Bulletin No. 2013-43October 21, 2013

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 2013–21, page 394.Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes ofsections 382, 642, 1274, 1288, and other sections of theCode, tables set forth the rates for October 2013.

T.D. 9636, page 331.These final regulations provide guidance on the application ofsections 162(a) and 263(a) of the Code to amounts paid toacquire, produce, or improve tangible property. They also pro-vide guidance under section 167 regarding accounting for andretirement 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 assetaccounts 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 propertysubject to depreciation under section 168 of the Code. Theproposed regulations also amend the general asset accountregulations under section 1.168(i)–1 and the accounting forMACRS property regulations under section 1.168(i)–7. Com-ments are requested by November 18, 2013. A public hearingis scheduled for December 19, 2013.

Rev. Proc. 2013–34, page 397.This revenue procedure provides guidance for a requestingspouse seeking equitable relief from income tax liability undersection 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 Revenue Proce-dure 2003–61 is superseded.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 requestingspouse seeking equitable relief from income tax liability undersection 66(c) or section 6015(f) of the Code. Revenue Proce-dure 2003–61 is superseded.

Finding Lists begin on page ii.

The IRS MissionProvide America’s taxpayers top-quality service by helpingthem understand and meet their tax responsibilities and en-

force the law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpayersor technical advice to Service field offices, identifying detailsand information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,court decisions, rulings, and procedures must be considered,

and Service personnel and others concerned are cautionedagainst reaching the same conclusions in other cases unlessthe 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 ofthe 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 thesesubjects are contained in the other Parts and Subparts. Alsoincluded in this part are Bank Secrecy Act Administrative Rul-ings. Bank Secrecy Act Administrative Rulings are issued bythe 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 indexfor the matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the last Bulletin of each semiannual period.

The contents 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, 2013 2013–43 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 42.—Low-IncomeHousing Credit

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 263.—CapitalExpenditures

T.D. 9636

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Parts 1 and 602

Guidance RegardingDeduction and Capitalizationof Expenditures Related toTangible Property

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations and removalof temporary regulations.

SUMMARY: This document contains finalregulations that provide guidance on theapplication of sections 162(a) and 263(a)of the Internal Revenue Code (Code)to amounts paid to acquire, produce, orimprove tangible property. The final reg-ulations clarify and expand the standardsin the current regulations under sections162(a) and 263(a). These final regulationsreplace and remove temporary regula-tions under sections 162(a) and 263(a) andwithdraw proposed regulations that crossreferenced the text of those temporaryregulations. This document also containsfinal regulations under section 167 re-garding accounting for and retirement ofdepreciable property and final regulationsunder section 168 regarding accountingfor property under the Modified Accel-erated Cost Recovery System (MACRS)other than general asset accounts. Thefinal regulations will affect all taxpayersthat acquire, produce, or improve tangibleproperty. These final regulations do notfinalize or remove the 2011 temporary

regulations under section 168 regardinggeneral asset accounts and disposition ofproperty subject to section 168, which areaddressed in this issue of the Bulletin.

DATES: Effective Date: These regulationsare effective on September 19, 2013.

Applicability Date: In general, thesefinal regulations apply to taxable years be-ginning on or after January 1, 2014. How-ever, certain rules apply only to amountspaid or incurred in taxable years beginningon or after January 1, 2014. For dates ofapplicability 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 FURTHER INFORMATIONCONTACT: 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 of Associate Chief Counsel(Income Tax and Accounting), (202)622–4950 (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 1.1016–3, Kathleen Reed orPatrick Clinton, Office Associate ChiefCounsel (Income Tax and Accounting),(202) 622–4930 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information containedin this final regulation has been reviewedand approved by the Office of Manage-ment and Budget in accordance with thePaperwork Reduction Act of 1995 (44U.S.C. 3507(d)) under control number1545–2248. An agency may not conductor sponsor, and a person is not requiredto respond to, a collection of informationunless the collection of information dis-plays a valid control number assigned bythe Office of Management and Budget.

The collection of information inthis regulation is in §§1.263(a)–1(f)(5),1.263(a)–3(h)(6), and 1.263(a)–3(n)(2).

This information is required in order fora taxpayer to elect to use the de minimissafe harbor, to elect to use the safe har-bor for small taxpayers, and to elect tocapitalize repair and maintenance costs.This information will inform the IRS thatthe taxpayer is electing to use these pro-visions, which allows taxpayers to obtainbeneficial treatment for the amounts thatqualify for these elections. The collectionof information is voluntary to obtain abenefit under the final regulations. Thelikely respondents are business or otherfor-profit institutions, and small busi-nesses or organizations.

Estimated total annual reporting bur-den: 1,100,000 hours.

Estimated annual burden hours per re-spondent varies from .25 hours to .5 hours,depending on individual circumstances,with an estimated average of .275 hours.

Estimated number of respondents:4,000,000.

Estimated frequency of responses: An-nually.

Books or records relating to a collectionof information must be retained as longas their contents may become material inthe administration of any internal revenuelaw. Generally, tax returns and tax returninformation are confidential, as requiredby section 6103.

Background

Section 263(a) provides that no deduc-tion is allowed for (1) any amount paid outfor new buildings or permanent improve-ments or betterments made to increase thevalue of any property or estate, or (2) anyamount expended in restoring property orin making good the exhaustion thereof forwhich an allowance has been made. Finalregulations previously issued under sec-tion 263(a) provided that capital expendi-tures included amounts paid or incurred to(1) add to the value, or substantially pro-long the useful life, of property owned bythe taxpayer, or (2) adapt the property to anew or different use. However, those regu-lations also provided that amounts paid orincurred for incidental repairs and mainte-nance of property within the meaning ofsection 162 and §1.162–4 of the Income

2013–43 I.R.B. 331 October 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 mustbe capitalized generally requires an ex-amination of all of a taxpayer’s particu-lar facts and circumstances. Moreover, thesubjective nature of the existing standardsdescribed above has resulted in consider-able controversy between taxpayers andthe 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 the FederalRegister August 21, 2006 (71 FR 48590)proposed amendments to the regulationsunder section 263(a) relating to amountspaid 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 thesecomments 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 the Federal Register March 10,2008 (73 FR 12838). The IRS and theTreasury Department also received manywritten comments and held a public hear-ing on the 2008 proposed regulations. OnDecember 27, 2011, the IRS and the Trea-sury Department published temporary reg-ulations in the Federal Register regard-ing the deduction and capitalization of ex-penditures related to tangible property (TD9564; 76 FR 81060), withdrew the 2008proposed regulations, and published newproposed regulations that cross referencedthe text of the 2011 temporary regulations.The 2011 temporary regulations initiallyapplied 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 helda public hearing on May 9, 2012. Afterconsidering these comments and the state-ments at the public hearing, the IRS andthe Treasury Department published No-tice 2012–73 (2012–51 I.R.B. 713), onNovember 20, 2012, announcing that, toassist taxpayers in their transitions to the2011 temporary regulations and final reg-ulations, the IRS and the Treasury Depart-ment would change the applicability dateof the 2011 temporary regulations to tax-able years beginning on or after January 1,

2014, while permitting taxpayers to chooseto apply the 2011 temporary regulations totaxable years beginning on or after January1, 2012, and before the applicability dateof the final regulations. The Notice alsoalerted taxpayers that the IRS and the Trea-sury Department intended to publish finalregulations in 2013 and expected the finalregulations to apply to taxable years begin-ning on or after January 1, 2014, but thatthe final regulations would permit taxpay-ers to apply its provisions to taxable yearsbeginning on or after January 1, 2012.On December 17, 2012, the Treasury De-partment and the IRS published technicalamendments to TD 9564, which amendedthe applicability date of the 2011 tempo-rary regulations to taxable years beginningon or after January 1, 2014, while permit-ting taxpayers to choose to apply the 2011temporary regulations to taxable years be-ginning on or after January 1, 2012, andbefore the applicability date of the finalregulations. See Federal Register (77 FR74583).

After considering all of the commentsand the statements made at the public hear-ing on the 2011 temporary and proposedregulations, the IRS and the Treasury De-partment are removing the 2011 temporaryregulations under sections 162, 165, 167,263(a), 263A, 1016, and §1.168(i)–7 andare issuing final regulations. The IRS andthe Treasury Department are also remov-ing the 2011 proposed regulations and areissuing new proposed regulations regard-ing the disposition of property subject tosection 168. The proposed regulations areset forth in this issue of the Bulletin.

Explanation of Provisions

I. Overview

Section 263(a) generally requires thecapitalization of amounts paid to acquire,produce, or improve tangible property.Section 162 allows a deduction for allthe ordinary and necessary expenses paidor incurred during the taxable year incarrying on any trade or business, includ-ing the costs of certain supplies, repairs,and maintenance. These final regula-tions provide a general framework fordistinguishing capital expenditures fromsupplies, repairs, maintenance, and otherdeductible business expenses. The finalregulations retain many of the provisions

of the 2011 temporary and proposed reg-ulations (2011 temporary regulations),which in many instances incorporatedstandards from case law and other ex-isting authorities under sections 162 and263(a). The final regulations also modifyseveral sections of the 2011 temporaryregulations in response to comments re-ceived and to clarify and simplify the ruleswhile achieving results that are consistentwith the case law. The final regulationsadopt the same general format as the 2011temporary regulations, where §1.162–3provides rules for materials and supplies,§1.162–4 addresses repairs and main-tenance, §1.263(a)–1 provides generalrules for capital expenditures, §1.263(a)–2provides rules for amounts paid for theacquisition or production of tangible prop-erty, and §1.263(a)–3 provides rules foramounts paid for the improvement oftangible property. However, the final reg-ulations refine and simplify some of therules contained in the 2011 temporary reg-ulations and create a number of new safeharbors. For example, the final regulationsadopt a revised and simplified de min-imis safe harbor under §1.263(a)–1(f) andextend the safe harbor for routine mainte-nance under §1.263(a)–3(i) to buildings.The final regulations also add a safe harborfor small taxpayers to the rules governingimprovements to tangible property under§1.263(a)–3. In addition, the final reg-ulations refine several of the criteria fordefining betterments and restorations totangible property.

In addition, these regulations finalizecertain temporary regulations under sec-tion 167 regarding accounting for andretirement of depreciable property andsection 168 regarding accounting forMACRS property, other than general assetaccounts. However, these regulations donot finalize the rules under §1.168(i)–1Tor §1.168(i)–8T addressing the definitionof disposition for property subject to sec-tion 168. Instead, to address significantchanges in this area, revised regulationsunder section 168 are being proposed con-currently with these final regulations (andappear in this issue of the Bulletin).

II. Materials and Supplies Under§1.162–3

Responding to generally favorablecomments on the treatment of materi-

October 21, 2013 332 2013–43 I.R.B.

als and supplies in the 2011 temporaryregulations, the final regulations retainthe framework and many of the rules setforth in the 2011 temporary regulations.In response to comments, however, thefinal regulations expand the definition ofmaterials and supplies to include propertythat has an acquisition or production costof $200 or less (increased from $100 orless), clarify application of the optionalmethod of accounting for rotable andtemporary spare parts, and simplify theapplication of the de minimis safe harborof §1.263(a)–1(f) to materials and sup-plies. The final regulations also definestandby emergency spare parts and limitthe application of the election to capital-ize materials and supplies to only rotable,temporary, and standby emergency spareparts.

A. Definition of materials and supplies

Commenters requested that the dollarthreshold for characterizing a unit of prop-erty as a material or supply be increasedfrom property with an acquisition cost of$100 or less to property with an acquisitioncost of $500 or $1,000. Specifically, com-menters were concerned that the low $100threshold would not capture many com-mon supplies such as calculators and cof-fee makers. Balancing concerns over dis-tortions to income that could result fromincreasing the acquisition cost to $500 (ormore) with the need to include the typicalmaterials and supplies ordinarily used bymany 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 TreasuryDepartment with the authority to changethe amount of this threshold through pub-lished guidance.

Commenters also continued to questionthe 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 inthis 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 andsupplies and provide that these parts are el-igible for the optional election to capitalizecertain materials and supplies provided in§1.162–3(d).

B. Election to capitalize certain materialsand supplies

The 2011 temporary regulations re-tained the rule from the 2008 proposedregulations permitting a taxpayer to electto capitalize and depreciate amounts paidfor certain materials and supplies. Sev-eral comments noted that the requirementto elect to capitalize certain material andsupply costs continued to be inconsistentwith prior IRS pronouncements that dis-tinguished certain depreciable propertyfrom 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 servicebusiness as depreciable assets); Rev. Rul.81–185 (1981–2 C.B. 59) (concluding thatmajor standby emergency spare parts aredepreciable property); Rev. Rul. 69–201(1969–1 C.B. 60) (holding that standbyreplacement parts used in pit mining busi-ness are items for which depreciation isallowable); Rev. Rul. 69–200 (1969–1C.B. 60) (holding that flight equipmentrotable spare parts and assemblies aretangible property for which deprecia-tion is allowable while expendable flightequipment spare parts are materials andsupplies); Rev. Proc. 2007–48 (2007–2C.B. 110) (providing a safe harbor methodof accounting to treat certain rotable spareparts as depreciable assets). In addition,several comments noted that the rule underthe 2011 temporary regulations could leadto problematic results, such as permittinga component acquired to improve a unit oftangible property owned by the taxpayerto be treated as an asset and depreciatedover a recovery period different from theunit of tangible property intended to beimproved.

To address these concerns, the final reg-ulations retain the rule permitting a tax-payer to elect to capitalize and depreciateamounts paid for certain materials and sup-plies but provide that this rule is only ap-plicable to rotable, temporary, or standbyemergency spare parts. By limiting the ap-plication of the rule to rotable, temporary,or standby emergency spare parts, the finalregulations resolve the potentially prob-lematic results arising in the 2011 tempo-rary regulations. And while the final rulemodifies 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 rulings as materials andsupplies, the treatment is consistent withthe holdings of the revenue rulings, whichpermit taxpayers to treat rotable, tempo-rary, or standby emergency spare parts asassets subject to the allowance for depreci-ation.

The final regulations also clarify theprocedure for a taxpayer that wants to re-voke the election to capitalize and depre-ciate certain materials and supplies. Thetaxpayer may revoke this election by filinga request for a letter ruling and obtainingthe consent of the Commissioner of Inter-nal Revenue to revoke this election. TheCommissioner 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 ofthe Government. In deciding whether togrant such a request, the Commissioner an-ticipates applying standards similar to thestandards under §301.9100–3 of this chap-ter for granting extensions of time for mak-ing regulatory elections.

Finally, one commenter requested thatthe rules governing materials and sup-plies be modified to address the cost ofacquiring or producing rotable spare partsthat a taxpayer leases to customers in theordinary course of the taxpayer’s leas-ing business. This commenter requestedthat the final regulations clarify that theseleased rotable spare parts are included inthe definition of rotable and temporaryspare parts and that a taxpayer may electto capitalize and depreciate these leasedrotable spare parts under the materials andsupplies rules. Under the 2011 temporaryregulations, the definition of rotable andtemporary spare parts includes only com-ponents acquired to maintain, repair, orimprove a unit of property owned, leased,or serviced by the taxpayer. This defini-tion of rotable and temporary spare partsdoes not include components that the tax-payer leases to its customers and that areunrelated to other property owned, leasedto other parties, or serviced by the tax-payer. The final regulations do not expandthe definition of rotable and temporaryspare parts to include leased rotable spareparts. The IRS and the Treasury Depart-ment believe that these parts are outsidethe scope of regulations governing materi-als and supplies.

2013–43 I.R.B. 333 October 21, 2013

C. Optional method for rotable andtemporary spare parts

One commenter requested that the finalregulations remove the requirement thatthe optional method for rotable and tem-porary spare parts, if elected, be used forall of a taxpayer’s rotable and temporaryspare parts in the same trade or business.Recognizing that taxpayers may havepools of rotable or temporary parts that aretreated differently for financial statementpurposes, the final regulations modify thisrule. The final regulations provide thata taxpayer that uses the optional methodfor rotable and temporary spare parts forFederal tax purposes must use the optionalmethod for all of the pools of rotable andtemporary spare parts used in the sametrade or business for which the optionalmethod is used for the taxpayer’s booksand records. Thus, a taxpayer generally isnot required to use the optional method forthose pools of rotable or temporary spareparts for which it does not use the optionalmethod in its books and records for thetrade or business. However, if a taxpayerchooses to use the optional method for anypool of rotable or temporary spare partsfor which the taxpayer does not use theoptional method in its books and recordsfor the trade or business, then the taxpayermust use the optional method for all itspools of rotable and temporary spare partsin that trade or business.

Commenters also requested that theoptional method for rotable and temporaryspare parts be treated as the default methodof accounting for rotable and temporaryspare parts, instead of treating rotable andtemporary spare parts as used and con-sumed in the taxable year when disposed.Many taxpayers do not use the optionalmethod of accounting for rotable andtemporary spare parts, and that methodrequires a degree of record keeping thatwould be overly burdensome for all tax-payers. Therefore, the final regulationsdo not adopt this suggestion and continueto generally treat rotable and temporaryspare parts as materials and supplies thatare used and consumed in the taxable yearwhen disposed of by the taxpayer, unlessthe taxpayer chooses a different treatmentunder §1.162–3.

D. Materials and supplies under the deminimis safe harbor

There were numerous comments on theapplication of the de minimis rule providedin the 2011 temporary regulations to ma-terials and supplies under §§1.162–3T(f)(election to apply de minimis rule to ma-terials and supplies) and 1.263(a)–2T(g)(general de minimis rule) and the interac-tion between the two sections. In responseto these comments, the final regulationsmore clearly coordinate the two provisionsas addressed below in the discussion of thede minimis safe harbor.

E. Property treated as materials andsupplies in published guidance

Several commenters questioned theeffect of the 2011 temporary regulationson prior published guidance that permitstaxpayers to treat certain property as ma-terials and supplies. For example, Rev.Proc. 2002–12 (2002–1 C.B. 374) allowsa taxpayer to treat smallwares as materialsand supplies that are not incidental under§1.162–3. Similarly, Rev. Proc. 2002–28(2002–1 C.B. 815) allows a qualifyingsmall business taxpayer to treat certaininventoriable items in the same manner asmaterials and supplies that are not inciden-tal under §1.162–3. The final regulationsdo not supersede, obsolete, or replacethese revenue procedures to the extentthey deem certain property to constitutematerials and supplies under §1.162–3.This designated property continues toqualify as materials and supplies under thefinal regulations, because the definitionof material and supplies includes propertythat is identified as materials and suppliesin published guidance.

III. Repairs Under §1.162–4

The 2011 temporary regulations pro-vided that amounts paid for repairs andmaintenance 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 fromthe 2011 temporary regulations. In addi-tion, the final regulations add a cross ref-erence to §1.263(a)–3(n), the new electionto capitalize amounts paid for repair andmaintenance consistent with the taxpayer’s

books and records, discussed later in thispreamble.

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 amountspaid to acquire or produce a unit ofreal or personal property, including therelated transaction costs. However,§1.263(a)–2T(g) provided a de minimisexception permitting a taxpayer to deductcertain amounts paid for tangible propertyif the taxpayer had an applicable financialstatement, had written accounting proce-dures for expensing amounts paid for suchproperty under specified dollar amounts,and treated such amounts as expenses onits applicable financial statement. Under§1.263(a)–2T(g)(1)(iv), a taxpayer’s deminimis deduction for the taxable year waslimited to a ceiling: the greater of (1) 0.1percent of the taxpayer’s gross receipts forthe taxable year as determined for Fed-eral income tax purposes, or (2) 2 percentof the taxpayer’s total depreciation andamortization expense for the taxable yearas determined on the taxpayer’s applicablefinancial statement.

The IRS and the Treasury Departmentreceived a significant number of com-ments addressing the de minimis safe har-bor provided in §1.263(a)–2T(g). Nearlyall comments raised concerns about theadministrative burden the ceiling wouldplace on taxpayers, noting that taxpay-ers would be required to keep detailedaccounts of amounts that they generallydo not track because such amounts areexpensed under their financial accountingcapitalization policies. Thus, while theceiling itself could be calculated relativelysimply, the financial accounting systemsemployed by most taxpayers would notallow them to easily determine whichcosts the de minimis rule applied to and,therefore, whether or not applicable costsexceeded the ceiling. Commenters alsopointed out that the operation of the ceil-ing requirement did not allow taxpayersto anticipate when they had reached thegross receipts or depreciation limitation orto identify assets that would be excludedunder the de minimis rule during a taxableyear, because the ceiling amount could

October 21, 2013 334 2013–43 I.R.B.

only be calculated after the end of a taxableyear. Commenters also highlighted thecomplexities inherent in the applicationof the ceiling requirement for consoli-dated groups. In many cases, commenterssuggested that the administrative burdenimposed would outweigh any potentialtax benefit. Many commenters suggestedthat this problem be resolved by remov-ing the ceiling altogether and permittingtaxpayers to deduct for Federal incometax purposes amounts properly expensedunder their financial accounting policies.

The final regulations adopt com-menters’ suggestions that the ceiling inthe de minimis rule in the 2011 tempo-rary regulations be eliminated and thatamounts properly expensed under a tax-payer’s financial accounting policies bedeductible for tax purposes. To bothaddress taxpayers’ concerns and ensurethat the de minimis safe harbor in thefinal regulations requires taxpayers touse 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 replacedwith a new safe harbor determined at theinvoice or item level and based on thepolicies that the taxpayer utilizes for itsfinancial accounting books and records.A taxpayer with an applicable financialstatement may rely on the de minimis safeharbor under §1.263(a)–1(f) of the finalregulations only if the amount paid forproperty does not exceed $5,000 per in-voice, or per item as substantiated by theinvoice. The final regulations provide theIRS and the Treasury Department with theauthority to change the safe harbor amountthrough published guidance.

Commenters also asked that the de min-imis safe harbor be expanded to includenot only amounts paid for property cost-ing less than a certain dollar amount butalso amounts paid for property having auseful life less than a certain period oftime. The final regulations adopt this sug-gestion and provide that the de minimissafe harbor also applies to a financial ac-counting procedure that expenses amountspaid for property with an economic use-ful life of 12 months or less as long as theamount per invoice (or item) does not ex-ceed $5,000. Such amounts are deductibleunder the de minimis rule whether this fi-nancial accounting procedure applies inisolation or in combination with a finan-

cial accounting procedure for expensingamounts paid for property that does not ex-ceed a specified dollar amount. Under ei-ther procedure, if the cost exceeds $5,000per invoice (or item), then the amountspaid for the property will not fall withinthe de minimis safe harbor. In addition,an anti-abuse rule is provided to aggregatecosts that are improperly split among mul-tiple invoices.

B. Taxpayers without an applicablefinancial statement

The 2011 temporary regulations didnot provide a de minimis safe harbor fortaxpayers without an applicable financialstatement, but the preamble requestedcomments addressing alternatives thatwould provide the IRS and the TreasuryDepartment with assurance that a taxpayeris using a reasonable, consistent method-ology that clearly reflects income. Onecommenter suggested that the definitionof applicable financial statement be ex-panded to include financial statementssubject to a compliance review under therules of the American Institute of CertifiedPublic Accountants’ (AICPA) Statementof Standards for Accounting and Re-view Services. Numerous comments alsorequested that the de minimis rule be gen-erally expanded to taxpayers without anapplicable financial statement.

The final regulations include a de min-imis rule for taxpayers without an applica-ble financial statement. While careful con-sideration was given to the suggestion ofrelying on reviewed financial statementsas defined in the AICPA’s Statement ofStandards for Accounting and Review Ser-vices, the final regulations do not adoptthis standard. While the AICPA standardfor reviewed financial statements ensuresthat the taxpayer’s policies comply withthe applicable financial accounting frame-work, the standard does not contemplate areview of the taxpayer’s internal control,fraud risk, or accounting records. Thus,the standard does not provide sufficientassurance to the IRS that such policiesare being followed and, accordingly, thatthe taxpayer is using a reasonable, consis-tent methodology that clearly reflects itsincome. However, the final regulationsdo provide a de minimis safe harbor fortaxpayers without an applicable financialstatement if accounting procedures are in

place to deduct amounts paid for propertycosting less than a specified dollar amountor amounts paid for property with an eco-nomic useful life of 12 months or less.The de minimis safe harbor for taxpayerswithout an applicable financial statementprovides a reduced per invoice (or item)threshold because there is less assurancethat the accounting procedures clearly re-flect income. A taxpayer without an appli-cable financial statement may rely on thede minimis safe harbor only if the amountpaid for property does not exceed $500 perinvoice, or per item as substantiated by theinvoice. If the cost exceeds $500 per in-voice (or item), then no portion of the costof the property will fall within the de min-imis safe harbor. Similar to the safe harborfor a taxpayer with an applicable financialstatement, this provision provides the IRSand the Treasury Department with the au-thority to change the safe harbor amountthrough published guidance. In addition,an anti-abuse rule is provided to aggregatecosts that are improperly split among mul-tiple invoices.

Finally, for both taxpayers with appli-cable financial statements and taxpayerswithout applicable financial statements,the de minimis safe harbor is not intendedto prevent a taxpayer from reaching anagreement with its IRS examining agentsthat, as an administrative matter, based onrisk analysis or materiality, the IRS exam-ining agents will not review certain items.It is not intended that examining agentsmust now revise their materiality thresh-olds in accordance with the de minimissafe harbor limitations provided in the fi-nal regulation. Thus, if examining agentsand a taxpayer agree that certain amountsin excess of the de minimis safe harborlimitations are not material or otherwiseshould not be subject to review, that agree-ment should be respected, notwithstandingthe requirements of the de minimis safeharbor. However, a taxpayer that seeksa deduction for amounts in excess of theamount allowed by the safe harbor hasthe burden of showing that such treatmentclearly reflects income.

C. Safe harbor election

Commenters asked whether the de min-imis rule in the 2011 temporary regula-tions was mandatory or elective and, ifmandatory, requested a change to make

2013–43 I.R.B. 335 October 21, 2013

the safe harbor elective. The final regula-tions adopt these suggestions and providethat the de minimis rule is a safe harbor,elected annually by including a statementon the taxpayer’s timely filed original Fed-eral tax return for the year elected. Thefinal regulations provide that, if elected,the de minimis safe harbor must be ap-plied to all amounts paid in the taxableyear for tangible property that meet the re-quirements of the de minimis safe harbor,including amounts paid for materials andsupplies that meet the requirements. In ad-dition, the final regulations provide that ataxpayer may not revoke an election to usethe de minimis safe harbor. An election touse the de minimis safe harbor may not bemade through the filing of an applicationfor change in accounting method.

D. Written accounting procedures

The 2011 temporary regulations re-quired that to utilize the de minimis safeharbor, a taxpayer must have writtenaccounting procedures in place at the be-ginning of the taxable year treating theamounts paid for property costing lessthan a certain dollar amount as an expensefor financial accounting purposes. Com-menters suggested that transition guidancebe issued for taxpayers that did not havewritten accounting procedures in place atthe beginning of 2012. Alternatively, onecommenter suggested that taxpayers beallowed to make the drafting of a writtenaccounting procedure retroactive to thebeginning of 2012.

The final regulations do not adopt thesesuggestions for transition relief. Althoughthe publication of the 2011 temporary reg-ulations late in the calendar year (Decem-ber 27, 2011) likely prevented taxpayerswithout written accounting procedures atthat time from implementing such proce-dures prior to the beginning of the 2012taxable year, the provisions of the 2011temporary regulations are elective for tax-able years beginning prior to January 1,2014. In addition, the final regulations arenot applicable until taxable years begin-ning on or after January 1, 2014. There-fore, taxpayers without written account-ing procedures that choose to elect the deminimis safe harbor for their 2014 tax-able years should have sufficient time toconsider and draft appropriate proceduresprior to the applicability date of the fi-

nal regulations. Moreover, the de minimissafe harbor is intended to provide record-keeping simplicity to taxpayers by allow-ing them to follow an established financialaccounting policy for federal tax purposes,and allowing retroactive application is in-consistent with such purpose.

E. Application to consolidated groupmembers

Several comments noted that the rulefor use of a consolidated group’s applica-ble financial statement failed to considersituations in which taxpayers are includedon a consolidated applicable financialstatement but are not members in an under-lying consolidated group for Federal in-come tax purposes. Comments requestedthat taxpayers in this situation be permit-ted to rely on the financial policies of thegroup that apply to them as well as thegroup’s consolidated applicable financialstatement to satisfy the requirements ofthe de minimis rule. The final regulationsadopt this suggestion and provide that ifa taxpayer’s financial results are reportedon the applicable financial statement for agroup of entities, then the group’s appli-cable financial statement may be treatedas the applicable financial statement ofthe taxpayer. Furthermore, in this situ-ation, the written accounting proceduresprovided for the group and utilized forthe group’s applicable financial statementmay be treated as the written accountingprocedures of the taxpayer.

F. Transaction and other additional costs

The preamble to the 2011 temporaryregulations provided that the de minimisrule did not apply to amounts paid forlabor and overhead incurred in repair-ing or improving property. Commenterspointed out that the preamble did not pro-vide any policy reason for excluding laborand overhead costs from the de minimisrule and that the exclusion would requirerules to allocate additional invoice costs,such as freight and installation costs, be-tween tangible property costs and laborand overhead costs, requiring additionalrecordkeeping by taxpayers. Addition-ally, one commenter pointed out that thede minimis rule in the 2011 temporaryregulations did not expressly provide foran exclusion of labor and overhead costs.Commenters requested that additional

costs included on an invoice for tangibleproperty be included within the scope ofthe de minimis rule.

The final regulations adopt the com-menters’ suggestions, in part, and clarifythe treatment under the de minimis safeharbor of transaction costs and other ad-ditional costs of acquiring and producingproperty subject to the safe harbor. Tosimplify the application of the de minimisrule to tangible property, the final regula-tions provide that a taxpayer electing to ap-ply the de minimis safe harbor is not re-quired to include in the cost of the tan-gible property the additional costs of ac-quiring or producing such property if thesecosts are not included in the same invoiceas the tangible property. However, the fi-nal regulations also provide that a taxpayerelecting to apply the de minimis safe 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 suchproperty if these costs are included on thesame invoice with the tangible property. Ifan invoice includes amounts paid for mul-tiple tangible properties and the invoiceincludes additional invoice costs relatedto the multiple properties, then the tax-payer must allocate the additional invoicecosts to each property using a reasonablemethod. The final regulations specify thata reasonable allocation method includes,but is not limited to, specific identification,a pro rata allocation, or a weighted aver-age method based on each property’s rela-tive cost. The final regulations also clarifythat additional costs consist of the trans-action costs (that is, the facilitative costsunder §1.263(a)–2(f)) of acquiring or pro-ducing the property and the costs under§1.263(a)–2(d) for work performed priorto 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 the de minimis rule to materialsand supplies under §1.162–3T of the 2011temporary regulations. Under the 2011temporary regulations, taxpayers were per-mitted to select materials and supplies tobe expensed under the de minimis rule pro-vided that these materials and supplies sat-isfied all requirements of the de minimis

October 21, 2013 336 2013–43 I.R.B.

rule, including the ceiling. Many com-ments raised concerns about the adminis-trative burdens associated with identifyingand allocating materials and supplies be-tween the de minimis rule and the generalrules for materials and supplies in a man-ner that would not exceed the de minimisrule ceiling. In many cases, commenterssuggested that the administrative burdenimposed would outweigh any potential taxbenefit. Thus, commenters requested revi-sions to the de minimis rule to reduce tax-payers’ administrative burden of comply-ing with the 2011 temporary regulations.

To simplify application of the de min-imis safe harbor, the final regulations re-quire that the de minimis safe harbor be ap-plied to all eligible materials and supplies(other than rotable, temporary, and standbyemergency spare parts subject to the elec-tion to capitalize or rotable and temporaryspare parts subject to the optional methodof accounting for such parts) if the tax-payer elects the de minimis safe 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 the de minimis safe harbor, therequirement in the final regulations to ap-ply the de minimis safe harbor, if elected,to all eligible materials and supplies sim-plifies the application of the de minimisrule and reduces the administrative burdenon the IRS. Taxpayers that do not elect thede minimis safe harbor provided in the fi-nal regulations for the taxable year musttreat their amounts paid for materials andsupplies in accordance with the rules pro-vided in §1.162–3.

H. Coordination with section 263A

Commenters asked for clarification onthe interaction of the de minimis rule withsection 263A. Several comments askedwhether the application of the de minimisrule resulted in property with an unad-justed basis of zero, which would then besubject to section 263A, or, alternatively,whether section 263A required taxpayersto capitalize the cost of property subjectto section 263A, regardless of whether thede minimis rule applied.

The final regulations clarify the interac-tion between the two provisions. The finalregulations provide that amounts paid fortangible property eligible for the de min-imis safe harbor may, nonetheless, be sub-

ject to capitalization under section 263Aif the amounts paid for this tangible prop-erty comprise the direct or allocable indi-rect costs of other property produced bythe 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 costsallocable to such property (for example,purchasing, storage, and handling costs),even though production has not begun. Ifproperty is not held for production, indi-rect costs incurred prior to the beginningof the production period must be allocatedto the property and capitalized if, at thetime the costs are incurred, it is reasonablylikely that production will occur at somefuture date. Thus, for example, a manu-facturer must capitalize the costs of stor-ing and handling raw materials before theraw materials are committed to production.In addition, §1.263A–1T(e)(2)(i) providesthat indirect material costs include the costof materials that are not an integral part ofspecific property produced and the cost ofmaterials that are consumed in the ordinarycourse of performing production or resaleactivities that cannot be identified or asso-ciated with particular units of property.

Therefore, if tangible property is ac-quired with the expectation of being usedin the production of other property, and it isreasonably likely that production will oc-cur at some future date, section 263A mayapply to capitalize the cost of the prop-erty acquired. Thus, for example, if a tax-payer acquires a component part, the costof which is otherwise eligible for the deminimis safe harbor, but the componentpart is installed, or expected to be installedin the future, in the taxpayer’s manufac-turing equipment used to produce propertyfor sale, under section 263A, the cost ofthe component part must be capitalized asan indirect cost of property produced bythe taxpayer. On the other hand, if prop-erty is acquired without the expectation ofbeing used in the production of propertyand the taxpayer elects and properly ap-plies the de minimis rule to the amount paidfor property in the taxable year, if expecta-tions change in a subsequent taxable yearand the property is actually used in pro-duction, then section 263A will not requirecapitalization of the cost of the property atthe time the expectation changes or whenthe property is used in production.

I. Change in accounting procedures notchange in method of accounting

Several commenters questionedwhether a change in a taxpayer’s financialaccounting procedures (for example, itsfinancial accounting capitalization policy)is a change in method of accounting forde minimis expenses to which the pro-visions of sections 446 and 481 and theaccompanying regulations apply. The fi-nal regulations provide that the use of thede minimis safe harbor is a taxable yearelection and may not be made by the filingof an application for a change in method ofaccounting. Thus, if a taxpayer meets therequirements for the safe harbor, whichrequires, in part, having written account-ing procedures in place at the beginning ofthe taxable year and treating amounts paidfor property as an expense in accordancewith those procedures, then a change inthe procedures, by itself, is not a changein accounting method. For example, ifa taxpayer’s written financial accountingcapitalization policy at the beginning of2014 states that amounts paid for propertycosting less than $200 will be treated asan expense, and the taxpayer changes itswritten policy as of the beginning of 2015to treat amounts paid for property costingless that $500 as an expense, the taxpayeris not required to file an application forits 2015 taxable year to change its methodof accounting for applying the de minimissafe harbor or determining amounts paidto acquire or produce tangible propertyunder §1.263(a)–1(f).

V. Amounts Paid to Acquire or ProduceTangible 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 toacquire 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 toacquire or produce a unit of real or per-sonal property, requirements to capitalizeamounts paid to defend or perfect title toreal or personal property, and rules for de-termining the extent to which taxpayersmust capitalize transaction costs related tothe acquisition of property. In the final reg-ulations, the de minimis safe harbor has

2013–43 I.R.B. 337 October 21, 2013

been moved to §1.263(a)–1(f) to reflectits broader application to amounts paid fortangible property, including amounts paidfor improvements and materials and sup-plies, except as otherwise provided undersection 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 personalproperty. To alleviate controversy betweentaxpayers and the IRS, the 2011 tempo-rary regulations included a list of inher-ently facilitative amounts. In addition, the2011 temporary regulations provided thatcosts relating to activities performed in theprocess of determining whether to acquirereal property and which real property toacquire generally are deductible pre-deci-sional costs unless they are described in theregulations as inherently facilitative costs.The 2011 temporary regulations also pro-vided that inherently facilitative amountsallocable to real or personal property arecapital expenditures related to such prop-erty, even if such property is not eventuallyacquired or produced.

Commenters requested that the require-ment to capitalize facilitative costs be re-moved as overbroad. Commenters alsostated that it was inappropriate to providea special rule that depends on the natureof the property acquired (real property orpersonal property) and inappropriate to re-quire capitalization of inherently facilita-tive amounts allocable to property not ac-quired. Other commenters recommendedthat the list describing inherently facili-tative amounts be revised to exclude ac-tivities that are dependent on the type ofservice provider (for example, 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 contingenton the buyer’s successful acquisition ofreal property but a portion of the broker’sactivities were performed in investigatingthe acquisition.

The final regulations generally retainthe 2011 temporary regulation rules ad-dressing facilitative amounts. As in the2011 temporary regulations, the final reg-ulations include the special rule for theacquisition of real property providing that,except for amounts specifically identifiedas inherently facilitative, an amount paid

by a taxpayer in the process of investigat-ing or otherwise pursuing the acquisitionof real property does not facilitate the ac-quisition if it relates to activities performedin the process of determining whether toacquire real property and which real prop-erty to acquire. The final regulations donot expand the deduction of such pre-de-cisional, investigatory costs to personalproperty because, unlike real property ac-quisitions, personal property acquisitionsdo not typically raise issues of whetherthe transaction costs should be charac-terized as deductible business expansioncosts rather than costs to acquire a specificproperty. In addition, personal propertyacquisitions do not typically provide clearevidence establishing the timing of deci-sions. Thus, such a rule could generatesignificant controversy over unduly smallamounts.

Moreover, the final regulations retainthe list of inherently facilitative costs thatgenerally must be capitalized as trans-action costs. However, in response tocomments, the final regulations clarifythe meaning of finders’ fees and brokers’commissions and provide a definition ofcontingency fees. The final regulationsprovide that for purposes of §1.263(a)–2,a contingency fee is an amount paid that iscontingent on the successful closing of theacquisition of real or personal property.The final regulations also clarify that con-tingency fees facilitate the acquisition ofthe property ultimately acquired and arenot allocable to real or personal propertynot acquired. Therefore, if a real estatebroker’s commission is contingent on thesuccessful closing of the acquisition ofreal property, the amount paid as the bro-ker’s commission inherently facilitatesthe acquisition of the property acquiredand, therefore, must be capitalized as partof the basis of such property. However,no portion of the broker’s contingencyfee is allocable to real property that thetaxpayer did not acquire. In addition, thefinal regulations retain the rule that inher-ently facilitative amounts allocable to realor personal property are capital expendi-tures related to such property, even if suchproperty is not eventually acquired or pro-duced. As discussed in the preamble to the2008 proposed regulations, the IRS andthe Treasury Department believe that thisrule 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. Thefinal regulations also clarify that, exceptfor contingency fees as discussed above,inherently facilitative amounts allocableto property not acquired may be allocatedto those properties and recovered in ac-cordance with the applicable provisions ofthe Code, including sections 165, 167, and168.

VI. Amounts Paid to Improve PropertyUnder §1.263(a)–3

A. Overview

Comments received with respect to therules under the 2011 temporary regulationsfor determining whether an amount im-proves, betters, or restores property largelyfocused on the application of the rules tobuilding property, the lack of a safe har-bor for routine maintenance for buildingproperty, the standards to be applied indetermining 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 parthas occurred.

The final regulations generally retainthe rules of the 2011 temporary regulationsfor determining the unit of property andfor determining whether there is an im-provement to a unit of property. The fi-nal regulations also retain the simplifyingconventions set out in the 2011 temporaryregulations, including the routine mainte-nance safe harbor and the optional regu-latory accounting method. In addition, inresponse to the comments, the final regu-lations modify the 2011 temporary regula-tions in several areas. The concerns raisedby commenters and the relevant changesto 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 asconsisting 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. The2011 temporary regulations also providedspecial rules for determining the units of

October 21, 2013 338 2013–43 I.R.B.

property for condominiums, cooperatives,and leased property, and for the treatmentof improvements (including leasehold im-provements). The final regulations retainthe unit of property rules contained in the2011 temporary regulations.

The 2011 temporary regulations gen-erally defined a building as a unit ofproperty, but required the application ofthe improvement standards to the build-ing structure and the enumerated buildingsystems. A number of comments ob-jected to the requirement that the taxpayerperform the improvement analysis at thebuilding structure and system level. Thecomments stated that such treatment isinconsistent with the treatment of othercomplex property under the 2011 tem-porary regulations, is inconsistent withthe treatment of building property underdepreciation rules, and fails to take intoaccount the relative importance of the var-ious building systems. Several commentsrequested that the building, including itsstructural components, should be treatedas the unit of property for applying theimprovement rules to buildings. Othercommenters pointed out that a functionalinterdependence standard, used in the2011 temporary regulations for non-build-ing property and applied by the courts andthe IRS for determining when componentsof a single property are placed in servicefor cost recovery purposes, may be a moreconsistent general standard for identifyingthe relevant property upon which to applythe improvement analysis.

Like plant property, buildings are com-plex properties composed of numerouscomponent parts that perform discrete andmajor functions or operations. Unlikeplant property, however, where the dis-crete and major functions or operationsare not consistent from plant to plant, thediscrete and major functions or operationsperformed from building to building arefrequently similar. The building systemdefinitions set forth in the 2011 temporaryregulations are based on well understoodcosting standards that have been routinelyapplied to buildings for many years forvaluations, cost accounting, and financialreporting. To help ensure that the im-provement standards are applied equitablyand consistently across building property,the final regulations continue to apply theimprovement rules to both the buildingstructure and the defined building systems.

To the extent the particular facts and cir-cumstances of a subset of buildings usedin one or more industries present uniquechallenges to application of the buildingstructure or building system definitions,taxpayers are encouraged to request guid-ance under the Industry Issue Resolution(IIR) procedures.

C. Unit of property for leaseholdimprovements

The 2011 temporary regulations pro-vide rules for determining the unit ofproperty for leased property and for deter-mining the unit of property for leaseholdimprovements. The IRS and the TreasuryDepartment received no written commentson these rules, and the final regulationsretain the rules from the 2011 tempo-rary regulations, with some clarifications.Under the rule in the 2011 temporary reg-ulations, a question could arise regardingthe property to be analyzed for determin-ing whether an improvement to a lesseeimprovement constitutes an improvementto the lessee’s property. In this context,the 2011 temporary regulations suggestedthat the taxpayer must determine whetherthere has been an improvement to thelessee improvement by itself, rather thanby applying the improvement standardsto the general unit of property rules forleased buildings or for leased propertyother than buildings. The final regulationsclarify that for purposes of determiningwhether an amount paid by a lessee con-stitutes a leasehold improvement, the unitof property and the improvement rulesare applied in accordance with the rulesfor leased buildings (or leased portions ofbuilding) under §1.263(a)–3(e)(2)(v) orfor leased property other than buildingsunder §1.263(a)–3(e)(3)(iv). Thus, for ex-ample, if a lessee pays an amount for workon an addition that it previously made toa leased building, the taxpayer determineswhether the work performed constitutes animprovement to the entire leased buildingstructure, not merely to the addition. Thefinal regulations also clarify that when alessee or lessor improvement is comprisedof a building erected on leased property,then the unit of property for the buildingand the application of the improvementrules are determined under the provisionsfor buildings, rather than under the provi-sions for leased buildings.

D. Special rules for determiningimprovement costs

1. Costs incurred during an improvement

The 2011 temporary regulations did notprescribe 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 maintenancecosts 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, 831F.2d 833 (9th Cir. 1987); United Statesv. 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 providingthat a taxpayer must capitalize both the di-rect costs of an improvement as well as theindirect costs that directly benefit or are in-curred by reason of the improvement. The2011 temporary regulations also includedan exception to this provision for an indi-vidual residence, which permitted an in-dividual taxpayer to capitalize repair andmaintenance costs incurred at the time of asubstantial residential remodel.

The final regulations retain the rulesfrom the 2011 temporary regulations andcontinue to provide that indirect costs,such as repair and maintenance costs, thatdo not directly benefit and that are notincurred by reason of an improvementare not required to be capitalized undersection 263(a), regardless of whether theyare incurred at the same time as an im-provement. In addition, in response tocomments 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 regulationsset out a clear rule for determining whenotherwise deductible indirect costs mustbe capitalized as part of an improvementto property and obsolete the plan of re-habilitation doctrine to the extent that thecourt-created doctrine provides differentstandards.

2013–43 I.R.B. 339 October 21, 2013

2. Removal Costs

The 2011 temporary regulations did notprovide a separate rule for the treatment ofremoval costs. Rather, the 2011 temporaryregulations addressed component removalcosts as an example of a type of indirectcost that must be capitalized if the removalcosts directly benefit or are incurred byreason of an improvement. The preambleto the 2011 temporary regulations statedthat the costs of removing a componentof a unit of property should be analyzedin the same manner as any other indirectcost (such as a repair cost) incurred dur-ing a repair or an improvement to prop-erty. Therefore, the preamble concluded, ifthe cost of removing a component of a unitof property directly benefitted or was in-curred by reason of an improvement to theunit of property, the cost must be capital-ized. The preamble to the 2011 temporaryregulations also noted that the 2011 tempo-rary regulations were not intended to affectthe holding of Rev. Rul. 2000–7 (2000–1C.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 requiredto capitalize the cost of removing a retireddepreciable asset under section 263(a) orsection 263A, even when the retirementand removal occur in connection with theinstallation of a replacement asset. Rev.Rul. 2000–7 reasoned that the costs of re-moving a depreciable asset generally havebeen allocable to the removed asset and,thus, generally have been deductible whenthe 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 2011temporary regulations did not explicitlystate that the costs incurred to remove anentire unit of property are not required tobe capitalized, even when incurred in con-nection with the installation of a replace-ment asset. Commenters requested that thefinal regulations include this explicit con-clusion. Commenters also asked whetherthe principles of Rev. Rul. 2000–7 wouldapply to allow the deduction of removalcosts when the taxpayer disposes of a com-ponent of a unit of property and the tax-payer takes into account the adjusted basisof 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 anindirect cost of a restoration (for example,the replacement of a component when thetaxpayer has properly deducted a loss forthat component) rather than a bettermentto the underlying unit of property.

The final regulations provide a spe-cific rule clarifying the treatment of re-moval costs in these contexts. The finalregulations state that if a taxpayer dis-poses of a depreciable asset (includinga 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 taxpurposes and has taken into account theadjusted basis of the asset or componentof the asset in realizing gain or loss, thecosts of removing the asset or componentare not required to be capitalized undersection 263(a). The final regulations alsoprovide that if a taxpayer disposes of acomponent of a unit of property and thedisposal is not a disposition for Federal taxpurposes, then the taxpayer must deductor capitalize the costs of removing thecomponent based on whether the removalcosts directly benefit or are incurred byreason of a repair to the unit of property oran improvement to the unit of property. Inaddition, the final regulations provide sev-eral examples illustrating these principles.

E. Safe harbor for small taxpayers

The 2011 temporary regulations did notprovide 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 taxpayersgenerally do not have the administrativemeans or sufficient documentation or in-formation to apply the improvement rulesto their building structures and systems asrequired 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 orless and that taxpayers be permitted todeduct annual amounts spent on the build-ing if they did not exceed the thresholdamount. In response to this request, the fi-nal regulations include a safe harbor elec-tion for building property held by taxpay-ers with gross receipts of $10,000,000 orless (“a qualifying small taxpayer”). The

final regulations permit a qualifying smalltaxpayer to elect to not apply the improve-ment rules to an eligible building propertyif the total amount paid during the taxableyear for repairs, maintenance, improve-ments, and similar activities performed onthe eligible building does not exceed thelesser of $10,000 or 2 percent of the un-adjusted basis of the building. Eligiblebuilding property includes a building unitof property that is owned or leased bythe 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 TreasuryDepartment with the authority to adjust theamounts of the safe harbor and gross re-ceipts limitations through published guid-ance. The final regulations provide sim-ple rules for determining the unadjustedbasis of both owned and leased buildingunits of property. In this situation, the fi-nal regulations also eliminate the need toseparately analyze the building structureand the building systems, as required else-where in the improvement rules in the finalregulations.

Under the safe harbor for small tax-payers, a taxpayer includes amounts notcapitalized under the de minimis safe har-bor election of §1.263(a)–1(f) and underthe routine maintenance safe harbor forbuildings (discussed later in this pream-ble) to determine the annual amount paidfor repairs, maintenance, improvements,and similar activities performed on thebuilding. If the amount paid for repairs,maintenance, improvements, and similaractivities performed on a building unit ofproperty exceeds the safe harbor thresholdfor a taxable year, then the safe harboris not applicable to any amounts spentduring the taxable year. In that case, thetaxpayer must apply the general rulesfor determining improvements, includingthe routine maintenance safe harbor forbuildings. The taxpayer may also electto apply the de minimis safe harbor under§1.263(a)–1(f) to amounts qualifying un-der the de minimis safe harbor, regardlessof the application of the safe harbor forsmall taxpayers.

The safe harbor for building propertyheld small taxpayers may be elected an-nually on a building-by-building basis byincluding a statement on the taxpayer’stimely filed original Federal tax return, in-cluding extensions, for the year the costs

October 21, 2013 340 2013–43 I.R.B.

are incurred for the building. Amountspaid by the taxpayer to which the tax-payer properly applies and elects the safeharbor are not treated as improvements tothe building under §1.263(a)–3 and maybe deducted under §1.162–1 or §1.212–1,as applicable, in the taxable year that theamounts are paid or incurred, provided theamounts otherwise qualify for deductionunder those sections. A taxpayer may notrevoke an election to apply the safe harborfor small taxpayers.

F. Safe harbor for routine maintenance

1. Buildings

The 2011 temporary regulations pro-vided that the costs of performing certainroutine maintenance activities for propertyother than a building or the structural com-ponents of a building are not required tobe capitalized as an improvement. Underthe routine maintenance safe harbor, anamount paid was deemed not to improvea 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 ofproperty to keep the unit of property in itsordinarily efficient operating condition.The 2011 temporary regulations providedthat the activities are routine only if, atthe time the unit of property was placedin service, the taxpayer reasonably ex-pected to perform the activities more thanonce during the period prescribed undersections 168(g)(2) and 168(g)(3) (the Al-ternative Depreciation System class life),regardless of whether the property wasdepreciated under the Alternative Depre-ciation System. The preamble to the 2011temporary regulations explained that theroutine maintenance safe harbor did notapply to building property, because thelong class life for such property (40 yearsunder section 168(g)(2)) arguably couldallow major remodeling or restorationprojects to be deducted under the safeharbor, regardless of the nature or extentof the work involved, and that deductingsuch costs would be inconsistent withcase law. The 2011 temporary regulationsprovided several factors for taxpayers toconsider 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 theactivity on its applicable financial state-ment.

