Change in method of accounting. A change to comply with this section for depreciable assets placed in service in a taxable year ending on or after December 30, 2003, is a change in method of ac- counting to which the provisions of sec- tion 446(e) and the regulations under sec- tion 446(e) apply. A taxpayer also may treat a change to comply with this section for depreciable assets placed in service in a taxable year ending before December 30, 2003, as a change in method of accounting to which the provisions of section 446(e) and the regulations under section 446(e) apply. This paragraph (j)(5) does not ap- ply to a change to comply with paragraph (d)(2) of this section (except as provided in paragraph (d)(2)(iii) or (d)(2)(iv)(B) of this section). Beth Tucker, Deputy Commissioner for Operations Support. (Filed by the Office of the Federal Register on September 13, 2013, 11:15 a.m., and published in the issue of the Federal Register for September 19, 2013, 78 F.R. 57547) October 21, 20134262013–43 I.R.B. Definition of Terms Revenue rulings and revenue procedures (hereinafter referred to as “rulings”) that have an effect on previous rulings use the following defined terms to describe the ef- fect: Amplifieddescribes a situation where no change is being made in a prior pub- lished position, but the prior position is be- ingextendedtoapplytoavariationofthe fact situation set forth therein. Thus, if an earlier ruling held that a principle ap- plied to A, and the new ruling holds that the same principle also applies to B, the earlier ruling is amplified. (Compare withmodi- fied,below). Clarifiedis used in those instances where the language in a prior ruling is be- ing made clear because the language has caused, or may cause, some confusion. It is not used where a position in a prior ruling is being changed. Distinguisheddescribes a situation where a ruling mentions a previously pub- lished ruling and points out an essential difference between them. Modifiedis used where the substance of a previously published position is being changed. Thus, if a prior ruling held that a principle applied to A but not to B, and the new ruling holds that it applies to both A and B, the prior ruling is modified because it corrects a published position. (Compare withamplifiedandclarified, above). Obsoleteddescribes a previously pub- lished ruling that is not considered deter- minative with respect to future transac- tions. This term is most commonly used in a ruling that lists previously published rul- ings that are obsoleted because of changes in laws or regulations. A ruling may also be obsoleted because the substance has been included in regulations subsequently adopted. Revokeddescribes situations where the position in the previously published ruling is not correct and the correct position is beingstatedinanewruling. Supersededdescribes a situation where the new ruling does nothing more than re- state the substance and situation of a previ- ously published ruling (or rulings). Thus, the term is used to republish under the 1986 Code and regulations the same po- sition published under the 1939 Code and regulations. The term is also used when it is desired to republish in a single rul- ing a series of situations, names, etc., that were previously published over a period of time in separate rulings. If the new rul- ing does more than restate the substance of a prior ruling, a combination of terms is used. For example,modifiedandsu- persededdescribes a situation where the substance of a previously published ruling is being changed in part and is continued without change in part and it is desired to restate the valid portion of the previously published ruling in a new ruling that is self contained. In this case,the previously pub- lished ruling is first modified and then, as modified, is superseded. Supplementedis used in situations in which a list, such as a list of the names of countries, is published in a ruling and that list is expanded by adding further names in subsequent rulings. After the original rul- ing has been supplemented several times, a new ruling may be published that includes the list in the original ruling and the ad- ditions, and supersedes all prior rulings in the series. Suspendedis used in rare situations to show that the previous published rulings will not be applied pending some future action such as the issuance of new or amended regulations, the outcome of cases in litigation, or the outcome of a Service study. Abbreviations The fol lowing abbreviations in current use and for merly used will appear in material publis hedintheBulletin. A—Individual. Acq.