Comments on the routine maintenancesafe harbor generally requested that thesafe harbor be extended to building prop-erty. One commenter stated that becausethe improvement standards under the 2011temporary regulations must now be ap-plied to the building structure and eachbuilding system separately, these compo-nents are more analogous to section 1245property, which qualifies for the routinemaintenance safe harbor. Commenterssuggested that using a period shorter thana building’s class life, such as 20 years,could alleviate the IRS and the TreasuryDepartment’s concern that the cost of trueimprovements would not be properly cap-italized if the safe harbor were extended tobuildings. Another commenter argued thatthe distinction between building propertyand non-building property for purposesof the safe harbor is arbitrary because, inmany respects, retail buildings are similarto other complex property, such as aircraft,which are not excluded from the safe har-bor.

In response to these comments, the finalregulations contain a safe harbor for rou-tine maintenance for buildings. The inclu-sion of a routine maintenance safe harborfor buildings is expected to alleviate someof the difficulties that could arise in ap-plying the improvement standards for cer-tain restorations to building structures andbuilding systems. To balance commenters’suggestions of using a shorter period, suchas 20 years, with the concerns expressed inthe preamble to the 2011 temporary regula-tions, the final regulations use 10 years asthe period of time in which a taxpayer mustreasonably expect to perform the relevantactivities more than once. While periodslonger than 10 years were considered, theuse of a period much longer than 10 yearswould, contrary to current authority, per-mit the costs of many major remodelingand restoration projects to be deducted un-der the safe harbor, regardless of the natureor extent of the work involved.

2. Other Changes

The final regulations make several ad-ditional changes and clarifications to thesafe harbor for routine maintenance, which

are applicable to both buildings and otherproperty. First, the regulations confirmthat routine maintenance can be performedany time during the life of the propertyprovided that the activities qualify as rou-tine under the regulation. Second, for pur-poses of determining whether a taxpayer isperforming routine maintenance, the finalregulations remove the taxpayer’s treat-ment of the activity on its applicable fi-nancial statement from the factors to beconsidered. Taxpayers may have severaldifferent reasons for capitalizing mainte-nance activities on their applicable finan-cial statements, and such treatment maynot be indicative of whether the activi-ties are routine. Third, the final regula-tions clarify the applicability of the routinemaintenance safe harbor by adding threeitems to the list of exceptions from the rou-tine maintenance safe harbor: (1) amountspaid for a betterment to a unit of property,(2) amounts paid to adapt a unit of propertyto a new or different use, and (3) amountspaid for repairs, maintenance, or improve-ment of network assets. The first two ex-ceptions were included in the general rulefor the safe harbor in the 2011 temporaryregulations, but were not clearly stated asexceptions. The exception for network as-sets was added because of the difficulty indefining the unit of property for networkassets and the preference for resolving is-sues involving network assets through theIIR program. Finally, the exception relat-ing to amounts paid for property for whicha taxpayer has taken a basis adjustmentresulting from a casualty loss is slightlymodified to be consistent with the revisedcasualty loss restoration rule, which is dis-cussed in this preamble.

3. Reasonable Expectation that ActivitiesWill be Performed More than Once

A taxpayer’s reasonable expectation ofwhether it will perform qualifying mainte-nance activities more than once during therelevant period will be determined at thetime the unit of property (or building struc-ture or system, as applicable) is placedin service. The final regulations modifythe safe harbor for routine maintenance byadding that a taxpayer’s expectation willnot 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. 341 October 21, 2013

taxpayer can otherwise substantiate that itsexpectation was reasonable at the time theproperty was placed in service. Thus, fora unit of property previously placed in ser-vice, whether the maintenance is actuallyperformed more than once during the rele-vant period is not controlling for assessingthe reasonableness of a taxpayer’s originalexpectation. However, if a similar or iden-tical unit of property is placed in servicein a future tax year, the taxpayer’s expe-rience with the original property may betaken into account as a factor in assess-ing whether the taxpayer reasonably ex-pects to perform the activities more thanonce during the relevant period for the sim-ilar or identical unit of property. The tax-payer’s actual experience, therefore, maybe used in assessing the reasonableness ofthe taxpayer’s expectation of the frequencyof restoration or replacement at the time anew unit of property is placed in service,but hindsight should not be used to inval-idate a taxpayer’s reasonable expectationas 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 theRoutine Maintenance Safe Harbor

The final regulations clarify thatamounts incurred for activities falling out-side the routine maintenance safe harborare not necessarily expenditures requiredto be capitalized under §1.263(a)–3.Amounts incurred for activities that do notmeet the routine maintenance safe harborare subject to analysis under the generalrules for improvements.

G. Betterments

1. Overview

The 2011 temporary regulations pro-vided that an amount paid results in abetterment, and accordingly, an improve-ment, if it (1) ameliorates a material con-dition or defect that existed prior to theacquisition of the property or arose duringthe production of the property; (2) resultsin a material addition to the unit of prop-erty (including a physical enlargement,expansion, or extension); or (3) results ina material increase in the capacity, pro-ductivity, efficiency, strength, or qualityof the unit of property or its output. As

applied to buildings, an amount results ina betterment to the building if it results ina betterment to the building structure orany of the building systems.

The final regulations retain the provi-sions of the 2011 temporary regulationsrelated to betterments with several refine-ments. Specifically, the final regulationsreorganize and clarify the types of activi-ties that constitute betterments to property.Also, the final regulations no longer phrasethe betterment test in terms of amountsthat result in a betterment. Rather, thefinal regulations provide that a taxpayermust capitalize amounts that are reason-ably expected to materially increase theproductivity, efficiency, strength, quality,or output of a unit of property or that arefor 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 orwhen the outcome of the expenditure is un-certain when the expenditure is made.

2. Amelioration of Material Condition orDefect

Commenters requested that certain ex-amples be clarified to distinguish moreclearly between circumstances that requirecapitalization of amounts paid to ame-liorate a material condition or defect andcircumstances that do not require capital-ization. One commenter requested that thefinal regulations include a rule that wouldprovide for an allocation of expendituresbetween pre- and post-acquisition periodsbased on facts and circumstances if anexpenditure both ameliorates a pre-ex-isting condition and ameliorates normalwear and tear that results from the tax-payer’s use of the property. With respectto whether amounts paid to ameliorateconditions are betterments, other com-ments reiterated suggestions provided inresponse to the 2008 proposed regulations,as described in the preamble to the 2011temporary regulations.

The final regulations do not adopt thecomments with respect to expenditures toameliorate pre-existing conditions or de-fects. The facts and circumstances ruleprovided 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 inProductivity, Efficiency, Strength,Quality, or Output

Many commenters requested that the fi-nal regulations provide explanations andquantitative bright lines for determiningthe materiality of an addition to a unit ofproperty or an increase in capacity, pro-ductivity, efficiency, strength, quality, oroutput of a unit of property. Addition-ally, commenters requested more explana-tion of terms such as productivity, qual-ity, and output, and how such standardsshould be applied across a variety of dif-ferent types of tangible property.

These suggestions were extensivelyconsidered, but the final regulations do notadopt the suggestions to establish quan-titative bright lines. Quantitative brightlines, although objective, would produceinconsistent results given the broad arrayof factual settings where the bettermentrules apply. Instead, the final regulationscontinue to rely on qualitative factors toprovide fair and equitable treatment forall taxpayers in determining whether aparticular cost constitutes a betterment.

The final regulations clarify, how-ever, that not every single quantitative orqualitative factor listed in the bettermentstandard applies to every type of property.Whether any single factor applies to aparticular unit of property depends on thenature of the property. For example, whileamounts paid for work performed on anoffice building or a retail building mayclearly comprise a physical enlargement orincrease the capacity, efficiency, strength,or quality of such building under certainfacts, it is unclear how to measure whetherwork performed on an office building orretail building increases the productiv-ity or output of such buildings, as thoseterms are generally understood. Thus,the productivity and output factors wouldnot generally apply to buildings. On theother hand, it is appropriate to evaluatemany items of manufacturing equipmentin terms of output or productivity as wellas size, capacity, efficiency, strength, andquality. Accordingly, the final regulationsclarify that the applicability of each quan-titative and qualitative factor depends onthe nature of the unit of property, and if anaddition or increase in a particular factorcannot be measured in the context of aspecific type of property, then the factor is

October 21, 2013 342 2013–43 I.R.B.

not relevant in determining whether therehas 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 factsand circumstances, including the treatmentof the expenditures on a taxpayer’s ap-plicable financial statement. One com-menter questioned whether the treatmentof an expenditure on a taxpayer’s applica-ble financial statement should be relevantin determining whether an amount paidresults 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 taxpayersmay apply different standards for capital-izing amounts on their applicable finan-cial statements and such standards may notbe controlling for whether the activitiesare betterments for Federal tax purposes.Thus, the final regulations remove the tax-payer’s treatment of the expenditure on itsfinancial statement as a factor to be consid-ered in performing a betterment analysisunder the final regulations. In addition, thefinal regulations omit the reference to thetaxpayer’s facts and circumstances in de-termining whether amounts are paid for abetterment to the taxpayer’s property. TheIRS and the Treasury Department believethat an analysis of a taxpayer’s particu-lar facts and circumstances is implicit inthe application of all the final regulationsgoverning improvements and need not bespecifically provided in the application ofthe 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 isfor the betterment of a unit of propertyis made by comparing the condition ofthe property immediately after the expen-diture with the condition of the propertyimmediately prior to the event necessi-tating the expenditure. The IRS and theTreasury Department received commentsrequesting that the final regulations clarifythe application of the appropriate com-parison rule for determining whether anexpenditure is for a betterment of a unitof property. The final regulations retainthis general rule but clarify that the rule

applies when the event necessitating theexpenditure is either normal wear and tearor damage to the unit of property duringthe taxpayer’s use of the property. Thus,the final regulations clarify that the appro-priate comparison rule focuses on eventsaffecting the condition of the property andnot on business decisions made by tax-payers. In addition, the final regulationsconfirm that the rule does not apply towear, tear, or damage that occurs prior tothe taxpayer’s acquisition or use of theproperty. In these situations, the ameliora-tion of a material condition or defect rulemay apply.

5. Retail Store Refresh or Remodels

A substantial number of commentswere received with respect to the better-ment examples in the 2011 temporaryregulations that address retail store refreshor remodel projects, requesting the addi-tion of quantitative bright lines and theinclusion of additional detail in the exam-ples.

As discussed previously in this pre-amble, the final regulations do not adoptthe suggestions to provide quantitativebright lines in applying the bettermentrules. However, the final regulations in-clude additional detail in a number of theexamples, including the examples relatedto building refresh or remodels, illustrat-ing distinctions between betterments andmaintenance activities when a taxpayerundertakes multiple simultaneous activi-ties on a building. To the extent the rulesin the final regulations present situationsthat might be addressed through the IIRprogram, taxpayers may pursue additionalguidance 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 propertyif it meets one of six tests: (1) it is forthe replacement of a component of a unitof property and the taxpayer has properlydeducted a loss for that component (otherthan a casualty loss under §1.165–7); (2)it is for the replacement of a componentof a unit of property and the taxpayer hasproperly taken into account the adjustedbasis of the component in realizing gain or

loss resulting from the sale or exchange ofthe component; (3) it is for the repair ofdamage to a unit of property for which thetaxpayer has properly taken a basis adjust-ment as a result of a casualty loss undersection 165, or relating to a casualty eventdescribed in section 165 (“casualty lossrule”); (4) it returns the unit of property toits ordinarily efficient operating conditionif the property has deteriorated to a state ofdisrepair and is no longer functional for itsintended use; (5) it results in the rebuildingof the unit of property to a like-new condi-tion after the end of its class life; or (6) it isfor the replacement of a major componentor a substantial structural part of the unit ofproperty (“major component rule”).

The IRS and the Treasury Departmentreceived a number of comments regardingthe 2011 temporary regulations restorationrules. The final regulations generally re-tain the restoration standards set forth inthe 2011 temporary regulations but reviseboth the major component rule and the ca-sualty loss rule in response to comments.

2. Replacement of a Major Component orSubstantial Structural Part

a. Definition of major component andsubstantial 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 isan amount paid to restore (and, therefore,improve) the unit of property. The deter-mination of whether a component or partwas “major” or “substantial” depended onthe facts and circumstances, including bothqualitative and quantitative factors.

Commenters expressed concern that thelack 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 finalregulations reintroduce a bright-line def-inition of what constitutes a major com-ponent or substantial structural part forpurposes of applying the restoration stan-dards, particularly with regard to build-ings. Several commenters suggested thata fixed percentage of a building should

2013–43 I.R.B. 343 October 21, 2013

be defined as the major component. Inaddition, commenters asked for clarifyingguidance or more examples, arguing thatthe 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 majorcomponent, and, more significantly, adda new definition for major componentsand substantial structural parts of build-ings. Although the IRS and the TreasuryDepartment considered several bright-linetests, none were found to fairly, equitably,and in a readily implementable mannerdistinguish between expenditures that con-stitute restorations and expenditures thatconstitute deductible repairs or mainte-nance consistent with the case law andadministrative rulings in the area.

In many cases, particularly with regardto buildings, establishing a clear threshold,such as 30 percent of a defined amount,would be unworkable. Largely due to thecomplex nature of the property involvedand the fact that units of property includeassets placed in service in multiple tax-able years, applying a fixed percentage toa building structure or a building systemin a way that creates a consistent and eq-uitable result proved exceedingly intricateand complex, thereby failing to achievethe simplifying objective of a bright linetest. The final regulations, therefore, donot adopt any of the bright-line tests sug-gested.

b. General rule for major component andsubstantial structural part

To provide additional guidance for de-termining what constitutes a major compo-nent or substantial structural part, the finalregulations clarify the distinction betweena major component and a substantial struc-tural part. Specifically, the final regula-tions separate “major component,” whichfocuses on the function of the componentin the unit of property, from “substantialstructural part,” which focuses on the sizeof the replacement component in relationto the unit of property. The final regula-tions define a major component as a partor combination of parts that performs a dis-crete and critical function in the operationof 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. The2011 temporary regulations provided thatthe replacement of a minor component,even though such component might affectthe function of the unit of property, gener-ally would not, by itself, constitute a ma-jor component. The exception was meantto apply to relatively minor components,such as a switch, which generally performsa discrete function (turning property onand off) and is critical to the operation of aunit of property (that is, property will notrun without it). To provide additional clar-ification regarding this exception, the finalregulations clarify that an incidental com-ponent of a unit of property, even thoughsuch component performs a discrete andcritical function in the operation of the unitof property, generally will not, by itself,constitute a major component.

c. Major component and substantialstructural part of buildings

The final regulations address the re-quest for additional clarity regarding thedefinition of major component for build-ings by adding a new definition for ma-jor components and substantial structuralparts of buildings. In the case of build-ings, the final regulations provide that anamount is for the replacement of a majorcomponent or substantial structural part ifthe replacement includes a part or combi-nation of parts that (1) comprises a ma-jor component or a significant portion of amajor component of the building structureor any building system, or (2) comprisesa large portion of the physical structure ofthe building structure or any building sys-tem.

While the definition of major compo-nent for buildings introduces an additionallevel of analysis (a significant portion ofa major component) that must be appliedin determining whether an amount spenton a building constitutes a restoration, therule provides an analytical framework andreaches conclusions that are generally con-sistent with the case law. Therefore, inpractice this framework should be readilyapplicable for amounts spent 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 smalltaxpayers, and the addition and revisionof many examples, the revised definitionof major component for buildings shouldrelieve much of the controversy in deter-mining whether the replacement of a majorcomponent or a substantial structural partof a unit of property is an amount paid torestore a building.

3. Casualty Loss Rule

The 2011 temporary regulations pro-vided that an amount is paid to restore aunit of property if it is for the repair ofdamage to the unit of property for whichthe taxpayer has properly taken a basis ad-justment as a result of a casualty loss un-der section 165, or relating to a casualtyevent described in section 165 (“casualtyloss rule”). Capitalization of restorationcosts is required under the casualty lossrule, even when the amounts paid for therepair exceed the adjusted basis remainingin the property and regardless of whetherthe amounts may otherwise qualify as re-pair costs. The 2011 temporary regulationsrecognized a taxpayer’s ability to deducta casualty loss under section 165 or, tothe extent eligible, to deduct the repair ex-pense associated with the casualty damage.But the 2011 temporary regulations did notpermit a taxpayer to deduct both amountsarising from the same event in the sametaxable year.

Commenters requested that the finalregulations eliminate the casualty lossrule. Commenters argued that recogni-tion of a casualty loss under section 165is irrelevant in determining whether thecosts to restore the damage resulting froma casualty should be capitalized, and the2011 temporary regulations should notdeny one tax benefit (the ability to deductrepair costs) based on a taxpayer’s real-ization of another tax benefit (the abilityto deduct a casualty loss). Similarly, com-menters argued that the Code allows botha casualty loss and a repair deduction, andthe IRS and the Treasury Department hadnot offered any justification for denying adeduction for the cost to repair damagedproperty only because the taxpayer hastaken a casualty loss deduction. Com-menters argued that the 2011 temporaryregulations penalize taxpayers that have

October 21, 2013 344 2013–43 I.R.B.

suffered a casualty as a result of propertydamage. Commenters suggested that thecasualty loss rule in the 2011 temporaryregulations results in similarly situatedtaxpayers being treated differently, basedon whether an asset has adjusted basis atthe time of a casualty event. As an alterna-tive to eliminating the casualty loss rule,commenters requested that the final regu-lations allow a taxpayer to elect to foregorecognizing the casualty loss and makinga corresponding adjustment to basis toavoid 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-ing property or in making good the ex-haustion thereof for which an allowanceis or has been made. When property hasbeen damaged in a casualty and a loss forsuch property has been claimed, amountspaid to replace the damaged property areincurred to restore property for which anallowance has been made. Thus, undersection 263(a)(2), when the basis in re-placed property has been recovered by thetaxpayer, capitalization of the replacementproperty is appropriate.

Recognizing that such a rule can pro-vide harsh results for a taxpayer withvaluable property with low adjusted ba-sis that is destroyed in a casualty event,considerable consideration was given tothe suggestion that the regulations pro-vide an election to forgo a casualty lossdeduction. Ultimately, however, it wasconcluded that the IRS and the TreasuryDepartment do not have the authority topermit taxpayers to electively avoid thebasis adjustment requirement imposed bysection 1016(a). Section 1016(a) statesthat “a proper adjustment in respect of theproperty shall in all cases be made for . . .losses, or other items, properly chargeableto capital account . . ..” Therefore, even ifa taxpayer could choose to forgo claiminga loss for property damage under section165, section 1016 requires an adjustmentto the basis of the property because a lossproperly could be claimed.

In response to commenters’ sugges-tions, the final regulations revise thecasualty loss rule to permit a deduction,where otherwise permissible, for amountsspent in excess of the adjusted basis ofthe property damaged in a casualty event.

Thus, a taxpayer is still required to cap-italize amounts paid to restore damageto property for which the taxpayer hasproperly recorded a basis adjustment, butthe costs required to be capitalized underthe casualty loss rule are limited to theexcess of (1) the taxpayer’s basis adjust-ments resulting from the casualty event,over (2) the amount paid for restoration ofdamage to the unit of property that alsoconstitutes a restoration under the othercriteria of §1.263(a)–3(k)(1) (excludingthe casualty loss rule). Casualty-relatedexpenditures in excess of this limitationare not treated as restoration costs under§1.263(a)–3(k)(1)(iii) and may be prop-erly deducted if they otherwise constituteordinary and necessary business expenses(for example, repair and maintenanceexpenses) under section 162. The finalregulations contain several examples illus-trating the casualty loss rule, including oneexample that demonstrates the operationof the new limitation on amounts requiredto be capitalized.

4. Salvage Value Exception

Under the 2011 temporary regulations,a restoration includes amounts paid for thereplacement of a component of a unit ofproperty when the taxpayer has properlydeducted a loss for that component (otherthan a casualty loss under §1.165–7) andfor the replacement of a component of aunit of property when the taxpayer hasproperly taken into account the adjustedbasis of the component in realizing gainor loss resulting from the sale or exchangeof the component. In response to com-ments, the final regulations retain theserules but provide an exception for propertythat cannot be depreciated to an adjustedbasis of zero due to the application of sal-vage value (for example, property placedin 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 lossis properly deducted or the adjusted ba-sis of the component is realized from asale or exchange, and the amount of lossor basis adjustment is attributable only tothe remaining salvage value (the amount ataxpayer is expected to receive in cash ortrade-in allowance upon disposition of anasset at the end of its useful life) as com-puted for Federal income tax purposes, a

taxpayer is not required to treat amountspaid for the replacement of the componentas 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 ifthe amounts are paid to improve tangibleproperty.

5. Rebuild to Like-New Condition

The 2011 temporary regulations pro-vided that a unit of property is rebuiltto a like-new condition if it is broughtto the status of new, rebuilt, remanufac-tured, or similar status under the termsof any federal regulatory guideline or themanufacturer’s original specifications.Commenters asked for clarification onwhether comprehensive maintenance pro-grams, conducted according to manufac-turer’s original specifications, constituterebuilding a unit of property to like-newcondition. The final regulations adoptthe standard provided in the 2011 tempo-rary regulations but clarify that generallya comprehensive maintenance program,even though substantial, does not return aunit of property to like-new condition.

I. Adaptation to a new or different use

The 2011 temporary regulations re-quired a taxpayer to capitalize amountspaid to adapt a unit of property to a newor different use (that is, a use inconsistentwith the taxpayer’s intended ordinary useat the time the property was originallyplaced in service by the taxpayer). Asapplied to buildings, the new or differentuse standard is applied separately to thebuilding structure and its building sys-tems. Commenters requested clarificationof the adaptation rules and additional ex-amples. Commenters also asked that, forspecific industries, the regulations providethat changes to facilities in response to achange in product mix, a reallocation offloor space, the need to rebrand, or theintroduction of a new product line do notconstitute 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 regulationsprovide that if an amount adapts the unitof property in a manner inconsistent withthe taxpayer’s intended ordinary use ofthe property when placed in service, the

2013–43 I.R.B. 345 October 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, twonew examples address circumstances inwhich part of a retail building unit of prop-erty is converted to provide new servicesor products. However, providing tailoredguidance for specific industries or specifictypes of property (for example, retail salesfacilities) is not appropriate for broadly ap-plicable guidance. Specific industry guid-ance is better addressed through the IIRprogram.

VII. Optional Regulatory AccountingMethod

The 2011 temporary regulations pro-vided an optional regulatory method,which permitted certain regulated taxpay-ers to follow the method of accountingthey used for regulatory accounting pur-poses in determining whether an amountpaid improves property. For purposes ofthe optional method, a taxpayer in a regu-lated industry is a taxpayer subject to theregulatory accounting rules of the FederalEnergy Regulatory Commission (FERC),the Federal Communications Commis-sion (FCC), or the Surface TransportationBoard (STB). A taxpayer that uses theregulatory accounting method does notapply the rules under sections 162, 212,or 263(a) in determining whether amountspaid to repair, maintain, or improve prop-erty are capital expenditures or deductibleexpenses. Section 263A continues to ap-ply to costs required to be capitalized toproperty produced by the taxpayer or toproperty acquired for resale.

The IRS and the Treasury Departmentreceived no comments on this methodol-ogy, and the final regulations retain the rulefrom the 2011 temporary regulations, withone modification. The final regulationsmodify the description of the regulatoryaccounting method to clarify that, for pur-poses of determining whether an amountis for a capital expenditure, an eligible tax-payer must apply the method of accountingthat it is required to follow by FERC, FCC,or STB (whichever is applicable).

VIII. Election to Capitalize Repair andMaintenance Costs

The 2011 temporary regulations didnot contain an election for taxpayers tocapitalize expenditures made with respect

to tangible property that would otherwisebe deductible under these regulations.Commenters requested that, to reduce un-certainty in applying subjective standardsand to reduce administrative burden, thefinal regulations include an election tocapitalize repair and maintenance expen-ditures as improvements if the taxpayertreats such costs as capital expendituresfor financial accounting purposes. Inresponse to these comments as well asin recognition of the significant admin-istrative burden reduction achieved bypermitting a taxpayer to follow for Federalincome tax purposes the capitalizationpolicies used for its books and records, thefinal regulations permit a taxpayer to electto treat amounts paid during the taxableyear for repair and maintenance to tangi-ble property as amounts paid to improvethat property and as an asset subject to theallowance for depreciation, as long as thetaxpayer incurs the amounts in carryingon a trade or business and the taxpayertreats the amounts as capital expenditureson its books and records used for regu-larly computing income. Under the finalregulations, a taxpayer that elects thistreatment must apply the election to allamounts paid for repair and maintenanceto tangible property that it treats as capi-tal expenditures on its books and recordsin that taxable year. A taxpayer makingthe election must begin to depreciate thecost of such improvements when the im-provements are placed in service by thetaxpayer under the applicable provisionsof the Code and regulations. The electionis made by attaching a statement to thetaxpayer’s timely filed original Federaltax return (including extensions) for thetaxable year in which the improvement isplaced in service. Once made, the electionmay not be revoked.

A taxpayer that capitalizes repair andmaintenance costs under the election isstill eligible to apply the de minimis safeharbor, the safe harbor for small taxpayers,and the routine maintenance safe harbor torepair and maintenance costs that are nottreated as capital expenditures on its booksand records.

IX. Applicability Dates

The final regulations generally apply totaxable years beginning on or after January1, 2014. However, certain provisions of

the final regulations only apply to amountspaid or incurred in taxable years beginningon or after January 1, 2014. For exam-ple, the de minimis safe harbor election un-der §1.263(a)–1(f) only applies to amountspaid or incurred for tangible property afterJanuary 1, 2014, for taxable years begin-ning on or after January 1, 2014.

Alternatively, a taxpayer may generallychoose to apply the final regulations to tax-able years beginning on or after January1, 2012. For taxpayers choosing this earlyapplication, certain provisions of the finalregulations only apply to amounts paid orincurred in taxable years beginning on orafter January 1, 2012. For example, forthese taxpayers, the de minimis safe har-bor election only applies to amounts paidor incurred for tangible property after Jan-uary 1, 2012, for taxable years beginningon or after January 1, 2012.

For taxpayers choosing to apply the fi-nal regulations to taxable years beginningon 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 makethe certain elections (for example, the elec-tion to apply the de minimis safe harboror the election to apply the safe harbor forsmall taxpayers) on their timely filed orig-inal Federal tax return for their 2012 or2013 taxable year (the applicable taxableyear). Specifically, for taxable years be-ginning on or after January 1, 2012, andending 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 Federaltax return for the applicable taxable year,notwithstanding that the taxpayer may nothave extended the due date.

Finally, a taxpayer may also choose toapply the 2011 temporary regulations totaxable 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, 2013 346 2013–43 I.R.B.

X. Change in Method of Accounting

The IRS and the Treasury Departmentreceived several comments regarding theprocedures that a taxpayer should utilize tochange its method of accounting to complywith the regulations. Several commentersfavored 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 inmethod of accounting to which the provi-sions of sections 446 and 481 and the ac-companying regulations apply. A taxpayerseeking to change to a method of account-ing permitted in the final regulations mustsecure the consent of the Commissioner inaccordance with §1.446–1(e) and followthe 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 tocomply with these regulations must takeinto 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 ultimatelyreduces the administrative burdens on tax-payers and the IRS in enforcing the re-quirements of section 263(a). Althoughthe IRS and the Treasury Department rec-ognize that requiring a section 481(a) ad-justment may place a burden on taxpayersto calculate reasonable adjustments, tax-payers have shown a willingness and abil-ity to make these calculations in request-ing method changes after the publicationof the 2008 proposed regulations and af-ter the publication of the 2011 temporaryregulations. In addition, taxpayers and theIRS routinely reach agreements on calcu-lation methodologies and amounts.

Separate procedures will be providedunder which taxpayers may obtain auto-matic consent for a taxable year beginningon or after January 1, 2012, to change toa 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 generallymust take into account a full adjustmentunder section 481(a), it is anticipated thatfor the specific situation where a taxpayerseeks to change to a method of account-ing that is applicable only to amounts paidor incurred in taxable years beginning onor after January 1, 2014, a limited section481(a) adjustment will apply, taking intoaccount only amounts paid or incurred intaxable years beginning on or after January1, 2014, or at a taxpayer’s option, amountspaid or incurred in taxable years beginningon 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 Order12866, 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 herebycertified that these final regulations willnot have a significant economic impacton a substantial number of small entities.This regulation affects all small businesstaxpayers. While a collection of infor-mation is required by this regulation in§§1.263(a)–1(f)(5), 1.263(a)–2(h)(6), and1.263(a)–3(n), this collection will not havea significant economic impact on smallentities. This information is required fora taxpayer to elect to use the de minimissafe harbor, to elect a safe harbor for de-termining the treatment of amounts relatedto buildings owned or leased by smalltaxpayers, and to elect to capitalize cer-tain repair and maintenance costs. Theseelections were provided in the regulationsin response to comment letters submittedon behalf of small business taxpayers re-questing that these types of provisions beadded to the regulations to assist smallbusinesses. All of these elections are vol-untary, beneficial, and were designed tosimplify the application of sections 162and 263(a) to small taxpayers. The provi-sions require a taxpayer to file a statementwith the taxpayer’s timely filed originaltax 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 thefiling of the statement allows the taxpayerto receive the beneficial treatment for theamounts that qualify for the statement.Based on these facts, a regulatory flexibil-ity analysis under Regulatory FlexibilityAct (5 U.S.C. chapter 6) is not required.Pursuant to section 7805(f) of the Code,this regulation was submitted to the ChiefCounsel for Advocacy of the Small Busi-ness Administration for comment on itsimpact on small business.

Statement of Availability for IRSDocuments

For copies of recently issued rev-enue procedures, revenue rulings, notices,and other guidance published in the In-ternal Revenue Bulletin or CumulativeBulletin, please visit the IRS website athttp://www.irs.gov.

Drafting Information

The principal authors of theseregulations are Merrill D. Feldsteinand Kathleen Reed, Office of theAssociate Chief Counsel (Income Tax andAccounting). Other personnel from theIRS and the Treasury Department haveparticipated in their development.

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR parts 1 and 602are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 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 providedin paragraphs (d), (e), and (f) of this sec-tion, amounts paid to acquire or producematerials and supplies (as defined in para-graph (c) of this section) are deductible inthe taxable year in which the materials andsupplies are first used in the taxpayer’s op-erations or are consumed in the taxpayer’soperations.

2013–43 I.R.B. 347 October 21, 2013

(2) Incidental materials and supplies.Amounts paid to acquire or produce inci-dental materials and supplies (as definedin paragraph (c) of this section) that arecarried on hand and for which no recordof consumption is kept or of which phys-ical inventories at the beginning and endof the taxable year are not taken, are de-ductible in the taxable year in which theseamounts are paid, provided taxable incomeis clearly reflected.

(3) Use or consumption of rotable andtemporary spare parts. Except as providedin paragraphs (d), (e), and (f) of this sec-tion, for purposes of paragraph (a)(1) ofthis section, rotable and temporary spareparts (defined under paragraph (c)(2) ofthis section) are first used in the taxpayer’soperations or are consumed in the tax-payer’s operations in the taxable year inwhich the taxpayer disposes of the parts.

(b) Coordination with other provisionsof the Internal Revenue Code. Nothing inthis section changes the treatment of anyamount that is specifically provided for un-der any provision of the Internal RevenueCode (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 improvetangible property and section 263A andthe regulations under section 263A, whichrequire taxpayers to capitalize the directand allocable indirect costs, including thecost of materials and supplies, of prop-erty produced by the taxpayer and propertyacquired 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 supplies means tangible propertythat is used or consumed in the taxpayer’soperations 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 taxpayerand 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 tobe consumed in 12 months or less, begin-ning when used in the taxpayer’s opera-tions;

(iii) Is a unit of property as determinedunder §1.263(a)–3(e) that has an economic

useful life of 12 months or less, beginningwhen the property is used or consumed inthe taxpayer’s operations;

(iv) Is a unit of property as determinedunder §1.263(a)–3(e) that has an acqui-sition cost or production cost (as deter-mined under section 263A) of $200 orless (or other amount as identified in pub-lished guidance in the Federal Registeror in the Internal Revenue Bulletin (see§601.601(d)(2)(ii)(b) of this chapter); or

(v) Is identified in published guid-ance in the Federal Register or inthe Internal Revenue Bulletin (see§601.601(d)(2)(ii)(b) of this chapter) asmaterials and supplies for which treatmentis permitted under this section.

(2) Rotable and temporary spare parts.For purposes of this section, rotable spareparts are materials and supplies underparagraph (c)(1)(i) of this section that areacquired for installation on a unit of prop-erty, removable from that unit of property,generally repaired or improved, and eitherreinstalled on the same or other propertyor stored for later installation. Tempo-rary spare parts are materials and suppliesunder paragraph (c)(1)(i) of this sectionthat are used temporarily until a new orrepaired part can be installed and then areremoved 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 machineryor equipment is acquired (or later acquiredand set aside for use in particular machin-ery or equipment);

(ii) Set aside for use as replacementsto avoid substantial operational time losscaused by emergencies due to particularmachinery or equipment failure;

(iii) Located at or near the site of theinstalled related machinery or equipmentso as to be readily available when needed;

(iv) Directly related to the particularmachinery or piece of equipment theyserve;

(v) Normally expensive;(vi) Only available on special order

and not readily available from a vendor ormanufacturer;

(vii) Not subject to normal periodic re-placement;

(viii) Not interchangeable in other ma-chines or equipment;

(x) Not acquired in quantity (generallyonly 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 ofproperty is not necessarily the useful lifeinherent in the property but is the periodover which the property may reasonably beexpected to be useful to the taxpayer or, ifthe taxpayer is engaged in a trade or busi-ness or an activity for the production of in-come, the period over which the propertymay reasonably be expected to be usefulto the taxpayer in its trade or business orfor the production of income, as applica-ble. See §1.167(a)–1(b) for the factors tobe considered in determining this period.

(ii) Taxpayers with an applicable finan-cial statement. For taxpayers with an ap-plicable financial statement (as defined inparagraph (c)(4)(iii) of this section), theeconomic useful life of a unit of prop-erty, solely for the purposes of applying theprovisions of paragraph (c)(4) of this sec-tion, is the useful life initially used by thetaxpayer for purposes of determining de-preciation in its applicable financial state-ment, regardless of any salvage value ofthe property. If a taxpayer does not havean applicable financial statement for thetaxable year in which a unit of propertywas originally acquired or produced, theeconomic 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 ofproperty as an expense in its applicable fi-nancial statement on a basis other than theuseful life of the property or if a taxpayerdoes not depreciate the unit of propertyon its applicable financial statement, theeconomic useful life of the unit of prop-erty must be determined under paragraph(c)(4)(i) of this section. For example, ifa taxpayer has a policy of treating as anexpense on its applicable financial state-ment amounts paid for a unit of propertycosting less than a certain dollar amount,notwithstanding that the unit of propertyhas a useful life of more than one year, theeconomic 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 applicablefinancial statement is the taxpayer’s fi-nancial statement listed in paragraphs

October 21, 2013 348 2013–43 I.R.B.

(c)(4)(iii)(A) through (C) of this sectionthat has the highest priority (includingwithin paragraph (c)(4)(iii)(B) of this sec-tion). The financial statements are, indescending priority—

(A) A financial statement required tobe filed with the Securities and ExchangeCommission (SEC) (the 10–K or the An-nual Statement to Shareholders);

(B) A certified audited financial state-ment that is accompanied by the report ofan independent certified public accountant(or in the case of a foreign entity, by thereport of a similarly qualified independentprofessional), 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 tothe federal or a state government or anyfederal or state agency (other than the SECor the Internal Revenue Service).

(5) Amount paid. For purposes of thissection, in the case of a taxpayer usingan accrual method of accounting, theterms amount paid and payment mean aliability incurred (within the meaning of§1.446–1(c)(1)(ii)). A liability may notbe taken into account under this sectionprior to the taxable year during which theliability is incurred.

(6) Produce. For purposes of this sec-tion, produce means construct, build, in-stall, manufacture, develop, create, raise,or grow. This definition is intended to havethe same meaning as the definition usedfor purposes of section 263A(g)(1) and§1.263A–2(a)(1)(i), except that improve-ments are excluded from the definition inthis paragraph (c)(6) and are separatelydefined and addressed in §1.263(a)–3.Amounts paid to produce materials andsupplies are subject to section 263A.

(d) Election to capitalize and depreci-ate certain materials and supplies—(1) Ingeneral. A taxpayer may elect to treat asa 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 emergencyspare part as defined in paragraph (c)(2) or(c)(3) of this section. Except as specifiedin paragraph (d)(2) of this section, an elec-tion made under this paragraph (d) appliesto amounts paid during the taxable year to

acquire or produce any rotable, temporary,or standby emergency spare part to whichparagraph (a) of this section would apply(but for the election under this paragraph(d)). Any property for which this electionis made shall not be treated as a material ora supply.

(2) Exceptions. A taxpayer may notelect to capitalize and depreciate underparagraph (d) of this section any amountpaid to acquire or produce a rotable, tem-porary, or standby emergency spare partdefined in paragraph (c)(2) or (c)(3) of thissection if—

(i) The rotable, temporary, or standbyemergency spare part is intended to be usedas a component of a unit of property underparagraph (c)(1)(iii), (iv), or (v) of this sec-tion;

(ii) The rotable, temporary, or standbyemergency spare part is intended to be usedas a component of a property described inparagraph (c)(1)(i) and the taxpayer cannotor has not elected to capitalize and depreci-ate that property under this paragraph (d);or

(iii) The amount is paid to acquire orproduce a rotable or temporary spare partand the taxpayer uses the optional methodof accounting for rotable and temporaryspare parts under paragraph (e) to of thissection.

(3) Manner of electing. A taxpayermakes the election under paragraph (d) ofthis section by capitalizing the amountspaid to acquire or produce a rotable, tem-porary, or standby emergency spare partin the taxable year the amounts are paidand by beginning to recover the costs whenthe asset is placed in service by the tax-payer for the purposes of determining de-preciation under the applicable provisionsof the Internal Revenue Code and the Trea-sury Regulations. See §1.263(a)–2 for thetreatment of amounts paid to acquire orproduce real or personal tangible property.A taxpayer must make this election in itstimely filed original Federal tax return (in-cluding extensions) for the taxable year theasset is placed in service by the taxpayerfor purposes of determining depreciation.See §§301.9100–1 through 301.9100–3 ofthis chapter for the provisions governingextensions of time to make regulatory elec-tions. In the case of an S corporation or apartnership, the election is made by the Scorporation or partnership, and not by theshareholders or partners. A taxpayer may

make an election for each rotable, tempo-rary, or standby emergency spare part thatqualifies 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 standbyemergency 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 maygrant a request to revoke this election ifthe taxpayer acted reasonably and in goodfaith and the revocation will not prejudicethe interests of the Government. See gen-erally §301.9100–3 of this chapter. Themanner 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) and601.602 of this chapter). An election maynot be made or revoked through the filingof 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 anamended Federal tax return.

(e) Optional method of accounting forrotable and temporary spare parts—(1) Ingeneral. This paragraph (e) provides anoptional method of accounting for rotableand temporary spare parts (the optionalmethod for rotable parts). A taxpayer mayuse the optional method for rotable parts,instead of the general rule under paragraph(a)(3) of this section, to account for itsrotable and temporary spare parts as de-fined in paragraph (c)(2) of this section.A taxpayer that uses the optional methodfor rotable parts must use this method forall of its pools of rotable and temporaryspare parts used in the same trade or busi-ness and for which it uses this method forits books and records. If a taxpayer usesthe optional method for rotable and tempo-rary spare parts for pools of rotable or tem-porary spare parts for which the taxpayerdoes not use the optional method for itsbook and records, then the taxpayer mustuse the optional method for all its poolsof rotable spare parts in the same trade orbusiness. The optional method for rotableparts is a method of accounting under sec-tion 446(a). Under the optional method forrotable parts, the taxpayer must apply therules in this paragraph (e) to each rotableor temporary spare part (part) upon the tax-payer’s initial installation, removal, repair,

2013–43 I.R.B. 349 October 21, 2013

maintenance or improvement, reinstalla-tion, and disposal of each part.

(2) Description of optional method forrotable parts—(i) Initial installation. Thetaxpayer must deduct the amount paid toacquire or produce the part in the taxableyear that the part is first installed on a unitof property for use in the taxpayer’s oper-ations.

(ii) Removal from unit of property. Ineach taxable year in which the part is re-moved from a unit of property to which itwas initially or subsequently installed, thetaxpayer must—

(A) Include in gross income the fairmarket value of the part; and

(B) Include in the basis of the part thefair market value of the part included in in-come under paragraph (e)(2)(ii)(A) of thissection and the amount paid to remove thepart 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 basisof the part any amounts paid to maintain,repair, or improve the part in the taxableyear these amounts are paid.

(iv) Reinstallation of part. The tax-payer must deduct the amounts paid to re-install the part and those amounts includedin 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 notbeen previously deducted under this para-graph (e)(2)(iv), in the taxable year that thepart is reinstalled on a unit of property.

(v) Disposal of the part. The tax-payer must deduct the amounts includedin 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 notbeen previously deducted under paragraph(e)(2)(iv) of this section, in the taxableyear in which the part is disposed of by thetaxpayer.

(f) Application of de minimis safe har-bor. If a taxpayer elects to apply the deminimis safe harbor under §1.263(a)–1(f)to amounts paid for the production or ac-quisition of tangible property, then thetaxpayer must apply the de minimis safeharbor to amounts paid for all materialsand supplies that meet the requirementsof §1.263(a)–1(f), except for those mate-rials and supplies that the taxpayer electsto capitalize and depreciate under para-graph (d) of this section or for whichthe taxpayer properly uses the optional

method of accounting for rotable and tem-porary spare parts under paragraph (e)of this section. If the taxpayer properlyapplies the de minimis safe harbor under§1.263(a)–1(f) to amounts paid for ma-terials and supplies, then these amountsare not treated as amounts paid for mate-rials and supplies under this section. See§1.263(a)–1(f)(5) for the time and mannerof electing the de minimis safe harbor and§1.263(a)–1(f)(3)(iv) for the treatment ofsafe harbor amounts.

(g) Sale or disposition of materials andsupplies. Upon sale or other disposition,materials and supplies as defined in thissection are not treated as a capital assetunder section 1221 or as property used inthe trade or business under section 1231.Any asset for which the taxpayer makesthe election to capitalize and depreciateunder paragraph (d) of this section shallnot be treated as a material or supply, andthe recognition and character of the gainor loss for such depreciable asset are deter-mined under other applicable provisions ofthe Code.

(h) Examples. The rules of this sectionare illustrated by the following examples,in which it is assumed, unless otherwisestated, that the property is not an incidentalmaterial 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 describedin paragraph (e) of this section, and thatthe taxpayer has not elected to apply the deminimis safe harbor under §1.263(a)–1(f).The following examples illustrate only theapplication of this section and, unless oth-erwise stated, do not address the treatmentunder other provisions of the Code (for ex-ample, section 263A).

Example 1. Non-rotable components. A owns afleet of aircraft that it operates in its business. In Year1, A purchases a stock of spare parts, which it usesto maintain and repair its aircraft. A keeps a recordof consumption of these spare parts. In Year 2, Auses the spare parts for the repair and maintenanceof one of its aircraft. Assume each aircraft is a unitof property under §1.263(a)–3(e) and that spare partsare not rotable or temporary spare parts under para-graph (c)(2) of this section. Assume these repair andmaintenance 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 becausethey are components acquired and used to maintainand repair A’s aircraft. Under paragraph (a)(1) of thissection, the amounts that A paid for the spare partsin Year 1 are deductible in Year 2, the taxable year

in which the spare parts are first used to repair andmaintain the aircraft.

Example 2. Rotable spare parts; disposalmethod. B operates a fleet of specialized vehiclesthat it uses in its service business. Assume that eachvehicle is a unit of property under §1.263(a)–3(e).At the time that it acquires a new type of vehicle, Balso acquires a substantial number of rotable spareparts that it will keep on hand to quickly replacesimilar parts in B’s vehicles as those parts breakdown or wear out. These rotable parts are removablefrom the vehicles and are repaired so that they canbe reinstalled on the same or similar vehicles. InYear 1, B acquires several vehicles and a number ofrotable spare parts to be used as replacement parts inthese vehicles. In Year 2, B repairs several vehiclesby using these rotable spare parts to replace worn ordamaged parts. In Year 3, B removes these rotablespare parts from its vehicles, repairs the parts, andreinstalls them on other similar vehicles. In Year 5,B can no longer use the rotable parts it acquired inYear 1 and disposes of them as scrap. Assume thatB does not improve any of the rotable spare partsunder §1.263(a)–3. Under paragraph (c)(1)(i) of thissection, the rotable spare parts acquired in Year 1 arematerials and supplies. Under paragraph (a)(3) ofthis section, rotable spare parts are generally used orconsumed in the taxable year in which the taxpayerdisposes of the parts. Therefore, under paragraph(a)(1) of this section, the amounts that B paid for therotable 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 ofoptional method of accounting. C operates a fleet ofspecialized 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 newtype of vehicle, C also acquires a substantial numberof rotable spare parts that it will keep on hand to re-place similar parts in C’s vehicles as those parts breakdown or wear out. These rotable parts are removablefrom the vehicles and are repaired so that they can bereinstalled on the same or similar vehicles. C usesthe optional method of accounting for all its rotableand temporary spare parts under paragraph (e) of thissection. In Year 1, C acquires several vehicles anda number of rotable spare parts (the “Year 1 rotableparts”) to be used as replacement parts in these vehi-cles. In Year 2, C repairs several vehicles and usesthe Year 1 rotable parts to replace worn or damagedparts. In Year 3, C pays amounts to remove these Year1 rotable parts from its vehicles. In Year 4, C paysamounts to maintain, repair, or improve the Year 1rotable parts. In Year 5, C pays amounts to reinstallthe Year 1 rotable parts on other similar vehicles. InYear 8, C removes the Year 1 rotable parts from thesevehicles 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 theamounts paid to acquire and install the Year 1 rotableparts in Year 2, the taxable year in which the rotableparts are first installed by C in C’s vehicles. In Year3, when C removes the Year 1 rotable parts from itsvehicles, C must include in its gross income the fairmarket value of each part. Also, in Year 3, C must in-clude in the basis of each Year 1 rotable part the fairmarket value of the rotable part and the amount paidto remove the rotable part from the vehicle. In Year4, C must include in the basis of each Year 1 rotable

October 21, 2013 350 2013–43 I.R.B.

part the amounts paid to maintain, repair, or improveeach rotable part. In Year 5, the year that C reinstallsthe Year 1 rotable parts (as repaired or improved) inother vehicles, C must deduct the reinstallation costsand the amounts previously included in the basis ofeach part. In Year 8, the year that C removes the Year1 rotable parts from the vehicles, C must include inincome the fair market value of each rotable part re-moved. In addition, in Year 8, C must include in thebasis of each part the fair market value of that part andthe amount paid to remove each rotable part from thevehicle. In Year 9, the year that C disposes of the Year1 rotable parts, C may deduct the amounts remainingin the basis of each rotable part.

Example 4. Rotable part acquired as part of asingle unit of property; not material or supply. Doperates a fleet of aircraft. In Year 1, D acquiresa 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, beginningwhen it is placed in service. In Year 5, after the air-craft is operated for several years in D’s business, Dremoves the engines from the aircraft, repairs or im-proves the engines, and either reinstalls the engineson 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 acquiredas part of the aircraft, a single unit of property, theengines are not materials or supplies under paragraph(c)(1)(i) of this section nor rotable or temporary spareparts under paragraph (c)(2) of this section. Accord-ingly, D may not apply the rules of this section tothe aircraft engines upon the original acquisition ofthe aircraft nor after the removal of the engines fromthe aircraft for use in the same or similar aircraft.Rather, D must apply the rules under §§1.263(a)–2and 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 afleet of aircraft that carries freight for its customers. Ehas several storage tanks on its premises, which holdjet fuel for its aircraft. Assume that once the jet fuelis placed in E’s aircraft, the jet fuel is reasonably ex-pected to be consumed within 12 months or less. OnDecember 31, Year 1, E purchases a two-year sup-ply of jet fuel. In Year 2, E uses a portion of the jetfuel purchased on December 31, Year 1, to fuel theaircraft 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 orless from the time it is placed in E’s aircraft. Underparagraph (a)(1) of this section, E may deduct in Year2 the amounts paid for the portion of jet fuel used inthe operation of E’s aircraft in Year 2.

Example 6. Unit of property that costs $200 orless. F operates a business that rents out a variety ofsmall individual items to customers (rental items). Fmaintains a supply of rental items on hand. In Year1, F purchases a large quantity of rental items to usein its rental business. Assume that each rental itemis a unit of property under §1.263(a)–3(e) and costs$200 or less. In Year 2, F begins using all the rentalitems 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 atany 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 paidfor the rental items in Year 1 are deductible in Year2, the taxable year in which the rental items are firstused in F’s business.

Example 7. Unit of property that costs $200 orless. G provides billing services to its customers. InYear 1, G pays amounts to purchase 50 scanners to beused by its employees. Assume each scanner is a unitof property under §1.263(a)–3(e) and costs less than$200. In Year 1, G’s employees begin using 35 ofthe scanners, and F stores the remaining 15 scannersfor use in a later taxable year. The scanners are ma-terials and supplies under paragraph (c)(1)(iv) of thissection. Under paragraph (a)(1) of this section, theamounts G paid for 35 of the scanners are deductiblein Year 1, the taxable year in which G first uses eachof those scanners. The amounts that G paid for eachof the remaining 15 scanners are deductible in the tax-able year in which each machine is first used in G’sbusiness.

Example 8. Materials and supplies that cost lessthan $200; de minimis safe harbor. Assume the samefacts as in Example 7 except that G’s scanners qualifyfor the de minimis safe harbor under §1.263(a)–1(f),and G properly elects to apply the de minimis safeharbor under §1.263(a)–1(f) to amounts paid in Year1. G must apply the de minimis safe harbor under§1.263(a)–1(f) to amounts paid for the scanners,rather than treat these amounts as costs of materialsand supplies under this section. In accordance with§1.263(a)–1(f)(3)(iv), G may deduct the amountspaid for all 50 scanners under §1.162–1 in the taxableyear the amounts are paid.

Example 9. Unit of property that costs $200 orless; bulk purchase. H provides consulting servicesto its customers. In Year 1, H pays $500 to purchaseone box of 10 toner cartridges to use as needed forH’s printers. Assume each toner cartridge is a unitof property under §1.263(a)–3(e). In Year 1, H’s em-ployees place 8 of the toner cartridges in printers inH’s office, and store the remaining 2 cartridges for usein a later taxable year. The toner cartridges are mate-rials and supplies under paragraph (c)(1)(iv) of thissection because even though purchased in one boxcosting more than $200, the allocable cost of eachunit of property equals $50. Therefore, under para-graph (a)(1) of this section, the $400 paid by H for 8 ofthe cartridges is deductible in Year 1, the taxable yearin which H first uses each of those cartridges. Theamounts paid by H for each of the remaining 2 car-tridges ($50 each) are deductible in the taxable yearin which each cartridge is first used in H’s business.