—A cquiescence. B—Individual. BE—Beneficiary. BK—Bank . B.T.A.—Board of Tax Appeals. C—Individual. C.B.—Cu mulative Bulletin. CFR—Code of Federal Regulations. CI—City. COOP—Coo perative. Ct.D.—Court Decision. CY—County. D—Decede nt. DC—Dummy Corporation. DE—Donee. Del. Order —Delegation Order. DISC—Domestic International Sales Corporation. DR—Donor. E—Estate. EE—Employee. E.O.—Executive Order. ER—Emp loyer. ERISA—Employee Retirement Income Security Act. EX—Executor. F—Fiduc iary. FC—Foreign Country. FICA—Federal Insurance Contributions Act. FISC—Fo reign International Sales Company. FPH—Foreign Personal Holding Company. F.R.—Federal Register. FUTA—Fed eral Unemployment Tax Act. FX—Foreign corporation. G.C.M.—Chief Counsel’s Memorandum. GE—Grante e. GP—General Partner. GR—Grantor. IC—Insura nce Company. I.R.B.—Internal Revenue Bulletin. LE—Lessee. LP—Limited Partner. LR—Lessor. M—Minor. Nonacq.—No nacquiescence. O—Organization. P—Parent Corporation. PHC—Persona l Holding Company. PO—Possession of the U.S. PR—Partner. PRS—Pa rtnership. PTE—Prohibited Transaction Exemption. Pub. L.—Public Law. REIT—Re al Estate Investment Trust. Rev. Proc.—Revenue Procedure. Rev. Rul.—Revenue Ruling. S—Subsi diary. S.P.R.—Statement of Procedural Rules. Stat.—Statutes at Large. T—Target Corporation. T.C.—Tax Court. T.D.—Treasury Decision. TFE—Trans feree. TFR—Transferor. T.I.R.—Technical Information Release. TP—Taxpay er. TR—Trust. TT—Trustee. U.S.C.—Uni ted States Code. X—Corporation. Y—Corporation. Z—Corporat ion. 2013–43 I.R.B.iOctober 21, 2013 Numerical Finding List 1 Bulletins 2013–27 through 2013–43 Announcements: 2013-35, 2013-27 I.R.B.46 2013-36, 2013-33 I.R.B.142 2013-37, 2013-34 I.R.B.155 2013-38, 2013-36 I.R.B.185 2013-39, 2013-35 I.R.B.167 2013-40, 2013-38 I.R.B.226 2013-41, 2013-40 I.R.B.322 Notices: 2013-41, 2013-29 I.R.B.60 2013-42, 2013-29 I.R.B.61 2013-43, 2013-31 I.R.B.113 2013-44, 2013-29 I.R.B.62 2013-45, 2013-31 I.R.B.116 2013-46, 2013-31 I.R.B.117 2013-47, 2013-31 I.R.B.120 2013-48, 2013-31 I.R.B.120 2013-49, 2013-32 I.R.B.127 2013-50, 2013-32 I.R.B.133 2013-51, 2013-34 I.R.B.153 2013-52, 2013-35 I.R.B.159 2013-53, 2013-36 I.R.B.173 2013-54, 2013-40 I.R.B.287 2013-55, 2013-38 I.R.B.207 2013-56, 2013-39 I.R.B.262 2013-57, 2013-40 I.R.B.293 2013-58, 2013-40 I.R.B.294 2013-59, 2013-40 I.R.B.297 Proposed Regulations: REG-132251-11, 2013-37 I.R.B.191 REG-111753-12, 2013-40 I.R.B.302 REG-112815-12, 2013-35 I.R.B.162 REG-114122-12, 2013-35 I.R.B.163 REG-136630-12, 2013-40 I.R.B.303 REG-140789-12, 2013-32 I.R.B.136 REG-144990-12, 2013-39 I.R.B.264 REG-110732-13, 2013-43 I.R.B.404 REG-111837-13, 2013-39 I.R.B.266 REG-113792-13, 2013-38 I.R.B.211 REG-115300-13, 2013-37 I.R.B.197 Revenue Procedures: 2013-28, 2013-27 I.R.B.28 2013-29, 2013-33 I.R.B.141 2013-30, 2013-36 I.R.B.173 2013-31, 2013-38 I.R.B.208 2013-32, 2013-28 I.R.B.55 2013-33, 2013-38 I.R.B.209 2013-34, 2013-43 I.R.B.397 Revenue Rulings: 2013-13, 2013-32 I.R.B.124 2013-15, 2013-28 I.R.B.47 2013-16, 2013-40 I.R.B.275 2013-17, 2013-38 I.R.B.201 2013-18, 2013-37 I.R.B.186 2013-19, 2013-39 I.R.B.240 2013-20, 2013-40 I.R.B.272 2013-21, 2013-43 I.R.B.394 Treasury Decisions: 9620, 2013-27 I.R.B.1 9621, 2013-28 I.R.B.49 9622, 2013-30 I.R.B.64 9623, 2013-30 I.R.B.73 9624, 2013-31 I.R.B.86 9625, 2013-34 I.R.B.147 9626, 2013-34 I.R.B.149 9627, 2013-35 I.R.B.156 9628, 2013-36 I.R.B.169 9629, 2013-37 I.R.B.188 9630, 2013-38 I.R.B.199 9631, 2013-38 I.R.B.205 9632, 2013-39 I.R.B.241 9633, 2013-39 I.R.B.227 9634, 2013-40 I.R.B.272 9635, 2013-40 I.R.B.273 9636, 2013-43 I.R.B.331 1 A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., publishedin Internal Revenue Bulletins 2013–1 through 2013–26 is in Internal Revenue Bulletin 2013–26, dated June 24, 2013. October 21, 2013ii2013–43 I.R.B. Finding List of Current Actions on Previously Published Items 1 Bulletins 2013–27 through 2013–43 Notices: 2004-23 Clarified by Notice 2013-57, 2013-40 I.R.B. 293 2004-50 Clarified by Notice 2013-57, 2013-40 I.R.B. 293 2005-70 Obsoleted by T.D. 9633, 2013-39 I.R.B. 227 2012-74 Obsoleted by Notice 2013-51, 2013-34 I.R.B. 153 2013-16 Superseded by Notice 2013-55, 2013-38 I.R.B. 207 2013-36 Appendix updated by Notice 2013-55, 2013-38 I.R.B. 207 Superseded by Notice 2013-55, 2013-38 I.R.B. 207 2013-39 Amplified by Notice 2013-47, 2013-31 I.R.B. 120 2013-40 Amplified by Notice 2013-47, 2013-31 I.R.B. 120 Revenue Procedures: 81-60 Modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 83-59 Modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 86-42 Modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 90-52 Modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 96-30 Modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 97-48 Situation 1 superseded, Situation 2 obsoleted by Rev. Proc. 2013-30, 2013-36 I.R.B. 173 Revenue Procedures— Continued: 2003-43 Modified and superseded by Rev. Proc. 2013-30, 2013-36 I.R.B. 173 2003-48 Obsoleted in part and superseded in part by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 2003-61 Superseded by Rev. Proc. 2013-34, 2013-43 I.R.B. 397 2004-34 Modified and clarified by Rev. Proc. 2013-29, 2013-33 I.R.B. 141 2004-48 Modified and superseded by Rev. Proc. 2013-30, 2013-36 I.R.B. 173 2004-49 Sections 4.01 & 4.02 modified and superseded, Section 4.03 obsoleted by Rev. Proc. 2013-30, 2013-36 I.R.B. 173 2007-44 Modified by Ann. 2013-37, 2013-34 I.R.B. 155 2007-62 Modified and superseded by Rev. Proc. 2013-30, 2013-36 I.R.B. 173 2009-25 Pilot program discontinued by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 2011-18 Modified and clarified by Rev. Proc. 2013-29, 2013-33 I.R.B. 141 2011-49 Modified by Ann. 2013-37, 2013-34 I.R.B. 155 2012-25 Obsoleted in part by Rev. Proc. 2013-28, 2013-27 I.R.B. 28 2013-1 Amplified and modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 2013-3 Amplified and modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55 Revenue Rulings: 58-66 Amplified and clarified by Rev. Rul. 2013-17, 2013-38 I.R.B. 201 Treasury Decisions: 9610 Corrected by by Ann. 2013-41, 2013-40 I.R.B. 322 9612 Corrected by Ann. 2013-35, 2013-27 I.R.B. 46 9622 Corrected by Ann. 2013-39, 2013-35 I.R.B. 167 1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2013–1 through 2013–26 is in Internal Revenue Bulletin 2013–26, dated June 24, 2013. 2013–43 I.R.B.iiiOctober 21, 2013 Internal Revenue Service W ashington,DC20224 Official Business Penalty for Private Use, $300 INTERNAL REVENUE BULLETIN The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue Bulletins are available atwww.irs.gov/irb/. CUMULATIVE BULLETINS The contents of the weekly Bulletins were consolidated semiannually into permanent, indexed, Cumulative Bulletins through the 2008–2 edition. INTERNAL REVENUE BULLETINS ON CD-ROM Internal Revenue Bulletins are available annually as partof Publication 1796 (Tax Products CD-ROM). The CD-ROM can be purchased from National Technical Information Service (NTIS)on the Internet atwww.irs.gov/cdorders(discount for online orders) or by calling 1-877-233-6767. The first release is available in mid-December and the final release is available in late January. WE WELCOME COMMENTS ABOUT THE INTERNAL REVENUE BUL LETIN If you have c omments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we would be ple ased to hear from you. You can email us your suggestionsor comments through the IRS Internet Home Page (www.irs.gov) or write to the IRS Bulletin Unit, SE:W:CAR:MP:P:SPA, Washington, DC 20224.
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