Example 10. Materials and supplies used inimprovements; coordination with §1.263(a)–3. Jowns 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 ofspare parts for its machines. J acquired the partsto use in the repair or maintenance of the machinesunder §1.162–4 or in the improvement of the ma-chines under §1.263(a)–3. The spare parts are notrotable or temporary spare parts under paragraph(c)(2) of this section. In Year 2, J uses all of thesespare parts in an activity that improves a machineunder §1.263(a)–3. Under paragraph (c)(1)(i) of thissection, the spare parts purchased by J in Year 1 arematerials and supplies. Under paragraph (a)(1) of

this section, the amounts paid for the spare parts areotherwise deductible as materials and supplies inYear 2, the taxable year in which J uses those parts.However, because these materials and supplies areused 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 andsupplies; coordination with section 263A. K is a man-ufacturer that produces liquid waste as part of its op-erations. K determines that its current liquid wastedisposal process is inadequate. To remedy the prob-lem, in Year 1, K constructs a leaching pit to provide adraining area for the liquid waste. Assume the leach-ing pit is a unit of property under §1.263(a)–3(e) andhas an economic useful life of 12 months or less, start-ing on the date that K begins to use the leaching pitas a draining area. At the end of this period, K’s fac-tory will be connected to the local sewer system. InYear 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 paidfor a material or supply under paragraph (c)(1)(iii) ofthis section. However, the amounts paid to constructthe leaching pit may be subject to capitalization undersection 263A if these amounts comprise the direct orallocable indirect costs of property produced by K.

Example 12. Costs of acquiring materials andsupplies for production of property; coordinationwith section 263A. In Year 1, L purchases jigs, dies,molds, and patterns for use in the manufacture of L’sproducts. Assume each jig, die, mold, and patternis a unit of property under §1.263(a)–3(e). The eco-nomic useful life of each jig, die, mold, and patternis 12 months or less, beginning when each item isused in the manufacturing process. The jigs, dies,molds, and patterns are not components acquired tomaintain, repair, or improve any of L’s equipmentunder paragraph (c)(1)(i) of this section. L beginsusing the jigs, dies, molds and patterns in Year 2 tomanufacture its products. These items are materi-als and supplies under paragraph (c)(1)(iii) of thissection. Under paragraph (a)(1) of this section, theamounts paid for the items are otherwise deductiblein Year 2, the taxable year in which L first uses thoseitems. However, the amounts paid for these materialsand supplies may be subject to capitalization undersection 263A if these amounts comprise the direct orallocable 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 handto avoid operational time loss in the event it mustmake temporary repairs to a unit of property that issubject to depreciation. These parts are not used toimprove property under §1.263(a)–3(d). These tem-porary spare parts are used until a new or repairedpart can be installed and then are removed and storedfor later temporary installation. M does not use theoptional method of accounting for rotable and tem-porary spare parts in paragraph (e) of this section forany of its rotable or temporary spare parts. The tem-porary spare parts are materials and supplies underparagraph (c)(1)(i) of this section. Under paragraphs(a)(1) and (a)(3) of this section, the amounts paid forthe 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. 351 October 21, 2013

parts will be disposed of in the near future, M wouldprefer to treat the amounts paid for the spare parts ascapital expenditures subject to depreciation. M mayelect under paragraph (d) of this section to treat thecost 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 theamounts paid for each spare part in the taxable yearthat M acquires the spare parts and by beginning torecover the costs of each part on its timely filed Fed-eral tax return for the taxable year in which the part isplaced 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 safeharbor. (i) N provides consulting services to its cus-tomers. In Year 1, N pays amounts to purchase 50laptop computers. Each laptop computer is a unit ofproperty under §1.263(a)–3(e), costs $400, and has aneconomic useful life of more than 12 months. Also inYear 1, N purchases 50 office chairs to be used by itsemployees. Each office chair is a unit of property thatcosts $100. N has an applicable financial statement(as defined in §1.263(a)–1(f)(4)) and N has a writtenaccounting policy at the beginning Year 1 to expenseamounts paid for units of property costing $500 orless. N treats amounts paid for property costing $500or less as an expense on its applicable financial state-ment in Year 1.

(ii) The laptop computers are not materials orsupplies under paragraph (c) of this section. There-fore, the amounts N pays for the computers mustgenerally be capitalized under §1.263(a)–2(d) asamounts paid for the acquisition of tangible property.The office chairs are materials and supplies underparagraph (c)(1)(iv) of this section. Thus, underparagraph (a)(1) of this section, the amounts paidfor the office chairs are deductible in the taxableyear in which they are first used in N’s business.However, under paragraph (f) of this section, if Nproperly elects to apply the de minimis safe harborunder §1.263(a)–1(f) to amounts paid in Year 1,then N must apply the de minimis safe harbor under§1.263(a)–1(f) to amounts paid for the computers andthe office chairs, rather than treat the office chairs asthe costs of materials and supplies under §1.162–3.Under the de minimis safe harbor, N may not cap-italize the amounts paid for the computers under§1.263(a)–2 nor treat the office chairs as materialsand supplies under §1.162–3. Instead, in accordancewith §1.263(a)–1(f)(3)(iv), under §1.162–1, N maydeduct the amounts paid for the computers and theoffice 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 achange in method of accounting to whichthe provisions of sections 446 and 481 andthe accompanying regulations apply. Ataxpayer seeking to change to a method ofaccounting permitted in this section mustsecure the consent of the Commissioner inaccordance with §1.446–1(e) and followthe 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) Ingeneral. This section generally applies toamounts paid or incurred in taxable yearsbeginning on or after January 1, 2014.However, a taxpayer may apply paragraph(e) of this section (the optional method ofaccounting for rotable and temporary spareparts) to taxable years beginning on or af-ter January 1, 2014. Except as provided inparagraphs (j)(2) and (j)(3) of this section,§1.162–3 as contained in 26 CFR part 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 2014.

(2) Early application of this sec-tion—(i) In general. Except for paragraph(e) of this section, a taxpayer may chooseto apply this section to amounts paid orincurred in taxable years beginning on orafter January 1, 2012. A taxpayer maychoose to apply paragraph (e) of this sec-tion (the optional method of accountingfor rotable and temporary spare parts) totaxable years beginning on or after Jan-uary 1, 2012.

(ii) Transition rule for election to capi-talize materials and supplies on 2012 and2013 returns. If under paragraph (j)(2)(i)of this section, a taxpayer chooses to makethe election to capitalize and depreciatecertain materials and supplies under para-graph (d) of this section for its taxable yearbeginning on or after January 1, 2012, andending on or before September 19, 2013(applicable taxable year), and the taxpayerdid not make the election specified in para-graph (d)(3) of this section on its timelyfiled original Federal tax return for the ap-plicable taxable year, the taxpayer mustmake the election specified in paragraph(d)(3) of this section for the applicable tax-able year by filing an amended Federal taxreturn for the applicable taxable year on orbefore 180 days from the due date includ-ing extensions of the taxpayer’s Federaltax return for the applicable taxable year,notwithstanding that the taxpayer may nothave extended the due date.

(3) Optional application of TD 9564.Except for section 1.162–3T(e), a tax-payer may choose to apply §1.162–3Tas contained in TD 9564 (76 FR 81060)December 27, 2011, to amounts paid orincurred (to acquire or produce property)in taxable years beginning on or afterJanuary 1, 2012, and before January 1,

2014. A taxpayer may choose to applysection 1.162–3T(e) (the optional methodof accounting for rotable and temporaryspare parts) as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears 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 deductamounts paid for repairs and maintenanceto tangible property if the amounts paidare not otherwise required to be capital-ized. For the election to capitalize amountspaid for repair and maintenance consistentwith the taxpayer’s books and records, see§1.263(a)–3(n).

(b) Accounting method changes. Achange to comply with this section is achange in method of accounting to whichthe provisions of sections 446 and 481 andthe accompanying regulations apply. Ataxpayer seeking to change to a method ofaccounting permitted in this section mustsecure the consent of the Commissionerin accordance with §1.446–1(e) and fol-low the administrative procedures issuedunder §1.446–1(e)(3)(ii) for obtaining theCommissioner’s consent to change its ac-counting method.

(c) Effective/applicability date—(1) Ingeneral. This section applies to taxableyears beginning on or after January 1,2014. Except as provided in paragraphs(c)(2) and (c)(3) of this section, §1.162–4as contained in 26 CFR part 1 edition re-vised as of April 1, 2011, applies to taxableyears beginning before January 1, 2014.

(2) Early application of this section. Ataxpayer may choose to apply this sectionto taxable years beginning on or after Jan-uary 1, 2012.

(3) Optional application of TD 9564. Ataxpayer may choose to apply §1.162–4Tas contained in TD 9564 (76 FR 81060),December 27, 2011, to taxable years be-ginning on or after January 1, 2012, andbefore January 1, 2014.

§1.162–4T [Removed]

Par. 5. Section 1.162–4T is removed.

October 21, 2013 352 2013–43 I.R.B.

Par. 6. Section 1.162–11 is amendedby:

1. Revising paragraph (b).2. Removing paragraphs (c) and (d).The revision reads as follows:

§1.162–11 Rentals.

* * * * *(b) Improvements by lessee on lessor’s

property—(1) In general. The cost to ataxpayer of erecting buildings or makingpermanent improvements on property ofwhich the taxpayer is a lessee is a capi-tal expenditure. For the rules regardingimprovements to leased property when theimprovements are tangible property, see§1.263(a)–3(f). For the rules regarding de-preciation or amortization deductions forleasehold improvements, see §1.167(a)–4.

(2) Effective/applicability date—(i) Ingeneral. This paragraph (b) applies totaxable 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 CFRpart 1 edition revised as of April 1, 2011,applies to taxable years beginning beforeJanuary 1, 2014.

(ii) Early application of this paragraph.A taxpayer may choose to apply this para-graph (b) to taxable years beginning on orafter January 1, 2012.

(iii) Optional application of TD9564. 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 nondepreciableproperty.

* * * * *(c) Cross references. For the allowance

under section 165(a) of losses arising fromthe permanent withdrawal of depreciableproperty 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 theobsolescence of depreciable property forwhich depreciation is determined undersection 167 (but not under section 168,section 1400I, section 1400L(c), section168 prior to its amendment by the TaxReform Act of 1986, Public Law 99–514(100 Stat. 2121 (1986)), or under an ad-ditional first year depreciation deductionprovision 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) Ingeneral. This section applies to taxableyears beginning on or after January 1,2014. Except as provided in paragraphs(d)(2) and (d)(3) of this section, §1.165–2as contained in 26 CFR part 1 edition re-vised as of April 1, 2011, applies to taxableyears beginning before January 1, 2014.

(2) Early application of §1.165–2(c). Ataxpayer 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. Ataxpayer may choose to apply §1.165–2Tas contained in TD 9564 (76 FR 81060)December 27, 2011, to taxable years be-ginning on or after January 1, 2012, andbefore 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 expendituresmade by either a lessee or lessor for theerection of a building or for other perma-nent improvements on leased property arerecovered by the lessee or lessor under theprovisions of the Internal Revenue Code(Code) applicable to the cost recovery ofthe building or improvements, if subjectto depreciation or amortization, withoutregard to the period of the lease. Forexample, if the building or improvementis 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 section168(i)(8)(A). If the improvement is prop-erty to which section 167 or section 197applies, the lessee or lessor determines thedepreciation or amortization deduction forthe improvement under section 167 or sec-tion 197, as applicable.

(b) Effective/applicability date—(1) Ingeneral. Except as provided in paragraph(b)(2) or (b)(3) of this section, this sectionapplies to taxable years beginning on orafter January 1, 2014.

(2) Application of this section to lease-hold improvements placed in service afterDecember 31, 1986, in taxable years be-ginning before January 1, 2014. For lease-hold improvements placed in service afterDecember 31, 1986, in taxable years be-ginning before January 1, 2014, a taxpayermay—

(i) Apply the provisions of this section;or

(ii) Depreciate any leasehold improve-ment to which section 168 applies underthe 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 thatare applicable to the cost recovery of thatleasehold improvement, without regard tothe 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)–4as contained in 26 CFR part 1 edition re-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), a change tocomply with this section for deprecia-ble assets placed in service in a taxableyear ending on or after December 30,2003, is a change in method of account-ing to which the provisions of section446(e) and the regulations under sec-tion 446(e) apply. Except as providedin §1.446–1(e)(2)(ii)(d)(3)(i), a taxpayeralso may treat a change to comply withthis section for depreciable assets placedin service in a taxable year ending beforeDecember 30, 2003, as a change in methodof accounting to which the provisions of

2013–43 I.R.B. 353 October 21, 2013

section 446(e) and the regulations undersection 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 amendedby:

1. Revising paragraphs (e) and (f).2. Removing paragraph (g).The revisions read as follows:

§1.167(a)–7 Accounting for depreciableproperty.

* * * * *(e) Applicability. Paragraphs (a), (b),

and (d) of this section apply to propertyfor which depreciation is determined undersection 167 (but not under section 168, sec-tion 1400I, section 1400L(c), section 168prior to its amendment by the Tax ReformAct of 1986, Public Law 99–514 (100 Stat.2121 (1986)), or under an additional firstyear depreciation deduction provision ofthe Internal Revenue Code (for example,section 168(k) through (n), 1400L(b), or1400N(d))). Paragraph (c) of this sectiondoes not apply to general asset accounts asprovided 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 January1, 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 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 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 TD9564. A taxpayer may choose to apply§1.167(a)–7T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears 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 amendedby:

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 depreciationis determined under section 167 (but notunder section 168, section 1400I, section1400L(c), section 168 prior to its amend-ment by the Tax Reform Act of 1986, Pub-lic Law 99–514 (100 Stat. 2121(1986)), orunder an additional first year depreciationdeduction 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 January1, 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 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 2014.

(2) Early application of§1.167(a)–8(g). A taxpayer may chooseto apply paragraph (g) of this sectionto taxable years beginning on or afterJanuary 1, 2012.

(3) Optional application of TD9564. A taxpayer may choose to apply§1.167(a)–8T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears 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. Section 1.168(i)–7 is added toread as follows:

§1.168(i)–7 Accounting for MACRSproperty.

(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 bycombining two or more assets in a singleaccount (a “multiple asset account” or a“pool”). A taxpayer may establish as manyaccounts 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, orProp. 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 taxpayeruses the asset both in a trade or business(or for the production of income) and in apersonal activity, or if the taxpayer placesin service and disposes of the asset duringthe same taxable year. Also, if generalasset 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) orProp. Reg. §1.168(i)–1(c)(1)(ii)(A),(e)(3)(iii), (e)(3)(vii), (g), or (h)(2)(September 19, 2013), as applicable, thetaxpayer must account for the asset ina single asset account beginning in thetaxable year in which the general assetaccount treatment for the asset termi-nates. If a taxpayer accounts for an assetin a multiple asset account or a pool andthe taxpayer disposes of the asset, thetaxpayer must account for the asset ina single asset account beginning in thetaxable 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 assetand the unadjusted depreciable basis ofthe disposed of component is included inthe unadjusted depreciable basis of thelarger asset, the taxpayer must accountfor the component in a single asset ac-count beginning in the taxable year inwhich 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 formultiple asset accounts or pools. Exceptas provided in paragraph (b) of this section,assets that are subject to either the generaldepreciation system of section 168(a) orthe alternative depreciation system of sec-tion 168(g) may be accounted for in one ormore multiple asset accounts or pools.

(2) Grouping assets in multiple assetaccounts or pools—(i) General rules. As-sets that are eligible to be grouped into asingle multiple asset account or pool maybe divided into more than one multiple as-set account or pool. Each multiple asset

October 21, 2013 354 2013–43 I.R.B.

account or pool must include only assetsthat—

(A) Have the same applicable deprecia-tion method;

(B) Have the same applicable recoveryperiod;

(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. In addition to the gen-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-quarterconvention may only be grouped into amultiple asset account or pool with assetsthat are placed in service in the same quar-ter of the taxable year;

(B) Assets subject to the mid-monthconvention may only be grouped into amultiple asset account or pool with as-sets that are placed in service in the samemonth of the taxable year;

(C) Passenger automobiles for whichthe depreciation allowance is limited un-der section 280F(a) must be grouped intoa separate multiple asset account or pool;

(D) Assets not eligible for any addi-tional first year depreciation deduction(including assets for which the taxpayerelected not to deduct the additional firstyear depreciation) provided by, for exam-ple, section 168(k) through (n), 1400L(b),or 1400N(d), must be grouped into a sep-arate multiple asset account or pool;

(E) Assets eligible for the additionalfirst year depreciation deduction may onlybe grouped into a multiple asset accountor pool with assets for which the taxpayerclaimed the same percentage of the addi-tional first year depreciation (for example,30 percent, 50 percent, or 100 percent);

(F) Except for passenger automobilesdescribed in paragraph (c)(2)(ii)(C) of thissection, listed property (as defined in sec-tion 280F(d)(4)) must be grouped into aseparate multiple asset account or pool;

(G) Assets for which the depreciationallowance for the placed-in-service year isnot 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 subjectto §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 intoa 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 therecords to be maintained by a taxpayer foreach general asset account.

(e) Effective/applicability date—(1) Ingeneral. This section applies to taxableyears beginning on or after January 1,2014.

(2) Early application of this section. Ataxpayer 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 TD9564. A taxpayer may choose to apply§1.168(i)–7T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears beginning on or after January 1,2012, and before January 1, 2014.

(4) Change in method of accounting. Achange 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 accountingto which the provisions of section 446(e)and the regulations under section 446(e)apply. A taxpayer also may treat a changeto comply with this section for deprecia-ble assets placed in service in a taxableyear ending before December 30, 2003, asa change in method of accounting to whichthe provisions of section 446(e) and theregulations 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 amendedby:

1. The table of contents introductorytext is revised.

2. Revising the section headingand 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 ofcontents.

The revisions and additions read as fol-lows:

§1.263(a)–0 Outline of regulations undersection 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; ingeneral.

(a) General rule for capital expendi-tures.

(b) Coordination with other provisionsof 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 minimis safe 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-qualifyingfinancial statement.

(2) Exceptions to de minimis safe har-bor.

(3) Additional rules.(i) Transaction and other additional

costs.(ii) Materials and supplies.(iii) Sale or disposition.(iv) Treatment of de minimis amounts.(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 for de minimis safe

harbor election on 2012 or 2013 returns.(3) Optional application of TD 9564.

2013–43 I.R.B. 355 October 21, 2013

§1.263(a)–2 Amounts paid to acquire orproduce 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 improvetangible 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 to leased 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) Time and manner of election.(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, 2013 356 2013–43 I.R.B.

(iii) Unavailability of replacementparts.

(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

and 2013 returns.(3) Optional application of TD 9564.

* * * * *

§1.263(a)–6 Election to deduct orcapitalize 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 revisedto read as follows:

§1.263(a)–1 Capital expenditures; ingeneral.

(a) General rule for capital expendi-tures. Except as provided in chapter 1 ofthe Internal Revenue Code, no deductionis allowed for—

(1) Any amount paid for new buildingsor for permanent improvements or better-ments made to increase the value of anyproperty or estate; or

(2) Any amount paid in restoring prop-erty or in making good the exhaustionthereof for which an allowance is or hasbeen made.

(b) Coordination with other provisionsof the Internal Revenue Code. Nothing inthis section changes the treatment of anyamount that is specifically provided for un-der any provision of the Internal RevenueCode or the Treasury Regulations otherthan section 162(a) or section 212 and theregulations under those sections. For ex-ample, see section 263A, which requirestaxpayers to capitalize the direct and allo-cable indirect costs to property producedby the taxpayer and property acquired forresale. See also section 195 requiring tax-payers to capitalize certain costs as start-upexpenditures.

(c) Definitions. For purposes of thissection, the following definitions apply:

(1) Amount paid. In the case of a tax-payer using an accrual method of account-ing, the terms amount paid and paymentmean a liability incurred (within the mean-ing of §1.446–1(c)(1)(ii)). A liability maynot be taken into account under this sectionprior to the taxable year during which theliability is incurred.

(2) Produce means construct, build, in-stall, manufacture, develop, create, raise,

or grow. This definition is intended to havethe same meaning as the definition usedfor purposes of section 263A(g)(1) and§1.263A–2(a)(1)(i), except that improve-ments are excluded from the definition inthis 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 examplesof capital expenditures:

(1) An amount paid to acquire or pro-duce a unit of real or personal tangibleproperty. See §1.263(a)–2.

(2) An amount paid to improve a unitof real or personal tangible property. See§1.263(a)–3.

(3) An amount paid to acquire or createintangibles. See §1.263(a)–4.

(4) An amount paid or incurred to facil-itate an acquisition of a trade or business,a change in capital structure of a businessentity, and certain other transactions. See§1.263(a)–5.

(5) An amount paid to acquire or createinterests 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 orshareholders of a corporation to be used ina reorganization of the corporation or vol-untary contributions by shareholders to thecapital of the corporation for any corporatepurpose. See section 118 and §1.118–1.

(7) An amount paid by a holding com-pany to carry out a guaranty of dividendsat a specified rate on the stock of a sub-sidiary corporation for the purpose of se-curing new capital for the subsidiary andincreasing the value of its stockholdings inthe subsidiary. This amount must be addedto 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 saleof property are not currently deductibleunder section 162 or 212. Instead, theamounts are capitalized costs that reducethe amount realized in the taxable yearin which the sale occurs or are taken intoaccount in the taxable year in which thesale is abandoned if a deduction is per-missible. These amounts are not added tothe basis of the property sold or treatedas an intangible asset under §1.263(a)–4.See §1.263(a)–5(g) for the treatment ofamounts paid to facilitate the dispositionof assets that constitute a trade or business.

2013–43 I.R.B. 357 October 21, 2013

(2) Dealer in property. In the case of adealer in property, amounts paid to facili-tate the sale of such property are treated asordinary and necessary business expenses.

(3) Examples. The following examples,which assume the sale is not an installmentsale under section 453, illustrate the rulesof this paragraph (e):

Example 1. Sales costs of real property. A ownsa parcel of real estate. A sells the real estate and payslegal fees, recording fees, and sales commissions tofacilitate 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 thesame facts as in Example 1, except that A is a dealerin real estate. The commissions and fees paid to fa-cilitate the sale of the real estate may be deducted asordinary and necessary business expenses under sec-tion 162.

Example 3. Sales costs of personal property usedin a trade or business. B owns a truck for use inB’s trade or business. B decides to sell the truck onNovember 15, Year 1. B pays for an appraisal todetermine a reasonable asking price. On February15, Year 2, B sells the truck to C. In Year 1, B mustcapitalize the amount paid to appraise the truck, andin Year 2, must reduce the amount realized from thesale of the truck by the amount paid for the appraisal.

Example 4. Costs of abandoned sale of personalproperty used in a trade or business. Assume thesame facts as in Example 3, except that, instead ofselling the truck on February 15, Year 2, B decides onthat date not to sell the truck and takes the truck offthe market. In Year 1, B must capitalize the amountpaid to appraise the truck. However, B may recognizethe amount paid to appraise the truck as a loss undersection 165 in Year 2, the taxable year when the saleis abandoned.

Example 5. Sales costs of personal property notused in a trade or business. Assume the same facts asin Example 3, except that B does not use the truck inB’s trade or business but instead uses it for personalpurposes. In Year 1, B must capitalize the amountpaid to appraise the truck, and in Year 2, must reducethe amount realized from the sale of the truck by theamount paid for the appraisal.

Example 6. Costs of abandoned sale of personalproperty not used in a trade or business. Assume thesame facts as in Example 5, except that, instead ofselling the truck on February 15, Year 2, B decides onthat date not to sell the truck and takes the truck offthe market. In Year 1, B must capitalize the amountpaid to appraise the truck. Although B abandons thesale in Year 2, B may not treat the amount paid toappraise the truck as a loss under section 165 becausethe truck was not used in B’s trade or business or in atransaction entered into for profit.

(f) De minimis safe harbor elec-tion—(1) In general. Except as otherwiseprovided in paragraph (f)(2) of this section,a taxpayer electing to apply the de minimissafe harbor under this paragraph (f) maynot 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 productionof a unit of tangible property nor treat as amaterial or supply under §1.162–3(a) anyamount paid in the taxable year for tangi-ble property if the amount specified underthis paragraph (f)(1) meets the require-ments of paragraph (f)(1)(i) or (f)(1)(ii)of this section. But see section 263A andthe regulations under section 263A, whichrequire taxpayers to capitalize the directand allocable indirect costs of propertyproduced by the taxpayer (for example,property improved by the taxpayer) andproperty acquired for resale.

(i) Taxpayer with applicable financialstatement. A taxpayer electing to apply thede minimis safe harbor may not capitalizeunder §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 beginningof the taxable year written accounting pro-cedures treating as an expense for non-taxpurposes—

(1) Amounts paid for property costingless than a specified dollar amount; or

(2) Amounts paid for property withan economic useful life (as defined in§1.162–3(c)(4)) of 12 months or less;

(C) The taxpayer treats the amount paidfor the property as an expense on its ap-plicable financial statement in accordancewith its written accounting procedures;and

(D) The amount paid for the propertydoes not exceed $5,000 per invoice (orper item as substantiated by the invoice)or other amount as identified in pub-lished guidance in the Federal Registeror in the Internal Revenue Bulletin (see§601.601(d)(2)(ii)(b) of this chapter).

(ii) Taxpayer without applicable fi-nancial statement. A taxpayer electingto apply the de minimis safe harbor maynot capitalize under §1.263(a)–2(d)(1) or§1.263(a)–3(d) nor treat as a material orsupply under §1.162–3(a) any amount paidin the taxable year for property describedin paragraph (f)(1) of this section if—

(A) The taxpayer does not have an ap-plicable financial statement (as defined inparagraph (f)(4) of this section);

(B) The taxpayer has at the beginningof the taxable year accounting procedurestreating as an expense for non-tax pur-poses—

(1) Amounts paid for property costingless than a specified dollar amount; or

(2) Amounts paid for property withan economic useful life (as defined in§1.162–3(c)(4)) of 12 months or less;

(C) The taxpayer treats the amount paidfor the property as an expense on its booksand 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 inpublished guidance in the Federal Reg-ister or in the Internal Revenue Bulletin(see §601.601(d)(2)(ii)(b) of this chapter).

(iii) Taxpayer with both an applicablefinancial statement and a non-qualifyingfinancial statement. For purposes of thisparagraph (f)(1), if a taxpayer has an appli-cable financial statement defined in para-graph (f)(4) of this section in addition to afinancial 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 sectionto qualify to elect the de minimis safe har-bor under this paragraph (f).

(2) Exceptions to de minimis safe har-bor. The de minimis safe harbor in para-graph (f)(1) of this section does not applyto the following:

(i) Amounts paid for property that isor is intended to be included in inventoryproperty;

(ii) Amounts paid for land;(iii) Amounts paid for rotable, tempo-

rary, and standby emergency spare partsthat the taxpayer elects to capitalize anddepreciate 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 ofaccounting for rotable parts pursuant to§1.162–3(e).

(3) Additional rules—(i) Transactionand other additional costs. A taxpayerelecting to apply the de minimis safe har-bor under paragraph (f)(1) of this sectionis not required to include in the cost ofthe tangible property the additional costsof acquiring or producing such propertyif these costs are not included in the sameinvoice as the tangible property. However,

October 21, 2013 358 2013–43 I.R.B.

the taxpayer electing to apply the de min-imis safe harbor under paragraph (f)(1)of this section must include in the costof such property all additional costs (forexample, delivery fees, installation ser-vices, or similar costs) if these additionalcosts are included on the same invoicewith the tangible property. For purposesof this paragraph, if the invoice includesamounts paid for multiple tangible prop-erties and such invoice includes additionalinvoice costs related to these multipleproperties, then the taxpayer must allocatethe additional invoice costs to each prop-erty using a reasonable method, and eachproperty, including allocable labor andoverhead, must meet the requirements ofparagraph (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, a pro rata allocation, or a weightedaverage method based on the property’srelative cost. For purposes of this para-graph (f)(3)(i), additional costs consist ofthe costs of facilitating the acquisition orproduction of such tangible property un-der §1.263(a)–2(f) and the costs for workperformed prior to the date that the tan-gible property is placed in service under§1.263(a)–2(d).

(ii) Materials and supplies. If a tax-payer elects to apply the de minimis safeharbor provided under this paragraph (f),then the taxpayer must also apply the deminimis safe harbor to amounts paid forall materials and supplies (as defined un-der §1.162–3) that meet the requirementsof §1.263(a)–1(f). See paragraph (f)(3)(iv)of this section for treatment of materialsand supplies under the de minimis safe har-bor.

(iii) Sale or disposition. Property towhich a taxpayer applies the de minimissafe harbor contained in this paragraph (f)is not treated upon sale or other dispositionas a capital asset under section 1221 oras property used in the trade or businessunder section 1231.

(iv) Treatment of de minimis amounts.An amount paid for property to which ataxpayer properly applies the de minimissafe 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) oras a material and supply under §1.162–3,and may be deducted under §1.162–1 inthe taxable year the amount is paid pro-

vided the amount otherwise constitutes anordinary and necessary expense incurredin carrying on a trade or business.

(v) Coordination with section 263A.Amounts paid for tangible property de-scribed in paragraph (f)(1) of this sectionmay be subject to capitalization undersection 263A if the amounts paid fortangible property comprise the direct orallocable indirect costs of other propertyproduced by the taxpayer or propertyacquired for resale. See, for example,§1.263A–1(e)(3)(ii)(R) requiring taxpay-ers to capitalize the cost of tools andequipment allocable to property producedor property acquired for resale.

(vi) Written accounting procedures forgroups of entities. If the taxpayer’s fi-nancial results are reported on the applica-ble financial statement (as defined in para-graph (f)(4) of this section) for a groupof entities then, for purposes of paragraph(f)(1)(i)(A) of this section, the group’s ap-plicable financial statement may be treatedas the applicable financial statement ofthe taxpayer, and for purposes of para-graphs (f)(1)(i)(B) and (f)(1)(i)(C) of thissection, the written accounting proceduresprovided for the group and utilized for thegroup’s applicable financial statement maybe treated as the written accounting proce-dures of the taxpayer.

(vii) Combined expensing accountingprocedures. For purposes of paragraphs(f)(1)(i) and (f)(1)(ii) of this section, ifthe taxpayer has, at the beginning of thetaxable year accounting procedures treat-ing as an expense for non-tax purposes (1)amounts paid for property costing less thana specified dollar amount; and (2) amountspaid for property with an economic use-ful life (as defined in §1.162–3(c)(4)) of12 months or less, then a taxpayer elect-ing to apply the de minimis safe 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 financialstatement. For purposes of this para-graph (f), the taxpayer’s applicable fi-nancial statement (AFS) is the taxpayer’sfinancial statement listed in paragraphs(f)(4)(i) through (iii) of this section thathas the highest priority (including withinparagraph (f)(4)(ii) of this section). Thefinancial statements are, in descendingpriority—

(i) A financial statement required tobe filed with the Securities and ExchangeCommission (SEC) (the 10–K or the An-nual Statement to Shareholders);

(ii) A certified audited financial state-ment that is accompanied by the report ofan independent certified public accountant(or in the case of a foreign entity, by thereport of a similarly qualified independentprofessional) 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 tothe federal or a state government or anyfederal or state agency (other than the SECor the Internal Revenue Service).

(5) Time and manner of election. Ataxpayer that makes the election under thisparagraph (f) must make the election forall amounts paid during the taxable yearfor 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. Ataxpayer makes the election by attachinga statement to the taxpayer’s timely filedoriginal Federal tax return (including ex-tensions) for the taxable year in whichthese amounts are paid. See §§301.9100–1through 301.9100–3 of this chapter for theprovisions governing extensions of time tomake regulatory elections. The statementmust be titled “Section 1.263(a)–1(f) deminimis safe harbor election” and includethe taxpayer’s name, address, taxpayeridentification number, and a statementthat the taxpayer is making the de minimissafe harbor election under §1.263(a)–1(f).In the case of a consolidated group fil-ing a consolidated income tax return, theelection is made for each member of theconsolidated group by the common parent,and the statement must also include thenames and taxpayer identification num-bers of each member for which the electionis made. In the case of an S corporation ora partnership, the election is made by the Scorporation or the partnership and not bythe shareholders or partners. An electionmay not be made through the filing ofan application for change in accountingmethod 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. 359 October 21, 2013

A taxpayer may not revoke an electionmade under this paragraph (f). The man-ner of electing the de minimis safe harborunder this paragraph (f) may be modifiedthrough guidance of general applicability(see §§601.601(d)(2) and 601.602 of thischapter).

(6) Anti-abuse rule. If a taxpayer actsto manipulate transactions with the intentto achieve a tax benefit or to avoid theapplication 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 thissection, appropriate adjustments will bemade to carry out the purposes of this sec-tion. For example, a taxpayer is deemedto act to manipulate transactions with anintent to avoid the purposes and require-ments of this section if—

(i) The taxpayer applies the de minimissafe harbor to amounts substantiated withinvoices created to componentize propertythat is generally acquired or produced bythe taxpayer (or other taxpayers in thesame or similar trade or business) as asingle unit of tangible property; and

(ii) This property, if treated asa single unit, would exceed any ofthe 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 thissection, as applicable.

(7) Examples. The following examplesillustrate the application of this paragraph(f). Unless otherwise provided, assumethat section 263A does not apply to theamounts described.

Example 1. De minimis safe harbor; taxpayerwithout AFS. In Year 1, A purchases 10 printers at$250 each for a total cost of $2,500 as indicated by theinvoice. 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 beginningof Year 1 to expense amounts paid for property cost-ing less than $500, and A treats the amounts paid forthe printers as an expense on its books and records.The amounts paid for the printers meet the require-ments for the de minimis safe harbor under paragraph(f)(1)(ii) of this section. If A elects to apply the deminimis safe harbor under this paragraph (f) in Year1, A may not capitalize the amounts paid for the 10printers or any other amounts meeting the criteria forthe de minimis safe harbor under paragraph (f)(1). In-stead, in accordance with paragraph (f)(3)(iv) of thissection, A may deduct these amounts under §1.162–1in the taxable year the amounts are paid provided theamounts otherwise constitute deductible ordinary andnecessary expenses incurred in carrying on a trade orbusiness.

Example 2. De minimis safe harbor; taxpayerwithout AFS. In Year 1, B purchases 10 computersat $600 each for a total cost of $6,000 as indicated by

the invoice. Assume that each computer is a unit ofproperty under §1.263(a)–3(e). B does not have anAFS. 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 amountspaid for the computers as an expense on its booksand records. The amounts paid for the printers donot meet the requirements for the de minimis safe har-bor under paragraph (f)(1)(ii) of this section becausethe amount paid for the property exceeds $500 perinvoice (or per item as substantiated by the invoice).B may not apply the de minimis safe harbor electionto the amounts paid for the 10 computers under para-graph (f)(1) of this section.

Example 3. De minimis safe harbor; taxpayerwith AFS. C is a member of a consolidated groupfor Federal income tax purposes. C’s financial re-sults are reported on the consolidated applicable fi-nancial statements for the affiliated group. C’s affili-ated group has a written accounting policy at the be-ginning of Year 1, which is followed by C, to expenseamounts paid for property costing $5,000 or less. InYear 1, C pays $6,250,000 to purchase 1,250 com-puters at $5,000 each. C receives an invoice from itssupplier indicating the total amount due ($6,250,000)and the price per item ($5,000). Assume that eachcomputer is a unit of property under §1.263(a)–3(e).The amounts paid for the computers meet the require-ments for the de minimis safe harbor under paragraph(f)(1)(i) of this section. If C elects to apply the deminimis safe harbor under this paragraph (f) for Year1, C may not capitalize the amounts paid for the 1,250computers or any other amounts meeting the criteriafor the de minimis safe harbor under paragraph (f)(1)of this section. Instead, in accordance with paragraph(f)(3)(iv) of this section, C may deduct these amountsunder §1.162–1 in the taxable year the amounts arepaid provided the amounts otherwise constitute de-ductible ordinary and necessary expenses incurred incarrying on a trade or business.

Example 4. De minimis safe harbor; taxpayerwith AFS. D is a member of a consolidated groupfor Federal income tax purposes. D’s financial re-sults are reported on the consolidated applicable 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 expenseamounts 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). Assumethat each elliptical machine is a unit of property un-der §1.263(a)–3(e). D may not apply the de minimissafe harbor election to the amounts paid for the 800elliptical 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 theinvoice).

Example 5. De minimis safe harbor; additionalinvoice costs. E is a member of a consolidated groupfor Federal income tax purposes. E’s financial re-sults are reported on the consolidated applicable fi-nancial statements for the affiliated group. E’s af-filiated group has a written accounting policy at thebeginning of Year 1, which is followed by E, to ex-pense amounts paid for property costing less than$5,000. In Year 1, E pays $45,000 for the purchaseand installation of wireless routers in each of its 10

office locations. Assume that each wireless routeris a unit of property under §1.263(a)–3(e). E re-ceives an invoice from its supplier indicating the totalamount due ($45,000), including the material priceper item ($2,500), and total delivery and installation($20,000). E allocates the additional invoice costs tothe materials on a pro rata basis, bringing the cost ofeach 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, meetthe requirements for the de minimis safe harbor underparagraph (f)(1)(i) of this section. If E elects to ap-ply the de minimis safe harbor under this paragraph(f) for Year 1, E may not capitalize the amounts paidfor the 10 routers (including the additional invoicecosts) or any other amounts meeting the criteria forthe de minimis safe harbor under paragraph (f)(1) ofthis section. Instead, in accordance with paragraph(f)(3)(iv) of this section, E may deduct these amountsunder §1.162–1 in the taxable year the amounts arepaid provided the amounts otherwise constitute de-ductible ordinary and necessary expenses incurred incarrying on a trade or business.

Example 6. De minimis safe harbor; non-invoiceadditional costs. F is a corporation that providesconsulting services to its customer. F does not havean AFS, but F has accounting procedures in placeat the beginning of Year 1 to expense amounts paidfor property costing less than $500. In Year 1, Fpays $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 theinterior designer for $600 for his services, and F re-ceives a separate invoice from the furniture supplierindicating a total amount due of $500 for the table and$300 for each chair. For Year 1, F treats the amountpaid for the table and each chair as an expense on itsbooks and records, and F elects to use the de minimissafe harbor for amounts paid for tangible propertythat qualify under the safe harbor. The amount paidto 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 theadditional costs of acquiring such property if thesecosts are not included in the same invoice as the tan-gible property. Thus, F is not required to include a prorata allocation of the amount paid to the interior de-signer to determine the application of the de minimissafe harbor to the table and the chairs. Accordingly,the amounts paid by F for the table and each chairmeet the requirements for the de minimis safe harborunder paragraph (f)(1)(ii) of this section, and F maynot capitalize the amounts paid for the table or eachchair under paragraph (f)(1) of this section. In addi-tion, F is not required to capitalize the amounts paid tothe 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 inthe taxable year the amounts are paid provided theamounts otherwise constitute deductible ordinary andnecessary expenses incurred in carrying on a trade orbusiness.

Example 7. De minimis safe harbor; 12-montheconomic useful life. G operates a restaurant. In Year

October 21, 2013 360 2013–43 I.R.B.

1, G purchases 10 hand-held point-of-service devicesat $300 each for a total cost of $3,000 as indicated byinvoice. G also purchases 3 tablet computers at $500each for a total cost of $1,500 as indicated by invoice.Assume each point-of-service device and each tabletcomputer has an economic useful life of 12 months orless, beginning when they are used in G’s business.Assume that each device and each tablet is a unit ofproperty under §1.263(a)–3(e). G does not have anAFS, but G has accounting procedures in place atthe beginning of Year 1 to expense amounts paid forproperty costing $300 or less and to expense amountspaid for property with an economic useful life of 12months or less. Thus, G expenses the amounts paidfor the hand-held devices on its books and recordsbecause each device costs $300. G also expenses theamounts paid for the tablet computers on its booksand records because the computers have an economicuseful life of 12 months of less, beginning when theyare used. The amounts paid for the hand-held devicesand the tablet computers meet the requirements forthe de minimis safe harbor under paragraph (f)(1)(ii)of this section. If G elects to apply the de minimissafe harbor under this paragraph (f) in Year 1, G maynot capitalize the amounts paid for the hand-held de-vices, the tablet computers, or any other amountsmeeting the criteria for the de minimis safe harbor un-der paragraph (f)(1) of this section. Instead, in accor-dance with paragraph (f)(3)(iv) of this section, G maydeduct the amounts paid for the hand-held devicesand tablet computers under §1.162–1 in the taxableyear the amounts are paid provided the amounts oth-erwise constitute deductible ordinary and necessarybusiness expenses incurred in carrying on a trade orbusiness.

Example 8. De minimis safe harbor; limitation.Assume the facts as in Example 7, except G purchasesthe 3 tablet computers at $600 each for a total cost of$1,800. The amounts paid for the tablet computers donot meet the de minimis rule safe harbor under para-graphs (f)(1)(ii) and (f)(3)(vii) of this section becausethe cost of each computer exceeds $500. Therefore,the amounts paid for the tablet computers may not bededucted under the safe harbor.

Example 9. De minimis safe harbor; materi-als and supplies. H is a corporation that providesconsulting services to its customers. H has an AFSand a written accounting policy at the beginning ofthe taxable year to expense amounts paid for prop-erty costing $5,000 or less. In Year 1, H purchases1,000 computers at $500 each for a total cost of$500,000. Assume that each computer is a unit ofproperty under §1.263(a)–3(e) and is not a materialor supply under §1.162–3. In addition, H purchases200 office chairs at $100 each for a total cost of$20,000 and 250 customized briefcases at $80 eachfor a total cost of $20,000. Assume that each officechair and each briefcase is a material or supply under§1.162–3(c)(1). H treats the amounts paid for thecomputers, office chairs, and briefcases as expenseson its AFS. The amounts paid for computers, officechairs, and briefcases meet the requirements for thede minimis safe harbor under paragraph (f)(1)(i) ofthis section. If H elects to apply the de minimis safeharbor under this paragraph (f) in Year 1, H may notcapitalize the amounts paid for the 1,000 computers,the 200 office chairs, and the 250 briefcases underparagraph (f)(1) of this section. H may deduct theamounts paid for the computers, the office chairs,

and the briefcases under §1.162–1 in the taxable yearthe amounts are paid provided the amounts other-wise constitute deductible ordinary and necessaryexpenses incurred in carrying on a trade or business.

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 AFSfor the affiliated group. J’s affiliated group has awritten accounting policy at the beginning of Year 1,which is followed by J, to expense amounts paid forproperty 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 inthe 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 Year1, J begins using the jigs, dies, molds and patternsto manufacture its products. Assume these items arematerials and supplies under §1.162–3(c)(1)(iii), andJ elects to apply the de minimis safe harbor underparagraph (f)(1)(i) of this section to amounts quali-fying under the safe harbor in Year 1. Under para-graph (f)(3)(v) of this section, the amounts paid forthe jigs, dies, molds, and patterns may be subject tocapitalization under section 263A if the amounts paidfor these tangible properties comprise the direct or al-locable indirect costs of other property produced bythe taxpayer or property acquired for resale.

Example 11. De minimis safe harbor; anti-abuserule. K is a corporation that provides hauling servicesto its customers. In Year 1, K decides to purchase atruck 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 propertycosting less than $500. K arranges to purchase a usedtruck for a total of $1,500. Prior to the acquisition,K requests the seller to provide multiple invoices fordifferent parts of the truck. Accordingly, the sellerprovides K with four invoices during Year 1—one in-voice of $500 for the cab, one invoice of $500 forthe engine, one invoice of $300 for the trailer, anda fourth invoice of $200 for the tires. K treats theamounts paid under each invoice as an expense on itsbooks and records. K elects to apply the de minimissafe harbor under paragraph (f) of this section in Year1 and does not capitalize the amounts paid for eachinvoice pursuant to the safe harbor. Under paragraph(f)(6) of this section, K has applied the de minimisrule to amounts substantiated with invoices createdto componentize property that is generally acquiredas a single unit of tangible property in the taxpayer’stype of business, and this property, if treated as sin-gle unit, would exceed the limitations provided underthe de minimis rule. Accordingly, K is deemed to ma-nipulate the transaction to acquire the truck with theintent to avoid the purposes of this paragraph (f). Asa result, K may not apply the de minimis rule to theseamounts and is subject to appropriate adjustments.

(g) Accounting method changes. Ex-cept for paragraph (f) of this section (thede minimis safe harbor election), a changeto comply with this section is a change inmethod of accounting to which the pro-visions of sections 446 and 481 and theaccompanying 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 inaccordance with §1.446–1(e) and followthe 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) ofthis section, this section generally appliesto taxable years beginning on or afterJanuary 1, 2014. Paragraph (f) of thissection applies to amounts paid in taxableyears 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 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 2014.

(2) Early application of this sec-tion—(i) In general. Except for paragraph(f) of this section, a taxpayer may chooseto apply this section to taxable years be-ginning on or after January 1, 2012. Ataxpayer may choose to apply paragraph(f) of this section to amounts paid in tax-able years beginning on or after January1, 2012.

(ii) Transition rule for de minimis safeharbor election on 2012 or 2013 returns.If under paragraph (h)(2)(i) of this section,a taxpayer chooses to make the electionto apply the de minimis safe harbor underparagraph (f) of this section for amountspaid 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 makethe election specified in paragraph (f)(5) ofthis section on its timely filed original Fed-eral tax return for the applicable taxableyear, the taxpayer must make the electionspecified in paragraph (f)(5) of this sectionfor the applicable taxable year by filing anamended Federal tax return for the appli-cable taxable year on or before 180 daysfrom the due date including extensions ofthe taxpayer’s Federal tax return for the ap-plicable taxable year, notwithstanding thatthe taxpayer may not have extended thedue date.

(3) Optional application of TD9564. A taxpayer may choose to apply§1.263(a)–1T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears beginning on or after January 1,2012, and before January 1, 2014.

2013–43 I.R.B. 361 October 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 revisedto read as follows:

§1.263(a)–2 Amounts paid to acquire orproduce tangible property.

(a) Overview. This section providesrules for applying section 263(a) toamounts paid to acquire or produce a unitof real or personal property. Paragraph (b)of this section contains definitions. Para-graph (c) of this section contains the rulesfor coordinating this section with otherprovisions of the Internal Revenue Code(Code). Paragraph (d) of this section pro-vides the general requirement to capitalizeamounts paid to acquire or produce a unitof real or personal property. Paragraph (e)of this section provides the requirementto capitalize amounts paid to defend orperfect title to real or personal property.Paragraph (f) of this section provides therules for determining the extent to whichtaxpayers must capitalize transaction costsrelated to the acquisition of tangible prop-erty. Paragraphs (g) and (h) of this sectionaddress the treatment and recovery of cap-ital expenditures. Paragraph (i) of thissection provides for changes in methodsof accounting to comply with this section,and paragraph (j) of this section providesthe effective and applicability dates for therules under this section.

(b) Definitions. For purposes of thissection, the following definitions apply:

(1) Amount paid. In the case of a tax-payer using an accrual method of account-ing, the terms amount paid and paymentmean a liability incurred (within the mean-ing of §1.446–1(c)(1)(ii)). A liability maynot be taken into account under this sectionprior to the taxable year during which theliability is incurred.

(2) Personal property means tangiblepersonal property as defined in §1.48–1(c).

(3) Real property means land and im-provements thereto, such as buildings orother inherently permanent structures (in-cluding items that are structural compo-nents of the buildings or structures) that arenot personal property as defined in para-graph (b)(2) of this section. Any propertythat constitutes other tangible property un-der §1.48–1(d) is treated as real property

for purposes of this section. Local lawis not controlling in determining whetherproperty is real property for purposes ofthis section.

(4) Produce means construct, build, in-stall, manufacture, develop, create, raise,or grow. This definition is intended to havethe same meaning as the definition usedfor purposes of section 263A(g)(1) and§1.263A–2(a)(1)(i), except that improve-ments are excluded from the definition inthis paragraph (b)(4) and are separately de-fined and addressed in §1.263(a)–3.

(c) Coordination with other provisionsof the Code—(1) In general. Nothing inthis section changes the treatment of anyamount 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 underthose sections. For example, see section263A requiring taxpayers to capitalize thedirect and allocable indirect costs of prop-erty produced by the taxpayer and prop-erty acquired for resale. See also section195 requiring taxpayers to capitalize cer-tain costs as start-up expenditures.

(2) Materials and supplies. Nothingin this section changes the treatment ofamounts paid to acquire or produce prop-erty that is properly treated as materialsand supplies under §1.162–3.

(d) Acquired or produced tangibleproperty—(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 a de minimissafe harbor election), a taxpayer must cap-italize amounts paid to acquire or producea unit of real or personal property (as de-termined under §1.263(a)–3(e)), includingleasehold improvements, land and landimprovements, buildings, machinery andequipment, and furniture and fixtures. See§1.263(a)–3(f) for the rules for determin-ing whether amounts are for leaseholdimprovements. Amounts paid to acquireor produce a unit of real or personal prop-erty include the invoice price, transactioncosts as determined under paragraph (f) ofthis section, and costs for work performedprior to the date that the unit of property isplaced in service by the taxpayer (withoutregard to any applicable convention undersection 168(d)). A taxpayer also mustcapitalize amounts paid to acquire real orpersonal property for resale.

(2) Examples. The following exam-ples illustrate the rules of this paragraph(d). Unless otherwise provided, assumethat the taxpayer does not elect the de min-imis safe harbor under §1.263(a)–1(f) andthat the property is not acquired for resaleunder section 263A.

Example 1. Acquisition of personal property. Apurchases new cash registers for use in its retail storelocated in leased space in a shopping mall. Assumeeach cash register is a unit of property as determinedunder §1.263(a)–3(e) and is not a material or supplyunder §1.162–3. A must capitalize under paragraph(d)(1) of this section the amount paid to acquire eachcash register.

Example 2. Acquisition of personal property thatis a material or supply; coordination with §1.162–3.B operates a fleet of aircraft. In Year 1, B acquiresa stock of component parts, which it intends to useto maintain and repair its aircraft. Assume thateach 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 ascapital expenditures. In Year 2, B uses the componentparts 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 amountspaid for the parts under paragraph (d)(1) of thissection. Rather, to determine the treatment of theseamounts, B must apply the rules under §1.162–3,governing the treatment of materials and supplies.

Example 3. Acquisition of unit of personalproperty; coordination with §1.162–3. C operatesa rental business that rents out a variety of smallindividual items to customers (rental items). Cmaintains a supply of rental items on hand to re-place worn or damaged items. C purchases a largequantity of rental items to be used in its business.Assume that each of these rental items is a unit ofproperty under §1.263(a)–3(e). Also assume that aportion of the rental items are materials and suppliesunder §1.162–3(c)(1). Under paragraph (d)(1) ofthis section, C must capitalize the amounts paid forthe rental items that are not materials and suppliesunder §1.162–3(c)(1). However, C must apply therules in §1.162–3 to determine the treatment of therental items that are materials and supplies under§1.162–3(c)(1).

Example 4. Acquisition or production cost. Dpurchases and produces jigs, dies, molds, and patternsfor use in the manufacture of D’s products. Assumethat each of these items is a unit of property as deter-mined under §1.263(a)–3(e) and is not a material andsupply under §1.162–3(c)(1). D is required to capital-ize under paragraph (d)(1) of this section the amountspaid to acquire and produce the jigs, dies, molds, andpatterns.

Example 5. Acquisition of land. F purchases aparcel of undeveloped real estate. F must capitalizeunder paragraph (d)(1) of this section the amount paidto acquire the real estate. See paragraph (f) of thissection for the treatment of amounts paid to facilitatethe acquisition of real property.

Example 6. Acquisition of building. G purchasesa 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, 2013 362 2013–43 I.R.B.

amounts paid to facilitate the acquisition of real prop-erty.

Example 7. Acquisition of property for resale andproduction of property for sale; coordination withsection 263A. H purchases goods for resale and pro-duces other goods for sale. H must capitalize underparagraph (d)(1) of this section the amounts paid toacquire and produce the goods. See section 263A forthe amounts required to be capitalized to the propertyproduced or to the property acquired for resale.

Example 8. Production of building; coordinationwith section 263A. J constructs a building. J mustcapitalize under paragraph (d)(1) of this section theamount paid to construct the building. See section263A for the costs required to be capitalized to thereal property produced by J.

Example 9. Acquisition of assets constituting atrade or business. K owns tangible and intangibleassets that constitute a trade or business. L purchasesall the assets of K in a taxable transaction. L mustcapitalize under paragraph (d)(1) of this sectionthe amount paid for the tangible assets of K. See§1.263(a)–4 for the treatment of amounts paid toacquire or create intangibles and §1.263(a)–5 for thetreatment of amounts paid to facilitate the acquisitionof assets that constitute a trade or business. Seesection 1060 for special allocation rules for certainasset acquisitions.

Example 10. Work performed prior to placing theproperty in service. In Year 1, M purchases a buildingfor 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 paintthe interiors and exteriors of the building. In Year2, M places the building in service and begins usingthe building as its business office. Assume that thework 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 ofproperty. Under paragraph (d)(1) of this section, theamounts paid must be capitalized as amounts to ac-quire the building unit of property because they werefor work performed prior to M’s placing the buildingin service.

Example 11. Work performed prior to placing theproperty in service. In January Year 1, N purchasesa new machine for use in an existing production lineof its manufacturing business. Assume that the ma-chine is a unit of property under §1.263(a)–3(e) andis not a material or supply under §1.162–3. N paysamounts to install the machine, and after the machineis installed, N pays amounts to perform a critical teston 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 themachine in service on the production line. N paysamounts to perform periodic quality control testingafter the machine is placed in service. Under para-graph (d)(1) of this section, the amounts paid forthe installation and the critical test performed beforethe machine is placed in service must be capitalizedby N as amounts to acquire the machine. However,amounts paid for periodic quality control testing afterN placed the machine in service are not required to becapitalized as amounts paid to acquire the machine.

(e) Defense or perfection of title toproperty—(1) In general. Amounts paid

to defend or perfect title to real or personalproperty are amounts paid to acquire orproduce property within the meaning ofthis section and must be capitalized.

(2) Examples. The following examplesillustrate the rule of this paragraph (e):

Example 1. Amounts paid to contest condemna-tion. X owns real property located in County. Countyfiles an eminent domain complaint condemning a por-tion of X’s property to use as a roadway. X hires anattorney to contest the condemnation. The amountsthat 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 andsupplying 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 prosecutionof a suit to invalidate the municipal ordinance. Yprosecutes the suit to preserve its business activitiesand not to defend Y’s title in the property. Therefore,the attorney’s fees that Y paid are not required to becapitalized under paragraph (e)(1) of this section.

Example 3. Amounts paid to challenge buildingline. 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 tothe attorney must be capitalized because they were todefend 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 the de minimis safe har-bor), a taxpayer must capitalize amountspaid to facilitate the acquisition of real orpersonal property. See §1.263(a)–5 for thetreatment of amounts paid to facilitate theacquisition of assets that constitute a tradeor 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 theamount is paid in the process of investigat-ing or otherwise pursuing the acquisition.Whether an amount is paid in the processof investigating or otherwise pursuing theacquisition is determined based on all ofthe facts and circumstances. In determin-ing whether an amount is paid to facili-tate an acquisition, the fact that the amountwould (or would not) have been paid butfor the acquisition is relevant but is not de-terminative. Amounts paid to facilitate anacquisition include, but are not limited to,inherently facilitative amounts specified inparagraph (f)(2)(ii) of this section.

(ii) Inherently facilitative amounts. Anamount is paid in the process of investigat-ing or otherwise pursuing the acquisitionof real or personal property if the amountis inherently facilitative. An amount is in-herently facilitative if the amount is paidfor—

(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 structureof the acquisition and obtaining tax adviceon the acquisition;

(D) Application fees, bidding costs, orsimilar expenses;

(E) Preparing and reviewing the docu-ments that effectuate the acquisition of theproperty (for example, preparing the bid,offer, sales contract, or purchase agree-ment);

(F) Examining and evaluating the titleof property;

(G) Obtaining regulatory approval ofthe acquisition or securing permits relatedto the acquisition, including applicationfees;

(H) Conveying property between theparties, including sales and transfer taxes,and title registration costs;

(I) Finders’ fees or brokers’ commis-sions, including contingency fees (definedin paragraph (f)(3)(iii) of this section);

(J) Architectural, geological, survey,engineering, environmental, or inspectionservices pertaining to particular 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 ofreal property—(A) In general. Exceptas provided in paragraph (f)(2)(ii) of thissection (relating to inherently facilitativeamounts), an amount paid by the tax-payer in the process of investigating orotherwise pursuing the acquisition of realproperty does not facilitate the acquisitionif it relates to activities performed in theprocess of determining whether to acquirereal property and which real property toacquire.

(B) Acquisitions of real and personalproperty in a single transaction. Anamount paid by the taxpayer in the processof investigating or otherwise pursuing theacquisition of personal property facilitatesthe acquisition of such personal property,

2013–43 I.R.B. 363 October 21, 2013

even if such property is acquired in a singletransaction that also includes the acquisi-tion of real property subject to the specialrule set out in paragraph (f)(2)(iii)(A) ofthis section. A taxpayer may use a rea-sonable allocation method to determinewhich costs facilitate the acquisition ofpersonal property and which costs relateto the acquisition of real property and aresubject to the special rule of paragraph(f)(2)(iii)(A) of this section.

(iv) Employee compensation and over-head costs—(A) In general. For purposesof paragraph (f) of this section, amountspaid for employee compensation (withinthe meaning of §1.263(a)–4(e)(4)(ii)) andoverhead are treated as amounts that do notfacilitate the acquisition of real or personalproperty. See section 263A, however, forthe treatment of employee compensationand overhead costs required to be capital-ized to property produced by the taxpayeror to property acquired for resale.

(B) Election to capitalize. A tax-payer may elect to treat amounts paid foremployee compensation or overhead asamounts that facilitate the acquisition ofproperty. The election is made separatelyfor each acquisition and applies to em-ployee compensation or overhead, or both.For example, a taxpayer may elect to treatoverhead, but not employee compensation,as amounts that facilitate the acquisitionof property. A taxpayer makes the electionby treating the amounts to which the elec-tion applies as amounts that facilitate theacquisition in the taxpayer’s timely filedoriginal Federal tax return (including ex-tensions) for the taxable year during whichthe amounts are paid. See §§301.9100–1through 301.9100–3 of this chapter for theprovisions governing extensions of timeto make regulatory elections. In the caseof an S corporation or a partnership, theelection is made by the S corporation or bythe partnership, and not by the sharehold-ers or partners. A taxpayer may revokean election made under this paragraph(f)(2)(iv)(B) with respect to each acquisi-tion only by filing a request for a privateletter ruling and obtaining the Commis-sioner’s consent to revoke the election.The Commissioner may grant a request torevoke this election if the taxpayer actedreasonably and in good faith and the re-vocation will not prejudice the interests ofGovernment. See generally §301.9100–3of this chapter. The manner of electing

and revoking the election to capitalizeunder this paragraph (f)(2)(iv)(B) maybe modified through guidance of generalapplicability (see §§606.601(d)(2) and601.602 of this section). An election maynot be made or revoked through the filingof an application for change in accountingmethod or, before obtaining the Commis-sioner’s consent to make the late electionor to revoke the election, by filing anamended 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 thede minimis safe harbor), all amounts paidto facilitate the acquisition of real or per-sonal property are capital expenditures.Facilitative amounts allocable to real orpersonal property must be included in thebasis of the property acquired.

(ii) Treatment of inherently facilitativeamounts. Inherently facilitative amountsallocable to real or personal property arecapital expenditures related to such prop-erty, even if the property is not eventuallyacquired. Except for contingency fees asdefined 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 theCode and the Treasury Regulations (for ex-ample, sections 165, 167, or 168). Seeparagraph (h) of this section for the recov-ery of capitalized amounts.

(iii) Contingency Fees. For purposes ofthis section, a contingency fee is an amountpaid that is contingent on the successfulclosing of the acquisition of real or per-sonal property. Contingency fees must beincluded in the basis of the property ac-quired and may not be allocated to theproperty not acquired.

(4) Examples. The following exam-ples illustrate the rules of paragraph (f)of this section. For purposes of theseexamples, assume that the taxpayer doesnot elect the de minimis safe harbor under§1.263(a)–1(f):

Example 1. Broker’s fees to facilitate an acqui-sition. A decides to purchase a building in whichto relocate its offices and hires a real estate brokerto 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 capitalizethe amounts paid to the broker because these costs areinherently 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 fora termite inspection and an environmental survey ofBuilding 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 thesecosts are inherently facilitative of the acquisition ofreal 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’splant. 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 costis inherently facilitative to the acquisition of personalproperty.

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 oiland gas. E considers acquiring a particular propertybut first incurs costs for the services of an engineeringfirm to perform geological and geophysical studies todetermine if the property is suitable for oil or gas pro-duction. Assume that the amounts that E paid to theengineering firm constitute geological and geophysi-cal expenditures under section 167(h). Although theamounts 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 thoseamounts in the basis of the real property acquired.Rather, under paragraph (c) of this section, E mustcapitalize these costs separately and amortize suchcosts as required under section 167(h) (addressing theamortization 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 designerto shop for, evaluate, and make recommendations toF regarding which new table to acquire. Under para-graphs (f)(1) and (2) of this section, F must capitalizethe amounts paid to the interior designer to providethese services because they are paid in the process ofinvestigating or otherwise pursuing the acquisition ofpersonal property.

Example 6. Transaction costs allocable to multi-ple properties. G, a retailer, wants to acquire land forthe purpose of building a new distribution facility forits products. G considers various properties on High-way X in State Y. G incurs fees for the services of anarchitect to advise and evaluate the suitability of thesites for the type of facility that G intends to constructon the selected site. G must capitalize the architectfees as amounts paid to acquire land because theseamounts are inherently facilitative to the acquisitionof land under paragraph (f)(2)(ii)(J) of this section.

Example 7. Transaction costs; coordination withsection 263A. H, a retailer, wants to acquire land forthe purpose of building a new distribution facility forits products. H considers various properties on High-way X in State Y. H incurs fees for the services ofan architect to prepare preliminary floor plans for abuilding that H could construct at any of the sites. Un-der these facts, the architect’s fees are not facilitative

October 21, 2013 364 2013–43 I.R.B.

to the acquisition of land under paragraph (f) of thissection. Therefore, H is not required to capitalize thearchitect fees as amounts paid to acquire land. How-ever, the amounts paid for the architect’s fees may besubject to capitalization under section 263A if theseamounts comprise the direct or allocable indirect costof property produced by H, such as the building.

Example 8. Special rule for acquisitions of realproperty. J owns several retail stores. J decides toexamine the feasibility of opening a new store in CityX. In October, Year 1, J hires and incurs costs for adevelopment consulting firm to study City X and per-form market surveys, evaluate zoning and environ-mental requirements, and make preliminary reportsand 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 topurchase real property in City X and which propertyto acquire. J hires, and incurs fees for, an appraiserto 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 sitesfor the location of its new store. At the same time, Jdetermines not to acquire the other site. Under para-graph (f)(2)(iii) of this section, J is not required tocapitalize amounts paid to the development consul-tant in Year 1 because the amounts relate to activitiesperformed in the process of determining whether toacquire real property and which real property to ac-quire, and the amounts are not inherently facilitativecosts under paragraph (f)(2)(ii) of this section. How-ever, J must capitalize amounts paid to the appraiserin Year 1 because the appraisal costs are inherentlyfacilitative costs under paragraph (f)(2)(ii)(B) of thissection. In Year 2, J must include the appraisal costsallocable to property acquired in the basis of the prop-erty acquired. In addition, J may recover the appraisalcosts 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 thepermanent withdrawal of non-depreciable property.

Example 9. Contingency fee. K owns severalrestaurant properties. K decides to open a new restau-rant in City X. In October, Year 1, K hires a real estateconsultant to identify potential property upon whichK 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 theconsultant constitutes a contingency fee under para-graph (f)(3)(iii) of this section because the payment iscontingent on the successful closing of the acquisitionof property. Accordingly, under paragraph (f)(3)(iii)of this section, K must include the amount paid to theconsultant in the basis of the property acquired. K isnot permitted to allocate the amount paid between theproperties acquired and not acquired.

Example 10. Employee compensation and over-head. L, a freight carrier, maintains an acquisitiondepartment whose sole function is to arrange for thepurchase of vehicles and aircraft from manufacturersor other parties to be used in its freight carrying busi-ness. As provided in paragraph (f)(2)(iv)(A) of thissection, L is not required to capitalize any portion ofthe 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 electto capitalize the compensation and/or overhead costsallocable to the acquisition of a vehicle or aircraft bytreating these amounts as costs that facilitate the ac-quisition of that property in its timely filed originalFederal 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 expendituresand must be taken into account through acharge to capital account or basis, or in thecase of property that is inventory in thehands of a taxpayer, through inclusion ininventory costs.

(h) Recovery of capitalizedamounts—(1) In general. Amounts thatare capitalized under this section arerecovered through depreciation, cost ofgoods sold, or by an adjustment to basis atthe time the property is placed in service,sold, used, or otherwise disposed of bythe taxpayer. Cost recovery is determinedby the applicable provisions of the Codeand regulations relating to the use, sale, ordisposition of property.

(2) Examples. The following examplesillustrate the rule of paragraph (h)(1) ofthis section. For purposes of these ex-amples, assume that the taxpayer does notelect the de minimis safe harbor under sec-tion §1.263(a)–1(f).

Example 1. Recovery when property placed inservice. X owns a 10-unit apartment building. Therefrigerator in one of the apartments stops function-ing, and X purchases a new refrigerator to replace theold 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, Xis required to capitalize the amounts paid for the ac-quisition, delivery, and installation of the refrigerator.Under this paragraph (h), the capitalized amounts arerecovered through depreciation, which begins whenthe refrigerator is placed in service by X.

Example 2. Recovery when property used in theproduction of property. Y operates a plant where itmanufactures widgets. Y purchases a tractor loaderto move raw materials into and around the plant foruse in the manufacturing process. Assume that thetractor 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), thecapitalized amounts are recovered through deprecia-tion, which begins when Y places the tractor loader inservice. However, because the tractor loader is usedin the production of property, under section 263Athe cost recovery (that is, the depreciation) may alsobe 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 achange in method of accounting to whichthe provisions of sections 446 and 481 andthe accompanying regulations apply. Ataxpayer seeking to change to a method ofaccounting permitted in this section mustsecure the consent of the Commissioner inaccordance with §1.446–1(e) and followthe 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) Ingeneral. Except for paragraphs (f)(2)(iii),(f)(2)(iv), and (f)(3)(ii) of this section,this section generally applies to taxableyears beginning on or after January 1,2014. Paragraphs (f)(2)(iii), (f)(2)(iv), and(f)(3)(ii) of this section apply to amountspaid in taxable years beginning on or afterJanuary 1, 2014. Except as provided inparagraphs (j)(1) and (j)(2) of this section,§1.263(a)–2 as contained in 26 CFR part 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 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 taxpayermay choose to apply this section to tax-able years beginning on or after January1, 2012. A taxpayer may choose to ap-ply paragraphs (f)(2)(iii), (f)(2)(iv), and(f)(3)(ii) of this section to amounts paidin 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) ofthis section for amounts paid in its tax-able year beginning on or after January 1,2012, and ending on or before September19, 2013 (applicable taxable year), and thetaxpayer did not make the election speci-fied in paragraph (f)(2)(iv)(B) of this sec-tion on its timely filed original Federal taxreturn for the applicable taxable year, thetaxpayer must make the election specifiedin paragraph (f)(2)(iv)(B) of this sectionfor the applicable taxable year by filing anamended Federal tax return for the appli-

2013–43 I.R.B. 365 October 21, 2013

cable taxable year on or before 180 daysfrom the due date including extensions ofthe taxpayer’s Federal tax return for the ap-plicable taxable year, notwithstanding thatthe taxpayer may not have extended thedue date.

(3) Optional application of TD9564. Except for §1.263(a)–2T(f)(2)(iii),(f)(2)(iv), (f)(3)(ii), and (g), a taxpayermay choose to apply §1.263(a)–2T ascontained in TD 9564 (76 FR 81060)December 27, 2011, to taxable years be-ginning on or after January 1, 2012, andbefore January 1, 2014. A taxpayer maychoose to apply §1.263(a)–2T(f)(2)(iii),(f)(2)(iv), (f)(3)(ii) and (g) as containedin TD 9564 (76 FR 81060) December 27,2011, to amounts paid in taxable yearsbeginning on or after January 1, 2012, andbefore 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 revisedto read as follows:

§1.263(a)–3 Amounts paid to improvetangible property.

(a) Overview. This section providesrules for applying section 263(a) toamounts paid to improve tangible prop-erty. Paragraph (b) of this section providesdefinitions. Paragraph (c) of this sectionprovides rules for coordinating this sec-tion with other provisions of the InternalRevenue Code (Code). Paragraph (d) ofthis section provides the requirement tocapitalize amounts paid to improve tangi-ble property and provides the general rulesfor determining whether a unit of propertyis improved. Paragraph (e) of this sectionprovides the rules for determining the ap-propriate unit of property. Paragraph (f)of this section provides rules for leaseholdimprovements. Paragraph (g) of this sec-tion provides special rules for determiningimprovement costs in particular contexts,including indirect costs incurred during animprovement, removal costs, aggregationof related costs, and regulatory compli-ance costs. Paragraph (h) of this sectionprovides a safe harbor for small taxpay-ers. Paragraph (i) provides a safe harborfor 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 fordetermining whether amounts are paid torestore the unit of property. Paragraph (l)of this section provides rules for amountspaid to adapt the unit of property to a newor different use. Paragraph (m) of thissection provides an optional regulatoryaccounting method. Paragraph (n) of thissection provides an election to capitalizerepair and maintenance costs consistentwith books and records. Paragraphs (o)and (p) of this section provide for the treat-ment and recovery of amounts capitalizedunder this section. Paragraphs (q) and(r) of this section provide for accountingmethod changes and state the effective/ap-plicability date for the rules in this section.

(b) Definitions. For purposes of thissection, the following definitions apply:

(1) Amount paid. In the case of a tax-payer using an accrual method of account-ing, the terms amounts paid and paymentmean a liability incurred (within the mean-ing of §1.446–1(c)(1)(ii)). A liability maynot be taken into account under this sectionprior to the taxable year during which theliability is incurred.

(2) Personal property means tangiblepersonal property as defined in §1.48–1(c).

(3) Real property means land and im-provements thereto, such as buildings orother inherently permanent structures (in-cluding items that are structural compo-nents of the buildings or structures) that arenot personal property as defined in para-graph (b)(2) of this section. Any propertythat constitutes other tangible property un-der §1.48–1(d) is also treated as real prop-erty for purposes of this section. Local lawis not controlling in determining whetherproperty is real property for purposes ofthis section.

(4) Owner means the taxpayer that hasthe benefits and burdens of ownership ofthe unit of property for Federal income taxpurposes.

(c) Coordination with other provisionsof the Code—(1) In general. Nothing inthis section changes the treatment of anyamount 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 thosesections. For example, see section 263Arequiring taxpayers to capitalize the di-rect and allocable indirect costs of propertyproduced and property acquired for resale.

(2) Materials and supplies. A materialor supply as defined in §1.162–3(c)(1) thatis acquired and used to improve a unit oftangible property is subject to this sectionand is not treated as a material or supplyunder §1.162–3.

(3) Example. The following exampleillustrates the rules of this paragraph (c):

Example. Railroad rolling stock. X is a railroadthat properly treats amounts paid for the rehabilitationof railroad rolling stock as deductible expenses un-der section 263(d). X is not required to capitalize theamounts paid because nothing in this section changesthe treatment of amounts specifically provided for un-der section 263(d).

(d) Requirement to capitalize amountspaid for improvements. Except as pro-vided in paragraph (h) or paragraph (n) ofthis section or under §1.263(a)–1(f), a tax-payer generally must capitalize the relatedamounts (as defined in paragraph (g)(3) ofthis section) paid to improve a unit of prop-erty owned by the taxpayer. However, seeparagraph (f) of this section for the treat-ment of amounts paid to improve leasedproperty. See section 263A for the require-ment to capitalize the direct and alloca-ble indirect costs of property produced bythe taxpayer and property acquired for re-sale; section 1016 for adding capitalizedamounts to the basis of the unit of prop-erty; and section 168 for the treatment ofadditions or improvements for deprecia-tion purposes. For purposes of this sec-tion, a unit of property is improved if theamounts paid for activities performed afterthe property is placed in service by the tax-payer—

(1) Are for a betterment to the unit ofproperty (see paragraph (j) of this section);

(2) Restore the unit of property (seeparagraph (k) of this section); or

(3) Adapt the unit of property to a newor different use (see paragraph (l) of thissection).

(e) Determining the unit of prop-erty—(1) In general. The unit of prop-erty rules in this paragraph (e) applyonly 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 basedupon the functional interdependence stan-dard provided in paragraph (e)(3)(i) of thissection. However, special rules are pro-vided for buildings (see paragraph (e)(2) ofthis section), plant property (see paragraph(e)(3)(ii) of this section), network assets(see paragraph (e)(3)(iii) of this section),

October 21, 2013 366 2013–43 I.R.B.

leased property (see paragraph (e)(2)(v)of this section for leased buildings andparagraph (e)(3)(iv) of this section forleased property other than buildings), andimprovements to property (see paragraph(e)(4) of this section). Additional rulesare provided if a taxpayer has assigneddifferent MACRS classes or depreciationmethods to components of property orsubsequently changes the class or depreci-ation method of a component or other itemof property (see paragraph (e)(5) of thissection). Property that is aggregated orsubject to a general asset account electionor accounted for in a multiple asset ac-count (that is, pooled) may not be treatedas a single unit of property.

(2) Building—(i) In general. Except asotherwise provided in paragraphs (e)(4),and (e)(5)(ii) of this section, in the case ofa 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 asingle unit of property (“building”). Seeparagraph (e)(2)(iii) of this section forcondominiums, paragraph (e)(2)(iv) ofthis section for cooperatives, and para-graph (e)(2)(v) of this section for leasedbuildings.

(ii) Application of improvement rules toa building. An amount is paid to improvea 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 buildingstructure consists of the building (as de-fined in §1.48–1(e)(1)), and its structuralcomponents (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 definedin §1.48–1(e)(2)), including the com-ponents thereof, constitutes a buildingsystem that is separate from the buildingstructure, and to which the improvementrules must be applied—

(1) Heating, ventilation, and air con-ditioning (“HVAC”) systems (includingmotors, 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 theproperty line and between buildings andother permanent structures);

(3) Electrical systems (includingwiring, outlets, junction boxes, lightingfixtures and associated connectors, andsite utility equipment used to distributeelectricity from the property line to andbetween buildings and other permanentstructures);

(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, fireescapes, fire doors, emergency exit light-ing and signage, and fire fighting equip-ment, such as extinguishers, and hoses);

(7) Security systems for the protectionof 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 junctionboxes, associated wiring and conduit);

(8) Gas distribution system (includingassociated pipes and equipment used todistribute gas to and from the property lineand between buildings or permanent struc-tures); and

(9) Other structural components iden-tified in published guidance in the Fed-eral Register or in the Internal RevenueBulletin (see §601.601(d)(2)(ii)(b) of thischapter) 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. Inthe case of a taxpayer that is the ownerof an individual unit in a building withmultiple units (such as a condominium),the unit of property (“condominium”) isthe individual unit owned by the taxpayerand the structural components (as definedin §1.48–1(e)(2)) that are part of the unit.

(B) Application of improvement rulesto a condominium. An amount is paidto improve a condominium under para-graph (d) of this section if the amount ispaid for an improvement under paragraphs(j), (k), or paragraph (l) of this section tothe 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 inparagraph (e)(2)(ii)(B) of this section) thatis part of the condominium. In the caseof the condominium management associ-ation, the association must apply the im-provement rules to the building structureor to any building system described underparagraphs (e)(2)(ii)(A) and (e)(2)(ii)(B)of this section.

(iv) Cooperative—(A) In general. Inthe case of a taxpayer that has an own-ership interest in a cooperative housingcorporation, the unit of property (“coop-erative”) is the portion of the building inwhich the taxpayer has possessory rightsand the structural components (as definedin §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 toa cooperative. An amount is paid to im-prove a cooperative under paragraph (d)of this section if the amount is paid foran improvement under paragraphs (j), (k),or (l) of this section to the portion of thebuilding structure (as defined in paragraph(e)(2)(ii)(A) of this section) in which thetaxpayer has possessory rights or to theportion of any building system (as definedin paragraph (e)(2)(ii)(B) of this section)that is part of the portion of the buildingstructure subject to the taxpayer’s posses-sory rights. In the case of a cooperativehousing corporation, the corporation mustapply the improvement rules to the build-ing structure or to any building system asdescribed under paragraphs (e)(2)(ii)(A)and (e)(2)(ii)(B) of this section.

(v) Leased building—(A) In general. Inthe case of a taxpayer that is a lessee of allor a portion of a building (such as an office,floor, or certain square footage), the unitof 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 toa leased building. An amount is paid toimprove a leased building property underparagraphs (d) and (f)(2) of this section ifthe 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. 367 October 21, 2013

der paragraph (e)(2)(ii)(A) of this section)or any building system (as defined underparagraph (e)(2)(ii)(B) of this section) thatis part of the leased building.

(2) Portion of a building. In the case ofa taxpayer that is a lessee of a portion of abuilding (such as an office, floor, or certainsquare footage), the portion of the build-ing structure (as defined under paragraph(e)(2)(ii)(A) of this section) subject to thelease 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 providedin paragraphs (e)(3), (e)(4), (e)(5), and(f)(1) of this section, in the case of realor personal property other than propertydescribed in paragraph (e)(2) of this sec-tion, all the components that are function-ally interdependent comprise a single unitof property. Components of property arefunctionally interdependent if the placingin 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. Forpurposes of this paragraph (e), the termplant property means functionally inter-dependent machinery or equipment, otherthan network assets, used to perform anindustrial 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 ofproperty determined under the general ruleof paragraph (e)(3)(i) of this section is fur-ther divided into smaller units comprisedof each component (or group of compo-nents) that performs a discrete and majorfunction or operation within the function-ally interdependent machinery or equip-ment.

(iii) Network assets—(A) Definition.For purposes of this paragraph (e), theterm network assets means railroad track,oil and gas pipelines, water and sewagepipelines, power transmission and distri-bution lines, and telephone and cable linesthat are owned or leased by taxpayers ineach of those respective industries. Theterm includes, for example, trunk andfeeder lines, pole lines, and buried conduit.It does not include property that would beincluded as building structure or building

systems under paragraphs (e)(2)(ii)(A)and (e)(2)(ii)(B) of this section, nor does itinclude separate property that is adjacentto, but not part of a network asset, such asbridges, culverts, or tunnels.

(B) Unit of property for network as-sets. In the case of network assets, theunit of property is determined by thetaxpayer’s particular facts and circum-stances except as otherwise provided inpublished guidance in the Federal Reg-ister or in the Internal Revenue Bulletin(see §601.601(d)(2)(ii)(b) of this chapter).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 alessee of real or personal property otherthan property described in paragraph (e)(2)of this section, the unit of property for theleased property is determined under para-graphs (e)(3)(i),(ii), (iii), and (e)(5) of thissection except that, after applying the ap-plicable rules under those paragraphs, theunit of property may not be larger than theproperty subject to the lease.

(4) Improvements to property. An im-provement to a unit of property generallyis not a unit of property separate from theunit of property improved. For the unit ofproperty for lessee improvements, see alsoparagraph (f)(2)(ii)) of this section. If ataxpayer elects to treat as a capital expen-diture under §1.162–3(d) the amount paidfor a rotable spare part, temporary sparepart, or standby emergency spare part, andsuch part is used in an improvement to aunit of property, then for purposes of ap-plying paragraph (d) of this section to theunit of property improved, the part is not aunit of property separate from the unit ofproperty improved.

(5) Additional rules—(i) Year placed inservice. Notwithstanding the unit of prop-erty determination under paragraph (e)(3)of this section, a component (or a groupof components) of a unit property mustbe treated as a separate unit of propertyif, 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 classof property under section 168(e) (MACRSclasses) than the class of the unit of prop-erty of which the component is a part, orthe taxpayer has properly depreciated the

component using a different depreciationmethod than the depreciation method ofthe 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 yearafter the unit of property is initially placedin service by the taxpayer, if the taxpayeror the Internal Revenue Service changesthe treatment of that property (or any por-tion thereof) to a proper MACRS class or aproper depreciation method (for example,as a result of a cost segregation study or achange in the use of the property), then thetaxpayer must change the unit of propertydetermination 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 ofproperty of which it was previously treatedas a part, then the reclassified portion ofthe property should be treated as a sepa-rate unit of property for purposes of thissection.

(6) Examples. The following examplesillustrate the application of this paragraph(e) and assume that the taxpayer has notmade a general asset account election withregard to property or accounted for prop-erty in a multiple asset account. In addi-tion, unless the facts specifically indicateotherwise, assume that the additional rulesin paragraph (e)(5) of this section do notapply:

Example 1. Building systems. A owns an officebuilding that contains a HVAC system. The HVACsystem incorporates ten roof-mounted units that ser-vice different parts of the building. The roof-mountedunits are not connected and have separate controlsand duct work that distribute the heated or cooled airto different spaces in the building’s interior. A paysan amount for labor and materials for work performedon 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, anamount is paid to improve a building if it is for an im-provement to the building structure or any designatedbuilding system. Under paragraph (e)(2)(ii)(B)(1) ofthis section, the entire HVAC system, including all ofthe 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 forwork on the roof-mounted units is an improvement(for example, a betterment) to the HVAC system,

October 21, 2013 368 2013–43 I.R.B.

A must treat this amount as an improvement to thebuilding.

Example 2. Building systems. B owns a buildingthat it uses in its retail business. The building containstwo elevator banks in different locations in its build-ing. Each elevator bank contains three elevators. Bpays an amount for labor and materials for work per-formed on the elevators. Under paragraph (e)(2)(i) ofthis 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, anamount is paid to improve a building if it is for an im-provement to the building structure or any designatedbuilding system. Under paragraph (e)(2)(ii)(B)(5) ofthis 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 amountpaid 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 tothe building.

Example 3. Building structure and systems;condominium. C owns a condominium unit in a con-dominium office building. C uses the condominiumunit in its business of providing medical services.The condominium unit contains two restrooms, eachof which contains a sink, a toilet, water and drainagepipes and other bathroom fixtures. C pays an amountfor labor and materials to perform work on the pipes,sinks, toilets, and plumbing fixtures that are part ofthe condominium. Under paragraph (e)(2)(iii) ofthis section, C must treat the individual unit that itowns, including the structural components that arepart 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 ifit is for an improvement to the building structurethat is part of the condominium or to a portion ofany designated building system that is part of thecondominium. Under paragraph (e)(2)(ii)(B)(2) ofthis section, the pipes, sinks, toilets, and plumbingfixtures that are part of C’s condominium comprisethe plumbing system for the condominium. There-fore, under paragraph (e)(2)(iii) of this section, if anamount paid by C for work on pipes, sinks, toilets,and plumbing fixtures is an improvement (for ex-ample, a betterment) to the portion of the plumbingsystem that is part of C’s condominium, C must treatthis amount as an improvement to the condominium.

Example 4. Building structure and systems; prop-erty other than buildings. D, a manufacturer, ownsa building adjacent to its manufacturing facility thatcontains office space and related facilities for D’semployees that manage and administer D’s manu-facturing operations. The office building containsequipment, such as desks, chairs, computers, tele-phones, and bookshelves that are not building struc-ture or building systems. D pays an amount to addan extension to the office building. Under paragraph(e)(2)(i) of this section, D must treat the building andits 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 isfor an improvement to the building structure or anydesignated building system. Therefore, under para-graph (e)(2)(ii) of this section, if an amount paid byD for the addition of an extension to the office build-ing is an improvement (for example, a betterment)to the building structure or any of the building sys-

tems, D must treat this amount as an improvement tothe building. In addition, because the equipment con-tained within the office building constitutes propertyother than the building, the units of property for theoffice equipment are initially determined under para-graph (e)(3)(i) of this section and are comprised of allthe components that are functionally interdependent(for example, each desk, each chair, and each bookshelf).

Example 5. Plant property; discrete and majorfunction. E is an electric utility company that oper-ates a power plant to generate electricity. The powerplant 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 producessteam, one turbine that converts the steam into me-chanical energy, and one generator that converts me-chanical energy into electrical energy. In addition, theturbine contains a series of blades that cause the tur-bine to rotate when affected by the steam. Becausethe plant is composed of real and personal tangibleproperty other than a building, the unit of propertyfor the generating equipment is initially determinedunder the general rule in paragraph (e)(3)(i) of thissection and is comprised of all the components thatare functionally interdependent. Under this rule, theinitial unit of property is the entire plant because thecomponents 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 smallerunits of property by determining the components (orgroups of components) that perform discrete and ma-jor functions within the plant. Under this paragraph,E must treat the structure, the boiler, the turbine, thegenerator, and the pulverizer each as a separate unitof property because each of these components per-forms a discrete and major function within the powerplant. E may not treat components, such as the tur-bine blades, as separate units of property becauseeach of these components does not perform a discreteand major function within the plant.

Example 6. Plant property; discrete and majorfunction. F is engaged in a uniform and linen rentalbusiness. F owns and operates a plant that utilizesmany different machines and equipment in an as-sembly line-like process to treat, launder, and pre-pare rental items for its customers. F utilizes twolaundering lines in its plant, each of which can op-erate independently. One line is used for uniformsand 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 forthe 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 arefunctionally interdependent. Under this rule, the ini-tial units of property are each laundering line be-cause each line is functionally independent and iscomprised of components that are functionally inter-dependent. However, because each line is comprisedof plant property under paragraph (e)(3)(ii) of thissection, F must further divide these initial units ofproperty into smaller units of property by determin-ing the components (or groups of components) thatperform 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, andwaste 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 withinthe line.

Example 7. Plant property; industrial process.G operates a restaurant that prepares and serves foodto retail customers. Within its restaurant, G hasa large piece of equipment that uses an assemblyline-like process to prepare and cook tortillas thatG serves only to its restaurant customers. Becausethe tortilla-making equipment is property other thana building, the unit of property for the equipment isinitially determined under the general rule in para-graph (e)(3)(i) of this section and is comprised of allthe components that are functionally interdependent.Under this rule, the initial unit of property is theentire tortilla-making equipment because the vari-ous components of the equipment are functionallyinterdependent. The equipment is not plant propertyunder paragraph (e)(3)(ii) of this section because theequipment is not used in an industrial process, asit performs a small-scale function in G’s restaurantoperations. Thus, G is not required to further dividethe equipment into separate units of property basedon the components that perform discrete and majorfunctions.

Example 8. Personal property. H owns locomo-tives that it uses in its railroad business. Each loco-motive consists of various components, such as anengine, generators, batteries, and trucks. H acquireda locomotive with all its components. Because H’slocomotive is property other than a building, the ini-tial unit of property is determined under the generalrule 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 itconsists entirely of components that are functionallyinterdependent.

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 printerare property other than a building, the initial unitsof property are determined under the general rule inparagraph (e)(3)(i) of this section and are comprisedof the components that are functionally interdepen-dent. Under paragraph (e)(3)(i) of this section, thecomputer and the printer are separate units of prop-erty because the computer and the printer are notcomponents that are functionally interdependent (thatis, 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 leasesfrom L. The leased building consists of the build-ing structure (including the floor, walls, and roof)and various building systems, including a plumbingsystem, an electrical system, an HVAC system, asecurity system, and a fire protection and preventionsystem. K pays an amount for labor and materialsto perform work on the HVAC system of the leasedbuilding. Under paragraph (e)(2)(v)(A) of this sec-tion, because K leases the entire building, K musttreat the leased building and its structural compo-nents as a single unit of property. As provided underparagraph (e)(2)(v)(B) of this section, an amount

2013–43 I.R.B. 369 October 21, 2013

is paid to improve a leased building property if itis for an improvement (for example, a betterment)to the leased building structure or to any buildingsystem 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 workon the HVAC system is for an improvement to theHVAC system in the leased building, K must treatthis amount as an improvement to the entire leasedbuilding property.

Example 11. Production of real property relatedto leased property. Assume the same facts as inExample 10, except that K receives a constructionallowance from L, and K uses the construction al-lowance to build a driveway adjacent to the leasedbuilding. Assume that under the terms of the lease,K, the lessee, is treated as the owner of any propertythat it constructs on or nearby the leased building.Also assume that section 110 does not apply to theconstruction allowance. Finally, assume that thedriveway is not plant property or a network asset.Because the construction of the driveway consists ofthe production of real property other than a building,all the components of the driveway are functionallyinterdependent and are a single unit of property underparagraphs (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 treatedas the owner of any property constructed on the leasedpremises. Because L, the lessor, is the owner of thedriveway and the driveway is real property other thana building, all the components of the driveway arefunctionally interdependent and are a single unit ofproperty 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 servicesbusiness in two office spaces in the same building,each of which it leases from N under separate leaseagreements. Each office space contains a separateHVAC system, which is part of the leased property.Both lease agreements provide that M is responsiblefor maintaining, repairing, and replacing the HVACsystem that is part of the leased property. M paysamounts to perform work on the HVAC system ineach office space. Because M leases two separate of-fice spaces subject to two leases, M must treat theportion of the building structure and the structuralcomponents subject to each lease as a separate unit ofproperty under paragraph (e)(2)(v)(A) of this section.As provided under paragraph (e)(2)(v)(B) of this sec-tion, an amount is paid to improve a leased buildingproperty, if it is for an improvement to the leased por-tion of the building structure or the portion of anydesignated building system subject to each lease. Un-der paragraphs (e)(2)(v)(B)(1) and (e)(2)(ii)(B)(1) ofthis 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 musttreat the HVAC system associated with the first leasedoffice space as a building system of the first leasedoffice space and the HVAC system associated withthe second leased office space as a building systemof the second leased office space. Under paragraph(e)(2)(v)(B) of this section, if the amount paid by Mfor work on the HVAC system in one leased officespace is for an improvement (for example, a better-

ment) to the HVAC system that is part of that leasedspace, 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 functionallyinterdependent as a single unit of property. Thus, Nmust treat each leased aircraft as a single unit of prop-erty.

Example 15. Improvement property. (i) P is a re-tailer of consumer products. In Year 1, P purchasesa building from Q, which P intends to use as a retailsales 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 ispaid to improve a building if it is for an improvementto the building structure or any designated buildingsystem.

(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 theaddition of walls, floors, roof, and doors, but doesnot include the addition or extension of any buildingsystems described in paragraph (e)(2)(ii)(B) of thissection. Also assume that the amount paid to buildthe extension is a betterment to the building structureunder paragraph (j) of this section, and is thereforetreated as an amount paid for an improvement to theentire building under paragraph (e)(2)(ii) of this sec-tion. Accordingly, P capitalizes the amount paid as animprovement to the building under paragraph (d) ofthis section. Under paragraph (e)(4) of this section,the extension is not a unit of property separate fromthe 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 whetherthe expenditure constitutes an improvement to thebuilding 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 transportingfreight throughout the United States. To conduct itsbusiness, 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 tractorwith all of its components, including tires. The trac-tor tires have an average useful life to R of more thanone year. At the time R placed the tractor in service, ittreated the tractor tires as a separate asset for depreci-ation purposes under section 168. R properly treatedthe tractor (excluding the cost of the tires) as 3-yearproperty and the tractor tires as 5-year property undersection 168(e). Because R’s tractor is property otherthan a building, the initial units of property for thetractor are determined under the general rule in para-graph (e)(3)(i) of this section and are comprised of allthe components that are functionally interdependent.Under this rule, R must treat the tractor, including itstires, as a single unit of property because the tractorand the tires are functionally interdependent (that is,the placing in service of the tires is dependent uponthe placing in service of the tractor). However, underparagraph (e)(5)(i) of this section, R must treat the

tractor and tires as separate units of property becauseR properly treated the tires as being within a differentclass of property under section 168(e).

Example 17. Additional rules; change in subse-quent year. S is engaged in the business of leasingnonresidential real property to retailers. In Year 1,S acquired and placed in service a building for usein its retail leasing operation. In Year 5, to accom-modate the needs of a new lessee, S incurred costs toimprove the building structure. S capitalized the costsof the improvement under paragraph (d) of this sec-tion and depreciated the improvement in accordancewith section 168(i)(6) as nonresidential real propertyunder section 168(e). In Year 7, S determined that thestructural improvement made in Year 5 qualified un-der section 168(e)(8) as qualified retail improvementproperty and, therefore, was 15-year property undersection 168(e). In Year 7, S changed its method ofaccounting to use a 15-year recovery period for theimprovement. Under paragraph (e)(5)(ii) of this sec-tion, in Year 7, S must treat the improvement as a unitof property separate from the building.

Example 18. Additional rules; change in sub-sequent year. In Year 1, T acquired and placed inservice 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 theparking 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 theparking 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 recoveryperiod and the 150-percent declining balance methodof depreciation. Under paragraph (e)(5)(ii) of thissection, beginning in Year 3, T must treat the parkinglot 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 inservice 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 section168(e). U capitalized the cost of the building and allother structural components of the building and be-gan depreciating them as nonresidential real propertyunder section 168(e). In Year 3, U completed a costsegregation study under which it properly determinedthat the wiring is a structural component of the build-ing and, therefore, should have been depreciated asnonresidential real property. In Year 3, U changedits 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 propertyfor the wiring in a manner that is consistent withthe change in treatment for depreciation purposes.Therefore, U must change the unit of property forthe wiring to treat it as a structural component of thebuilding, 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 providedin paragraph (h) of this section (safeharbor for small taxpayers) and under§1.263(a)–1(f) (de minimis safe harbor),this paragraph (f) provides the exclusiverules for determining whether amounts

October 21, 2013 370 2013–43 I.R.B.

paid by a taxpayer are for an improvementto a leased property and must be capital-ized. In the case of a leased building ora leased portion of a building, an amountis paid to improve a leased property if theamount is paid for an improvement to anyof 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 doesnot apply to amounts paid for improve-ments to leased property or to amountspaid for the acquisition or production ofleasehold improvement property.

(2) Lessee improvements—(i) Require-ment to capitalize. A taxpayer lessee mustcapitalize the related amounts (see para-graph (g)(3) of this section) that it pays toimprove (as defined under paragraph (d)of this section) a leased property exceptto the extent that section 110 applies toa construction allowance received by thelessee for the purpose of such improve-ment or when the improvement constitutesa substitute for rent. See §1.61–8(c) forthe treatment of lessee expenditures thatconstitute 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) ofthis section) a leased property if the lesseeis the owner of the improvement, exceptto the extent that section 110 applies toa construction allowance received by thelessee for the purpose of such improve-ment. An amount paid for a lessee im-provement under this paragraph (f)(2)(i) istreated 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 determiningwhether an amount paid by a lessee con-stitutes a lessee improvement to a leasedproperty under paragraph (f)(2)(i) of thissection, the unit of property and the im-provement rules are applied to the leasedproperty in accordance with paragraph(e)(2)(v) (leased buildings) or paragraph(e)(3)(iv) (leased property other thanbuildings) of this section and include pre-vious lessee improvements. However, ifa lessee improvement is comprised of anentire building erected on leased property,then the unit of property for the buildingand the application of the improvement

rules to the building are determined underparagraphs (e)(2)(i) and (e)(2)(ii) of thissection.

(3) Lessor improvements—(i) Require-ment to capitalize. A taxpayer lessor mustcapitalize the related amounts (see para-graph (g)(3) of this section) that it paysdirectly, 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 theowner of the improvement or to the extentthat section 110 applies to the construc-tion allowance. A lessor must also capital-ize the related amounts that the lessee paysto improve a leased property (as definedin paragraph (e) of this section) when thelessee’s improvement constitutes a substi-tute for rent. See §1.61–8(c) for treatmentof expenditures by lessees that constitutea substitute for rent. Amounts capitalizedby the lessor under this paragraph (f)(3)(i)may not be capitalized by the lessee. Ifa lessor improvement is comprised of anentire building erected on leased property,then the amount paid for the building istreated as an amount paid by the lessor toacquire 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 fora 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 capitalizedas 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 improvementis comprised of an entire building erectedon leased property, then the unit of prop-erty for the building and the application ofthe improvement rules to the building aredetermined under paragraphs (e)(2)(i) and(e)(2)(ii) of this section.

(4) Examples. The following examplesillustrate the application of this paragraph(f) and do not address whether capitaliza-tion is required under another provision ofthe Code (for example, section 263A). Forpurposes of the following examples, as-sume that section 110 does not apply to thelessee and the amounts paid by the lesseeare not a substitute for rent.

Example 1. Lessee improvements; additions tobuilding. (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, andan HVAC system. Under the terms of the lease, Tis permitted to improve the building at its own ex-pense. Under paragraph (e)(2)(v)(A) of this section,because T leases the entire building, T must treat theleased 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 toimprove a leased building property if the amount ispaid 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 Tmust 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 affectany building systems. Accordingly, the amount thatT pays for the building extension is for a bettermentto the leased building structure, and thus, under para-graph (e)(2)(v)(B)(1) of this section, is treated as animprovement to the entire leased building under para-graph (d) of this section. Because T, the lessee, paidan amount to improve a leased building property, T isrequired 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 amountpaid for the improvement as the acquisition or pro-duction of a unit of property (leasehold improvementproperty) under §1.263(a)–2(d)(1).

(iii) In Year 5, T pays an amount to add a largeoverhead door to the building extension that it con-structed in Year 2 to accommodate the loading oflarger products into the warehouse space. Underparagraph (f)(2)(ii) of this section, to determinewhether the amount paid by T is for a leaseholdimprovement, 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 previousimprovements to the leased property. Therefore,under paragraph (e)(2)(v)(A) of this section, the unitof property is the entire leased building, includingthe extension built in Year 2. In addition, underparagraph (e)(2)(v)(B) of this section, the leasedbuilding property is improved if the amount is paidfor an improvement to the building structure or anybuilding system. Assume that the amount paid toadd the overhead door is for a betterment, underparagraph (j) of this section, to the building structure,which includes the extension. Accordingly, T mustcapitalize the amounts paid to add the overhead dooras a leasehold improvement to the leased buildingproperty. In addition, paragraph (f)(2)(i) of thissection requires T to treat the amount paid for theimprovement as the acquisition or production of aunit of property (leasehold improvement property)under §1.263(a)–2(d)(1). However, to determinewhether a future amount paid by T is for a leaseholdimprovement to the leased building, the unit of prop-

2013–43 I.R.B. 371 October 21, 2013

erty and the improvement rules are again applied inaccordance with paragraph (e)(2)(v) of this sectionand include the new overhead door.

Example 2. Lessee improvements; additions tocertain structural components of buildings. (i) As-sume the same facts as Example 1 except that in Year2, T also pays an amount to construct an extensionof 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) ofthis section). Accordingly, the amount that T paysfor 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) of thissection, is treated as an improvement to the entireleased building property under paragraph (d) of thissection. 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 improvementunder paragraph (f)(2)(i) of this section. Under para-graph (f)(2)(i) of this section, T must treat the amountpaid for the HVAC extension as the acquisition andproduction 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 systemthat 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 leaseholdimprovement, 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 im-provements to the leased building property. There-fore, under paragraph (e)(2)(v)(B) of this section, theleased building property is improved if the amount ispaid for an improvement to the building structure orany building system. Assume that the amount paid toadd 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 addthe chiller as a leasehold improvement to the leasedbuilding property. In addition, paragraph (f)(2)(i) ofthis section requires T to treat the amount paid forthe chiller as the acquisition or production of a unitof property (leasehold improvement property) under§1.263(a)–2(d)(1). However, to determine whether afuture amount paid by T is for a leasehold improve-ment to the leased building, the unit of property andthe 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 tobuilding. (i) T is a retailer of consumer products. InYear 1, T leases a building from L, which T intendsto use as a retail sales facility. Pursuant to the lease,L provides a construction allowance to T, which Tintends to use to construct an extension to the retailsales facility for additional warehouse space. As-sume that the amount paid for any improvement to thebuilding does not exceed the construction allowanceand that L is treated as the owner of any improvementto 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 ispaid 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 toconstruct an extension to the leased building to pro-vide additional warehouse space in the building. As-sume that the extension is a betterment (as definedunder paragraph (j) of this section) to the buildingstructure, 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 theimprovement, must capitalize the amounts paid to Tto construct the extension to the retail sales facility. Tis not permitted to capitalize the amounts paid for thelessor-owned improvement. Finally, under paragraph(f)(3)(ii) of this section, the extension to L’s buildingis not a unit of property separate from the buildingand its structural components.

Example 4. Lessee property; personal propertyadded to leased building. T is a retailer of consumerproducts. T leases a building from L, which T intendsto use as a retail sales facility. Pursuant to the lease, Lprovides a construction allowance to T, which T usesto acquire and construct partitions for fitting rooms,counters, and shelving. Assume that each partition,counter, and shelving unit is a unit of property underparagraph (e)(3) of this section. Assume that for Fed-eral income tax purposes T is treated as the owner ofthe partitions, counters, and shelving. T’s expendi-tures for the partitions, counters, and shelving are notimprovements to the leased property under paragraph(d) of this section, but rather constitute amounts paidto acquire or produce separate units of personal prop-erty under §1.263(a)–2(d)(1).

Example 5. Lessor property; buildings on leasedproperty. L is the owner of a parcel of unimprovedreal 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 costingnot more than $500,000 on the leased real propertyand to lease the building from L after it is constructed.Assume that for Federal income tax purposes, L istreated as the owner of the building that T will con-struct. T uses the $500,000 to construct the buildingas required under the lease. The building consists ofthe building structure and the following building sys-tems: (1) a plumbing system; (2) an electrical sys-tem; and (3) an HVAC system. Because L providesa construction allowance to T to construct a build-ing and L is treated as the owner of the building, Lmust capitalize the amounts that it pays indirectly toT to construct the building as a lessor improvementunder paragraph (f)(3)(i) of this section. In addition,the amounts paid by L for the construction allowanceare 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 treatthe building and its structural components as a sin-gle unit of property. Under paragraph (f)(3)(i) of thissection, T, the lessee, may not capitalize the amountspaid (with the construction allowance received fromL) for construction of the building.

Example 6. Lessee contribution to constructioncosts. Assume the same facts as in Example 5, exceptT spends $600,000 to construct the building. T usesthe $500,000 construction allowance provided by Lplus $100,000 of its own funds to construct the build-ing that L will own pursuant to the lease. Also assumethat the additional $100,000 that T pays is not a sub-

stitute for rent. For the reasons discussed in Example5, 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 thebuilding, T has a depreciable interest of $100,000 inthe building and must capitalize the $100,000 it paidto construct the building as a leasehold improvementunder §1.263(a)–2(d)(1) of the regulations. Underparagraph (e)(2)(i) of this section, L must treat thebuilding as a single unit of property to the extent ofits depreciable interest of $500,000 In addition, un-der paragraphs (f)(2)(ii) and (e)(2)(i) of this section, Tmust also treat the building as a single unit of propertyto 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) Ingeneral. A taxpayer must capitalize allthe direct costs of an improvement and allthe indirect costs (including, for example,otherwise deductible repair costs) that di-rectly benefit or are incurred by reasonof an improvement. Indirect costs arisingfrom activities that do not directly bene-fit and are not incurred by reason of animprovement are not required to be capi-talized under section 263(a), regardless ofwhether the activities are performed at thesame time as an improvement.

(ii) Exception for individuals’ resi-dences. A taxpayer who is an individualmay capitalize amounts paid for repairsand maintenance that are made at the sametime as capital improvements to units ofproperty not used in the taxpayer’s tradeor business or for the production of in-come if the amounts are paid as part of animprovement (for example, a remodeling)of the taxpayer’s residence.

(2) Removal Costs—(i) In general. Ifa taxpayer disposes of a depreciable asset,including a partial disposition under Prop.Reg. §1.168(i)–1(e)(2)(ix) (September19, 2013), or Prop. Reg. §1.168(i)–8(d)(September 19, 2013), for Federal incometax purposes and has taken into accountthe adjusted basis of the asset or com-ponent of the asset in realizing gain orloss, then the costs of removing the as-set or component are not required to becapitalized under this section. If a de-preciable asset is included in a generalasset account under section 168(i)(4),and neither the regulations under section168(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, 2013 372 2013–43 I.R.B.

in the amount of zero upon the dispositionof the asset solely for purposes of thisparagraph (g)(2)(i). If a taxpayer disposesof a component of a unit of property, butthe disposal of the component is not adisposition for Federal tax purposes, thenthe taxpayer must deduct or capitalize thecosts of removing the component based onwhether the removal costs directly benefitor are incurred by reason of a repair tothe unit of property or an improvement tothe unit of property. But see §1.280B–1for the rules applicable to demolition ofstructures.

(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 provisionof 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), appliesand that §1.280B–1 does not apply.

Example 1. Component removed during improve-ment; no disposition. X owns a factory buildingwith a storage area on the second floor. X pays anamount to remove the original columns and girderssupporting the second floor and replace them withnew columns and girders to permit storage of sup-plies with a gross weight 50 percent greater thanthe previous load-carrying capacity of the storagearea. Assume that the replacement of the columnsand girders constitutes a betterment to the buildingstructure and is therefore an improvement to thebuilding unit of property under paragraphs (d)(1)and (j) of this section. Assume that X disposes ofthe original columns and girders and the disposal ofthese structural components is not a disposition underProp. 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, theamount paid to remove the columns and girders mustbe capitalized as a cost of the improvement, becauseit directly benefits and is incurred by reason of theimprovement to the building.

Example 2. Component removed during improve-ment; disposition. Assume the same facts as Ex-ample 1, except X disposes of the original columnsand girders and elects to treat the disposal of thesestructural components as a partial disposition of thefactory 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 thedisposition. Under paragraph (g)(2)(i) of this section,the amount paid to remove the columns and girders isnot required to be capitalized as part of the cost of theimprovement regardless of their relation to the im-provement. However, all the remaining costs of re-placing the columns and girders must be capitalizedas improvements to the building unit of property un-der paragraphs (d)(1), (j), and (g)(1) of this section.

Example 3. Component removed during repairor maintenance; no disposition. Y owns a buildingin which it conducts its retail business. The roof overY’s building is covered with shingles. Over time, theshingles begin to wear and Y begins to experienceleaks into its retail premises. However, the build-ing still functions in Y’s business. To eliminate theproblems, a contractor recommends that Y removethe original shingles and replace them with new shin-gles. Accordingly, Y pays the contractor to replacethe old shingles with new but comparable shingles.The new shingles are comparable to original shin-gles but correct the leakage problems. Assume thatY disposes of the original shingles, and the disposalof 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 ofthe building structure or systems under paragraph (j)or (k) of this section and does not adapt the buildingstructure or systems to a new or different use underparagraph (l) of this section. Thus, the amounts paidby Y to replace the shingles are not improvements tothe building unit of property under paragraph (d) ofthis 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 benefitand are incurred by reason of repair or maintenanceto the building structure.

Example 4. Component removed with dispositionand restoration. Assume the same facts as Example3 except Y disposes of the original shingles, and Yelects to treat the disposal of these components as apartial disposition of the building under Prop. Reg.§1.168(i)–8(d) (September 19, 2013), and deducts theadjusted 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 the building structure becausethe amounts are paid for the replacement of a com-ponent of the structure and the taxpayer has properlydeducted a loss for that component. Thus, under para-graphs (d)(2) and (k) of this section, Y is required tocapitalize the amounts paid for the replacement of theshingles as an improvement to the building unit ofproperty. However, under paragraph (g)(2)(i) of thissection, the amounts paid by Y to remove the originalshingles are not required to be capitalized as part ofthe costs of the improvement, regardless of their re-lation to the improvement.

(3) Related amounts. For purposes ofparagraph (d) of this section, amountspaid to improve a unit of property includeamounts paid over a period of more thanone taxable year. Whether amounts arerelated to the same improvement dependson 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 certainrepairs or maintenance on a unit of prop-erty to continue operating the property is

not relevant in determining whether theamount 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 thissection) may elect to not apply paragraph(d) or paragraph (f) of this section to aneligible building property (as defined inparagraph (h)(4) of this section) if the totalamount paid during the taxable year forrepairs, maintenance, improvements, andsimilar activities performed on the eligi-ble building property does not exceed thelesser of—

(i) 2 percent of the unadjusted basis (asdefined 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 forrepairs, maintenance, improvements, andsimilar activities performed on eligiblebuilding property include those amountsnot capitalized under the de minimis safeharbor election under §1.263(a)–1(f) andthose amounts deemed not to improveproperty under the safe harbor for routinemaintenance under paragraph (i) of thissection.

(3) Qualifying taxpayer—(i) In general.For purposes of this paragraph (h), theterm qualifying taxpayer means a taxpayerwhose average annual gross receipts as de-termined under this paragraph (h)(3) forthe three preceding taxable years is lessthan or equal to $10,000,000.

(ii) Application to new taxpayers. Ifa taxpayer has been in existence for lessthan three taxable years, the taxpayer de-termines its average annual gross receiptsfor the number of taxable years (includingshort taxable years) that the taxpayer (or itspredecessor) has been in existence.

(iii) Treatment of short taxable year. Inthe case of any taxable year of less than12 months (a short taxable year), the grossreceipts shall be annualized by—

(A) Multiplying the gross receipts forthe short period by 12; and

(B) Dividing the product determined inparagraph (h)(3)(iii)(A) of this section bythe number of months in the short period.

(iv) Definition of gross receipts. Forpurposes of applying paragraph (h)(3)(i) ofthis section, the term gross receipts meansthe taxpayer’s receipts for the taxable yearthat are properly recognized under the tax-

2013–43 I.R.B. 373 October 21, 2013

payer’s methods of accounting used forFederal income tax purposes for the tax-able year. For this purpose, gross receiptsinclude total sales (net of returns and al-lowances) and all amounts received forservices. In addition, gross receipts in-clude any income from investments andfrom 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 section103), dividends, rents, royalties, and annu-ities, regardless of whether such amountsare derived in the ordinary course of thetaxpayer’s trade of business. Gross re-ceipts are not reduced by cost of goodssold or by the cost of property sold if suchproperty is described in section 1221(a)(1),(3), (4), or (5). With respect to sales ofcapital assets as defined in section 1221,or sales of property described in section1221(a)(2) (relating to property used in atrade or business), gross receipts shall bereduced by the taxpayer’s adjusted basisin such property. Gross receipts do notinclude the repayment of a loan or simi-lar instrument (for example, a repaymentof the principal amount of a loan held bya commercial lender) and, except to theextent of gain recognized, do not includegross receipts derived from a non-recog-nition transaction, such as a section 1031exchange. Finally, gross receipts do notinclude amounts received by the taxpayerwith respect to sales tax or other similarstate 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 andremits the tax to the taxing authority. If,in contrast, the tax is imposed on the tax-payer under the applicable law, then grossreceipts include the amounts received thatare allocable to the payment of such tax.

(4) Eligible building property. For pur-poses of this section, the term, eligiblebuilding property refers to each unit ofproperty 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 anunadjusted basis of $1,000,000 or less.

(5) Unadjusted basis—(i) Eligiblebuilding property owned by taxpayer. Forpurposes of this section, the unadjustedbasis of eligible building property owned

by the taxpayer means the basis as de-termined under section 1012, or otherapplicable sections of Chapter 1, includingsubchapters O (relating to gain or loss ondispositions of property), C (relating tocorporate distributions and adjustments),K (relating to partners and partnerships),and P (relating to capital gains and losses).Unadjusted basis is determined withoutregard to any adjustments described insection 1016(a)(2) or (3) or to amounts forwhich the taxpayer has elected to treat asan expense (for example, under sections179, 179B, or 179C).

(ii) Eligible building property leased tothe taxpayer. For purposes of this sec-tion, the unadjusted basis of eligible build-ing property leased to the taxpayer is thetotal amount of (undiscounted) rent paidor expected to be paid by the lessee underthe lease for the entire term of the lease,including renewal periods if all the factsand circumstances in existence during thetaxable year in which the lease is enteredindicate a reasonable expectancy of re-newal. See §1.263(a)–4(f)(5)(ii) for thefactors significant in determining whetherthere exists a reasonable expectancy of re-newal.

(6) Time and manner of election. Ataxpayer makes the election described inparagraph (h)(1) of this section by attach-ing a statement to the taxpayer’s timelyfiled original Federal tax return (includingextensions) for the taxable year in whichamounts are paid for repairs, maintenance,improvements, and similar activities per-formed on the eligible building propertyproviding that such amounts qualify un-der the safe harbor provided in paragraph(h)(1) of this section. See §§301.9100–1through 301.9100–3 of this chapter for theprovisions governing extensions of time tomake regulatory elections. The statementmust be titled, “Section 1.263(a)–3(h) SafeHarbor Election for Small Taxpayers” andinclude the taxpayer’s name, address, tax-payer identification number, and a descrip-tion of each eligible building property towhich the taxpayer is applying the elec-tion. In the case of an S corporation or apartnership, the election is made by the Scorporation or by the partnership, and notby the shareholders or partners. An elec-tion may not be made through the filingof 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). Thetime and manner of making the electionunder this paragraph (h) may be modifiedthrough guidance of general applicability(see §§601.601(d)(2) and 601.602 of thischapter).

(7) Treatment of safe harbor amounts.Amounts paid by the taxpayer for repairs,maintenance, improvements, and similaractivities to which the taxpayer properlyapplies the safe harbor under paragraph(h)(1) of this section and for which thetaxpayer properly makes the election un-der paragraph (h)(6) of this section are nottreated 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 amountsare paid, provided the amounts otherwisequalify for a deduction under these sec-tions.

(8) Safe harbor exceeded. If totalamounts paid by a qualifying taxpayerduring the taxable year for repairs, main-tenance, improvements, and similar ac-tivities performed on an eligible buildingproperty exceed the safe harbor limita-tions specified in paragraph (h)(1) of thissection, then the safe harbor election isnot available for that eligible buildingproperty and the taxpayer must apply thegeneral improvement rules under this sec-tion to determine whether amounts arefor 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 the deminimis safe harbor under §1.263(a)–1(f)to amounts qualifying under that safe har-bor irrespective of the application of thisparagraph (h).

(9) Modification of safe harboramounts. The amount limitations pro-vided in paragraphs (h)(1)(i), (h)(1)(ii),and (h)(3) of this section may be modifiedthrough published guidance in the Fed-eral Register or in the Internal RevenueBulletin (see §601.601(d)(2)(ii)(b) of thischapter).

(10) Examples. The following exam-ples illustrate the rules of this paragraph(h). Assume that §1.212–1 does not applyto 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, 2013 374 2013–43 I.R.B.

in which A provides consulting services. In Year1, A’s building has an unadjusted basis of $750,000as 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 theoffice 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 aggregateamount paid by A during Year 1 for repairs, main-tenance, improvements and similar activities on thiseligible building property does not exceed the lesserof $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 applythe 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-ing in Year 1. If A properly makes the election underparagraph (h)(6) of this section for the office build-ing and the amounts otherwise constitute deductibleordinary and necessary expenses incurred in carryingon a trade or business, A may deduct these amountsunder §1.162–1 in Year 1.

Example 2. Safe harbor for small taxpayers in-applicable. Assume the same facts as in Example 1,except that A pays $10,500 for repairs, maintenance,improvements, and similar activities performed onits office building in Year 1. Because this amountexceeds $10,000, the lesser of the two limitationsprovided in paragraph (h)(1) of this section, A maynot apply the safe harbor for small taxpayers underparagraph (h)(1) of this section to the total amountspaid for repairs, maintenance, improvements, andsimilar activities performed on the building. There-fore, A must apply the general improvement rulesunder this section to determine which of the aggre-gate amounts paid are for improvements and must becapitalized under paragraph (d) of this section andwhich of the amounts are for repair and maintenanceunder §1.162–4.

Example 3. Safe harbor applied build-ing-by-building. (i) B is a qualifying taxpayer underparagraph (h)(3) of this section. B owns two rentalproperties, Building M and Building N. BuildingM and Building N are both multi-family residentialbuildings. In Year 1, each property has an unad-justed basis of $300,000 under paragraph (h)(5) ofthis section. Because Building M and Building Neach have an unadjusted basis of $1,000,000 or less,Building M and Building N each constitute eligiblebuilding property in Year 1 under paragraph (h)(4)of this section. In Year 1, B pays $5,000 for repairs,maintenance, improvements, and similar activitiesperformed on Building M. In Year 1, B also pays$7,000 for repairs, maintenance, improvements, andsimilar activities performed on Building N.

(ii) The total amount paid by B during Year 1 forrepairs, maintenance, improvements and similar ac-tivities on Building M ($5,000) does not exceed thelesser 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 mayelect 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 electionunder paragraph (h)(6) of this section for Building Mand the amounts otherwise constitute deductible ordi-

nary and necessary expenses incurred in carrying onB’s trade or business, B may deduct these amountsunder §1.162–1.

(iii) The total amount paid by B during Year 1for repairs, maintenance, improvements and similaractivities 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 providedunder paragraph (h)(1) of this section. Therefore, Bmay not apply the safe harbor under paragraph (h)(1)of this section to the total amounts paid for repairs,maintenance, improvements, and similar activitiesperformed on Building N. Instead, B must applythe general improvement rules under this sectionto determine which of the total amounts paid forwork performed on Building N are for improvementsand must be capitalized under paragraph (d) of thissection 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 isa triple-net lease, and the lease term is 20 years, in-cluding reasonably expected renewals. C pays $4,000per 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’sleased unit of property is $960,000 ($4,000 monthlyrent x 12 months x 20 years). Because C’s leasedbuilding has an unadjusted basis of $1,000,000 orless, the building is eligible building property for Year1 under paragraph (h)(4) of this section. The totalamount paid by C during Year 1 for repairs, main-tenance, improvements, and similar activities on theleased 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 electto not apply the capitalization rule under paragraph(d) of this section to the amounts it paid for repairs,maintenance, improvements, and similar activities onthe leased building. If C properly makes the elec-tion under paragraph (h)(6) of this section for theleased building and the amounts otherwise constitutedeductible ordinary and necessary expenses incurredin carrying on C’s trade or business, C may deductthese amounts under §1.162–1.

(i) Safe harbor for routine mainte-nance on property—(1) In general. Anamount paid for routine maintenance (asdefined in paragraph (i)(1)(i) or (i)(1)(ii)of this section, as applicable) on a unit oftangible property, or in the case of a build-ing, on any of the properties designatedin paragraphs (e)(2)(ii), (e)(2)(iii)(B),(e)(2)(iv)(B), or paragraph (e)(2)(v)(B) ofthis section, is deemed not to improve thatunit of property.

(i) Routine maintenance for buildings.Routine maintenance for a building unitof property is the recurring activities thata taxpayer expects to perform as a resultof 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, andtesting of the building structure or eachbuilding system, and the replacement ofdamaged or worn parts with comparableand commercially available replacementparts. Routine maintenance may be per-formed any time during the useful lifeof the building structure or building sys-tems. However, the activities are routineonly if the taxpayer reasonably expectsto perform the activities more than onceduring the 10-year period beginning at thetime the building structure or the buildingsystem upon which the routine mainte-nance is performed is placed in serviceby the taxpayer. A taxpayer’s expectationwill not be deemed unreasonable merelybecause the taxpayer does not actuallyperform the maintenance a second timeduring the 10-year period, provided thatthe taxpayer can otherwise substantiatethat its expectation was reasonable at thetime the property was placed in service.Factors to be considered in determin-ing whether maintenance is routine andwhether a taxpayer’s expectation is rea-sonable include the recurring nature of theactivity, industry practice, manufacturers’recommendations, and the taxpayer’s ex-perience with similar or identical property.With respect to a taxpayer that is a lessorof a building or a part of the building,the taxpayer’s use of the building unit ofproperty includes the lessee’s use of itsunit of property.

(ii) Routine maintenance for propertyother than buildings. Routine maintenancefor property other than buildings is therecurring activities that a taxpayer expectsto perform as a result of the taxpayer’suse of the unit of property to keep theunit of property in its ordinarily efficientoperating condition. Routine maintenanceactivities include, for example, the inspec-tion, cleaning, and testing of the unit ofproperty, and the replacement of damagedor worn parts of the unit of property withcomparable and commercially availablereplacement parts. Routine maintenancemay be performed any time during the use-ful life of the unit of property. However,the activities are routine only if, at the timethe unit of property is placed in service

2013–43 I.R.B. 375 October 21, 2013

by the taxpayer, the taxpayer reasonablyexpects to perform the activities morethan once during the class life (as definedin paragraph (i)(4) of this section) of theunit of property. A taxpayer’s expectationwill not be deemed unreasonable merelybecause the taxpayer does not actuallyperform the maintenance a second timeduring the class life of the unit of property,provided that the taxpayer can otherwisesubstantiate that its expectation was rea-sonable at the time the property was placedin service. Factors to be considered in de-termining whether maintenance is routineand whether the taxpayer’s expectation isreasonable include the recurring nature ofthe activity, industry practice, manufactur-ers’ recommendations, and the taxpayer’sexperience with similar or identical prop-erty. With respect to a taxpayer that is alessor of a unit of property, the taxpayer’suse of the unit of property includes thelessee’s use of the unit of property.

(2) Rotable and temporary spare parts.Except as provided in paragraph (i)(3) ofthis section, for purposes of paragraph(i)(1)(ii) of this section, amounts paid forroutine maintenance include routine main-tenance performed on (and with regard to)rotable and temporary spare parts.

(3) Exceptions. Routine maintenancedoes not include the following:

(i) Amounts paid for a betterment to aunit of property under paragraph (j) of thissection;

(ii) Amounts paid for the replacementof a component of a unit of property forwhich the taxpayer has properly deducteda 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 replacementof a component of a unit of property forwhich the taxpayer has properly taken intoaccount the adjusted basis of the compo-nent in realizing gain or loss resulting fromthe sale or exchange of the component (seeparagraph (k)(1)(ii) of this section);

(iv) Amounts paid for the restoration ofdamage to a unit of property for which thetaxpayer is required to take a basis adjust-ment as a result of a casualty loss undersection 165, or relating to a casualty eventdescribed 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 ofproperty to its ordinarily efficient operat-

ing condition, if the property has deterio-rated to a state of disrepair and is no longerfunctional for its intended use (see para-graph (k)(1)(iv) of this section);

(vi) Amounts paid to adapt a unit ofproperty to a new or different use underparagraph (l) of this section;

(vii) Amounts paid for repairs, mainte-nance, or improvement of network assets(as defined in paragraph (e)(3)(iii)(A) ofthis section); or

(viii) Amounts paid for repairs, mainte-nance, or improvement of rotable and tem-porary spare parts to which the taxpayerapplies the optional method of accountingfor rotable and temporary spare parts un-der §1.162–3(e).

(4) Class life. The class life of a unitof property is the recovery period pre-scribed for the property under sections168(g)(2) and (3) for purposes of the alter-native depreciation system, regardless ofwhether the property is depreciated undersection 168(g). For purposes of determin-ing class life under this section, section168(g)(3)(A) (relating to tax-exempt useproperty subject to lease) does not ap-ply. If the unit of property is comprisedof components with different class lives,then the class life of the unit of property isdeemed to be the same as the componentwith the longest class life.

(5) Coordination with section 263A.Amounts paid for routine maintenanceunder this paragraph (i) may be subjectto capitalization under section 263A ifthese amounts comprise the direct or al-locable indirect costs of other propertyproduced by the taxpayer or propertyacquired for resale. See, for example,§1.263A–1(e)(3)(ii)(O) requiring tax-payers to capitalize the cost of repairingequipment or facilities allocable to prop-erty produced or property acquired forresale.

(6) Examples. The following examplesillustrate the application of this paragraph(i) and, unless otherwise stated, do not ad-dress the treatment under other provisionsof the Code (for example, section 263A).In addition, unless otherwise stated, as-sume that the taxpayer has not appliedthe optional method of accounting forrotable and temporary spare parts under§1.162–3(e).

Example 1. Routine maintenance on component.(i) A is a commercial airline engaged in the businessof transporting passengers and freight throughout the

United States and abroad. To conduct its business, Aowns or leases various types of aircraft. As a con-dition of maintaining its airworthiness certificationfor these aircraft, A is required by the Federal Avia-tion Administration (FAA) to establish and adhere toa continuous maintenance program for each aircraftwithin its fleet. These programs, which are designedby A and the aircraft’s manufacturer and approved bythe FAA, are incorporated into each aircraft’s main-tenance manual. The maintenance manuals require avariety of periodic maintenance visits at various in-tervals. One type of maintenance visit is an engineshop visit (ESV), which A expects to perform on itsaircraft engines approximately every 4 years to keepits aircraft in its ordinarily efficient operating condi-tion. In Year 1, A purchased a new aircraft, whichincluded four new engines attached to the airframe.The four aircraft engines acquired with the aircraftare not materials or supplies under §1.162–3(c)(1)(i)because they are acquired as part of a single unit ofproperty, the aircraft. In Year 5, A performs its firstESV on the aircraft engines. The ESV includes disas-sembly, cleaning, inspection, repair, replacement, re-assembly, and testing of the engine and its componentparts. During the ESV, the engine is removed fromthe 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 specificationsin A’s maintenance program, the part is repaired, or ifnecessary, replaced with a comparable and commer-cially available replacement part. After the ESVs, theengines are returned to A to be reinstalled on anotheraircraft or stored for later installation. Assume thatthe class life for A’s aircraft, including the engines, is12 years. Assume that none of the exceptions set outin paragraph (i)(3) of this section apply to the costs ofperforming the ESVs.

(ii) Because the ESVs involve the recurring ac-tivities that A expects to perform as a result of its useof the aircraft to keep the aircraft in ordinarily effi-cient operating condition and consist of maintenanceactivities that A expects to perform more than onceduring the 12 year class life of the aircraft, A’s ESVsare within the routine maintenance safe harbor underparagraph (i)(1)(ii) of this section. Accordingly, theamounts paid for the ESVs are deemed not to improvethe 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, except thatin year 15 A pays amounts to perform an ESV onone of the original aircraft engines after the end ofthe class life of the aircraft. Because this ESV in-volves the same routine maintenance activities thatwere performed on aircraft engines in Example 1, thisESV 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 deemednot to improve the aircraft and are not required to becapitalized under paragraph (d) of this section.

Example 3. Routine maintenance on rotablespare parts. (i) Assume the same facts as in Example1, except that in addition to the four engines pur-chased as part of the aircraft, A separately purchasesfour additional new engines that A intends to use inits aircraft fleet to avoid operational downtime whenESVs are required to be performed on the enginespreviously installed on an aircraft. Later in Year

October 21, 2013 376 2013–43 I.R.B.

1, A installs these four engines on an aircraft in itsfleet. In Year 5, A performs the first ESVs on thesefour engines. Assume that these ESVs involve thesame routine maintenance activities that were per-formed on the engines in Example 1, and that noneof the exceptions set out in paragraph (i)(3) of thissection apply to these ESVs. After the ESVs wereperformed, these engines were reinstalled on otheraircraft or stored for later installation.

(ii) The additional aircraft engines are rotablespare parts because they were acquired separatelyfrom the aircraft, they are removable from the air-craft, and are repaired and reinstalled on other aircraftor 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 theairframe, 12 years. Because the ESVs involve therecurring activities that A expects to perform as aresult of its use of the engines to keep the engines inordinarily efficient operating condition, and consistof maintenance activities that A expects to performmore than once during the 12 year class life of theengine, the ESVs fall within the routine maintenancesafe harbor under paragraph (i)(1)(ii) of this section.Accordingly, the amounts paid for the ESVs for thefour additional engines are deemed not to improvethese engines and are not required to be capitalizedunder 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 fromprior owner’s use. (i) In January, Year 1, B purchasesa used machine for use in its manufacturing opera-tions. Assume that the machine is the unit of propertyand has a class life of 10 years. B places the machinein 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 includesthe 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 withcomparable and commercially available replacementparts. 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 manufacturerrecommended scheduled maintenance. Assume thatnone of the exceptions set out in paragraph (i)(3) ofthis 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 useof 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 paidfor the scheduled maintenance resulted from the priorowner’s, and not B’s, use of the property and must becapitalized 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 otherwiseresult in an improvement under paragraph (d) of thissection.

Example 5. Routine maintenance resulting fromnew owner’s use. Assume the same facts as in Ex-ample 4, except that after B pays amounts for themaintenance in Year 1, B continues to operate the ma-

chine in its manufacturing business. In Year 4, B paysamounts to perform the next scheduled manufacturerrecommended maintenance on the machine. Assumethat the scheduled maintenance activities performedare the same as those performed in Example 4 and thatnone of the exceptions set out in paragraph (i)(3) ofthis 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 themachine, keeps the machine in an ordinarily efficientoperating 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 thissection. 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 ofsubstantial structural part; coordination with section263A. C is in the business of producing commercialproducts for sale. As part of the production process,C places raw materials into lined containers in whicha chemical reaction is used to convert raw materialsinto the finished product. The lining, which com-prises 60 percent of the total physical structure of thecontainer, 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 hasa class life of 12 years. At the time that C placedthe container into service, C was aware that approx-imately every three years, the container lining wouldneed to be replaced with comparable and commer-cially available replacement materials. At the end ofthree years, the container will continue to function,but will become less efficient and the replacement ofthe lining will be necessary to keep the container inan ordinarily efficient operating condition. In Year 1,C acquired 10 new containers and placed them intoservice. In Year 4, Year 7, Year 9, and Year 12, Cpays amounts to replace the containers’ linings withcomparable and commercially available replacementparts. Assume that none of the exceptions set out inparagraph (i)(3) of this section apply to the amountspaid for the replacement linings. Because the replace-ment of the linings involves recurring activities that Cexpects to perform as a result of its use of the contain-ers to keep the containers in their ordinarily efficientoperating 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 liningreplacement costs are within the routine maintenancesafe 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 subjectto capitalization under section 263A if the amountspaid 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 duringclass life. D is a Class I railroad that owns a fleet offreight cars. Assume that a freight car, including allits components, is a unit of property and has a classlife 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 thefreight 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 amountsto perform a cyclical reconditioning on the car. Be-cause D expects to perform the reconditioning onlyonce during the 14 year class life of the freight car, theamounts D pays for the reconditioning do not qualifyfor the routine maintenance safe harbor under para-graph (i)(1)(ii) of this section. Accordingly, D mustcapitalize the amounts paid for the reconditioning ofthe freight car if these amounts result in an improve-ment under paragraph (d) of this section.

Example 8. Routine maintenance; reasonable ex-pectation. Assume the same facts as Example 7, ex-cept in Year 1, D acquires and places in service sev-eral refrigerated freight cars, which also have a classlife of 14 years. Because of the special requirementsof 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 yearsto keep the freight car in an ordinarily efficient op-erating condition. During the reconditioning, D paysamounts to disassemble, inspect, and recondition orreplace the refrigeration components of the freightcar with comparable and commercially available re-placement parts. Assume that none of the exceptionsset out in paragraph (i)(3) of this section apply to theamounts paid for the reconditioning of these freightcars. In Year 6, D pays amounts to perform a recondi-tioning on the refrigeration components on one of thefreight 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 freightcar until Year 15, after the end of the 14-year class lifeof the car. Under paragraph (i)(1)(ii) of this section,D’s reasonable expectation that it would perform thereconditioning every 6 years will not be deemed un-reasonable merely because D did not actually performthe reconditioning a second time during the 14-yearclass life, provided that D can substantiate that its ex-pectation was reasonable at the time the property wasplaced in service. If D can demonstrate that its ex-pectation was reasonable in Year 1 using the factorsprovided in paragraph (i)(1)(ii) of this section, thenthe amounts paid by D to recondition the refriger-ated freight car components in Year 6 and in Year 15are within the routine maintenance safe harbor underparagraph (i)(1)(ii) of this section.

Example 9. Routine maintenance on non-rotablepart. E is a towboat operator that owns and leases afleet of towboats. Each towboat is equipped with twodiesel-powered engines. Assume that each towboat,including its engines, is the unit of property and thata towboat has a class life of 18 years. At the timethat E places its towboats into service, E is awarethat approximately every three to four years E willneed to perform scheduled maintenance on the twotowboat engines to keep the engines in their ordinar-ily efficient operating condition. This maintenanceis completed while the engines are attached to thetowboat and involves the cleaning and inspectingof the engines to determine which parts are withinacceptable operating tolerances and can continue tobe used, which parts must be reconditioned to be

2013–43 I.R.B. 377 October 21, 2013

brought back to acceptable tolerances, and whichparts must be replaced. Engine parts replaced duringthese procedures are replaced with comparable andcommercially available replacement parts. Assumethe 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 towboatinto service. In Year 5, E pays amounts to performscheduled maintenance on both engines in the tow-boat. Assume that none of the exceptions set out inparagraph (i)(3) of this section apply to the scheduledmaintenance costs. Because the scheduled mainte-nance involves recurring activities that E expects toperform more than once during the 18-year class lifeof the towboat, the maintenance results from E’s useof the towboat, and the maintenance is performed tokeep the towboat in an ordinarily efficient operatingcondition, the scheduled maintenance on E’s towboatis within the routine maintenance safe harbor underparagraph (i)(1)(ii) of this section. Accordingly, theamounts paid for the scheduled maintenance to itstowboat engines in Year 5 are deemed not to improvethe towboat and are not required to be capitalizedunder paragraph (d) of this section.

Example 10. Routine maintenance with relatedbetterments. Assume the same facts as Example 9,except that in Year 9 E’s towboat engines are due foranother scheduled maintenance visit. At this time, Edecides 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 atthe same time, E incurs costs to upgrade certain en-gine parts to increase the towing capacity of the boatsin excess of the capacity of the boats when E placedthem in service. In combination with the replace-ment of parts with new and upgraded parts, the sched-uled maintenance must be completed to perform thehorsepower and propulsion upgrade. Thus, the workdone 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 keepthe towboat in its ordinarily efficient operating con-dition. Rather under paragraph (j) of this section, theamounts 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 routinemaintenance safe harbor under paragraph (i)(3)(i) ofthis section. In addition, under paragraph (g)(1)(i) ofthis section, the scheduled maintenance proceduresdirectly benefit the upgrades. Therefore, the amountsthat E paid in Year 9 for the maintenance and upgradeof 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 amountspaid for maintenance and upgrades of the engines asan improvement to the towboats under paragraph (d)of this section.

Example 11. Routine maintenance with unrelatedimprovements. Assume the same facts as Example 9,except in Year 5, in addition to paying amounts toperform the scheduled engine maintenance on bothengines, E also incurs costs to upgrade the communi-cations and navigation systems in the pilot house ofthe 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 resultin an improvement to the towboat under paragraph(d) of this section. In contrast with Example 9, theamounts paid for the scheduled maintenance on E’stowboat 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 routinemaintenance deemed not to improve the towboat andare 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 withan irrigation system that provides water for crops.Assume that each canal in the irrigation system is asingle 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 thecanals every three years to keep the canals in theirordinarily efficient operating condition. This mainte-nance includes draining the canals, and then cleaning,inspecting, repairing, and reconditioning or replacingparts of the canal with comparable and commerciallyavailable replacement parts. F placed the canals intoservice in Year 1 and did not perform any mainte-nance on the canals until Year 6. At that time, thecanals had fallen into a state of disrepair and no longerfunctioned for irrigation. In Year 6, F pays amounts todrain the canals and do extensive cleaning, repairing,reconditioning, and replacing parts of the canals withcomparable and commercially available replacementparts. Although the work performed on F’s canalswas similar to the activities that F expected to per-form, but did not perform, every three years, the costsof these activities do not fall within the routine main-tenance safe harbor. Specifically, under paragraph(i)(3)(v) of this section, routine maintenance does notinclude activities that return a unit of property to itsformer ordinarily efficient operating condition if theproperty has deteriorated to a state of disrepair andis no longer functional for its intended use. Accord-ingly, amounts that F pays for work performed on thecanals in Year 6 must be capitalized if they result inimprovements under paragraph (d) of this section (forexample, restorations under paragraph (k) of this sec-tion).

Example 13. Routine maintenance on a building;escalator system. In Year 1, G acquires a large retailmall in which it leases space to retailers. The mallcontains an escalator system with 40 escalators,which includes landing platforms, trusses, tracks,steps, handrails, and safety brushes. In Year 1, whenG placed its building into service, G reasonably ex-pected that it would need to replace the handrails onthe escalators approximately every four years to keepthe escalator system in its ordinarily efficient operat-ing condition. After a routine inspection and test ofthe escalator system in Year 4, G determines that thehandrails need to be replaced and pays an amountto 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) of this section. Assumethat none of the exceptions in paragraph (i)(3) of thissection apply to the scheduled maintenance costs.Because the replacement of the handrails involvesrecurring activities that G expects to perform as aresult of its use of the escalator system to keep theescalator system in an ordinarily efficient operatingcondition, and G reasonably expects to perform theseactivities more than once during the 10-year periodbeginning at the time building system was placedin service, the amounts paid by G for the handrailreplacements are within the routine maintenancesafe harbor under paragraph (i)(1)(i) of this section.Accordingly, the amounts paid for the replacementof the handrails in Year 4 are deemed not to improvethe building unit of property and are not required tobe capitalized under paragraph (d) of this section.

Example 14. Not routine maintenance; escala-tor system. Assume the same facts as in Example 13,except that in Year 9, G pays amounts to replace thesteps of the escalators. In Year 1, when G placed itsbuilding 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 Gexpects to perform more than once during the 10-yearperiod beginning at the time the building structure orthe building system was placed in service, the costsof these activities do not fall within the routine main-tenance safe harbor. Accordingly, amounts that Gpays to replace the steps in Year 9 must be capitalizedif 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 newoffice building, which it uses to provide services.The building contains an HVAC system, which is abuilding system under paragraph (e)(2)(ii)(B)(1) ofthis section. In Year 1, when H placed its buildinginto service, H reasonably expected that every fouryears H would need to pay an outside contractor toperform detailed testing, monitoring, and preventa-tive maintenance on its HVAC system to keep theHVAC system in its ordinarily efficient operatingcondition. This scheduled maintenance includes dis-assembly, cleaning, inspection, repair, replacement,reassembly, and testing of the HVAC system andmany of its component parts. If inspection or testingdiscloses a problem with any component, the part isrepaired, or if necessary, replaced with a comparableand commercially available replacement part. Thescheduled maintenance at these intervals is recom-mended by the manufacturer of the HVAC systemand is routinely performed on similar systems in sim-ilar buildings. Assume that none of the exceptions inparagraph (i)(3) of this section apply to the amountspaid for the maintenance on the HVAC system. InYear 4, H pays amounts to a contractor to performthe scheduled maintenance. However, H does notperform this scheduled maintenance on its buildingagain until Year 11. Under paragraph (i)(1)(i) ofthis section, H’s reasonable expectation that it wouldperform the maintenance every 4 years will not bedeemed unreasonable merely because H did not ac-tually perform the maintenance a second time duringthe 10-year period, provided that H can substantiatethat its expectation was reasonable at the time the

October 21, 2013 378 2013–43 I.R.B.

property was placed in service. If H can demonstratethat its expectation was reasonable in Year 1 usingthe other factors considered in paragraph (i)(1)(i),then the amounts H paid for the maintenance of theHVAC system in Year 4 and in Year 11 are withinthe routine maintenance safe harbor under paragraph(i)(1)(i) of this section.

(j) Capitalization of betterments—(1)In general. A taxpayer must capitalize asan improvement an amount paid for a bet-terment to a unit of property. An amount ispaid for a betterment to a unit of propertyonly if it—

(i) Ameliorates a material condition ordefect that either existed prior to the tax-payer’s acquisition of the unit of propertyor arose during the production of the unitof property, whether or not the taxpayerwas aware of the condition or defect at thetime 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 additionalcubic 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 ofproperty.

(2) Application of betterment rules—(i)In general. The applicability of each quan-titative and qualitative factor provided inparagraphs (j)(1)(ii) and (j)(1)(iii) of thissection to a particular unit of property de-pends on the nature of the unit of property.For example, if an addition or an increasein a particular factor cannot be measured inthe context of a specific type of property,this factor is not relevant in the determina-tion of whether an amount has been paidfor a betterment to the unit of property.

(ii) Application of betterment rules tobuildings. An amount is paid to improvea building if it is paid for a betterment,as defined under paragraph (j)(1) of thissection, to a property specified underparagraph (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 leasedportion of building) of this section. Forexample, an amount is paid to improve abuilding if it is paid for an increase in theefficiency of the building structure or anyone of its building systems (for example,the HVAC system).

(iii) Unavailability of replacementparts. If a taxpayer replaces a part of aunit of property that cannot reasonablybe replaced with the same type of part(for example, because of technologicaladvancements or product enhancements),the replacement of the part with an im-proved, but comparable, part does not, byitself, result in a betterment to the unit ofproperty.

(iv) Appropriate comparison—(A) Ingeneral. In cases in which an expenditureis necessitated by normal wear and tearor damage to the unit of property that oc-curred during the taxpayer’s use of the unitof property, the determination of whetheran expenditure is for the betterment of theunit of property is made by comparingthe condition of the property immediatelyafter the expenditure with the condition ofthe property immediately prior to the cir-cumstances necessitating the expenditure.

(B) Normal wear and tear. If the ex-penditure is made to correct the effects ofnormal wear and tear to the unit of prop-erty that occurred during the taxpayer’suse of the unit of property, the conditionof the property immediately prior to thecircumstances necessitating the expendi-ture is the condition of the property af-ter the last time the taxpayer corrected theeffects of normal wear and tear (whetherthe amounts paid were for maintenance orimprovements) or, if the taxpayer has notpreviously corrected the effects of normalwear and tear, the condition of the propertywhen placed in service by the taxpayer.

(C) Damage to property. If the expen-diture is made to correct damage to a unitof property that occurred during the tax-payer’s use of the unit of property, the con-dition of the property immediately prior tothe circumstances necessitating the expen-diture is the condition of the property im-mediately prior to damage.

(3) Examples. The following examplesillustrate 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 ofthe Internal Revenue Code (for example,section 263A). Unless otherwise provided,assume that the appropriate comparison inparagraph (j)(2)(iv) of this section is notapplicable under the facts.

Example 1. Amelioration of pre-existing materialcondition or defect. In Year 1, A purchases a storelocated 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, causingsoil contamination. A is not aware of the contamina-tion at the time of purchase. In Year 2, A discovers thecontamination and incurs costs to remediate the soil.The remediation costs are for a betterment to the landunder paragraph (j)(1)(i) of this section because A in-curred the costs to ameliorate a material condition ordefect 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 wasconstructed with insulation that contained asbestos.The health dangers of asbestos were not widelyknown when the building was constructed. Severalyears after B places the building into service, Bdetermines that certain areas of asbestos-containinginsulation have begun to deteriorate and could even-tually pose a health risk to employees. Therefore, Bpays an amount to remove the asbestos-containinginsulation from the building structure and replace itwith new insulation that is safer to employees, butno more efficient or effective than the asbestos insu-lation. Under paragraphs (e)(2)(ii) and (j)(2)(ii) ofthis section, an amount is paid to improve a buildingunit of property if the amount is paid for a bettermentto the building structure or any building system.Although the asbestos is determined to be unsafeunder certain circumstances, the presence of asbestosinsulation in a building, by itself, is not a preexistingmaterial condition or defect of the building structureunder paragraph (j)(1)(i) of this section. In addition,the removal and replacement of the asbestos is notfor a material addition to the building structure ora material increase in the capacity of the buildingstructure under paragraphs (j)(1)(ii) and (j)(2)(iv)of this section as compared to the condition of theproperty prior to the deterioration of the insulation.Similarly, the removal and replacement of asbestosis not reasonably expected to materially increase theproductivity, efficiency, strength, quality, or outputof 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 theinsulation. Therefore, the amount paid to remove andreplace the asbestos insulation is not for a bettermentto the building structure or an improvement to thebuilding 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 aunit of property and has a class life of 10 years. Cplaced the machine in service in January, Year 1 andat that time expected to perform manufacturer recom-mended scheduled maintenance on the machine ev-ery three years. The scheduled maintenance includescleaning and oiling the machine, inspecting parts fordefects, and replacing minor items, such as springs,bearings, and seals, with comparable and commer-cially available replacement parts. The scheduledmaintenance does not include any material additionsor materially increase the capacity, productivity, effi-ciency, strength, quality, or output of the machine. Atthe time C purchased the machine, it was approachingthe end of a three-year scheduled maintenance period.As a result, in February, Year 1, C pays an amountto perform the manufacturer recommended scheduled

2013–43 I.R.B. 379 October 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 resultsfrom the prior owner’s use of the property and notthe 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 thescheduled maintenance results from the prior owner’suse 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 doesnot ameliorate a material condition or defect in themachine under paragraph (j)(1)(i) of this section, isnot for a material addition to or increase in capacity ofthe machine under paragraph (j)(1)(ii) of this section,and is not reasonably expected to materially increasethe productivity, efficiency, strength, quality, or out-put of the machine under paragraph (j)(1)(iii) of thissection. Therefore, C is not required to capitalize theamount 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 iceresurfacing machine for use in the operation of itsice skating rink. To comply with local regulations,D is required to routinely monitor the air quality inthe 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 retunethe machine, which includes replacing minor com-ponents of the engine that had worn out prior to D’sacquisition of the machine. Assume the resurfacingmachine, 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 tothe taxpayer’s use of the machine. The amount thatD pays to inspect, retune, and replace minor com-ponents of the ice resurfacing machine ameliorates acondition or defect that existed prior to D’s acquisi-tion of the equipment. Nevertheless, considering thepurpose and minor nature of the work performed, thisamount does not ameliorate a material condition ordefect in the machine under paragraph (j)(1)(i) of thissection. In addition, the amount is not paid for a ma-terial addition to the machine or a material increase inthe capacity of the machine under paragraph (j)(1)(ii)of this section. Also, the activities are not reasonablyexpected to materially increase the productivity, ef-ficiency, strength, quality, or output of the machineunder 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 themachine as a betterment under this paragraph (j).

Example 5. Amelioration of material conditionor defect. (i) E acquires a building for use in itsbusiness of providing assisted living services. Be-fore and after the purchase, the building functionsas an assisted living facility. However, at the timeof the purchase, E is aware that the building is in acondition that is below the standards that E requiresfor facilities used in its business. Immediately afterthe acquisition and during the following two years,

while E continues to use the building as an assistedliving facility, E pays amounts for extensive repairsand 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 workon 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 workthat E performs affects only the building structure un-der paragraph (e)(2)(ii)(A) of this section and doesnot affect any of the building systems described inparagraph (e)(2)(ii)(B) of this section. Assume thateach section 1245 property is a separate unit of prop-erty.

(ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) ofthis 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 andthe 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 bettermentto the building structure under paragraph (j)(1)(i) ofthis section because the amounts ameliorate mate-rial conditions that existed prior to E’s acquisition ofthe building. Therefore, E must treat the amountspaid for the betterment to the building structure asan improvement to the building and must capitalizethe amounts under paragraphs (j) and (d)(1) of thissection. Moreover, E is required to capitalize theamounts paid to acquire and install each section 1245property, including each window treatment, each itemof 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 sella wide variety of items. To maintain the appearanceand functionality of its store buildings after severalyears of wear, F periodically pays amounts to refreshthe 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 repairsand maintenance to the store building to modernizethe store buildings and reorganize the merchandisedisplays. 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 reconfigurationof tables and racks, patching holes in walls, repaintingthe interior structure with a new color scheme to coor-dinate with new signage, replacing damaged ceilingtiles, cleaning and repairing wood flooring through-out the store building, and power washing buildingexteriors. The display tables and the racks all consti-tute section 1245 property. F pays amounts to refresh50 stores during the taxable year. Assume that eachsection 1245 property within each store is a separateunit of property. Finally, assume that the work doesnot ameliorate any material conditions or defects thatexisted when F acquired the store buildings or resultin any material additions to the store buildings.

(ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) ofthis 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, theamounts paid for the refresh of each building are notfor any material additions to, or material increasesin the capacity of, the buildings’ structure or sys-tems as compared with the condition of the structureor systems after the previous refresh. Moreover, theamounts 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, thework performed keeps F’s store buildings’ structuresand buildings’ systems in their ordinarily efficient op-erating condition. Therefore, F is not required to treatthe 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) ofthis section. However, F is required to capitalize theamounts paid to acquire and install each section 1245property in accordance with §1.263(a)–2(d)(1).

Example 7. Building refresh; limited improve-ment. (i) Assume the same facts as Example 6 except,in the course of the refresh to one of its store build-ings, F also pays amounts to increase the building’sstorage space, add a second loading dock, and add asecond overhead door. Specifically, at the same timeF pays amounts to perform the refresh, F pays addi-tional amounts to construct an addition to the backof the store building, including adding a new over-head door and loading dock to the building. Thework also involves upgrades to the electrical systemof the building, including the addition of a secondservice box with increased amperage and new wiringfrom the service box to provide lighting and powerthroughout the new space. Although it is performedat the same time, the construction of the additionsdoes not affect, and is not otherwise related to, therefresh of the retail space.

(ii) Under paragraphs (e)(2)(ii) and (j)(2)(ii) ofthis 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. Under paragraph (j)(1)(ii) of this section, theamounts paid by F to add the storage space, loadingdock, overhead door, and expand the electrical sys-tem are for betterments to F’s building structure andto the electrical system because they are for mate-rial additions to, and a material increase in capacityof, the structure and the electrical system of F’s storebuilding. Accordingly, F must treat the amounts paidfor these betterments as improvements to the buildingunit of property and capitalize these amounts underparagraphs (d)(1) and (j) of this section. However,for the reasons discussed in Example 6, F is not re-quired to treat the amounts paid for the refresh of itsstore building structure and systems as a bettermentsunder paragraph (j)(1) of this section. In addition, Fis not required under paragraph (g)(1) of this sectionto capitalize the refresh costs described in Example6 because these costs do not directly benefit and arenot incurred by reason of the additions to the buildingstructure and electrical system. As in Example 6, F isrequired to capitalize the amounts paid to acquire andinstall each section 1245 property in accordance with§1.263(a)–2(d)(1).

October 21, 2013 380 2013–43 I.R.B.

Example 8. Betterment; building remodel. (i) Gowns a large chain of retail stores that sell a varietyof items. G determines that due to changes in the re-tail market, it can no longer compete in its currentstore class and decides to upgrade its stores to offerhigher end products to a different type of customer.To offer these products and attract different types ofcustomers, 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 monumentalstaircase, adding a new glass enclosed elevator, re-building the interior and exterior facades, replacingvinyl floors with ceramic flooring, replacing ceilingtiles with acoustical tiles, and removing and rebuild-ing walls to move changing rooms and create spe-cialty departments. The work also includes upgradesto increase the capacity of the buildings’ electricalsystem to accommodate the structural changes andthe addition of new section 1245 property, such asnew product information kiosks and point of sale sys-tems. The work to the electrical system also involvesthe 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-gradefixtures that conserve water and energy. Finally, Galso pays amounts to clean debris resulting from con-struction during the remodel, patch holes in walls thatwere made to upgrade the electrical system, repaintexisting walls with a new color scheme to match thenew 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) ofthis 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 ofthe 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 amountspaid to replace large parts of the exterior walls withwindows, replace the escalators with a monumen-tal staircase, add a new elevator, rebuild the interiorand exterior facades, replace vinyl floors with ce-ramic flooring, replace the ceiling tiles with acous-tical tiles, and to remove and rebuild walls are formaterial additions, that is the addition of major com-ponents, to the building structure under paragraph(j)(1)(ii) of this section and are reasonably expectedto increase the quality of the building structure un-der paragraph (j)(1)(iii) of this section. Similarly,the amounts paid to upgrade the electrical systemare to materially increase the capacity of the electri-cal system under paragraph (j)(1)(ii) of this sectionand are reasonably expected to increase the qualityof this system under paragraph (j)(1)(iii) of this sec-tion. In addition, the amounts paid to remodel thebathrooms with higher grade and more resource-ef-ficient materials are reasonably expected to increasethe 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 washbuilding 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 amountspaid for betterments to the store buildings’ structuresand systems, including the costs of cleaning, patch-ing, repairing, and power washing the building, asimprovements to G’s buildings and must capitalizethese amounts under paragraphs (d)(1) and (j) of thissection. Moreover, G is required to capitalize theamounts paid to acquire and install each section 1245property in accordance with §1.263(a)–2(d)(1). Forthe treatment of amounts paid to remove componentsof 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 storelocated in leased space in a shopping mall. Assumethat each cash register is a unit of property as deter-mined under paragraph (e)(3) of this section. In Year1, H capitalizes the costs of acquiring and installingthe new cash registers under §1.263(a)–2(d)(1). InYear 3, H’s lease expires, and H decides to relocateits retail store to a different building. In addition tovarious other costs, H pays $5,000 to move the cashregisters and $1,000 to reinstall them in the new store.The cash registers are used for the same purpose andin the same manner that they were used in the formerlocation. The amounts that H pays to move and rein-stall the cash registers into its new store do not resultin a betterment to the cash registers under paragraph(j) of this section.

Example 10. Betterment; relocation and reinstal-lation of equipment. J operates a manufacturing facil-ity in Building A, which contains various machinesthat J uses in its manufacturing business. J decidesto expand part of its operations by relocating a ma-chine to Building B to reconfigure the machine withadditional components. Assume that the machine is asingle unit of property under paragraph (e)(3) of thissection. 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 machineas 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 tothe machine under paragraph (g)(1) of this section.

Example 11. Betterment; regulatory requirement.K owns a building that it uses in its business. In Year1, City C passes an ordinance setting higher safetystandards for buildings because of the hazardousconditions caused by earthquakes. To comply withthe ordinance, K pays an amount to add expansionbolts to its building structure. These bolts anchorthe wooden framing of K’s building to its cementfoundation, providing additional structural supportand resistance to seismic forces, making the buildingmore 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 unitof property if the amount is paid for a bettermentto the building structure or any building system.The framing and foundation are part of the buildingstructure as defined in paragraph (e)(2)(ii)(A) of thissection. Prior to the ordinance, the old building wasin good condition but did not meet City C’s newrequirements for earthquake resistance. The amountpaid by K for the addition of the expansion boltsmet City C’s new requirement, but also materiallyincreased the strength of the building structure underparagraph (j)(1)(iii) of this section. Therefore, Kmust treat the amount paid to add the expansion boltsas a betterment to the building structure and mustcapitalize this amount as an improvement to buildingunder paragraphs (d)(1) and (j) of this section. CityC’s new requirement that K’s building meet certainsafety standards to continue to operate is not relevantin determining whether the amount paid improvedthe building. See paragraph (g)(4) of this section.

Example 12. Not a betterment; regulatory re-quirement. L owns a meat processing plant. Afteroperating the plant for many years, L discovers thatoil is seeping through the concrete walls of the plant.Federal inspectors advise L that it must correct theseepage problem or shut down its plant. To correctthe problem, L pays an amount to add a concrete lin-ing to the walls from the floor to a height of about fourfeet 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 ofproperty if the amount is paid for a betterment to thebuilding structure or any building system. The wallsare 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 oilinto the plant. Prior to the seepage, the walls did notleak and were functioning for their intended use. L isnot required to treat the amount paid as a bettermentunder 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’sstructure as compared to the condition of the structureprior to the seepage of oil. Moreover, the amount paidis not reasonably expected to materially increase theproductivity, efficiency, strength, quality, or output ofthe building structure under paragraphs (j)(1)(iii) and(j)(2)(iv) as compared to the condition of the structureprior to the seepage of the oil. Therefore, L is not re-quired to treat the amount paid to correct the seepageas 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 operatingthe plant is not relevant in determining whether theamount paid improves the plant.

Example 13. Not a betterment; new roof mem-brane. M owns a building that it uses for its retailbusiness. Over time, the waterproof membrane (toplayer) on the roof of M’s building begins to wear,and M began to experience water seepage and leaksthroughout 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. Thenew membrane is comparable to the worn membranewhen it was originally placed in service by the tax-payer. Under paragraphs (e)(2)(ii) and (j)(2)(ii) ofthis section, an amount is paid to improve a building

2013–43 I.R.B. 381 October 21, 2013

unit of property if the amount is paid for a bettermentto the building structure or any building system. Theroof 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, thecondition 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 becauseM has not previously corrected the effects of normalwear and tear. Under these facts, the amount paid toadd the new membrane to the roof is not for a ma-terial addition or a material increase in the capacityof the building structure under paragraph (j)(1)(ii) ofthis section as compared to the condition of the struc-ture when it was placed in service. Moreover, the newmembrane is not reasonably expected to materiallyincrease the productivity, efficiency, strength, quality,or output of the building structure under paragraph(j)(1)(iii) of this section as compared to the conditionof the building structure when it was placed in ser-vice. Therefore, M is not required to treat the amountpaid to add the new membrane as a betterment to thebuilding 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 toreinforce the columns and girders supporting thesecond floor to permit storage of supplies with agross weight 50 percent greater than the previousload-carrying capacity of the storage area. Underparagraphs (e)(2)(ii) and (j)(2)(ii) of this section, anamount is paid to improve a building unit of propertyif the amount is paid for a betterment to the buildingstructure or any building system. The columns andgirders are part of the building structure definedunder paragraph (e)(2)(ii)(A) of this section. N musttreat the amount paid to reinforce the columns andgirders 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 ofthe building structure. Therefore, N must capitalizethis amount as an improvement to the building underparagraphs (d)(1) and (j) of this section.

Example 15. Material increase in capacity; chan-nel. O owns harbor facilities consisting of a slip forthe loading and unloading of barges and a channelleading from the slip to the river. At the time ofpurchase, the channel was 150 feet wide, 1,000 feetlong, and 10 feet deep. Several years after purchasingthe harbor facilities, to allow for ingress and egressand for the unloading of larger barges, O decides todeepen the channel to a depth of 20 feet. O pays acontractor to dredge the channel to 20 feet. Assumethe channel is the unit of property. O must capitalizethe amounts paid for the dredging as an improvementto the channel because they are for a material increasein 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 in Example15, except that the channel was susceptible to silta-tion and, after dredging to 20 feet, the channel depthhad been reduced to 18 feet. O pays a contractor toredredge 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, thedepth 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 notfor a betterment under paragraph (j)(1)(ii) of this sec-tion because they are not for a material addition to, ora material increase in the capacity of, the unit of prop-erty as compared to the condition of the property priorto the siltation. Similarly, these amounts are not for abetterment under paragraph (j)(1)(iii) of this sectionbecause the amounts are not reasonably expected toincrease the productivity, efficiency, strength, quality,or output of the unit of property as compared to thecondition of the property before the siltation. There-fore, O is not required to capitalize these amounts asimprovement under paragraphs (d)(1) and (j) of thissection.

Example 17. Material increase in capacity; chan-nel. Assume the same facts as in Example 16 exceptthat after the redredging, there is more siltation, andthe channel depth is reduced back to 18 feet. In ad-dition, to allow for additional ingress and egress andfor the unloading of even larger barges, O decides todeepen the channel to a depth of 25 feet. O pays acontractor to redredge the channel to 25 feet. O mustcapitalize the amounts paid for the dredging as an im-provement to the channel because the amounts are fora 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 thesiltation. As part of this improvement, O is also re-quired to capitalize the portion of the redredge costsallocable to restoring the depth lost to the siltation be-cause, under paragraph (g)(1)(i) of this section, theseamounts directly benefit and are incurred by reasonof 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 orbusiness. The first floor has a drop-ceiling. To fullyexpose windows on the first floor, P pays an amountto remove the drop-ceiling and repaint the originalceiling. Under paragraphs (e)(2)(ii) and (j)(2)(ii) ofthis 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 asdefined under paragraph (e)(2)(ii)(A) of this section.P is not required to treat the amount paid to removethe drop-ceiling as a betterment to the building be-cause it was not for a material addition or materialincrease in the capacity of the building structure un-der paragraph (j)(1)(ii) of this section and it was notreasonably expected to materially increase to the ef-ficiency, strength, or quality of the building structureunder paragraph (j)(1)(iii) of this section. In addi-tion, under paragraph (j)(2)(i) of this section, becausethe effect on productivity and output of the buildingstructure cannot be measured in this context, thesefactors are not relevant in determining whether thereis a betterment to the building structure.

Example 19. Material increase in capacity;building. Q owns a building that it uses in its retailbusiness. The building contains one floor of retailspace with very high ceilings. Q pays an amount toadd a stairway and a mezzanine for the purposes ofadding 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 unitof property if the amount is paid for a betterment tothe building structure or any building system. Thestairway 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 amountpaid to add the stairway and mezzanine as a bet-terment because it is for a material addition to, andan increase in the capacity of, the building structureunder paragraph (j)(1)(ii) of this section. Therefore,Q must capitalize this amount as an improvement tothe 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 ituses to provide services to customers. The build-ing contains an HVAC system that incorporates10 roof-mounted units that provide heating and airconditioning for different parts of the building. TheHVAC system also consists of controls for the entiresystem and duct work that distributes the heated orcooled 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 invarious offices throughout the office building andconsults with a contractor to determine the cause.The contractor recommends that R replace two ofthe roof-mounted units. R pays an amount to re-place the two specified units. The two new units areexpected to eliminate the climate control problemsand to be 10 percent more energy efficient than thereplaced units in their original condition. No work isperformed on the other roof-mounted heating/cool-ing units, the duct work, or the controls. Underparagraphs (e)(2)(ii) and (j)(2)(ii) of this section, anamount is paid to improve a building unit of propertyif the amount is paid for a betterment to the buildingstructure or any building system. The HVAC system,including the two-roof mounted units, is a buildingsystem under paragraph (e)(2)(ii)(B)(1) of this sec-tion. The replacement of the two roof-mounted unitsis not a material addition to or a material increase inthe capacity of the HVAC system under paragraphs(j)(1)(ii) and (j)(3)(ii) of this section as comparedto the condition of the system prior to the climatecontrol problems. In addition, given the 10 percentefficiency increase in two units of the entire HVACsystem, the replacement is not expected to materiallyincrease 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 comparedto the condition of the system prior to the climatecontrol problems. Therefore, R is not required tocapitalize the amounts paid for these replacementsas betterments to the building unit of property underparagraphs (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 assessmentand determines that it could significantly reduce itsenergy costs by adding insulation to its building. Spays an insulation contractor to apply a combinationof loose-fill, spray foam, and blanket insulationthroughout S’s building structure, including withinthe attic, walls, and crawl spaces. S reasonably ex-pects the new insulation to make the building moreenergy efficient because the contractor indicated thatthe new insulation would reduce its annual energyand power costs by approximately 50 percent ofits annual costs during the last five years. Underparagraphs (e)(2)(ii) and (j)(2)(ii) of this section, anamount is paid to improve a building if the amount ispaid for a betterment to the building structure or any

October 21, 2013 382 2013–43 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 becausethe insulation is reasonably expected to materiallyincrease the efficiency of the building structure underparagraph (j)(1)(iii) of this section.

Example 22. Material addition; building. T ownsand operates a restaurant, which provides a varietyof prepared foods to its customers. To better accom-modate its customers and increase customer traffic,T decides to add a drive-through service area. Asa result, T pays amounts to partition an area withinits restaurant for a drive-through service counter, toconstruct a service window with necessary securityfeatures, to build an overhang for vehicles, and toconstruct a drive-up menu board. Assume that thedrive-up menu board is section 1245 property that isa separate unit of property under paragraph (e)(3) ofthis 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 windowand overhang are betterments to the building struc-ture because they comprise a material addition (thatis, a physical expansion, extension, and addition ofa major component) to the building structure underparagraph (j)(1)(ii) of this section. Accordingly, Tmust capitalize as an improvement the amounts paidto 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 toacquire and install each section 1245 property in ac-cordance with §1.263(a)–2(d)(1).

Example 23. Costs incurred during betterment. Uowns a building that it uses in its service business. Toaccommodate new employees and equipment, U paysamounts to increase the load capacity of its electricalsystem 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, Ualso 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 wiringare for betterments to U’s electrical system becausethey increase the capacity of the electrical system un-der paragraph (j)(1)(ii) of this section and increasethe strength and output of the electrical system un-der paragraph (j)(1)(iii) of this section. Accordingly,U is required to capitalize the costs of the upgrade tothe electrical system as an improvement to the build-ing unit of property under paragraphs (d)(1) and (j) ofthis section. Moreover, under paragraph (g)(1) of thissection, U is required to capitalize the amounts paidto patch holes and repaint several walls in its buildingbecause these costs directly benefit and are incurredby reason of the improvement to U’s building unit ofproperty.

(k) Capitalization of restorations—(1)In general. A taxpayer must capitalize asan improvement an amount paid to restorea unit of property, including an amountpaid to make good the exhaustion for

which an allowance is or has been made.An amount restores a unit of property onlyif 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 thatcomponent, other than a 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 theadjusted basis of the component in realiz-ing gain or loss resulting from the sale orexchange of the component;

(iii) Is for the restoration of damage toa unit of property for which the taxpayeris required to take a basis adjustment as aresult of a casualty loss under section 165,or relating to a casualty event describedin section 165, subject to the limitation inparagraph (k)(4) of this section;

(iv) Returns the unit of property to itsordinarily efficient operating condition ifthe property has deteriorated to a state ofdisrepair and is no longer functional for itsintended use;

(v) Results in the rebuilding of the unitof property to a like-new condition afterthe 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 acombination of parts that comprise a majorcomponent or a substantial structural partof a unit of property (see paragraph (k)(6)of this section).

(2) Application of restorations tobuildings. An amount is paid to im-prove a building if it is paid to restore(as defined under paragraph (k)(1) ofthis section) a property specified underparagraph (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 portionof building) of this section. For example,an amount is paid to improve a buildingif it is paid for the replacement of a partor combination of parts that comprise amajor component or substantial structuralpart of the building structure or any oneof its building systems (for example, theHVAC system). See paragraph (k)(6) ofthis section.

(3) Exception for losses based on sal-vage value. A taxpayer is not required totreat as a restoration amounts paid underparagraph (k)(1)(i) or paragraph (k)(1)(ii)

of this section if the unit of property hasbeen fully depreciated and the loss is at-tributable only to remaining salvage valueas 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 amountpaid for restoration of damage to the unitof property that must be capitalized underthis paragraph (k) is limited to the excess(if any) of—

(A) The amount prescribed by§1.1011–1 as the adjusted basis ofthe single, identifiable property (under§1.167–7(b)(2)(i)) for determining the lossallowable on account of the casualty, over

(B) The amount paid for restorationof damage to the unit of property underparagraph (k)(1)(iii) of this section thatalso constitutes an improvement under anyother provision of paragraph (k)(1) of thissection.

(ii) Amounts in excess of limitation. Theamounts paid for restoration of damage toa 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 inaccordance with the provisions of the In-ternal Revenue Code and regulations thatare otherwise applicable. See, for exam-ple, §1.162–4 (repairs and maintenance);§1.263(a)–2 (costs to acquire and produceunits of property); and §1.263(a)–3 (coststo improve units of property).

(5) Rebuild to like-new condition. Forpurposes of paragraph (k)(1)(v) of thissection, a unit of property is rebuilt to alike-new condition if it is brought to thestatus of new, rebuilt, remanufactured, ora 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 aunit of property to a like-new condition.

(6) Replacement of a major componentor a substantial structural part—(i) Ingeneral. To determine whether an amountis for the replacement of a part or a com-bination of parts that comprise a majorcomponent or a substantial structural partof the unit of property under paragraph(k)(1)(vi) of this section, it is appropriateto consider all the facts and circumstances.These facts and circumstances include thequantitative and qualitative significance of

2013–43 I.R.B. 383 October 21, 2013

the part or combination of parts in relationto the unit of property.

(A) Major component. A major com-ponent is a part or combination of partsthat performs a discrete and critical func-tion in the operation of the unit of prop-erty. An incidental component of the unitof property, even though such componentperforms a discrete and critical function inthe operation of the unit of property, gen-erally will not, by itself, constitute a majorcomponent.

(B) Substantial structural part. A sub-stantial structural part is a part or combina-tion of parts that comprises a large portionof the physical structure of the unit of prop-erty.

(ii) Major components and substantialstructural parts of buildings. In the caseof a building, an amount is for the replace-ment of a major component or a substantialstructural part of the building unit of prop-erty if—

(A) The replacement includes a partor combination of parts that comprise amajor component (as defined in para-graph (k)(6)(i)(A) of this section), or asignificant portion of a major component,of any of the properties designated inparagraph (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 leasedportion of a building) of this section; or

(B) The replacement includes a partor combination of parts that comprisesa large portion of the physical structureof any of the properties designated inparagraph (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 ofbuilding) of this section.

(7) Examples. The following examplesillustrate 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 ofthe 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 basison 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. Aowns a manufacturing building containing varioustypes of manufacturing equipment. A does a cost

segregation study of the manufacturing building andproperly 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 partof the building structure or the HVAC system underparagraph (e)(2)(i) or (e)(2)(ii)(B)(1) of this section.Several components of the walk-in freezer cease tofunction, and A decides to replace them. A abandonsthe old freezer components and properly recognizesa loss from the abandonment of the components. Areplaces the abandoned freezer components with newcomponents and incurs costs to acquire and install thenew components. Under paragraph (k)(1)(i) of thissection, A must capitalize the amounts paid to ac-quire and install the new freezer components becauseA 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 thatA did not abandon the components but instead soldthem to another party and properly recognized a losson the sale. Under paragraph (k)(1)(ii) of this sec-tion, A must capitalize the amounts paid to acquireand install the new freezer components because A re-placed components for which it had properly takeninto account the adjusted basis of the components inrealizing a loss from the sale of the components.

Example 3. Restoration after casualty loss. Bowns an office building that it uses in its trade or busi-ness. A storm damages the office building at a timewhen the building has an adjusted basis of $500,000.B deducts under section 165 a casualty loss in theamount of $50,000, and properly reduces its basis inthe office building to $450,000. B hires a contractorto repair the damage to the building, including the re-pair of the building roof and the removal of debrisfrom the building premises. B pays the contractor$50,000 for the work. Under paragraph (k)(1)(iii) ofthis section, B must treat the $50,000 amount paid tothe contractor as a restoration of the building structurebecause B properly adjusted its basis in that amountas a result of a casualty loss under section 165, and theamount does not exceed the limit in paragraph (k)(4)of this section. Therefore, B must treat the amountpaid as an improvement to the building unit of prop-erty and, under paragraph (d)(2) of this section, mustcapitalize the amount paid.

Example 4. Restoration after casualty event. As-sume the same facts as in Example 3, except that Breceives insurance proceeds of $50,000 after the ca-sualty to compensate for its loss. B cannot deduct acasualty loss under section 165 because its loss wascompensated 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 thissection, B must treat the $50,000 amount paid to thecontractor as a restoration of the building structurebecause 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 treatthe amount paid as an improvement to the buildingunit of property and, under paragraph (d)(2) of thissection, must capitalize the amount paid.

Example 5. Restoration after casualty loss; lim-itation. (i) C owns a building that it uses in its tradeor business. A storm damages the building at a timewhen 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 165in the amount of $500,000, and properly reduces itsbasis in the building to $0. C hires a contractor torepair 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 acost of $350,000 and pumping water from the build-ing, cleaning debris from the interior and exterior, andreplacing areas of damaged dry wall and flooring at acost of $400,000. Although resulting from the casu-alty event, the pumping, cleaning, and replacing dam-aged drywall and flooring, does not directly benefitand 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 $350,000amount paid to the contractor to replace the roofstructure because the roof structure constitutes amajor component and a substantial structural partof the building unit of property. In addition, underparagraphs (k)(1)(iii) and (k)(4)(i), C must treat as arestoration the remaining costs, limited to the excessof the adjusted basis of the building over the amountspaid 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 theportion of the costs related to repairing and cleaningthe building structure under paragraph (k)(1)(iii) ofthis section. Thus, in addition to the $350,000 toreplace the roof structure, C must also capitalize the$150,000 as an improvement to the building unit ofproperty under paragraph (d)(2) of this section. Cis not required to capitalize the remaining $250,000repair and cleaning costs under paragraph (k)(1)(iii)of this section.

Example 6. Restoration of property in a state ofdisrepair. D owns and operates a farm with severalbarns and outbuildings. D did not use or maintain oneof 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 longerbe used for that purpose because the building is notstructurally sound. D decides to restore the outbuild-ing and pays an amount to shore up the walls andreplace the siding. Under paragraphs (e)(2)(ii) and(k)(2) of this section, an amount is paid to improvea building if the amount is paid to restore the build-ing structure or any building system. The walls andsiding 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 amountpaid to shore up the walls and replace the siding asa restoration of the building structure because theamounts return the building structure to its ordinarilyefficient operating condition after it had deterioratedto a state of disrepair and was no longer functional forits intended use. Therefore, D must treat the amountpaid to shore up the walls and replace the siding asan improvement to the building unit of property and,under paragraph (d)(2) of this section, must capitalizethe 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 thefreight cars have a recovery period of 7 years un-der section 168(c) and a class life of 14 years. Ev-ery 8 to 10 years, E rebuilds its freight cars. Tenyears 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, 2013 384 2013–43 I.R.B.

spection, and reconditioning or replacement of com-ponents of the suspension and draft systems, trailerhitches, and other special equipment. E also modi-fies the car to upgrade various components to the lat-est engineering standards. The freight car is strippedto the frame, with all of its substantial componentseither reconditioned or replaced. The frame itselfis the longest-lasting part of the car and is recondi-tioned. The walls of the freight car are replaced orare sandblasted and repainted. New wheels are in-stalled on the car. All the remaining components ofthe car are restored before they are reassembled. Atthe end of the rebuild, the freight car has been restoredto 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 improvementand capitalize the amounts paid to rebuild the freightcar under paragraph (k)(1)(v) of this section because,although the amounts paid restore the freight car tolike-new condition, the amounts were not paid afterthe end of the class life of the freight car. However,see paragraphs (k)(1)(vi) and (k)(6) of this section todetermine whether any amounts must be capitalizedbecause they are paid for the replacement of a majorcomponent or a substantial structural part of the unitof property.

Example 8. Rebuild of property to like-new con-dition after end of class life. Assume the same factsas in Example 7, except that E rebuilds the freightcar 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 rebuildthe freight car because the amounts paid restore thefreight car to like-new condition after the end of theclass 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, Fis required by the FAA to establish and adhere to acontinuous maintenance program for each aircraft inits fleet. F performs heavy maintenance on its air-frames every 8 to 10 years. In Year 1, F purchasedan aircraft for $15 million. In Year 16, F paid $2 mil-lion for the labor and materials necessary to performthe second heavy maintenance visit on the airframeof an aircraft. To perform the heavy maintenancevisit, F extensively disassembles the airframe, remov-ing items such as engines, landing gear, cabin andpassenger compartment seats, side and ceiling pan-els, baggage stowage bins, galleys, lavatories, floorboards, cargo loading systems, and flight control sur-faces. As specified by F’s maintenance manual forthe 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 lubricationand service, operational and visual checks, inspectionand functional checks, reconditioning of minor partsand components, and removal, discard, and replace-ment of certain life-limited single cell parts, such ascartridges, canisters, cylinders, and disks. Recondi-tioning of parts includes burnishing corrosion, repair-ing cracks, dents, gouges, punctures, tightening orreplacing loose or missing fasteners, replacing dam-aged seals, gaskets, or valves, and similar activities.In addition to the tasks described above, to complywith certain FAA airworthiness directives, F inspects

specific skin locations, applies doublers over smallareas where cracks were found, adds structural rein-forcements, and replaces skin panels on a small sec-tion of the fuselage. However, the heavy maintenancedoes not include the replacement of any major com-ponents or substantial structural parts of the aircraftwith new components. In addition, the heavy main-tenance visit does not bring the aircraft to the status ofnew, rebuilt, remanufactured, or a similar status underFAA guidelines or the manufacturer’s original spec-ifications. After the heavy maintenance, the aircraftwas reassembled. Assume the aircraft, including theengines, is a unit of property and has a class life of12 years under section 168(c). Although the heavymaintenance is performed after the end of the classlife of the aircraft, F is not required to treat the heavymaintenance as a restoration and improvement of theunit of property under paragraph (k)(1)(v) of this sec-tion because, although extensive, the amounts paid donot restore the aircraft to like-new condition. See alsoparagraph (i)(1)(iii) of this section for the applicationof the safe harbor for routine maintenance.

Example 10. Replacement of major component orsubstantial structural part; personal property. G is acommon carrier that owns a fleet of petroleum haul-ing trucks. G pays amounts to replace the existingengine, cab, and petroleum tank with a new engine,cab, and tank. Assume the tractor of the truck (whichincludes the cab and the engine) is a single unit ofproperty and that the trailer (which contains the pe-troleum tank) is a separate unit of property. The newengine and the cab each constitute a part or combi-nation of parts that comprise a major component ofG’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 ofparts that comprise a substantial structural part of G’stractor. Therefore, the amounts paid for the replace-ment of the engine and the cab must be capitalizedunder 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 asubstantial structural part of the trailer. Accordingly,the amounts paid for the replacement of the tank alsomust be capitalized under paragraph (k)(1)(vi) of thissection.

Example 11. Repair performed during restora-tion. Assume the same facts as in Example 10, exceptthat, at the same time the engine and cab of the tractorare replaced, G pays amounts to paint the cab of thetractor with its company logo and to fix a broken tail-light on the tractor. The repair of the broken taillightand the painting of the cab generally are deductibleexpenses under §1.162–4. However, under paragraph(g)(1)(i) of this section, a taxpayer must capitalize allthe direct costs of an improvement and all the indirectcosts that directly benefit or are incurred by reasonof an improvement. Repairs and maintenance that donot directly benefit or are not incurred by reason of animprovement are not required to be capitalized undersection 263(a), regardless of whether they are madeat the same time as an improvement. For the amountspaid to paint the logo on the cab, G’s need to paint thelogo arose from the replacement of the cab with a newcab. Therefore, under paragraph (g)(1)(i) of this sec-tion, G must capitalize the amounts paid to paint thecab as part of the improvement to the tractor becausethese amounts directly benefit and are incurred byreason 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 replacementof the cab or the engine under paragraph (g)(1)(i) ofthis section, even though the repair was performed atthe same time as these replacements. Thus, G is notrequired to capitalize the amounts paid to repair thebroken taillight.

Example 12. Related amounts to replace majorcomponent or substantial structural part; personalproperty. (i) H owns a retail gasoline station, consist-ing of a paved area used for automobile access to thepumps and parking areas, a building used to marketgasoline, and a canopy covering the gasoline pumps.The premises also consist of underground storagetanks (USTs) that are connected by piping to thepumps and are part of the gasoline pumping systemused in the immediate retail sale of gas. The USTsare components of the gasoline pumping system. Tocomply with regulations issued by the Environmen-tal Protection Agency, H is required to remove andreplace leaking USTs. In Year 1, H hires a contrac-tor to perform the removal and replacement, whichconsists of removing the old tanks and installing newtanks with leak detection systems. The removal ofthe old tanks includes removing the paving materialcovering the tanks, excavating a hole large enoughto gain access to the old tanks, disconnecting anystrapping and pipe connections to the old tanks, andlifting the old tanks out of the hole. Installation ofthe new tanks includes placement of a liner in theexcavated hole, placement of the new tanks, instal-lation of a leak detection system, installation of anoverfill system, connection of the tanks to the pipesleading to the pumps, backfilling of the hole, andreplacement of the paving. H also is required to pay apermit fee to the county to undertake the installationof the new tanks.

(ii) H pays the permit fee to the county on October15, Year 1. On December 15, Year 1, the contractorcompletes the removal of the old USTs and bills Hfor the costs of removal. On January 15, Year 2, thecontractor completes the installation of the new USTsand bills H for the remainder of the work. Assumethat H computes its taxes on a calendar year basisand H’s gasoline pumping system is the unit of prop-erty. Under paragraph (k)(1)(vi) of this section, Hmust capitalize the amounts paid to replace the USTsas a restoration to the gasoline pumping system be-cause the USTs are parts or combinations of parts thatcomprise 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 Hhas not taken a loss on the disposition of the USTs,and the amounts to remove the USTs directly benefitand are incurred by reason of the restoration of, andimprovement to, the gasoline pumping system. In ad-dition, under paragraph (g)(1) of this section, H mustcapitalize the permit fees because they directly ben-efit and are incurred by reason of the improvementto 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 pumpingsystem, including the permit fees, the amount paid toremove the old USTs, and the amount paid to installthe new USTs, even though the amounts were sepa-rately invoiced, paid to different parties, and incurredin different tax years.

2013–43 I.R.B. 385 October 21, 2013

Example 13. Not replacement of major compo-nent; incidental. J owns a machine shop in which itmakes 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 tothe drill press, has become damaged and cannot op-erate. To correct this problem, J pays amounts toreplace the power switch assembly with comparableand commercially available replacement parts. As-sume that the drill press is a unit of property underparagraph (e) of this section and the power switch as-sembly is a small component of the drill press thatmay be removed and installed with relative ease. Thepower switch assembly is not a major component ofthe unit of property under paragraph (k)(6)(i)(A) ofthis section because, although the power assemblymay affect the function of J’s drill press by control-ling the supply of electric power, the power assemblyis an incidental component of the drill press. In addi-tion, the power assembly is not a substantial structuralpart of J’s drill press under paragraph (k)(6)(i)(B) ofthis section. Therefore, J is not required to capitalizethe costs to replace the power switch assembly underparagraph (k)(1)(vi) of this section.

Example 14. Replacement of major componentor substantial structural part; roof. K owns a man-ufacturing building. K discovers several leaks in theroof of the building and hires a contractor to inspectand fix the roof. The contractor discovers that a ma-jor portion of the decking has rotted and recommendsthe 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, anamount is paid to improve a building if the amount ispaid to restore the building structure or any buildingsystem. The roof is part of the building structure asdefined 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 structureunder paragraph (k)(6)(ii)(A) of this section. In addi-tion, because the roof comprises a large portion of thephysical structure of the building structure, the roofcomprises 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 treatthe amount paid to replace the roof as a restoration ofthe building under paragraphs (k)(1)(vi) and (k)(2) ofthis section and must capitalize the amount paid as animprovement 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 coveredwith a waterproof rubber membrane. Over time, therubber membrane begins to wear, and L begins to ex-perience leaks into its retail premises. However, thebuilding is still functioning in L’s business. To elim-inate the problems, a contractor recommends that Lreplace the membrane on the roof with a new rub-ber membrane. Accordingly, L pays the contractor tostrip the original membrane and replace it with a newrubber membrane. The new membrane is compara-ble to the original membrane but corrects the leakageproblems. Under paragraphs (e)(2)(ii) and (k)(2) ofthis 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 themembrane, is part of the building structure as definedunder paragraph (e)(2)(ii)(A) of this section. Be-cause the entire roof performs a discrete and criticalfunction in the building structure, the roof comprisesa major component of the building structure underparagraph (k)(6)(ii)(A) of this section. Although thereplacement membrane may aid in the function of thebuilding structure, it does not, by itself, comprise asignificant 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 asubstantial 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 buildingunder 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 officethat provides medical services. The building con-tains one HVAC system, which is comprised of threefurnaces, three air conditioning units, and duct workthat runs throughout the building to distribute the hotor cold air throughout the building. One furnace inM’s building breaks down, and M pays an amountto replace it with a new furnace. Under paragraphs(e)(2)(ii) and (k)(2) of this section, an amount is paidto improve a building if the amount is paid to restorethe building structure or any building system. TheHVAC system, including the furnaces, is a buildingsystem under paragraph (e)(2)(ii)(B)(1) of this sec-tion. As the parts that provide the heating functionin the system, the three furnaces, together, perform adiscrete and critical function in the operation of theHVAC system and are therefore a major componentof the HVAC system under paragraph (k)(6)(i)(A) ofthis section. However, the single furnace is not a sig-nificant portion of this major component of the HVACsystem under paragraph (k)(6)(ii)(A) of this section,or a substantial structural part of the HVAC systemunder 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 underparagraph (k)(1)(vi) of this section.

Example 17. Replacement of major component orsubstantial structural part; HVAC system. N owns alarge office building in which it provides consultingservices. The building contains one HVAC system,which is comprised of one chiller unit, one boiler,pumps, duct work, diffusers, air handlers, outside airintake, and a cooling tower. The chiller unit includesthe compressor, evaporator, condenser, and expan-sion valve, and it functions to cool the water used togenerate air conditioning throughout the building. Npays an amount to replace the chiller with a compa-rable unit. Under paragraphs (e)(2)(ii) and (k)(2) ofthis section, an amount is paid to improve a buildingif the amount is paid to restore the building structureor 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 unitperforms 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, thechiller 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 componentof a building system, N must treat the amount paid to

replace the chiller unit as a restoration to the buildingunder paragraphs (k)(1)(vi) and (k)(2) of this sectionand must capitalize the amount paid as an improve-ment to the building under paragraph (d)(2) of thissection.

Example 18. Not replacement of major compo-nent or substantial structural part; HVAC system. Oowns an office building that it uses to provide ser-vices to customers. The building contains a HVACsystem that incorporates ten roof-mounted units thatprovide 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 heatedor cooled air to the various spaces in the building’sinterior. O begins to experience climate control prob-lems in various offices throughout the office buildingand consults with a contractor to determine the cause.The contractor recommends that O replace three ofthe roof-mounted heating and cooling units. O paysan amount to replace the three specified units. Nowork is performed on the other roof-mounted heatingand cooling units, the duct work, or the controls. Un-der paragraphs (e)(2)(ii) and (k)(2) of this section, anamount 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-mountedheating and cooling units, is a building system un-der paragraph (e)(2)(ii)(B)(1) of this section. As thecomponents that generate the heat and the air con-ditioning in the HVAC system, the 10 roof-mountedunits, together, perform a discrete and critical func-tion in the operation of the HVAC system and, there-fore, are a major component of the HVAC system un-der paragraph (k)(6)(ii)(A) of this section. The threeroof-mounted heating and cooling units are not a sig-nificant portion of a major component of the HVACsystem under (k)(6)(ii)(A) of this section, or a sub-stantial structural part of the HVAC system, underparagraph (k)(6)(ii)(B) of this section. Accordingly,O is not required to treat the amount paid to replacethe three roof-mounted heating and cooling units as arestoration of the building under paragraph (k)(1)(iv)of this section.

Example 19. Replacement of major component orsubstantial structural part; fire protection system. Powns a building that it uses to operate its business. Ppays an amount to replace the sprinkler system in thebuilding with a new sprinkler system. Under para-graphs (e)(2)(ii) and (k)(2) of this section, an amountis paid to improve a building if the amount restoresthe building structure or any building system. Thefire 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 thatprovides the fire suppression mechanism in the sys-tem, the sprinkler system performs a discrete and crit-ical function in the operation of the fire protectionand alarm system and is therefore a major compo-nent of the system under paragraph (k)(6)(ii)(A) ofthis section. Because the sprinkler system comprisesa major component of a building system, P must treatthe amount paid to replace the sprinkler system asrestoration to the building unit of property under para-graphs (k)(1)(vi) and (k)(2) of this section and mustcapitalize the amount paid as an improvement to thebuilding under paragraph (d)(2) of this section.

Example 20. Replacement of major componentor substantial structural part; electrical system. Qowns a building that it uses to operate its business. Q

October 21, 2013 386 2013–43 I.R.B.

pays an amount to replace the wiring throughout thebuilding with new wiring that meets building code re-quirements. Under paragraphs (e)(2)(ii) and (k)(2) ofthis section, an amount is paid to improve a build-ing if the amount restores the building structure orany 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 componentthat distributes the electricity throughout the system,the wiring performs a discrete and critical functionin the operation of the electrical system under para-graph (k)(6)(ii)(A) of this section. The wiring alsocomprises a large portion of the physical structure ofthe electrical system under paragraph (k)(6)(ii)(B) ofthis section. Because the wiring comprises a majorcomponent and a substantial structural part of a build-ing system, Q must treat the amount paid to replacethe wiring as a restoration to the building under para-graphs (k)(1)(vi) and (k)(2) of this section and mustcapitalize the amount paid as an improvement to thebuilding 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 itsbusiness. R pays an amount to replace 30 percent ofthe wiring throughout the building with new wiringthat meets building code requirements. Under para-graphs (e)(2)(ii) and (k)(2) of this section, an amountis paid to improve a building if the amount restoresthe building structure or any building system. Theelectrical system, including the wiring, is a buildingsystem under paragraph (e)(2)(ii)(B)(3) of this sec-tion. All the wiring in the building comprises a majorcomponent because it performs a discrete and criti-cal function in the operation of the electrical system.However, the portion of the wiring that was replacedis 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 ofthe electrical system under paragraph (k)(6)(ii)(B) ofthis section. Therefore, under paragraph (k)(6) of thissection, the replacement of 30 percent of the wiringis 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 percentof the wiring as a restoration to the building underparagraph (k)(1)(iv) of this section.

Example 22. Replacement of major componentor substantial structural part; plumbing system. Sowns 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 ontwo 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 thetoilets and sinks, with modern style plumbing fixturesof similar quality and function. S does not replace thepipes connecting the fixtures to the building’s plumb-ing system. Under paragraphs (e)(2)(ii) and (k)(2) ofthis section, an amount is paid to improve a buildingif the amount restores the building structure or anybuilding system. The plumbing system, including theplumbing fixtures, is a building system under para-graph (e)(2)(ii)(B)(2) of this section. All the toiletstogether perform a discrete and critical function in theoperation of the plumbing system, and all the sinks,together, also perform a discrete and critical functionin 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 plumbingsystem, and all the sinks comprise a major componentof the plumbing system. Accordingly, S must treatthe amount paid to replace all of the toilets and all ofthe sinks as a restoration of the building under para-graphs (k)(1)(vi) and (k)(2) of this section and mustcapitalize the amount paid as an improvement to thebuilding 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 22 except that Sdoes not update all the bathroom fixtures. Instead,S only pays an amount to replace 8 of the total of20 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 ofthe physical structure of the plumbing system underparagraph (k)(6)(ii)(B) of this section. Therefore, un-der paragraph (k)(6) of this section, the replacementof the eight sinks does not constitute the replacementof a major component or substantial structural part ofthe building, and S is not required to treat the amountpaid to replace the eight sinks as a restoration of abuilding under paragraph (k)(1)(iv) of this section.

Example 24. Replacement of major componentor substantial structural part; plumbing system. (i) Towns and operates a hotel building. T decides that, toattract customers and to remain competitive, it needsto update the guest rooms in its facility. Accordingly,T pays amounts to replace the bathtubs, toilets, andsinks, and to repair, repaint, and retile the bathroomwalls 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 adifferent style, but are similar in function and qualityto the replaced items. T also pays amounts to replacecertain section 1245 property, such as the guest roomfurniture, carpeting, drapes, table lamps, and parti-tion walls separating the bathroom area. T completesthis work on two floors at a time, closing those floorsand leaving the rest of the hotel open for business. InYear 1, T pays amounts to perform the updates for 4of the 20 hotel room floors and expects to completethe renovation of the remaining rooms over the nexttwo years.

(ii) Under paragraphs (e)(2)(ii) and (k)(2) of thissection, an amount is paid to improve a buildingif the amount restores the building structure or anybuilding system. The plumbing system, includingthe bathtubs, toilets, and sinks, is a building systemunder paragraph (e)(2)(ii)(B)(2) of this section. Allthe bathtubs, together, all the toilets, together, andall the sinks together in the hotel building performdiscrete and critical functions in the operation ofthe plumbing system under paragraph (k)(6)(ii)(A)of this section and comprise a large portion of thephysical structure of the plumbing system under para-graph (k)(6)(ii)(B) of this section. Therefore, underparagraph (k)(6)(ii) of this section, these plumbingcomponents comprise major components and sub-stantial structural parts of the plumbing system, and Tmust treat the amount paid to replace these plumbingcomponents 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 directlybenefit 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 inYears 1, 2, and 3 for the bathroom remodeling asimprovement costs, even though they are incurredover a period of several taxable years, because theyare related amounts paid to improve the building unitof property. Accordingly, under paragraph (d)(2) ofthis section, T must treat all the amounts it incursto update its hotel restrooms as an improvementto 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 andinstall each section 1245 property.

Example 25. Not replacement of major compo-nent or substantial structural part; windows. U ownsa large office building that it uses to provide officespace for employees that manage U’s operations. Thebuilding has 300 exterior windows that represent 25percent of the total surface area of the building. InYear 1, U pays an amount to replace 100 of the ex-terior windows that had become damaged. At thetime of these replacements, U has no plans to replaceany other windows in the near future. Under para-graphs (e)(2)(ii) and (k)(2) of this section, an amountis paid to improve a building if the amount restoresthe building structure or any building system. Theexterior windows are part of the building structure asdefined 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 structureand are, therefore, a major component of the buildingstructure 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 buildingstructure under paragraph (k)(6)(ii)(B) of this section.Therefore, under paragraph (k)(6) of this section, thereplacement of the 100 windows does not constitutethe replacement of a major component or substantialstructural part of the building, and U is not required totreat the amount paid to replace the 100 windows asrestoration of the building under paragraph (k)(1)(iv)of this section.

Example 26. Replacement of major component;windows. Assume the same facts as Example 25,except that that U replaces 200 of the 300 windowson the building. The 300 exterior windows performa discrete and critical function in the operation ofthe building structure and are, therefore, a majorcomponent 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 ofthe building structure under paragraph (k)(6)(ii)(A)of this section. Therefore, under paragraph (k)(6)of this section, the replacement of the 200 windowscomprise the replacement of a major component ofthe building structure. Accordingly, U must treat theamount 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 amountpaid 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 as Ex-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. 387 October 21, 2013

total surface area of the building. U replaces 100of 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. The100 windows do not comprise a significant portion ofthis major component of the building structure underparagraph (k)(6)(ii)(A) of this section, however, theydo 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 comprisethe replacement of a substantial structural part of thebuilding structure. Accordingly, U must treat theamount 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 buildingunder paragraph (d)(2) of this section.

Example 28. Not replacement of major compo-nent or substantial structural part; floors. V ownsand operates a hotel building. V decides to refresh theappearance of the hotel lobby by replacing the floorsin the lobby. The hotel lobby comprises less than 10percent of the square footage of the entire hotel build-ing. V pays an amount to replace the wood flooring inthe 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 abuilding if the amount restores the building structureor any building system. The wood flooring is part ofthe building structure under paragraph (e)(2)(ii)(A) ofthis 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 inthe operation of the building structure. However, thelobby floors are not a significant portion of a majorcomponent (that is, all the floors) under paragraph(k)(6)(ii)(A) of this section, nor do the lobby floorscomprise a substantial structural part of the buildingstructure under paragraph (k)(6)(ii)(B) of this section.Therefore, under paragraph (k)(6) of this section, thereplacement of the lobby floors is not the replacementof a major component or substantial structural part ofthe building unit of property, and V is not required totreat the amount paid for the replacement of the lobbyfloors as a restoration to the building under paragraph(k)(1)(iv) of this section.

Example 29. Replacement of major componentor substantial structural part; floors. Assume thesame facts as Example 28, except that V decides torefresh the appearance of all the public areas of thehotel building by replacing all the floors in the pub-lic areas. To that end, V pays an amount to replaceall the wood floors in all the public areas of the ho-tel building with new wood floors. The public areasinclude the lobby, the hallways, the meeting rooms,the ballrooms, and other public rooms throughout thehotel interiors. The public areas comprise approxi-mately 40 percent of the square footage of the entirehotel building. All the floors in the hotel buildingcomprise a major component of the building struc-ture because they perform a discrete and critical func-tion in the operation of the building structure. Thefloors in all the public areas of the hotel comprise asignificant 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, thereplacement of all the public area floors constitutesthe replacement of a major component of the build-ing structure. Accordingly, V must treat the amountpaid 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 buildingunder 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 theelevators. The elevator is a structural component ofthe office building. X chooses to apply Prop. Reg.§1.168(i)–8 to taxable years beginning on or afterJanuary 1, 2012, and before the applicability date ofthe final regulations. In accordance with Prop. Reg.§1.168(i)–8(c)(4)(ii)(A) (September 19, 2013), theoffice building (including its structural components)is the asset for tax disposition purposes. X does nottreat 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 elevatoris not a disposition under section 168, and no loss istaken into account for purposes of paragraph (k)(1)(i)of this section.

(ii) Under paragraphs (e)(2)(ii) and (k)(2) of thissection, an amount is paid to improve a buildingif the amount restores the building structure or anybuilding system. The elevator system, including allfour elevators, is a building system under paragraph(e)(2)(ii)(B)(5) of this section. The replacementelevator does not perform a discrete and criticalfunction in the operation of elevator system underparagraph (k)(6)(ii)(A) of this section nor does itcomprise a large portion of the physical structure ofthe elevator system under paragraph (k)(6)(ii)(B) ofthis section. Therefore, under paragraph (k)(6) of thissection, the replacement elevator does not constitutethe replacement of a major component or substantialstructural part of the elevator system. Accordingly,X is not required to treat the amount paid to replacethe elevator as a restoration to the building undereither paragraph (k)(1)(i) or paragraph (k)(1)(vi) ofthis section.

Example 31. Replacement with disposition. Thefacts are the same as in Example 30, except X makesthe 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 assetfor disposition purposes, the result of X making thepartial disposition election for the elevator is that theretirement of the replaced elevator is a disposition.Thus, depreciation for the retired elevator ceases atthe time of its retirement (taking into account theapplicable convention), and X recognizes a loss uponthis retirement. Accordingly, X must treat the amountpaid to replace the elevator as a restoration of thebuilding under paragraphs (k)(1)(i) and (k)(2) of thissection and must capitalize the amount paid as an im-provement to the building under paragraph (d)(2) ofthis section. In addition, the replacement elevator istreated as a separate asset for tax disposition purposespursuant to Prop. Reg. §1.168(i)–8(c)(4)(ii)(D)

(September 19, 2013), and for depreciation purposespursuant to section 168(i)(6).

(l) Capitalization of amounts to adaptproperty to a new or different use—(1) Ingeneral. A taxpayer must capitalize as animprovement an amount paid to adapt aunit of property to a new or different use.In general, an amount is paid to adapt a unitof property to a new or different use if theadaptation is not consistent with the tax-payer’s ordinary use of the unit of propertyat the time originally placed in service bythe taxpayer.

(2) Application of adaption rule tobuildings. In the case of a building, anamount is paid to improve a buildingif it is paid to adapt to a new or dif-ferent use a property specified underparagraph (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 leasedportion of building) of this section. Forexample, an amount is paid to improve abuilding if it is paid to adapt the buildingstructure or any one of its buildings sys-tems to a new or different use.

(3) Examples. The following examplesillustrate the application of this paragraph(l) only and do not address whether capital-ization is required under another provisionof this section or under another provisionof the Code (for example, section 263A).Unless otherwise stated, assume that thetaxpayer has not properly deducted a lossfor any unit of property, asset, or compo-nent of a unit of property that is removedand 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 sinceYear 1, when A placed it in service. In Year 30, Apays an amount to convert its manufacturing buildinginto 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 showroomand 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 ordifferent use. Under paragraph (l)(1) of this section,the amount paid to convert the manufacturing build-ing into a showroom adapts the building structure toa new or different use because the conversion to ashowroom is not consistent with A’s ordinary use ofthe building structure at the time it was placed in ser-vice. Therefore, A must capitalize the amount paid toconvert the building into a showroom as an improve-

October 21, 2013 388 2013–43 I.R.B.

ment to the building under paragraphs (d)(3) and (l)of this section.

Example 2. Not a new or different use; leasedbuilding. B owns and leases out space in a buildingconsisting of twenty retail spaces. The space was de-signed to be reconfigured; that is, adjoining spacescould be combined into one space. One of the tenantsexpands its occupancy by leasing two adjoining retailspaces. To facilitate the new lease, B pays an amountto remove the walls between the three retail spaces.Assume that the walls between spaces are part of thebuilding and its structural components. Under para-graphs (l)(2) and (e)(2)(ii) of this section, an amountis paid to improve B’s building if it adapts the build-ing structure or any of the building systems to a newor different use. Under paragraph (l)(1) of this sec-tion, the amount paid to convert three retail spacesinto one larger space for an existing tenant does notadapt B’s building structure to a new or different usebecause the combination of retail spaces is consistentwith B’s intended, ordinary use of the building struc-ture. Therefore, the amount paid by B to remove thewalls does not improve the building under paragraph(l) of this section and is not required to be capitalizedunder paragraph (d)(3) of this section.

Example 3. Not a new or different use; prepar-ing building for sale. C owns a building consisting oftwenty retail spaces. C decides to sell the building. Inanticipation of selling the building, C pays an amountto repaint the interior walls and to refinish the hard-wood floors. Under paragraphs (l)(2) and (e)(2)(ii) ofthis 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 newor different use. Preparing the building for sale doesnot 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 buildingunder paragraph (l) of this section and is not requiredto be capitalized under paragraph (d)(3) of this sec-tion.

Example 4. New or different use; land. D owns aparcel of land on which it previously operated a man-ufacturing facility. Assume that the land is the unitof property. During the course of D’s operation ofthe manufacturing facility, the land became contami-nated with wastes from its manufacturing processes.D discontinues manufacturing operations at the siteand decides to develop the property for residentialhousing. 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 itcan be used for residential purposes. Amounts that Dpays to clean up wastes do not adapt the land to a newor different use, regardless of the extent to which theland was cleaned, because this cleanup merely returnsthe land to the condition it was in before the land wascontaminated in D’s operations. Therefore, D is notrequired to capitalize the amount paid for the cleanupunder paragraph (l)(1) of this section. However, theamount paid to regrade the land so that it can be usedfor residential purposes adapts the land to a new ordifferent use that is inconsistent with D’s intended or-dinary use of the property at the time it was placed inservice. Accordingly, the amounts paid to regrade theland must be capitalized as improvements to the landunder 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 forfilling medication prescriptions and various depart-ments where customers can purchase food, toiletries,home goods, school supplies, cards, over-the-countermedications, and other similar items. E decides tocreate a walk-in medical clinic where nurse practi-tioners and physicians’ assistants diagnose, treat, andwrite prescriptions for common illnesses and injuries,administer common vaccinations, conduct physicalsand wellness screenings, and provide routine lab testsand 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 wallscreating an examination room, lab room, receptionarea, and waiting area. E installs additional plumb-ing, electrical wiring, and outlets to support the lab. Ealso acquires section 1245 property, such as comput-ers, furniture, and equipment necessary for the newclinic. E treats the amounts paid for those units ofproperty as costs of acquiring new units of propertyunder §1.263(a)–2.

(ii) Under paragraphs (l)(2) and (e)(2)(ii) of thissection, an amount is paid to improve E’s building ifit adapts the building structure or any of the buildingsystems to a new or different use. Under paragraph(l)(1) of this section, the amount paid to convert partof the retail drug store building structure into a med-ical clinic adapts the building structure to a new anddifferent use, because the use of the building structureto provide clinical medical services is not consistentwith 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 andthe electrical systems to support the new medical ser-vices is not consistent with E’s intended ordinary useof these systems when the systems were placed in ser-vice. Therefore, E must treat the amount paid for theconversion of the building structure, plumbing sys-tem, and electrical system as an improvement to thebuilding and capitalize the amount under paragraphs(d)(3) and (l) of this section.

Example 6. Not a new or different use; part ofbuilding. (i) F owns a building in which it operatesa grocery store. The grocery store includes variousdepartments for fresh produce, frozen foods, freshmeats, dairy products, toiletries, and over-the-countermedicines. The grocery store also includes separatecounters for deli meats, prepared foods, and bakedgoods, often made to order. To better accommodateits customers’ shopping needs, F decides to add asushi bar where customers can order freshly preparedsushi from the counter for take-home or to eat at thecounter. To create the sushi bar, F pays amounts toadd a sushi counter and chairs, add additional wiringand 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 replaceflooring and wall coverings in the sushi bar area withdecorative coverings to reflect more appropriate dé-cor. Assume the sushi counter and chairs are section1245 property, and F treats the amounts paid for thoseunits of property as costs of acquiring new units ofproperty under §1.263(a)–2.

(ii) Under paragraphs (l)(2) and (e)(2)(ii) of thissection, an amount is paid to improve F’s building ifit adapts the building structure or any of the buildingsystems to a new or different use. Under paragraph

(l)(1) of this section, the amount paid to convert apart of F’s retail grocery into a sushi bar area doesnot adapt F’s building structure, plumbing system, orelectrical system to a new or different use, becausethe sale of sushi is consistent with F’s intended, ordi-nary use of the building structure and these systemsin its grocery sales business, which includes sellingfood to its customers at various specialized counters.Accordingly, the amount paid by F to replace the walland floor finishes, add wiring, and add plumbing tocreate the sushi bar space does not improve the build-ing unit of property under paragraph (l) of this sectionand is not required to be capitalized under paragraph(d)(3) of this section.

Example 7. Not a new or different use; part ofbuilding. (i) G owns a hospital with various depart-ments dedicated to the provision of clinical medicalcare. To better accommodate its patients’ needs, Gdecides to modify the emergency room space to pro-vide both emergency care and outpatient surgery. Tomodify the space, G pays amounts to move interiorwalls, add additional wiring and outlets, replace floortiles and doors, and repaint the walls. To complete theoutpatient surgery center, G also pays amounts to in-stall miscellaneous medical equipment necessary forthe provision of surgical services. Assume the med-ical equipment is section 1245 property, and G treatsthe amounts paid for those units of property as costsof acquiring new units of property under §1.263(a)–2.

(ii) Under paragraphs (l)(2) and (e)(2)(ii) of thissection, an amount is paid to improve G’s buildingif 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 outpatientsurgery center does not adapt G’s building structureor electrical system to a new or different use, becausethe provision of outpatient surgery is consistent withG’s intended, ordinary use of the building structureand these systems in its clinical medical care busi-ness. Accordingly, the amounts paid by G to relocateinterior walls, add additional wiring and outlets, re-place floor tiles and doors, and repaint the walls tocreate outpatient surgery space do not improve thebuilding under paragraph (l) of this section and arenot required to be capitalized under paragraph (d)(3)of this section.

(m) Optional regulatory accountingmethod—(1) In general. This para-graph (m) provides an optional simpli-fied method (the regulatory accountingmethod) for regulated taxpayers to de-termine whether amounts paid to repair,maintain, or improve tangible propertyare to be treated as deductible expensesor capital expenditures. A taxpayer thatuses the regulatory accounting method de-scribed in paragraph (m)(3) of this sectionmust use that method for property subjectto regulatory accounting instead of deter-mining whether amounts paid to repair,maintain, or improve property are capi-tal expenditures or deductible expensesunder the general principles of sections162(a), 212, and 263(a). Thus, the capi-

2013–43 I.R.B. 389 October 21, 2013

talization rules in paragraph (d) (and theroutine maintenance safe harbor describedin paragraph (i)) of this section do notapply to amounts paid to repair, maintain,or improve property subject to regula-tory accounting by taxpayers that use theregulatory accounting method under thisparagraph (m).

(2) Eligibility for regulatory account-ing method. A taxpayer that is engagedin a trade or business in a regulated in-dustry is a regulated taxpayer and mayuse the regulatory accounting method un-der this paragraph (m). For purposes ofthis paragraph (m), a taxpayer is in a reg-ulated industry only if the taxpayer is sub-ject to the regulatory accounting rules ofthe Federal Energy Regulatory Commis-sion (FERC), the Federal CommunicationsCommission (FCC), or the Surface Trans-portation Board (STB).

(3) Description of regulatory account-ing method. Under the regulatory ac-counting method, a taxpayer must followthe method of accounting for regulatoryaccounting purposes that it is required tofollow for FERC, FCC, or STB (whicheveris applicable) in determining whether anamount paid repairs, maintains, or im-proves property under this section. There-fore, a taxpayer must capitalize for Federalincome tax purposes an amount paid thatis capitalized as an improvement for reg-ulatory accounting purposes. A taxpayermay not capitalize for Federal income taxpurposes under this section an amountpaid 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 forall of its tangible property that is subject toregulatory accounting rules. The methoddoes not apply to tangible property thatis not subject to regulatory accountingrules. The method also does not apply toproperty for the taxable years in whichthe taxpayer elected to apply the repairallowance under §1.167(a)–11(d)(2). Theregulatory accounting method is a methodof accounting under section 446(a).

(4) Examples. The following examplesillustrate 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 totransmit and distribute the electricity to its customers.

W is subject to the regulatory accounting rules ofFERC, and W uses the regulatory accounting methodunder 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. Underthe regulatory accounting method, W may not capi-talize for Federal income tax purposes amounts paidfor repairs performed on its turbines or its networkassets.

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 regulatory accounting method pro-vided in this paragraph (m).

Example 3. Taxpayer subject to regulatory ac-counting rules of FCC. Y is a telecommunicationscompany that is subject to the regulatory accountingrules of the FCC. Y uses the regulatory accountingmethod under this paragraph (m). Y’s assets includea telephone central office switching center, whichcontains numerous switches and various switchingequipment. Y capitalizes on its books and records forregulatory accounting purposes the cost of replac-ing each switch. Under the regulatory accountingmethod, Y is required to capitalize for Federal in-come tax purposes amounts paid to replace eachswitch.

Example 4. Taxpayer subject to regulatory ac-counting rules of STB. Z is a Class I railroad thatis subject to the regulatory accounting rules of theSTB. Z uses the regulatory accounting method un-der this paragraph (m). Z capitalizes on its books andrecords for regulatory accounting purposes the cost oflocomotive 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 andmaintenance costs—(1) In general. Ataxpayer may elect to treat amounts paidduring the taxable year for repair andmaintenance (as defined under §1.162–4)to tangible property as amounts paid toimprove that property under this sectionand as an asset subject to the allowance fordepreciation if the taxpayer incurs theseamounts in carrying on the taxpayer’strade or business and if the taxpayer treatsthese amounts as capital expenditures onits books and records regularly used incomputing income (“books and records”).A taxpayer that elects to apply this para-graph (n) in a taxable year must applythis paragraph to all amounts paid for re-pair and maintenance to tangible propertythat it treats as capital expenditures on itsbooks and records in that taxable year.Any amounts for which this election ismade shall not be treated as amounts paidfor repair or maintenance under §1.162–4.

(2) Time and manner of election. Ataxpayer makes this election under thisparagraph (n) by attaching a statement tothe taxpayer’s timely filed original Federaltax return (including extensions) for thetaxable year in which the taxpayer paysamounts described under paragraph (n)(1)of this paragraph. See §§301.9100–1through 301.9100–3 of this chapter for theprovisions governing extensions of timeto 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 makingthe election to capitalize repair and main-tenance costs under §1.263(a)–3(n). In thecase of a consolidated group filing a con-solidated income tax return, the electionis made for each member of the consoli-dated group by the common parent, andthe statement must also include the namesand taxpayer identification numbers ofeach member for which the election ismade. In the case of an S corporation or apartnership, the election is made by the Scorporation or partnership and not by theshareholders or partners. A taxpayer mak-ing this election for a taxable year musttreat any amounts paid for repairs andmaintenance during the taxable year thatare capitalized on the taxpayer’s booksand records as improvements to tangibleproperty. The taxpayer must begin to de-preciate the cost of such improvementsamounts when they are placed in serviceby the taxpayer under the applicable pro-visions of the Code and regulations. Anelection may not be made through thefiling of an application for change in ac-counting method or, before obtaining theCommissioner’s consent to make a lateelection, by filing an amended Federal taxreturn. The time and manner of electingto capitalize repair and maintenance costsunder this paragraph (n) may be modifiedthrough guidance of general applicability(see §§601.601(d)(2) and 601.602 of thischapter).

(3) Exception. This paragraph (n) doesnot apply to amounts paid for repairsor maintenance of rotable or temporaryspare parts to which the taxpayer appliesthe optional method of accounting forrotable and temporary spare parts under§1.162–3(e).

October 21, 2013 390 2013–43 I.R.B.

(4) Examples. The following examplesillustrate the application of this paragraph(n):

Example 1. Election to capitalize routine main-tenance on non-rotable part. (i) Q is a towboat op-erator that owns a fleet of towboats that it uses inits trade or business. Each towboat is equipped withtwo diesel-powered engines. Assume that each tow-boat, including its engines, is the unit of property andthat a towboat has a class life of 18 years. Assumethe 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 intoservice. 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 onQ’s towboat is within the routine maintenance safeharbor 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 deemednot to improve the towboat and are not required to becapitalized under paragraph (d) of this section.

(ii) On its books and records, Q treats amountspaid for scheduled maintenance on its towboat en-gines as capital expenditures. For administrative con-venience, Q decides to account for these costs in thesame way for Federal income tax purposes. Underparagraph (n) of this section, in Year 4, Q may electto 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 paidfor repair and maintenance to tangible property that Qtreats as capital expenditures on its books and recordsin Year 4.

Example 2. No election to capitalize routinemaintenance. Assume the same facts as Example1, except in Year 8, Q pays amounts to performscheduled maintenance for a second time on thetowboat engines. On its books and records, Q treatsthe amounts paid for this scheduled maintenance ascapital expenditures. However, in Year 8, Q decidesnot to make the election to capitalize the amountspaid for scheduled maintenance under paragraph(n) of this section. Because Q does not make theelection under paragraph (n) for Year 8, Q may applythe 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 costscapitalized by Q on its Federal tax return for Year 4.

Example 3. Election to capitalize replacement ofbuilding component. (i) R owns an office buildingthat it uses to provide services to customers. Thebuilding contains a HVAC system that incorporatesten roof-mounted units that provide heating and airconditioning for different parts of the building. InYear 1, R pays an amount to replace 2 of the 10 unitsto address climate control problems in various officesthroughout the office building. Assume that the re-placement of the two units does not constitute an im-provement to the HVAC system, and, accordingly, tothe building unit of property under paragraph (d) ofthis section, and that R may deduct these amounts asrepairs and maintenance under §1.162–4.

(ii) On its books and records, R treats amountspaid for the two HVAC components as capital expen-

ditures. R determines that it would prefer to accountfor these amounts in the same way for Federal in-come tax purposes. Under this paragraph (n), in Year1, R may elect to capitalize the amounts paid for thenew HVAC components. If R elects to capitalize suchamounts, R must capitalize all amounts paid for repairand maintenance to tangible property that R treats ascapital expenditures on its books and records in Year1.

(o) Treatment of capital expenditures.Amounts required to be capitalized un-der this section are capital expendituresand must be taken into account through acharge to capital account or basis, or in thecase of property that is inventory in thehands of a taxpayer, through inclusion ininventory costs.

(p) Recovery of capitalized amounts.Amounts that are capitalized under thissection are recovered through deprecia-tion, cost of goods sold, or by an adjust-ment to basis at the time the property isplaced in service, sold, used, or otherwisedisposed of by the taxpayer. Cost recoveryis determined by the applicable Code andregulation 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 achange in method of accounting to whichthe provisions of sections 446 and 481 andthe accompanying regulations apply. Ataxpayer seeking to change to a method ofaccounting permitted in this section mustsecure the consent of the Commissioner inaccordance with §1.446–1(e) and followthe 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) Ingeneral. 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) of this section apply to amountspaid in taxable years beginning on or af-ter January 1, 2014. Except as provided inparagraphs (r)(2) and (r)(3) of this section,§1.263(a)–3 as contained in 26 CFR part 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 2014.

(2) Early application of this sec-tion—(i) In general. Except for para-graphs (h), (m), and (n) of this section, ataxpayer may choose to apply this sectionto taxable years beginning on or after Jan-

uary 1, 2012. A taxpayer may choose toapply paragraphs (h), (m), and (n) of thissection to amounts paid in taxable yearsbeginning on or after January 1, 2012.

(ii) Transition rule for certain electionson 2012 or 2013 returns. If under para-graph (r)(2)(i) of this section, a taxpayerchooses to make the election to apply thesafe harbor for small taxpayers under para-graph (h) of this section or the electionto capitalize repair and maintenance costsunder paragraph (n) of this section foramounts paid in its taxable year beginningon or after January 1, 2012, and ending onor before September 19, 2013 (applicabletaxable year), and the taxpayer did notmake the election specified in paragraph(h)(6) or paragraph (n)(2) of this sectionon its timely filed original Federal taxreturn for the applicable taxable year, thetaxpayer must make the election specifiedin paragraph (h)(6) or paragraph (n)(2) ofthis section for the applicable taxable yearby filing an amended Federal tax return(including the required statements) for theapplicable taxable year on or before 180days from the due date including exten-sions of the taxpayer’s Federal tax returnfor the applicable taxable year, notwith-standing that the taxpayer may not haveextended the due date.

(3) Optional application of TD9564. A taxpayer may choose to apply§1.263(a)–3T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears 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 toread as follows:

§1.263(a)–6 Election to deduct orcapitalize certain expenditures.

(a) In general. Under certain provisionsof the Internal Revenue Code (Code), tax-payers may elect to treat capital expendi-tures as deductible expenses or as deferredexpenses, or to treat deductible expensesas capital expenditures.

(b) Election provisions. The sectionsreferred to in paragraph (a) of this sectioninclude:

(1) Section 173 (circulation expendi-tures);

2013–43 I.R.B. 391 October 21, 2013

(2) Section 174 (research and experi-mental expenditures);

(3) Section 175 (soil and water conser-vation expenditures; endangered speciesrecovery expenditures);

(4) Section 179 (election to expensecertain 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 expensecertain refineries);

(8) Section 179D (energy efficient com-mercial buildings deduction);

(9) Section 179E (election to expenseadvanced mine safety equipment);

(10) Section 180 (expenditures by farm-ers for fertilizer);

(11) Section 181 (treatment of certainqualified 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 January1, 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 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 2014. For the effective dates of theenumerated election provisions, see thoseCode sections and the regulations underthose sections.

(2) Early application of this section. Ataxpayer may choose to apply this section

to taxable years beginning on or after Jan-uary 1, 2012.

(3) Optional application of TD9564. A taxpayer may choose to apply§1.263(a)–6T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears 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 amendedby adding new entries in the outline for§1.263A–1(k) and (l) to read as follows:

§1.263A–0 Outline of the Regulationsunder Section 263A.

* * * * *

§1.263A–1 Uniform Capitalization ofCosts.

* * * * *(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 ofcosts.

* * * * *(c) * * *(4) Recovery of capitalized costs. Costs

that are capitalized under section 263A arerecovered through depreciation, amortiza-

tion, cost of goods sold, or by an adjust-ment to basis at the time the property isused, sold, placed in service, or otherwisedisposed 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 ofproperty.

* * * * *(e) * * *(2) * * *(i) * * *(A) Direct material costs. Direct mate-

rials costs include the cost of those materi-als that become an integral part of specificproperty produced and those materials thatare consumed in the ordinary course ofproduction and that can be identified or as-sociated with particular units or groups ofunits of property produced. For example, acost described in §1.162–3, relating to thecost of a material or supply, may be a di-rect material cost.

* * * * *(3) * * *(ii) * * *(E) Indirect material costs. Indirect

material costs include the cost of mate-rials that are not an integral part of spe-cific property produced and the cost ofmaterials that are consumed in the ordi-nary course of performing production orresale activities that cannot be identifiedor associated with particular units of prop-erty. Thus, for example, a cost describedin §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 inparagraph (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) ofthis section apply for taxable years endingon 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 sectionapply to amounts paid (to acquire or pro-duce property) in taxable years beginningon or after January 1, 2014. Except as

October 21, 2013 392 2013–43 I.R.B.

provided in paragraph (l)(3)(ii) or para-graph (l)(3)(iii) of this section, section1.263A–1 as contained in 26 CFR part 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 2014.

(ii) Early application of this section.A taxpayer may choose to apply the lastsentence of paragraphs (e)(2)(i)(A) and(e)(2)(ii)(E) of this section, and paragraph(l)(3) of this section to amounts paid (toacquire or produce property) in taxableyears beginning on or after January 1,2012.

(iii) Optional application of TD9564. A taxpayer may choose to ap-ply §1.263A–1T(b)(14), the introductoryphrase of §1.263A–1T(c)(4), the lastsentence of §1.263A–1T(e)(2)(i)(A), thelast 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 TD9564 (76 FR 81060) December 27, 2011,to amounts paid (to acquire or produceproperty) in taxable years beginning on orafter January 1, 2012, and before January1, 2014.

§1.263A–1T [Removed]

Par. 30. Section 1.263A–1T is re-moved.

Par. 31. Section 1.1016–3 is amendedby revising paragraphs (a)(1)(ii), (j)(1),and (j)(3) to read as follows:

§1.1016–3 Exhaustion, wear and tear,obsolescence, amortization, and depletionfor periods since February 13, 1913.

(a)* * *(1)* * *(ii) The determination of the amount

properly allowable for exhaustion, wearand tear, obsolescence, amortization, anddepletion must be made on the basis offacts reasonably known to exist at the endof the taxable year. A taxpayer is notpermitted to take advantage in a later year

of the taxpayer’s prior failure to take anysuch allowance or the taxpayer’s takingan allowance plainly inadequate underthe known facts in prior years. In thecase of depreciation, if in prior years thetaxpayer has consistently taken properdeductions under one method, the amountallowable for such prior years may not beincreased, even though a greater amountwould have been allowable under anotherproper method. For rules governing losseson retirement or disposition of depreciableproperty, including rules for determiningbasis, 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 paragraphis illustrated by the following example (forpurposes of this example, assume section167(f)(1) as in effect on September 19,2013, applies to taxable years beginningon or after January 1, 2014):

Example. On July 1, 2014, A, a calendar-year tax-payer, purchased and placed in service “off-the-shelf”computer software at a cost of $36,000. This com-puter software is not an amortizable section 197intangible. Pursuant to section 167(f)(1), the usefullife of the computer software is 36 months. It has nosalvage value. Computer software placed in servicein 2014 is not eligible for the additional first yeardepreciation deduction provided by section 168(k).A did not deduct any depreciation for the computersoftware for 2014 and deducted depreciation of$12,000 for the computer software for 2015. As aresult, the total amount of depreciation allowed forthe computer software as of December 31, 2015, was$12,000. However, the total amount of depreciationallowable for the computer software as of December31, 2015, is $18,000 ($6,000 for 2014 + $12,000 for2015). 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 theremaining 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. Forthe applicability of regulations before De-cember 30, 2003, see §1.1016–3 in effectprior to December 30, 2003 (§1.1016–3 ascontained in 26 CFR part 1 edition revisedas of April 1, 2003).

* * * * *(3) Application of

§1.1016–3T(a)(1)(ii)—(i) In general.Paragraph (a)(1)(ii) of this section appliesto taxable years beginning on or afterJanuary 1, 2014. Except as provided inparagraphs (j)(3)(ii) and (j)(3)(iii) of thissection, §1.1016–3(a)(1)(ii) as containedin 26 CFR part 1 edition revised as ofApril 1, 2011, applies to taxable yearsbeginning before January 1, 2014.

(ii) Early application of§1.1016–3(a)(1)(ii). A taxpayer maychoose to apply paragraph (a)(1)(ii) of thissection to taxable years beginning on orafter January 1, 2012.

(iii) Optional application of TD9564. A taxpayer may choose to apply§1.1016–3T(a)(1)(ii) as contained in TD9564 (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 CONTROLNUMBERS UNDER THE PAPERWORKREDUCTION ACT

Par. 33. The authority citation for part602 continues to read as follows:

Authority: 26 U.S.C. 7805.Par. 34. In §602.101, paragraph (b) is

amended by adding the following entriesto the table in numerical order to read asfollows:

§602.101 OMB Control numbers.

* * * * *(b) * * *

CFR part or section whereIdentified and described

Current OMBcontrol No.

* * * * *1.263(a)–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–2248

1.263(a)–3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–2248

* * * * *

2013–43 I.R.B. 393 October 21, 2013

Beth Tucker,Deputy Commissioner for

Operations Support.

Approved August 15, 2013.

Mark J. Mazur,Assistant Secretary

of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on September 13,2013, 11:15 a.m., and published in the issue of the FederalRegister for September 19, 2013, 78 F.R. 57686)

Section 280G.—GoldenParachute Payments

Federal short-term, mid-term, and long-term ratesare set forth for the month of October 2013. See Rev.Rul. 2013-21, page 394.

Section 382.—Limitationon Net Operating LossCarryforwards and CertainBuilt-In Losses FollowingOwnership Change

The adjusted applicable federal long-term rate isset forth for the month of October 2013. See Rev.Rul. 2013-21, page 394.

Section 412.—MinimumFunding Standards

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 467.—CertainPayments for the Use ofProperty or Services

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 468.—SpecialRules for Mining and SolidWaste Reclamation andClosing Costs

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 482.—Allocationof Income and DeductionsAmong Taxpayers

Federal short-term, mid-term, and long-term ratesare set forth for the month of October 2013. See Rev.Rul. 2013-21, page 394.

Section 483.—Interest onCertain Deferred Payments

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 642.—SpecialRules for Credits andDeductions

Federal short-term, mid-term, and long-term ratesare set forth for the month of October 2013. See Rev.Rul. 2013-21, page 394.

Section 807.—Rules forCertain Reserves

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 846.—DiscountedUnpaid Losses Defined

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 1274.—Determi-nation of Issue Price in theCase 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 sections382, 642, 1274, 1288, and other sections ofthe Code, tables set forth the rates for Oc-tober 2013.

Rev. Rul. 2013–21

This revenue ruling provides variousprescribed rates for federal income taxpurposes for October 2013 (the currentmonth). Table 1 contains the short-term,mid-term, and long-term applicable fed-eral rates (AFR) for the current monthfor purposes of section 1274(d) of theInternal Revenue Code. Table 2 containsthe short-term, mid-term, and long-termadjusted applicable federal rates (adjustedAFR) for the current month for purposesof section 1288(b). Table 3 sets forth theadjusted federal long-term rate and thelong-term tax-exempt rate described insection 382(f). Table 4 contains the ap-propriate percentages for determining thelow-income housing credit described insection 42(b)(1) for buildings placed inservice during the current month. How-ever, under section 42(b)(2), the applicablepercentage for non-federally subsidizednew buildings placed in service after July30, 2008, with respect to housing creditdollar amount allocations made beforeJanuary 1, 2014, shall not be less than 9%.Finally, Table 5 contains the federal ratefor determining the present value of anannuity, an interest for life or for a termof years, or a remainder or a reversionaryinterest for purposes of section 7520.

October 21, 2013 394 2013–43 I.R.B.

REV. RUL. 2013–21 TABLE 1

Applicable Federal Rates (AFR) for October 2013

Period for Compounding

Annual Semiannual Quarterly Monthly

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

AFR 1.93% 1.92% 1.92% 1.91%110% AFR 2.12% 2.11% 2.10% 2.10%120% AFR 2.31% 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% AFR 3.86% 3.82% 3.80% 3.79%120% AFR 4.20% 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

Annual Semiannual Quarterly Monthly

Short-term adjustedAFR

.32% .32% .32% .32%

Mid-term adjusted AFR 1.78% 1.77% 1.77% 1.76%

Long-term adjustedAFR

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 adjustedfederal 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 July30, 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 credit 7.63%

Appropriate percentage for the 30% present value low-income housing credit 3.27%

2013–43 I.R.B. 395 October 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 interest 2.4%

Section 1288.—Treatmentof Original Issue Discounton Tax-Exempt Obligations

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 7520.—ValuationTables

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

Section 7872.—Treatmentof Loans With Below-MarketInterest Rates

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof October 2013. See Rev. Rul. 2013-21, page 394.

October 21, 2013 396 2013–43 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous26 CFR 601.105: Examination of returns and claimsfor refund, credit, or abatement; determination ofcorrect liability.(Also: sections 66, 6015)

Rev. Proc. 2013–34

SECTION 1. PURPOSE AND SCOPE

.01 Purpose. This revenue procedureprovides guidance for a taxpayer seekingequitable relief from income tax liabilityunder section 66(c) or section 6015(f) ofthe Internal Revenue Code (a “requestingspouse”). Section 4.01 of this revenueprocedure provides the threshold require-ments for any request for equitable relief.Section 4.02 of this revenue procedure setsforth the conditions under which the In-ternal Revenue Service will make stream-lined relief determinations granting equi-table relief under section 6015(f) from anunderstatement of income tax or an un-derpayment of income tax reported on ajoint return, or the operation of communityproperty law under section 66(c). Section4.03 of this revenue procedure provides anonexclusive list of factors for considera-tion in determining whether relief shouldbe granted under section 6015(f) because itwould be inequitable to hold a requestingspouse jointly and severally liable whenthe conditions of section 4.02 are not met.The factors in section 4.03 also will applyin determining whether to relieve a spousefrom income tax liability resulting fromthe operation of community property lawunder the equitable relief provision of sec-tion 66(c).

.02 Scope. This revenue procedure ap-plies to spouses who request either equi-table relief from joint and several liabilityunder section 6015(f), or equitable reliefunder 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 thatmarried taxpayers who file a joint returnunder section 6013 will be jointly andseverally liable for the income tax arisingfrom that joint return. For purposes ofsection 6013(d)(3) and this revenue pro-cedure, the term “tax” includes penalties,

additions to tax, and interest. See sections6601(e)(1) and 6665(a)(2).

.02 Section 3201(a) of the Internal Rev-enue Service Restructuring and ReformAct of 1998, Pub. L. No. 105–206, 112Stat. 685, 734 (RRA), enacted section6015, which provides relief in certaincircumstances from the joint and severalliability imposed by section 6013(d)(3).Section 6015(b) and (c) specify two setsof circumstances under which relief fromjoint and several liability is available incases involving understatements of tax.Section 6015(b) is modeled after formersection 6013(e), the prior innocent spousestatute, and section 6015(c) provides forseparation of liability for taxpayers whoare no longer married to, are legally sepa-rated from, or not living together with theperson with whom they filed a joint re-turn. If relief is not available under section6015(b) or (c), section 6015(f) authorizesthe Secretary to grant equitable relief if,taking into account all the facts and cir-cumstances, the Secretary determines thatit is inequitable to hold a requesting spouseliable 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 propertystate who do not file a joint return. Sec-tion 3201(b) of the RRA amended section66(c) to add an equitable relief provisionsimilar to section 6015(f).

.03 Section 6015 provides relief onlyfrom joint and several liability arising froma joint return. If an individual signs a jointreturn under duress, the election to filejointly is not valid and there is no valid re-turn with respect to the requesting spouse.The individual is not jointly and severallyliable for any income tax liabilities aris-ing from that return. In that case, section6015 does not apply and is not necessaryfor obtaining relief. If an individual filesa claim for relief under section 6015, butalso maintains that there is no valid jointreturn due to duress, the Service will firstmake a determination as to the validity ofthe joint return and may accordingly denythe request for section 6015 relief based onthe fact that no joint return was filed (andthus, relief is not necessary). If it is ulti-mately determined that a valid joint return

was filed, the Service will then considerwhether the individual would be entitled torelief from joint and several liability on themerits.

.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 jointreturn. 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 notknow, and had no reason to know, thatfunds intended for the payment of tax wereinstead taken by the other spouse for suchother spouse’s benefit.” H.R. Conf. Rep.No. 105–599, at 254 (1998). Congressalso intended for the Secretary to exercisethe equitable relief authority under section6015(f) in other situations if, “taking intoaccount all the facts and circumstances, itis inequitable to hold an individual liablefor 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 Departmentof Treasury and the Service released No-tice 2012–8, 2012–4 I.R.B. 309, whichset forth a proposed revenue procedure toupdate and revise Rev. Proc. 2003–61,2003–2 C.B. 296. Notice 2012–8 alsomodified and clarified the criteria for equi-table relief, and it eliminated the two-yearrule for filing a claim for relief as set forthin 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, 45of which were general comments either insupport of the revisions, asking for assis-tance in specific cases, or totally unrelatedto innocent spouse relief. The nine sub-stantive comments ranged from discussingone or two discrete issues to commentingon all aspects of the proposed revenue pro-cedure and innocent spouse relief in gen-eral. Treasury and the Service consideredall comments received, and the proposedrevenue procedure has been modified to

2013–43 I.R.B. 397 October 21, 2013

take into account many of the concernsraised.

This revenue procedure supersedesRev. Proc. 2003–61. The structure andformat of this revenue procedure generallyfollows that of Rev. Proc. 2003–61 withthe following significant changes:

.01 This revenue procedure givesgreater deference to the presence of abusethan Rev. Proc. 2003–61. The Servicerecognizes that the issue of abuse can berelevant with respect to the analysis ofother factors and can negate the presenceof certain factors. This change is intendedto give greater weight to the presence ofabuse when its presence impacts the anal-ysis of other factors.

.02 The timeliness threshold conditionin section 4.01(3) of this revenue proce-dure provides that a request for equitablerelief under section 6015(f) or section66(c) must be filed before the expiration ofthe period of limitation for collection un-der section 6502 to the extent the taxpayerseeks relief from an outstanding liability,or before the expiration of the period oflimitation for credit or refund under sec-tion 6511 to the extent the taxpayer seeksa refund of taxes paid. This is a significantchange 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 reliefmust be filed no later than two years afterthe date of the Service’s first collectionactivity. See Notice 2011–70. In responseto a comment received with respect toNotice 2012–8, section 4.01(3)(a) refersto the period of limitation for collection asits commonly used IRS term — CollectionStatute Expiration Date or CSED.

.03 The attribution threshold conditionin 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 ofthe nonrequesting spouse. Under section4.01(7)(e) of the revenue procedure, reliefwould not be precluded for an item attrib-utable to the requesting spouse if the non-requesting spouse’s fraud gave rise to theunderstatement of tax or deficiency.

.04 Streamlined determinations undersection 4.02 of this revenue procedure nowapply 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 undersection 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 thedetermination. Therefore, depending onthe facts and circumstances of the case, re-lief may still be appropriate if the numberof factors weighing against relief exceedsthe number of factors weighing in favor ofrelief, or a denial of relief may still be ap-propriate if the number of factors weigh-ing in favor of relief exceeds the numberof factors weighing against relief.

.06 The economic hardship factor insection 4.03(2)(b) of this revenue proce-dure now provides minimum standardsbased on income, expenses, and assets,for determining whether the requestingspouse would suffer economic hardship ifrelief is not granted. Section 4.03(2)(b)also now provides that the lack of a find-ing of economic hardship does not weighagainst 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 howthe factor works in cases involving equi-table relief under section 66(c), in additionto cases involving equitable relief undersection 6015(f). Section 4.03(2)(c)(i)(A)provides that actual knowledge of the itemgiving rise to an understatement or defi-ciency will no longer be weighed moreheavily than other factors, as it did underRev. Proc. 2003–61. Further, section4.03(2)(c)(i)(A) clarifies that, for purposesof this factor, if the nonrequesting spouseabused the requesting spouse or main-tained control over the household financesby restricting the requesting spouse’s ac-cess to financial information, and becauseof the abuse or financial control, the re-questing spouse was not able to challengethe treatment of any items on the joint re-turn for fear of the nonrequesting spouse’sretaliation, then that abuse or financialcontrol will result in this factor weighingin favor of relief even if the requestingspouse knew or had reason to know of theitems giving rise to the understatement ordeficiency.

.08 The knowledge factor for under-payment cases in section 4.03(2)(c)(ii) ofthis revenue procedure now provides that,in determining whether the requestingspouse knew or had reason to know that

the nonrequesting spouse would not paythe tax reported as due on the return, theService will consider whether the request-ing spouse reasonably expected that thenonrequesting spouse would pay the taxliability at the time the return was filed orwithin a reasonable period of time afterthe filing of the return. In response tocomments received with respect to Notice2012–8, section 4.03(2)(c)(ii) providesthat a requesting spouse may be presumedto have reasonably expected that the non-requesting spouse would pay the liabilityif a request for an installment agreementto pay the tax was filed by the later of90 days after the due date for paymentof the tax, or 90 days after the returnwas filed. Further, section 4.03(2)(c)(ii)clarifies that for purposes of this factor,if the nonrequesting spouse abused therequesting spouse or maintained controlover the household finances by restrictingthe requesting spouse’s access to financialinformation, and because of the abuse orfinancial control, the requesting spousewas not able to question the payment ofthe taxes reported as due on the return orchallenge the nonrequesting spouse’s as-surance regarding payment of the taxes forfear of the nonrequesting spouse’s retali-ation, then that abuse or financial controlwill result in this factor weighing in fa-vor of relief even if the requesting spouseknew or had reason to know that the non-requesting spouse would not pay the taxliability. Finally, section 4.03(2)(c)(ii)provides that if the requesting spouse didnot reasonably expect that the nonrequest-ing spouse would pay the tax liabilityreported on an amended return that wasbased on items not properly reported onthe original return, the Service will alsoconsider whether the requesting spouseknew 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 procedureclarifies that a requesting spouse’s legalobligation to pay outstanding tax liabili-ties is a factor to consider in determiningwhether equitable relief should be granted,in addition to whether the nonrequestingspouse has a legal obligation to pay the taxliabilities.

.10 The significant benefit factor in sec-tion 4.03(2)(e) of this revenue procedureprovides that any significant benefit a re-questing spouse may have received from

October 21, 2013 398 2013–43 I.R.B.

the unpaid tax or understatement will notweigh against relief (will be neutral) if thenonrequesting spouse abused the request-ing spouse or maintained financial controland made the decisions regarding livinga more lavish lifestyle. Further, section4.03(2)(e) provides that if only the non-requesting spouse significantly benefittedfrom the unpaid tax or understatement, andthe requesting spouse had little or no ben-efit, or the nonrequesting spouse enjoyedthe benefit to the requesting spouse’s detri-ment, this factor will weigh in favor ofrelief. Section 4.03(2)(e) also providesthat 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 tocomments received with respect to Notice2012–8, section 4.03(2)(e) provides thatthe determination that the tax liability wassmall such that neither spouse received asignificant benefit will vary depending onthe facts and circumstances of each case.

.11 The compliance with the income taxlaws factor in section 4.03(2)(f) of this rev-enue procedure now provides that a re-questing spouse’s subsequent compliancewith all Federal income tax laws is a factorthat may weigh in favor of relief, insteadof always being neutral under Rev. Proc.2003–61.

.12 Section 4.04 of this revenue proce-dure broadens the availability of refunds incases 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 bythe requesting spouse pursuant to an in-stallment agreement.

SECTION 4. GENERAL CONDITIONSFOR RELIEF

.01 Eligibility for equitable relief. Arequesting spouse must satisfy all of thefollowing 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 tosubmit a request for equitable relief undersection 66(c). The Service may relieve arequesting 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 account all the facts and cir-cumstances, the Service determines that itwould be inequitable to hold the requestingspouse liable for the income tax liability.The threshold conditions are as follows:

(1) The requesting spouse filed a jointreturn for the taxable year for which he orshe 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 forrelief 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 InternalRevenue Code.

(b) Claims for credit or refund ofamounts paid must be made before theexpiration of the period of limitation oncredit or refund, as provided in section6511. Generally, that period expires threeyears from the time the return was filed ortwo years from the time the tax was paid,whichever is later.

(4) No assets were transferred betweenthe spouses as part of a fraudulent schemeby the spouses.

(5) The nonrequesting spouse did nottransfer disqualified assets to the request-ing spouse. For this purpose, the term “dis-qualified asset” has the meaning given theterm by section 6015(c)(4)(B). If the non-requesting spouse transferred disqualifiedassets to the requesting spouse, relief willbe available only to the extent that the in-come tax liability exceeds the value of thedisqualified assets. Even if there was atransfer of disqualified assets, the request-ing spouse may be eligible for relief if thenonrequesting spouse abused the request-ing spouse or maintained control over thehousehold finances by restricting the re-questing spouse’s access to financial in-formation, or the requesting spouse didnot have actual knowledge that disquali-fied assets were transferred.

(6) The requesting spouse did notknowingly participate in the filing of afraudulent joint return.

(7) The income tax liability from whichthe requesting spouse seeks relief is attrib-

utable (either in full or in part) to an itemof the nonrequesting spouse or an under-payment resulting from the nonrequestingspouse’s income. If the liability is partiallyattributable to the requesting spouse, thenrelief 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 (infull or in part) to the requesting spouse ifany of the following exceptions applies:

(a) Attribution solely due to the oper-ation of community property law. If anitem is attributable or partially attribut-able to the requesting spouse solely due tothe operation of community property law,then for purposes of this revenue proce-dure, that item (or portion thereof) will beconsidered to be attributable to the nonre-questing spouse.

(b) Nominal ownership. If the item istitled in the name of the requesting spouse,the item is presumptively attributable tothe requesting spouse. This presumptionis rebuttable. For example, H opens an in-dividual retirement account (IRA) in W’sname and forges W’s signature on the IRAin 2006. Thereafter, H makes contribu-tions to the IRA and in 2008 takes a tax-able distribution from the IRA. H and Wfile a joint return for the 2008 taxable year,but do not report the taxable distributionon their joint return. The Service later de-termines a deficiency relating to the tax-able IRA distribution. W requests relieffrom joint and several liability under sec-tion 6015. W establishes that W did notcontribute to the IRA, sign paperwork re-lating to the IRA, or otherwise act as if Wwere the owner of the IRA. W, thereby, re-buts the presumption that the IRA is attrib-utable to W.

(c) Misappropriation of funds. If therequesting spouse did not know, and hadno reason to know, that funds intended forthe payment of tax were misappropriatedby the nonrequesting spouse for the nonre-questing spouse’s benefit, the Service willconsider granting equitable relief althoughthe underpayment may be attributable inpart or in full to an item of the requestingspouse. The Service will consider grantingrelief in this case only to the extent that thefunds intended for the payment of tax weretaken by the nonrequesting spouse.

2013–43 I.R.B. 399 October 21, 2013

(d) Abuse. If the requesting spouse es-tablishes that he or she was the victim ofabuse 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’sretaliation, 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 nonrequestingspouse. The Service will consider grantingrelief notwithstanding that the item givingrise to the understatement or deficiency isattributable to the requesting spouse, if therequesting spouse establishes that the non-requesting spouse’s fraud is the reason forthe erroneous item. For example, W fraud-ulently accesses H’s brokerage account tosell stock that H had separately receivedfrom an inheritance. W deposits the fundsfrom the sale in a separate bank accountto which H does not have access. H andW file a joint Federal income tax returnfor the year, which does not report the in-come from the sale of the stock. The Ser-vice determines a deficiency based on theomission of the income from the sale ofthe stock. H requests relief from the defi-ciency under section 6015(f). The incomefrom the sale of the stock normally wouldbe attributable to H. Because W commit-ted fraud with respect to H, however, andbecause this fraud was the reason for theerroneous item, the liability is properly at-tributable to W.

.02. Circumstances under which theService will make streamlined determina-tions granting equitable relief under sec-tions 66(c) and 6015(f).

If a requesting spouse who filed a jointreturn, or a requesting spouse who did notfile 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 section6015(f) under this section 4.02. If a re-questing spouse is not entitled to a stream-lined determination because the requestingspouse does not satisfy all the elements inthis section 4.02, the requesting spouse isstill 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 undersection 66(c) or section 6015(f), in casesin which the requesting spouse establishesthat the requesting spouse:

(1) Marital status. Is no longer marriedto the nonrequesting spouse as set forth insection 4.03(2)(a);

(2) Economic hardship. Would suf-fer economic hardship if relief were notgranted as set forth in section 4.03(2)(b);and

(3) Knowledge or reason to know.(a) Section 6015(f) cases. Did not

know or have reason to know that therewas an understatement or deficiency onthe joint income tax return, as set forth insection 4.03(2)(c)(i), or did not know orhave reason to know that the nonrequest-ing spouse would not or could not pay theunderpayment of tax reported on the jointincome tax return, as set forth in section4.03(2)(c)(ii). If the nonrequesting spouseabused the requesting spouse or main-tained control over the household financesby restricting the requesting spouse’s ac-cess to financial information, and becauseof the abuse or financial control, the re-questing spouse was not able to challengethe treatment of any items on the jointreturn, or to question the payment of thetaxes reported as due on the joint returnor challenge the nonrequesting spouse’sassurance regarding payment of the taxes,for fear of the nonrequesting spouse’sretaliation, then the abuse or financial con-trol will result in this factor being satisfiedeven if the requesting spouse knew or hadreason to know of the items giving rise tothe understatement or deficiency or knewor had reason to know that the nonrequest-ing spouse would not pay the tax liability.

(b) Section 66(c) cases. Did not knowor have reason to know of an item ofcommunity income properly includible ingross income, which, under the rules con-tained in section 879(a), would be treatedas the income of the nonrequesting spouse.

.03. Factors for determining whether togrant equitable relief.

(1) Applicability. This section 4.03applies to a requesting spouse who re-quests relief under section 66(c) or section6015(f), and who satisfies the thresholdconditions of section 4.01, but does notqualify for streamlined determinationsgranting relief under section 4.02.

(2) Factors. In determining whether itis inequitable to hold the requesting spouseliable for all or part of the unpaid incometax liability or deficiency, and whether fullor partial equitable relief under section66(c) or section 6015(f) should be granted,all the facts and circumstances of the caseare to be taken into account. The factorslisted below are designed as guides andnot intended to comprise an exclusive list.Other factors relevant to a specific claimfor relief may also be taken into account inmaking the determination. In evaluating aclaim for relief, no one factor or a majorityof factors necessarily determines the out-come. The degree of importance of eachfactor varies depending on the requestingspouse’s facts and circumstances. Abuseor the exercise of financial control bythe nonrequesting spouse is a factor thatmay impact the other factors, as describedbelow. Factors to consider include thefollowing:

(a) Marital status. Whether the request-ing spouse is no longer married to the non-requesting spouse as of the date the Servicemakes its determination. If the requestingspouse is still married to the nonrequestingspouse, this factor is neutral. If the request-ing spouse is no longer married to the non-requesting spouse, this factor will weigh infavor of relief. For purposes of this sec-tion, a requesting spouse will be treated asbeing no longer married to the nonrequest-ing spouse only in the following situations:

(i) The requesting spouse is divorcedfrom the nonrequesting spouse,

(ii) The requesting spouse is legallyseparated from the nonrequesting spouseunder applicable state law,

(iii) The requesting spouse is a widowor widower and is not an heir to the non-requesting spouse’s estate that would havesufficient assets to pay the tax liability, or

(iv) The requesting spouse has not beena member of the same household as thenonrequesting spouse at any time duringthe 12-month period ending on the datethe Service makes its determination. Forthese 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. SeeTreas. Reg. § 1.6015–3(b)(3)(i). A re-questing spouse is a member of the samehousehold as the nonrequesting spouse for

October 21, 2013 400 2013–43 I.R.B.

any period in which the spouses maintainthe same residence.

(b) Economic hardship. Whether therequesting spouse will suffer economichardship if relief is not granted. For pur-poses of this factor, an economic hardshipexists if satisfaction of the tax liabil-ity in whole or in part will cause therequesting spouse to be unable to pay rea-sonable basic living expenses. Whetherthe requesting spouse will suffer eco-nomic hardship is determined based onrules similar to those provided in Treas.Reg. § 301.6343–1(b)(4), and the Servicewill take into consideration a requestingspouse’s current income and expenses andthe requesting spouse’s assets. In deter-mining the requesting spouse’s reasonablebasic living expenses, the Service willconsider whether the requesting spouseshares expenses or has expenses paidby another individual (such as a familymember, including a current spouse). Ifdenying relief from the joint and severalliability will cause the requesting spouseto suffer economic hardship, this factorwill weigh in favor of relief. If denyingrelief from the joint and several liabilitywill not cause the requesting spouse tosuffer economic hardship, this factor willbe neutral.

In determining whether the requestingspouse would suffer economic hardship ifrelief is not granted, the Service will com-pare the requesting spouse’s income tothe Federal poverty guidelines (as updatedperiodically in the Federal Register by theU.S. Department of Health and HumanServices under the authority of 42 U.S.C.§ 9902(2)) for the requesting spouse’sfamily size and will determine by howmuch, if at all, the requesting spouse’smonthly income exceeds the spouse’s rea-sonable basic monthly living expenses.This factor will weigh in favor of relief ifthe requesting spouse’s income is below250% of the Federal poverty guidelines,unless the requesting spouse has assetsout of which the requesting spouse canmake payments towards the tax liabilityand still adequately meet the requestingspouse’s reasonable basic living expenses.If the requesting spouse’s income exceeds250% of the Federal poverty guidelines,this factor will still weigh in favor of reliefif the requesting spouse’s monthly incomeexceeds the requesting spouse’s reason-able basic monthly living expenses by

$300 or less, unless the requesting spousehas assets out of which the requestingspouse can make payments towards the taxliability and still adequately meet the re-questing spouse’s reasonable basic livingexpenses. If the requesting spouse’s in-come exceeds 250% of the Federal povertyguidelines and monthly income exceedsmonthly expenses by more than $300, orif the requesting spouse qualifies undereither standard but has sufficient assets tomake payments towards the tax liabilityand still adequately meet the requestingspouse’s reasonable basic living expenses,the Service will consider all facts andcircumstances (including the size of therequesting spouse’s household) in deter-mining whether the requesting spousewould suffer economic hardship if reliefis not granted. If the requesting spouse isdeceased, this factor is neutral.

(c) Knowledge or reason to know.(i) Understatement cases.(A) Section 6015(f) cases. Whether the

requesting spouse knew or had reason toknow of the item giving rise to the un-derstatement or deficiency as of the datethe joint return (including a joint amendedreturn) was filed, or the date the request-ing spouse reasonably believed the jointreturn was filed. If the requesting spousedid not know and had no reason to knowof the item giving rise to the understate-ment, this factor will weigh in favor ofrelief. If the requesting spouse knew orhad reason to know of the item givingrise to the understatement, this factor willweigh against relief. Actual knowledgeof the item giving rise to the understate-ment or deficiency will not be weighedmore heavily than any other factor. De-pending on the facts and circumstances, ifthe requesting spouse was abused by thenonrequesting spouse (as described in sec-tion 4.03(2)(c)(iv)), or the nonrequestingspouse maintained control of the house-hold finances by restricting the requestingspouse’s access to financial information,and because of the abuse or financial con-trol, the requesting spouse was not able tochallenge the treatment of any items on thejoint return for fear of the nonrequestingspouse’s retaliation, this factor will weighin favor of relief even if the requestingspouse knew or had reason to know of theitems giving rise to the understatement ordeficiency.

(B) Section 66(c) cases. Whether therequesting spouse knew or had reasonto know of an item of community in-come properly includible in gross income,which, under the rules contained in section879(a), would be treated as the income ofthe nonrequesting spouse.

(ii) Underpayment cases. In the caseof an income tax liability that was prop-erly reported but not paid, whether, as ofthe date the return was filed or the datethe requesting spouse reasonably believedthe return was filed, the requesting spouseknew or had reason to know that the non-requesting spouse would not or could notpay the tax liability at that time or within areasonable period of time after the filing ofthe return. This factor will weigh in favorof relief if the requesting spouse reason-ably expected the nonrequesting spouse topay the tax liability reported on the return.A reasonable expectation of payment willbe presumed if the spouses submitted a re-quest for an installment agreement to paythe tax reported as due on the return. Tobenefit from the presumption, the requestfor an installment agreement must be filedby the later of 90 days after the due datefor payment of the tax, or 90 days after thereturn was filed. The request must detailthe plan for paying the tax, interest, andpenalties, satisfy the liability within a rea-sonable time, and it must not be unreason-able for the requesting spouse to believethat the nonrequesting spouse will be ableto make the payments contemplated in therequested installment agreement.

This factor will weigh against relief if,based on the facts and circumstances ofthe case, it was not reasonable for the re-questing spouse to believe that the non-requesting spouse would or could pay thetax 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 nonrequestingspouse’s prior bankruptcies, financial dif-ficulties, or other issues with the Service orother creditors, or was otherwise aware ofdifficulties in timely paying bills, then thisfactor will generally weigh against relief.

Depending on the facts and circum-stances, if the requesting spouse wasabused by the nonrequesting spouse (asdescribed in section 4.03(2)(c)(iv)), or thenonrequesting spouse maintained controlof the household finances by restricting

2013–43 I.R.B. 401 October 21, 2013

the requesting spouse’s access to financialinformation, and because of the abuse orfinancial control, the requesting spousewas not able to question the payment ofthe taxes reported as due on the returnor challenge the nonrequesting spouse’sassurance regarding payment of the taxesfor fear of the nonrequesting spouse’s re-taliation, this factor will weigh in favor ofrelief even if the requesting spouse knewor had reason to know about the nonre-questing spouse’s intent or ability to paythe taxes due.

With respect to an underpayment of taxon an amended return that reports a liabil-ity based on items not properly reportedon the original return, the initial inquiryis whether, as of the date the amended re-turn was filed, or the date the requestingspouse reasonably believed the amendedreturn was filed, the requesting spouse rea-sonably expected that the nonrequestingspouse 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 toknow of the understatement on the origi-nal return will also be considered. If therequesting spouse knew or had reason toknow of the item giving rise to the under-statement on the original return, then thisfactor will weigh against relief. If the re-questing spouse did not know or have rea-son to know of the item, then this factorwill weigh in favor of relief.

(iii) Reason to know. The facts and cir-cumstances that are considered in deter-mining whether the requesting spouse hadreason to know of an understatement, orreason to know whether the nonrequestingspouse could or would pay the reported taxliability, include, but are not limited to, therequesting spouse’s level of education, anydeceit 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 orhousehold financial matters, 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, ifthe requesting spouse establishes that he or

she was the victim of abuse (not amountingto 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 againstrelief. Abuse comes in many forms andcan include physical, psychological, sex-ual, or emotional abuse, including effortsto 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 whatis required under the tax laws. All thefacts and circumstances are considered indetermining whether a requesting spousewas abused. The impact of a nonrequest-ing spouse’s alcohol or drug abuse is alsoconsidered in determining whether a re-questing spouse was abused. Dependingon the facts and circumstances, abuse ofthe requesting spouse’s child or other fam-ily member living in the household mayconstitute abuse of the requesting spouse.

(d) Legal obligation. Whether therequesting spouse or the nonrequestingspouse has a legal obligation to pay theoutstanding Federal income tax liability.For purposes of this factor, a legal obliga-tion is an obligation arising from a divorcedecree or other legally binding agreement.This factor will weigh in favor of relief ifthe nonrequesting spouse has the sole legalobligation to pay the outstanding incometax liability pursuant to a divorce decreeor agreement. This factor, however, willbe neutral if the requesting spouse knewor had reason to know, when entering intothe divorce decree or agreement, that thenonrequesting spouse would not pay theincome tax liability. This factor will weighagainst relief if the requesting spouse hasthe sole legal obligation. The fact that thenonrequesting spouse has been relieved ofliability for the taxes at issue as a result ofa discharge in bankruptcy is disregarded indetermining whether the requesting spousehas the sole legal obligation. This factorwill be neutral if, based on an agreementor consent order, both spouses have a legalobligation to pay the outstanding incometax liability, the spouses are not sepa-rated or divorced, or the divorce decree oragreement is silent as to any obligation topay the outstanding income tax liability.

(e) Significant benefit. Whether therequesting spouse significantly benefit-

ted from the unpaid income tax liabil-ity or understatement. See Treas. Reg.§ 1.6015–2(d). A significant benefit isany 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 takingexpensive vacations, this factor will weighagainst relief. If, however, the nonrequest-ing spouse controlled the household andbusiness finances or there was abuse (asdescribed in section 4.03(2)(c)(iv)) suchthat the nonrequesting spouse made thedecision on spending funds for a lavishlifestyle, then this mitigates this factor sothat it is neutral. If only the nonrequestingspouse significantly benefitted from theunpaid tax or understatement, and the re-questing spouse had little or no benefit, orthe nonrequesting spouse enjoyed the ben-efit to the requesting spouse’s detriment,this factor will weigh in favor of relief. Ifthe amount of unpaid tax or understate-ment was small such that neither spousereceived a significant benefit, then thisfactor is neutral. Whether the amount ofunpaid tax or understatement is small suchthat neither spouse received a significantbenefit will vary depending on the factsand circumstances of each case.

(f) Compliance with income tax laws.Whether the requesting spouse has madea good faith effort to comply with the in-come tax laws in the taxable years follow-ing the taxable year or years to which therequest for relief relates.

(i) If the requesting spouse is compliantfor taxable years after being divorced fromthe nonrequesting spouse, then this factorwill weigh in favor of relief. If the re-questing spouse is not compliant, then thisfactor will weigh against relief. If the re-questing spouse made a good faith effort tocomply with the tax laws but was unable tofully comply, then this factor will be neu-tral. For example, if the requesting spousetimely filed an income tax return but wasunable to fully pay the tax liability due tothe requesting spouse’s poor financial oreconomic situation after the divorce, thenthis factor will be neutral.

(ii) If the requesting spouse remainsmarried to the nonrequesting spouse,whether or not legally separated or livingapart, and continues to file joint returnswith the nonrequesting spouse after re-questing relief, then this factor will beneutral if the joint returns are compliant

October 21, 2013 402 2013–43 I.R.B.

with the tax laws, but will weigh againstrelief if the returns are not compliant.

(iii) If the requesting spouse remainsmarried to the nonrequesting spouse butfiles separate returns, this factor will weighin favor of relief if the requesting spouse iscompliant with the tax laws and will weighagainst relief if the requesting spouse is notcompliant with the tax laws. If the request-ing spouse made a good faith effort to com-ply with the tax laws but was unable tofully comply, then this factor will be neu-tral. For example, if the requesting spousetimely filed an income tax return but wasunable to fully pay the tax liability due tothe requesting spouse’s poor financial oreconomic 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. Whetherthe requesting spouse was in poor physicalor mental health. This factor will weighin favor of relief if the requesting spousewas in poor mental or physical health at thetime the return or returns for which the re-quest for relief relates were filed (or at thetime the requesting spouse reasonably be-lieved the return or returns were filed), orat the time the requesting spouse requestedrelief. The Service will consider the na-ture, extent, and duration of the condition,including the ongoing economic impact ofthe illness. If the requesting spouse was

in neither poor physical nor poor mentalhealth, this factor is neutral.

.04. Refunds. In both understatementand underpayment cases, a requestingspouse is eligible for a refund of sepa-rate payments made by the requestingspouse after July 22, 1998, if the request-ing spouse establishes that the funds usedto make the payment for which a refundis sought were provided by the requestingspouse. A requesting spouse is not eligiblefor refunds of payments made with thejoint return, joint payments, or paymentsthat the nonrequesting spouse made. A re-questing spouse, however, may be eligiblefor a refund of the requesting spouse’s por-tion of the requesting and nonrequestingspouse’s joint overpayment from anothertax year that was applied to the joint in-come tax liability to the extent that therequesting spouse can establish that therequesting spouse provided the funds forthe overpayment. The availability of re-funds is subject to the refund limitationsof section 6511.

SECTION 5. PROCEDURE

A requesting spouse seeking equi-table relief under section 66(c) or section6015(f) must file Form 8857, Request forInnocent Spouse Relief (and Separation ofLiability, and Equitable Relief), or other

similar statement signed under penaltiesof perjury, within the applicable period oflimitation as set forth in section 4.01(3) ofthis revenue procedure.

SECTION 6. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 2003–61, 2003–2 C.B. 296,is modified and superseded.

SECTION 7. EFFECTIVE DATE

This revenue procedure is effective forrequests 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, 2013whether with the Service, the Office of Ap-peals, or in a case docketed with a Federalcourt.

SECTION 8. DRAFTINGINFORMATION

The principal authors of this rev-enue procedure are Nancy Roseand Sheida Lahabi of the Office ofAssociate Chief Counsel (Procedure andAdministration). For further informationregarding this revenue procedure contactBranches 1 or 2 of Procedure andAdministration on (202) 622–4910 or(202) 622–4940 (not a toll free call).

2013–43 I.R.B. 403 October 21, 2013

Part IV. Items of General InterestNotice of ProposedRulemaking and Notice ofPublic Hearing

Guidance RegardingDispositions of TangibleDepreciable Property

REG–110732–13

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemak-ing, notice of public hearing, and partialwithdrawal of previously proposed regula-tions.

SUMMARY: This document containsproposed regulations regarding disposi-tions of property subject to depreciationunder section 168 of the Internal Rev-enue Code (Code) (Modified AcceleratedCost Recovery System (MACRS) prop-erty). The proposed regulations alsoamend the general asset account regula-tions under §1.168(i)–1 and the accountingfor MACRS property regulations under§1.168(i)–7. The proposed regulationswill affect all taxpayers that dispose ofMACRS property. This document alsoprovides notice of a public hearing onthese proposed regulations and partiallywithdraws the proposed regulations pub-lished in the Federal Register on 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 oftopics to be discussed at the public hear-ing scheduled for December 19, 2013, at10 a.m. must be received by November 18,2013.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–110732–13), room5205, Internal Revenue Service, P.O. Box7604, Ben Franklin Station, Washington,DC 20044. Submissions may be hand-de-livered Monday through Friday betweenthe hours of 8:00 a.m. and 4:00 p.m.to CC:PA:LPD:PR (REG–110732–13),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW.,

Washington, DC 20224, or sent elec-tronically, via the Federal eRulemak-ing Portal at www.regulations.gov (IRSREG–110732–13). The public hearingwill be held in the IRS Auditorium,Internal Revenue Building, 1111Constitution Avenue, NW., Washington,DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the pro-posed regulations, Kathleen Reed andPatrick Clinton, Office of AssociateChief Counsel (Income Tax andAccounting) (202) 622–4930; andconcerning submission of comments,the hearing, and/or to be placed on thebuilding access list to attend the hearing,Oluwafunmilayo (Funmi) Taylor, (202)622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

On December 27, 2011, the IRS andthe Treasury Department published in theFederal Register (76 FR 81060) tem-porary regulations (TD 9564) regardingthe accounting for, and dispositions of,property subject to depreciation undersection 168 (MACRS property). Thetemporary regulations also amended thegeneral asset account regulations under§1.168(i)–1. On the same date, the IRSpublished in the Federal Register (76 FR81128) a notice of proposed rulemaking(REG–168745–03) cross-referencing thetemporary regulations (2011 proposedregulations). The IRS and the TreasuryDepartment received numerous writtencomments responding to the notice ofproposed rulemaking and held a publichearing on May 9, 2012.

The temporary regulations generallyapply to taxable years beginning on or afterJanuary 1, 2012. In response to the com-ments received and the statements made atthe public hearing, the IRS and the Trea-sury Department released Notice 2012–73,2012–51 I.R.B. 713, on November 20,2012, announcing that, to help taxpayerstransition to the final regulations, the IRSand the Treasury Department will changethe applicability date of the temporaryregulations to taxable years beginning on

or after January 1, 2014, while permittingtaxpayers to choose to apply the temporaryregulations to taxable years beginning onor after January 1, 2012, and before theapplicability date of the final regulations.Notice 2012–73 also alerts taxpayers thatthe IRS and the Treasury Department in-tend to publish final regulations in 2013and expect the final regulations to applyto taxable years beginning on or after Jan-uary 1, 2014, but that the final regulationswould permit taxpayers to apply the pro-visions of the final regulations to taxableyears beginning on or after January 1,2012. On December 17, 2012, the IRSand the Treasury Department publishedin the Federal Register (77 FR 74583) atechnical amendment to TD 9564, whichamended the applicability date of thetemporary regulations to taxable years be-ginning on or after January 1, 2014, whilepermitting taxpayers to choose to applythe temporary regulations to taxable yearsbeginning on or after January 1, 2012, andbefore the applicability date of the finalregulations.

Notice 2012–73 also alerts taxpayersthat the IRS and the Treasury Departmentintend to revise the disposition rules in thetemporary regulations. After consideringthe comment letters and the statementsmade at the public hearing, the IRS andthe Treasury Department decided to with-draw the 2011 proposed regulations under§§1.168(i)–1 and 1.168(i)–8 and to pro-pose new regulations. This documentcontains the new proposed regulationsunder §§1.168(i)–1 and 1.168(i)–8 aswell as new proposed regulations under§1.168(i)–7. The temporary regulationsunder §§1.168(i)–1T and 1.168(i)–8T arenot revised and taxpayers continue to havethe option of applying those temporaryregulations to taxable years beginning onor after January 1, 2012, and before theapplicability date of the final regulations.

Summary of Comments andExplanation of Provisions

I. Overview

These proposed regulations under§§1.168(i)–1 and 1.168(i)–8 include manyof the provisions contained in the 2011proposed regulations and the temporary

October 21, 2013 404 2013–43 I.R.B.

regulations under §§1.168(i)–1T and1.168(i)–8T. However, these proposedregulations provide significant changesto the rules relating to the determinationof the asset disposed of and a qualify-ing disposition of an asset in a generalasset 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 andthe 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 regulationsgenerally are proposed to apply to taxableyears beginning on or after January 1,2014.

II. Disposition Rules for MACRS Property

The IRS and the Treasury Departmentreceived several comments on the dis-position rules under §§1.168(i)–1T and1.168(i)–8T. Most of the comments relatedto dispositions of structural componentsof a building, dispositions of assets in ageneral asset account, and determinationof the unadjusted depreciable basis of adisposed asset in a multiple asset accountor a general asset account.

A. Determination of Asset Disposed Ofand 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 ofMACRS property that are generally con-sistent with the disposition rules under§1.168–6 of the proposed regulations onthe Accelerated Cost Recovery System offormer section 168 (ACRS) (which havebeen generally applied to MACRS prop-erty). However, if an abandoned asset issubject to nonrecourse indebtedness, thetemporary regulations clarify that the assetis treated in the same manner as an assetdisposed of by sale.

Section 1.168–2(l)(1) of the proposedACRS regulations provides that a dispo-sition does not include the retirement ofa structural component of a building and,consequently, §1.168–6(b) of the proposedACRS regulations provides that no loss isrecognized 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, thetemporary 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 computingdepreciation for general asset accounts,and for determining gain or loss uponthe 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 assetfrom a general asset account. However,§1.168–1T(e)(3)(iii) provides that a tax-payer may elect to recognize gain or lossupon the disposition of an asset in a gen-eral asset account if there is a qualifyingdisposition. The temporary regulationsdefine the term “disposition” to includethe retirement of a structural componentof a building and define the term “quali-fying disposition” to allow the recognitionof gain or loss upon most dispositions ofassets in general asset accounts. Thus, ataxpayer has the option of recognizing aloss on most dispositions of assets in gen-eral asset accounts under the temporaryregulations.

The temporary regulations under§§1.168(i)–1T and 1.168(i)–8T also pro-vide rules for determining the disposedasset. Those sections of the temporaryregulations provide that the facts andcircumstances of each disposition areconsidered in determining the appro-priate disposed asset. In general, theasset for disposition purposes cannot belarger than the unit of property as deter-mined under §1.263(a)–3(e)(2), (e)(3),and (e)(5) or as otherwise provided inpublished guidance in the Federal Reg-ister or in the Internal Revenue Bul-letin. However, under §§1.168(i)–1T and1.168(i)–8T, each building is the asset fordisposition purposes, unless more thanone building is treated as the asset un-der §1.1250–1(a)(2)(ii). If the buildingincludes two or more condominium orcooperative units, then each condominiumor cooperative unit (instead of the build-ing) is the asset for disposition purposes.Consistent with including a retirement ofa structural component of a building asa disposition, the temporary regulationsprovide that each structural componentof a building, condominium unit, or co-

operative unit is the asset for dispositionpurposes. Further, if a taxpayer prop-erly includes an item in one of the assetclasses 00.11 through 00.4 of Rev. Proc.87–56 (1987–2 C.B. 674), (see 26 CFR601.601(d)(2)(ii)(b)) or classifies an itemin one of the categories under section168(e)(3) (other than a category that in-cludes buildings or structural components;for example, retail motor fuels outlet andqualified leasehold improvement prop-erty), each item is the asset provided itis not larger than the unit of property asdetermined under §1.263(a)–3(e)(3) or(e)(5). Consistent with section 168(i)(6),the temporary regulations also providethat if the taxpayer places in service animprovement or addition to an asset afterthe taxpayer placed the asset in service,the improvement or addition is a sepa-rate asset for depreciation purposes. Thetemporary regulations also provide that ataxpayer generally may use any reason-able, consistent method to treat each of anasset’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 fromthe underlying building increases admin-istrative burdens for taxpayers because ofthe 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 taxpayersthe ability to recognize a loss on the par-tial retirement of a larger item, some com-menters indicated that such an approachis unduly complicated and will pose sig-nificant administrative burdens for taxpay-ers. Other commenters suggested that theability to use any reasonable, consistentmethod to treat each of an asset’s compo-nents as the asset for disposition purposesbe expanded to assets classified in assetclasses 00.11 through 00.4 of Rev. Proc.87–56, which accounts for the propertythat 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 itsstructural components)).

Several commenters suggested that theuse of general asset accounts be the default

2013–43 I.R.B. 405 October 21, 2013

rule to eliminate traps for taxpayers. Com-menters stated that requiring taxpayersto make a general asset account electionwhen structural components are placed inservice to forgo the loss on dispositionsof structural components occurring yearslater was a trap for taxpayers. For exam-ple, because a taxpayer that did not electgeneral asset account treatment cannotforgo a mandatory loss on a dispositionof a structural component, the taxpayerwould be required to capitalize the re-placement of the structural componentunder §1.263(a)–3(k)(1)(i) even if thereplacement of the structural componentdoes not constitute the replacement of amajor component, a significant portionof a major component, or a substantialstructural part of the building unit of prop-erty under §§1.263(a)–3(k)(1)(vi) and1.263(a)–3(k)(6)(ii). Further, becausesome structural components are definedin §1.48–1(e)(2) at a diminutive level (forexample, one window in a building), com-menters stated that absent including allstructural components in a general assetaccount, taxpayers run the risk of failingto identify every disposition in a giventaxable year.

The IRS and the Treasury Departmentdo not think that the use of general assetaccounts should be the default rule. How-ever, the IRS and the Treasury Departmentagree that taxpayers that do not elect gen-eral asset account treatment should havethe same flexibility to forgo a loss upon thedisposition of a structural component astaxpayers that elect general asset accounttreatment. As discussed in this preamble,these proposed regulations make signifi-cant modifications to the disposition rulesto allow this flexibility.

3. Structural components

These proposed regulations change therule in the temporary regulations under§§1.168(i)–1T and 1.168(i)–8T that eachstructural component of a building, condo-minium, or cooperative is the asset for taxdisposition purposes. The proposed regu-lations provide that a building (includingits structural components), a condominium(including its structural components), or acooperative (including its structural com-ponents) is the asset for disposition pur-poses. This rule allows taxpayers to forgoa loss upon the disposition of a structural

component of a building without making ageneral asset account election.

4. Partial dispositions

A. Assets not included in general assetaccounts

The proposed regulations under§1.168(i)–8 also provide that the disposi-tion rules apply to a partial disposition ofan asset (for example, the disposition of aroof (or a portion of the roof)). This ruleallows taxpayers to claim a loss upon thedisposition of a structural component (or aportion thereof) of a building or upon thedisposition of a component (or a portionthereof) of any other asset without iden-tifying the component as an asset beforethe disposition event. The partial dispo-sition rule also minimizes circumstancesin which an original part and any subse-quent replacements of the same part arerequired to be capitalized and depreciatedsimultaneously. These proposed regula-tions provide examples demonstrating theapplication of the partial disposition rule.

In many cases, the partial dispositionrule is elective (“partial disposition elec-tion”). However, consistent with the oper-ation of sections 165, 168(i)(7), 1031, and1033, and because sales of a portion of anasset are common, the partial dispositionrule is required to be applied to a disposi-tion of a portion of an asset as a result ofa casualty event described in section 165,to a disposition of a portion of an asset forwhich gain (determined without regard tosection 1245 or 1250) is not recognizedin whole or in part under section 1031 or1033, 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 saleof a portion of an asset. Consequently, adisposition 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 disposedportion. For other transactions, a disposi-tion includes a disposition of a portion ofan asset only if the taxpayer makes the par-tial disposition election for that disposedportion.

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 includedin one of the asset classes 00.11 through

00.4 of Rev. Proc. 87–56. However, con-sistent with section 168(i)(6), a taxpayermaking the partial disposition election forthe disposition of a portion of an asset thatis properly included in one of the assetclasses 00.11 through 00.4 of Rev. Proc.87–56 must classify the replacement por-tion of the asset under the same asset classas the disposed portion of the asset.

The partial disposition election is madeon the taxpayer’s timely filed original Fed-eral tax return, including extensions, forthe taxable year in which the portion of theasset is disposed of by the taxpayer. Thiselection may not be made or revoked bythe filing of an application for a change inmethod 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 Commissionerof Internal Revenue to revoke this elec-tion. The Commissioner may grant a re-quest to revoke this election if the taxpayeracted reasonably and in good faith, and therevocation will not prejudice the interestsof the Government. In deciding whetherto grant such a request, the Commissioneranticipates applying standards similar tothe standards under 26 CFR 301.9100–3for granting extensions of time for mak-ing regulatory elections. If a taxpayerchooses to apply these proposed regula-tions to its taxable year beginning in 2012or 2013, these proposed regulations alsoprovide rules for making the partial dispo-sition election for the portion of an assetdisposed of by the taxpayer during thosetaxable 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’scharacterization of the replacement of aportion of an asset as a repair. When theIRS disallows a taxpayer’s repair deduc-tion for the amount paid or incurred for thereplacement of a portion of an asset andcapitalizes such amount under §1.263(a)–2or §1.263(a)–3, the taxpayer may make thepartial disposition election for the disposi-tion of the portion of the asset to which theIRS’s adjustment pertains by filing an ap-plication for change in accounting method,provided the asset of which the disposedportion was a part is owned by the taxpayerat the beginning of the year of change (asdefined for purposes of section 446(e)).

October 21, 2013 406 2013–43 I.R.B.

B. Assets included in general assetaccounts

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 dispositionincludes a disposition of a portion of an as-set as a result of a casualty event describedin section 165, a disposition of a portion ofan asset for which gain (determined with-out regard to section 1245 or 1250) is notrecognized in whole or in part under sec-tion 1031 or 1033, a transfer of a portion ofan asset in a transaction described in sec-tion 168(i)(7)(B), a sale of a portion of anasset, or a disposition of a portion of anasset in a transaction described under theanti-abuse rules applicable to general as-set accounts. For other transactions, a dis-position includes a disposition of a portionof an asset only if the taxpayer makes theelection 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 qualifyingdisposition election for that disposed por-tion. A separate partial disposition elec-tion is not provided for assets in a generalasset account because a taxpayer can claima loss upon the disposition of an asset (or aportion thereof) in a general asset accountonly when the taxpayer makes these twoelections.

5. Components of an asset

Because the partial disposition ruleunder these proposed regulations allowstaxpayers to treat the disposition of an as-set’s component as a disposition, the IRSand the Treasury Department believe thatthe rule in §§1.168(i)–1T and 1.168(i)–8Tallowing taxpayers to use any reason-able, consistent method to treat an asset’scomponents as the asset for dispositionpurposes is no longer needed. Accord-ingly, these proposed regulations do notinclude that temporary regulations rule.The IRS and the Treasury Departmentrequest comments addressing whether therule in §§1.168(i)–1T and 1.168(i)–8Tallowing taxpayers to use any reason-able, consistent method to treat an asset’scomponents as the asset for dispositionpurposes is still needed.

6. Disposition definition

Consistent with these changes, theseproposed regulations modify the tempo-rary regulations’ definition of a dispositionunder §§1.168(i)–1T and 1.168(i)–8T toprovide that a disposition includes thedisposition of a structural component(or a portion thereof) of a building onlyif the partial disposition rule applies tosuch structural component (or a portionthereof).

7. General asset accounts

Finally, these proposed regulationschange the temporary regulation defi-nition of a qualifying disposition under§1.168(i)–1T(e)(3)(iii). The purpose of ageneral asset account is to reduce the ad-ministrative burden of tracking deprecia-ble assets. This purpose was accomplishedin the final regulations for general assetaccounts under §1.168(i)–1 (as in effectbefore the temporary regulations under§1.168(i)–1T) by allowing a taxpayer togroup assets in one or more general assetaccounts and by allowing a taxpayer toelect to terminate general asset accounttreatment only when the taxpayer disposesof all of the assets, or the last asset, in theaccount, or disposes of an asset in a qual-ifying disposition, which generally was acasualty or other extraordinary event. Thetemporary regulations under §1.168(i)–1Texpand a qualifying disposition to includegenerally any disposition and, as a result,increased the administrative burden oftracking depreciable assets. To reduce thisburden, the IRS and the Treasury Depart-ment have decided to change the definitionof a qualifying disposition so that it isthe 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 regulationsprovide that a qualifying disposition is adisposition that does not involve all theassets, the last asset, or the remainingportion of the last asset, remaining in ageneral asset account and that is: (1) adirect result of a fire, storm, shipwreck, orother casualty, or from theft; (2) a chari-table contribution for which a deductionis allowable under section 170; (3) a di-rect result of a cessation, termination, ordisposition of a business, manufacturing,

or other income producing process, oper-ation, facility, plant, or other unit (otherthan by transfer to a supplies, scrap, orsimilar account); or (4) generally a trans-action to which a nonrecognition sectionof the Code applies.

B. Determination of Basis andIdentification of Disposed or ConvertedAsset

The temporary regulations under§§1.168(i)–1T and 1.168(i)–8T providethat 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 isimpracticable from the taxpayer’s recordsto determine the unadjusted depreciablebasis of the disposed asset, the taxpayermay use any reasonable method that isconsistently applied to the taxpayer’sgeneral asset accounts, multiple asset ac-counts, or larger assets, as applicable.

Several commenters requested that oneor more specific methodologies be pro-vided. They suggested using replacementcost adjusted for inflation using an objec-tive index, using third-party constructionestimating and valuation services, or usingrelative fair market value of acquired com-ponents.

In response, these proposed regulationsprovide nonexclusive examples of reason-able methods. Such examples include: (1)discounting the cost of the replacement as-set to its placed-in-service year cost usingthe Consumer Price Index; (2) a pro rataallocation of the unadjusted depreciablebasis of the general asset account or mul-tiple asset account, as applicable, based onthe replacement cost of the disposed assetand the replacement cost of all of the as-sets in the general asset account or multi-ple asset account, as applicable; and (3) astudy allocating the cost of the asset to itsindividual components. The IRS and theTreasury Department expect that reason-able methods are available that use infor-mation readily available or known to thetaxpayer 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)–1Tand 1.168(i)–8T that allows taxpayers touse any reasonable, consistent method totreat an asset’s components as the asset fortax disposition purposes. Consistent with

2013–43 I.R.B. 407 October 21, 2013

this change, these proposed regulations donot include the temporary regulation rulesin §§1.168(i)–1T and 1.168(i)–8T regard-ing the determination of the unadjusteddepreciable basis, and identification, ofthe disposed component of a larger as-set. However, these proposed regulationsprovide rules regarding the determinationof the unadjusted depreciable basis, andidentification, of the disposed portion ofan asset when the partial disposition ruleapplies.

If the partial disposition rule applies,these proposed regulations provide that ataxpayer may use any reasonable methodfor determining the unadjusted deprecia-ble basis of the disposed portion of theasset. Also, if a taxpayer disposes of morethan one portion of the same asset, the tax-payer may use any reasonable method thatis consistently applied to all portions ofthe same asset for purposes of determiningthe unadjusted depreciable basis of eachdisposed portion of the asset. These pro-posed regulations provide nonexclusiveexamples of reasonable methods.

If a taxpayer disposes of a portion ofthe asset and the partial disposition ruleapplies to that disposition, these proposedregulations provide rules regarding theidentification of the asset. When it is im-practicable from the taxpayer’s records todetermine the particular taxable year inwhich the asset was placed in service bythe taxpayer, the taxpayer must identifythe asset by using the methods allowedwhen the asset is in a general asset accountor a multiple asset account: the first-in,first-out (FIFO) method, the modifiedFIFO method, a mortality dispersion tableif the asset is a mass asset, or any othermethod designated by the Secretary inpublished 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 taxpayerdisposes of a portion of an asset and thepartial disposition rule applies to that dis-position, the taxpayer must account for thedisposed portion in a single asset accountbeginning in the taxable year in whichthe disposition occurs. This new rule alsois provided in the proposed regulationsunder §1.168(i)–7.

The proposed regulations under§§1.168(i)–1 and 1.168(i)–8 also provideexamples demonstrating the interactionbetween 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 afterJanuary 1, 2014. The regulations also per-mit taxpayers to rely on the provisions ofthe proposed regulations for taxable yearsbeginning on or after January 1, 2012,and before the applicability date of thefinal regulations. The proposed regula-tions provide that taxpayers may apply theprovisions of the final regulations to tax-able years beginning on or after January1, 2012. The temporary regulations under§§1.168(i)–1T and 1.168(i)–8T allow tax-payers to apply the temporary regulationsto taxable years beginning on or after Jan-uary 1, 2012, but the final regulations willprovide that taxpayers may not apply thetemporary regulations to taxable years be-ginning on or after January 1, 2014.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866, as supplemented by Execu-tive Order 13563. Therefore, a regulatoryassessment is not required. It also has beendetermined 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 smallentities, the Regulatory Flexibility Act (5U.S.C. chapter 6) does not apply. Pursuantto section 7805(f) of the Code, this regula-tion has been submitted to the Chief Coun-sel for Advocacy of the Small BusinessAdministration for comment on its impacton small business.

Comments and Public Hearing

Before the proposed regulations areadopted as final regulations, considerationwill be given to any comments that aresubmitted timely to the IRS as prescribedin this preamble under the “Addresses”

heading. The IRS and the Treasury De-partment request comments on all aspectsof these proposed rules. All commentswill be available for public inspection andcopying at www.regulations.gov or uponrequest.

A public hearing has been scheduled forDecember 19, 2013, beginning at 10 a.m.in the IRS Auditorium, Internal RevenueBuilding, 1111 Constitution Avenue, NW.,Washington, DC. Due to building securityprocedures, visitors must enter at the Con-stitution Avenue entrance. In addition, allvisitors must present photo identificationto enter the building. Because of accessrestrictions, visitors will not be admittedbeyond the immediate entrance area morethan 30 minutes before the hearing starts.For information about having your nameplaced on the building access list to attendthe hearing, see the “FOR FURTHER IN-FORMATION CONTACT” section of thispreamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish topresent oral comments at the hearing mustsubmit electronic or written comments, anoutline of the topics to be discussed, andthe time to be devoted to each topic (signedoriginal and eight (8) copies) by Novem-ber 18, 2013. A period of 10 minutes willbe allotted to each person for making com-ments. An agenda showing the schedulingof the speakers will be prepared after thedeadline for receiving outlines has passed.Copies of the agenda will be available freeof charge at the hearing.

Statement of Availability for IRSDocument

For copies of recently issued RevenueProcedures, Revenue Rulings, noticesand other guidance published in the In-ternal Revenue Bulletin or CumulativeBulletin please visit the IRS website athttp://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 fromthe IRS and the Treasury Department par-ticipated in their development.

* * * * *

October 21, 2013 408 2013–43 I.R.B.

Partial Withdrawal of ProposedAmendments to the Regulations

Accordingly, under the authority of 26U.S.C. 7805, §§1.168(i)–1 and 1.168(i)–8of the notice of proposed rulemaking(REG–168745–03) that was published inthe Federal Register on December 27,2011 (76 FR 81128), are withdrawn.

Proposed Amendment to theRegulations

Accordingly, 26 CFR part 1 is proposedto be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 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 entriesfor paragraph (h)(2).

The additions and revisions read as fol-lows:

§1.168(i)–0 Table of contents for thegeneral 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 accountare 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. Section 1.168(i)–1 is amended

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 rulesfor general asset accounts under section168(i)(4). The provisions of this sectionapply only to assets for which an electionhas been made under paragraph (l) of thissection.

(b) Definitions. For purposes of thissection, the following definitions apply:

(1) Unadjusted depreciable basis hasthe same meaning given such term in§1.168(b)–1(a)(3).

(2) Unadjusted depreciable basis of thegeneral asset account is the sum of theunadjusted depreciable bases of all assetsincluded in the general asset account.

(3) Adjusted depreciable basis of thegeneral asset account is the unadjusted de-preciable basis of the general asset account

less the adjustments to basis described insection 1016(a)(2) and (3).

(4) Building has the same meaning asthat term is defined in §1.48–1(e)(1).

(5) Expensed cost is the amount of anyallowable credit or deduction treated asa deduction allowable for depreciation oramortization for purposes of section 1245(for example, a credit allowable under sec-tion 30 or a deduction allowable under sec-tion 179, 179A, or 190). Expensed costdoes not include any additional first yeardepreciation deduction.

(6) Mass assets is a mass or group ofindividual items of depreciable assets—

(i) That are not necessarily homoge-nous;

(ii) Each of which is minor in valuerelative to the total value of the mass orgroup;

(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) Portion of an asset is any part of

an asset that is less than the entire asset asdetermined under paragraph (e)(2)(viii) ofthis section.

(8) Remaining adjusted depreciable ba-sis of the general asset account is the un-adjusted depreciable basis of the generalasset 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 component has thesame 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. Assetsthat are subject to either the general de-preciation system of section 168(a) or thealternative depreciation system of section168(g) may be accounted for in one ormore general asset accounts. An asset isincluded in a general asset account only tothe extent of the asset’s unadjusted depre-ciable basis. However, an asset is not to beincluded in a general asset account if theasset is used both in a trade or business (orfor 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. 409 October 21, 2013

in service and disposed of during the sametaxable year.

(ii) Special rules for assets generat-ing foreign source income. (A) Assetsthat generate foreign source income, bothUnited States and foreign source income,or combined gross income of a foreignsales corporation (FSC) (as defined in for-mer section 922), domestic internationalsales corporation (DISC) (as defined insection 992(a)), or possessions corpora-tion (as defined in section 936) and itsrelated supplier may be included in a gen-eral asset account if the requirements ofparagraph (c)(2)(i) of this section are sat-isfied. If, however, the inclusion of theseassets in a general asset account resultsin a substantial distortion of income, theCommissioner may disregard the generalasset account election and make any real-locations of income or expense necessaryto clearly reflect income.

(B) A general asset account shall betreated as a single asset for purposes ofapplying the rules in §1.861–9T(g)(3)(relating to allocation and apportion-ment of interest expense under the assetmethod). A general asset account thatgenerates income in more than one group-ing of income (statutory and residual)is a multiple category asset (as definedin §1.861–9T(g)(3)(ii)), and the incomeyield from the general asset account mustbe determined by applying the rules formultiple category assets as if the generalasset account were a single asset.

(2) Grouping assets in general asset ac-counts—(i) General rules. If a taxpayermakes the election under paragraph (l) ofthis section, assets that are subject to theelection are grouped into one or more gen-eral asset accounts. Assets that are eligibleto be grouped into a single general asset ac-count may be divided into more than onegeneral asset account. Each general assetaccount must include only assets that—

(A) Have the same applicable deprecia-tion method;

(B) Have the same applicable recoveryperiod;

(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. In addition to the gen-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-quarterconvention may only be grouped into ageneral asset account with assets that areplaced in service in the same quarter of thetaxable year;

(B) Assets subject to the mid-monthconvention may only be grouped into ageneral asset account with assets that areplaced in service in the same month of thetaxable year;

(C) Passenger automobiles for whichthe depreciation allowance is limited un-der section 280F(a) must be grouped intoa separate general asset account;

(D) Assets not eligible for any addi-tional first year depreciation deduction(including assets for which the taxpayerelected not to deduct the additional firstyear depreciation) provided by, for ex-ample, section 168(k), 168(l), 168(m),168(n), 1400L(b), or 1400N(d), must begrouped into a separate general asset ac-count;

(E) Assets eligible for the additionalfirst year depreciation deduction may onlybe grouped into a general asset accountwith assets for which the taxpayer claimedthe same percentage of the additional firstyear depreciation (for example, 30 percent,50 percent, or 100 percent);

(F) Except for passenger automobilesdescribed in paragraph (c)(2)(ii)(C) of thissection, listed property (as defined in sec-tion 280F(d)(4)) must be grouped into aseparate general asset account;

(G) Assets for which the depreciationallowance for the placed-in-service year isnot 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 assetis 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 inuse results in a shorter recovery period ora more accelerated depreciation method)for which the depreciation allowancefor 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 assetaccount.

(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 effecton 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 oneitem 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 returnfor 2014, J makes an election under section 179 to ex-pense $25,000 of the equipment’s cost and makes anelection under paragraph (l) of this section to includethe equipment in a general asset account. As a result,the unadjusted depreciable basis of the equipment is$525,000. In accordance with paragraph (c)(1) of thissection, 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 acalendar year-end, purchases and places in service100 items of equipment. All of these items are 5-yearproperty 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 equipmentand does make an election under paragraph (l) of thissection to include the 100 items of equipment in ageneral 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 balancemethod, a 5-year recovery period, and the half-yearconvention. In accordance with paragraph (c)(2) ofthis section, K includes all of the 100 items of equip-ment in one general asset account.

Example 3. The facts are the same as in Example2, except that K decides not to include all of the 100items of equipment in one general asset account. In-stead and in accordance with paragraph (c)(2) of thissection, K establishes 100 general asset accounts andincludes one item of equipment in each general assetaccount.

Example 4. L, a calendar-year corporation, is awholesale distributer. In 2014, L places in service thefollowing properties for use in its wholesale distribu-tion business: computers, automobiles, and forklifts.On its Federal tax return for 2014, L does not makean election under section 179 to expense the cost ofany of these items of equipment and does make anelection under paragraph (l) of this section to includeall of these items of equipment in a general asset ac-count. All of these items are 5-year property undersection 168(e) and are not eligible for any additionalfirst year depreciation deduction. The computers arelisted property, and the automobiles are listed prop-erty and are subject to section 280F(a). L depreciatesits 5-year property placed in service in 2014 using theoptional depreciation table that corresponds with thegeneral depreciation system, the 200-percent declin-ing balance method, a 5-year recovery period, and thehalf-year convention. Although the computers, auto-mobiles, and forklifts are 5-year property, L cannot

October 21, 2013 410 2013–43 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 onegeneral asset account because the automobiles alsoare subject to section 280F(a). In accordance withparagraph (c)(2) of this section, L establishes threegeneral asset accounts: one for the computers, onefor the automobiles, and one for the forklifts.

Example 5. M, a fiscal-year corporation with ataxable year ending June 30, purchases and placesin service ten items of new equipment in October2014, and purchases and places in service five otheritems of new equipment in February 2015. On itsFederal tax return for the taxable year ending June30, 2015, M does not make an election under sec-tion 179 to expense the cost of any of these itemsof equipment and does make an election under para-graph (l) of this section to include all of these itemsof equipment in a general asset account. All of theseitems of equipment are 7-year property under section168(e), are not listed property, and are property de-scribed in section 168(k)(2)(B). All of the ten itemsof equipment placed in service in October 2014 areeligible 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 servicein February 2015 are not eligible for any additionalfirst year depreciation deduction. M depreciates its7-year property placed in service for the taxable yearending June 30, 2015, using the optional depreciationtable that corresponds with the general depreciationsystem, the 200-percent declining balance method, a7-year recovery period, and the half-year convention.Although the 15 items of equipment are depreciatedusing the same depreciation method, recovery period,and convention, M cannot include all of them in onegeneral 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 assetaccounts: one for the ten items of equipment eligiblefor the 50-percent additional first year depreciationdeduction and one for the five items of equipment noteligible for any additional first year depreciation de-duction.

(d) Determination of depreciation al-lowance—(1) In general. Depreciationallowances 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 theamount of depreciation allowable undersection 167(a).

(2) Assets in general asset account areeligible 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 depreciationdeduction for the general asset account forthe placed-in-service year and then must

determine the amount otherwise allowableas a depreciation deduction for the gen-eral asset account for the placed-in-serviceyear and any subsequent taxable year. Theallowable additional first year depreciationdeduction for the general asset account forthe placed-in-service year is determined bymultiplying the unadjusted depreciable ba-sis of the general asset account by the ad-ditional first year depreciation deductionpercentage applicable to the assets in theaccount (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 theapplicable depreciation method, recoveryperiod, and convention for the assets in theaccount.

(3) No assets in general asset accountare eligible for additional first year depre-ciation deduction. If none of the assetsin a general asset account are eligible forthe additional first year depreciation de-duction, the taxpayer must determine theallowable depreciation deduction for thegeneral asset account for the placed-in-service year and any subsequent taxableyear by using the applicable depreciationmethod, recovery period, and conventionfor the assets in the account.

(4) Special rule for passenger automo-biles. For purposes of applying section280F(a), the depreciation allowance fora general asset account established forpassenger automobiles is limited for eachtaxable year to the amount prescribed insection 280F(a) multiplied by the excessof the number of automobiles originallyincluded in the account over the number ofautomobiles disposed of during the taxableyear 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 subjectto section 168(i)(7)), (e)(3)(v) (transac-tions subject to section 1031 or section1033), (e)(3)(vi) (technical terminationof a partnership), (e)(3)(vii) (anti-abuserule), (g) (assets subject to recapture),(h)(1) (conversion to personal use), or(h)(2) (business or income-producing usepercentage changes) of this section.

(e) Dispositions from a general assetaccount—(1) Scope and Definition—(i)In general. This paragraph (e) providesrules applicable to dispositions of assetsincluded in a general asset account. Forpurposes of this paragraph (e), an asset in a

general asset account is disposed of whenownership of the asset is transferred orwhen the asset is permanently withdrawnfrom use either in the taxpayer’s trade orbusiness or in the production of income.A disposition includes the sale, exchange,retirement, physical abandonment, or de-struction of an asset. A disposition alsooccurs when an asset is transferred toa supplies, scrap, or similar account, orwhen a portion of an asset is disposed ofas described in paragraph (e)(1)(ii) of thissection. If a structural component (or aportion thereof) of a building is disposedof in a disposition described in paragraph(e)(1)(ii) of this section, a disposition alsoincludes the disposition of such structuralcomponent (or such portion thereof).

(ii) Disposition of a portion of an asset.For purposes of applying paragraph (e) ofthis section, a disposition includes a dispo-sition of a portion of an asset in a generalasset account as a result of a casualty eventdescribed in section 165, a disposition of aportion of an asset in a general asset ac-count for which gain (determined withoutregard to section 1245 or section 1250) isnot recognized in whole or in part undersection 1031 or section 1033, a transfer ofa portion of an asset in a general asset ac-count in a transaction described in section168(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 thissection. For other transactions, a dispo-sition includes a disposition of a portionof an asset in a general asset account onlyif the taxpayer makes the election underparagraph (e)(3)(ii) of this section to ter-minate the general asset account in whichthat disposed portion is included or makesthe election under paragraph (e)(3)(iii) ofthis section for that disposed portion.

(2) General rules for a disposition—(i)No immediate recovery of basis. Exceptas provided in paragraph (e)(3) of this sec-tion, immediately before a disposition ofany asset in a general asset account or adisposition 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 anadjusted depreciable basis (as defined in§1.168(b)–1(a)(4)) of zero for purposes ofsection 1011. Therefore, no loss is realizedupon the disposition of an asset from the

2013–43 I.R.B. 411 October 21, 2013

general asset account or upon the disposi-tion of a portion of such asset as describedin 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 transferto a supplies, scrap, or similar account, thebasis of the asset or the portion of the as-set, as applicable, in the supplies, scrap, orsimilar account will be zero.

(ii) Treatment of amount realized. Anyamount realized on a disposition is recog-nized as ordinary income (notwithstand-ing any other provision of subtitle A ofthe Internal Revenue Code) to the extentthe 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 recognizedas ordinary income upon the disposition ofother 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 anyexcess amount realized are determined un-der other applicable provisions of the In-ternal Revenue Code (other than sections1245 and 1250 or provisions of the InternalRevenue Code that treat gain on a disposi-tion as subject to section 1245 or 1250).

(iii) Effect of disposition on a generalasset account. Except as provided in para-graph (e)(3) of this section, the unadjusteddepreciable basis and the depreciation re-serve of the general asset account are notaffected as a result of a disposition of anasset from the general asset account or of adisposition of a portion of such asset as de-scribed in paragraph (e)(1)(ii) of this sec-tion.

(iv) Coordination with nonrecognitionprovisions. For purposes of determiningthe basis of an asset or a portion of anasset, as applicable, acquired in a trans-action, other than a transaction describedin paragraphs (e)(3)(iv) (pertaining totransactions subject to 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, towhich a nonrecognition section of the In-ternal Revenue Code applies (determinedwithout regard to this section), the amountof ordinary income recognized under thisparagraph (e)(2) is treated as the amountof gain recognized on the disposition.

(v) Manner of disposition. The man-ner of disposition (for example, normalretirement, abnormal retirement, ordinaryretirement, or extraordinary retirement)is not taken into account in determiningwhether a disposition occurs or gain orloss is recognized.

(vi) Disposition by transfer to a sup-plies account. If a taxpayer made anelection under §1.162–3(d) to treat thecost of any rotable spare part, temporaryspare part, or standby emergency sparepart (as defined in §1.162–3(c)) as a cap-ital expenditure subject to the allowancefor depreciation and also made an electionunder paragraph (l) of this section to in-clude that rotable, temporary, or standbyemergency spare part in a general as-set account, the taxpayer can dispose ofthe rotable, temporary, or standby emer-gency spare part by transferring it to asupplies account only if the taxpayer hasobtained the consent of the Commissionerto 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. Therules of paragraph (e) of this section alsoapply to—

(A) A lessor of leased property thatmade an improvement to that property forthe lessee of the property, has a depreciablebasis in the improvement, made an elec-tion under paragraph (l) of this section toinclude the improvement in a general assetaccount, and disposes of the improvement(or disposes of a portion of the improve-ment as described in paragraph (e)(1)(ii) ofthis section) before or upon the terminationof the lease with the lessee. See section168(i)(8)(B); and

(B) A lessee of leased property thatmade an improvement to that property, hasa depreciable basis in the improvement,made an election under paragraph (l) ofthis section to include the improvement ina general asset account, and disposes of theimprovement (or disposes of a portion ofthe improvement as described in paragraph(e)(1)(ii) of this section) before or upon thetermination of the lease.

(viii) Determination of asset disposedof—(A) General rules. For purposes of ap-plying paragraph (e) of this section to thedisposition of an asset in a general assetaccount (instead of the disposition of thegeneral 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 itemsplaced in service by the taxpayer on dif-ferent dates. For purposes of determin-ing what is the appropriate asset disposedof, 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) ofthis chapter) does not apply.

(B) Special rules. In addition to thegeneral rules in paragraph (e)(2)(viii)(A)of this section, the following rules applyfor purposes of applying paragraph (e) ofthis section to the disposition of an assetin a general asset account (instead of thedisposition of the general asset account):

(1) Each building (including its struc-tural components) is the asset exceptas provided in §1.1250–1(a)(2)(ii) or inparagraph (e)(2)(viii)(B)(2) or paragraph(e)(2)(viii) (B)(4) of this section.

(2) If a building has two or more con-dominium or cooperative units, each con-dominium or cooperative unit (includingits structural components) is the asset ex-cept as provided in §1.1250–1(a)(2)(ii) orin paragraph (e)(2)(viii)(B)(4) of this sec-tion.

(3) If a taxpayer properly includes anitem in one of the asset classes 00.11through 00.4 of Rev. Proc. 87–56 (1987–2C.B. 674) (see §601.601(d)(2) of this chap-ter) or properly classifies an item in one ofthe categories under section 168(e)(3) (ex-cept for a category that includes buildingsor structural components; for example,retail motor fuels outlet, qualified lease-hold improvement property, qualifiedrestaurant property, and qualified retailimprovement property), each item is theasset provided paragraph (e)(2)(viii)(B)(4)of this section does not apply to the item.For example, each desk is the asset, eachcomputer is the asset, and each qualifiedsmart electric meter is the asset.

(4) If the taxpayer places in service animprovement or addition to an asset afterthe taxpayer placed the asset in service,the improvement or addition is a separateasset.

(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, 2013 412 2013–43 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 theroof of the building and decides to replace the entireroof. 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 retirementof the replaced roof is not a disposition under para-graph (e)(1) of this section. As a result, A continuesto depreciate the $10 million cost of the general as-set account. If A must capitalize the amount paid forthe 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) of thissection 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 accountfor five aircraft that cost a total of $500 million.These aircraft are described in asset class 45.0 ofRev. Proc. 87–56. B replaces the existing engines onone of the aircraft with new engines. Assume eachaircraft is a unit of property as determined under§1.263(a)–3(e)(3) and each engine of an aircraft isa major component or substantial structural part ofthe aircraft as determined under §1.263(a)–3(k)(6).Assume also that B treats each aircraft as the asset fordisposition purposes in accordance with paragraph(e)(2)(viii) of this section. The retirement of thereplaced engines is not a disposition of a portion ofan asset as described in paragraph (e)(1)(ii) of thissection. Thus, the retirement of the replaced enginesis not a disposition under paragraph (e)(1) of thissection. As a result, B continues to depreciate the$500 million cost of the general asset account. If Bmust capitalize the amount paid for the replacementengines pursuant to §1.263(a)–3, the replacementengines are a separate asset for disposition purposespursuant to paragraph (e)(2)(viii)(B)(4) of this sec-tion and for depreciation purposes pursuant to section168(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 placedin service in June 2014. Of the ten machines, onemachine 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 thatcorresponds with the general depreciation system, the200-percent declining balance method, a 5-year re-covery period, and a half-year convention. R doesnot make a section 179 election for any of the ma-chines, and all of the machines are not eligible forany additional first year depreciation deduction. Asof 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 thatcost $8,200 to an unrelated party for $9,000. Underparagraph (e)(2)(i) of this section, this machine hasan adjusted depreciable basis of zero.

(iii) On its 2015 tax return, R recognizes theamount realized of $9,000 as ordinary incomebecause such amount does not exceed the unad-

justed depreciable basis of the general asset account($10,000), plus any expensed cost for assets in theaccount ($0), less amounts previously recognizedas ordinary income ($0). Moreover, the unadjusteddepreciable basis and depreciation reserve of theaccount are not affected by the disposition of themachine. Thus, the depreciation allowance for theaccount in 2015 is $3,200 ($10,000 x 32%).

Example 4. (i) The facts are the same as in Ex-ample 3. In addition, on June 4, 2016, R sells sevenmachines 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 ofzero.

(ii) On its 2016 tax return, R recognizes $1,000as ordinary income (the unadjusted depreciable ba-sis of $10,000, plus the expensed cost of $0, lessthe amount of $9,000 previously recognized as ordi-nary income). The recognition and character of theexcess amount realized of $100 ($1,100-$1,000) aredetermined under applicable provisions of the Inter-nal Revenue Code other than section 1245 (such assection 1231). Moreover, the unadjusted depreciablebasis and depreciation reserve of the account are notaffected 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. Thisparagraph (e)(3) provides the rules for ter-minating general asset account treatmentupon certain dispositions. While the rulesunder paragraphs (e)(3)(ii) and (iii) of thissection are optional rules, the rules underparagraphs (e)(3)(iv), (v), (vi), and (vii) ofthis section are mandatory rules. A tax-payer elects to apply paragraph (e)(3)(ii)or paragraph (e)(3)(iii) of this section byreporting the gain, loss, or other deductionon the taxpayer’s timely filed original Fed-eral tax return (including extensions) forthe taxable year in which the dispositionoccurs. 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 andobtaining the Commissioner’s consent torevoke the election. The Commissionermay grant a request to revoke this elec-tion if the taxpayer acted reasonably andin good faith, and the revocation will notprejudice 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 orrevoked through the filing of an applica-tion for change in accounting method. Forpurposes 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 term asset is:

(A) The asset as determined under para-graph (e)(2)(viii) of this section, or

(B) The portion of such asset that isdisposed of in a disposition described inparagraph (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 theassets, the last asset, or the remaining por-tion of the last asset, in a general assetaccount, 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 accountterminates and the amount of gain or lossfor the general asset account is determinedunder section 1001(a) by taking into ac-count the adjusted depreciable basis of thegeneral 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 ofthe gain or loss are determined under otherapplicable provisions of the Internal Rev-enue Code, except that the amount of gainsubject to section 1245 (or section 1250)is limited to the excess of the depreciationallowed or allowable for the general assetaccount, including any expensed cost (orthe excess of the additional depreciationallowed or allowable for the general as-set account), over any amounts previouslyrecognized 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 areplaced in service in 2014. Assume T depreciates thisgeneral asset account using the optional depreciationtable that corresponds with the general depreciationsystem, the 200-percent declining balance method, a5-year recovery period, and a half-year convention.T does not make a section 179 election for any of thecalculators, and all of the calculators are not eligiblefor 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. 413 October 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 remainingcalculators 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 (unadjusteddepreciable 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 $35,000less the adjusted depreciable basis of $23,040). Thegain of $11,960 is subject to section 1245 to the ex-tent of the depreciation allowed or allowable for theaccount (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 tosection 1245.

Example 2. (i) J, a calendar-year corporation,maintains a general asset account for one item ofequipment. This equipment costs $2,000 and isplaced in service in 2014. Assume J depreciates thisgeneral asset account using the optional depreciationtable that corresponds with the general depreciationsystem, 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 theequipment, and it is not eligible for any additionalfirst year depreciation deduction. In June 2016, Jsells 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 isdetermined 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 allowedor allowable of $1,232). Thus, in 2016, J recognizesgain of $232 (amount realized of $1,000 less the ad-justed depreciable basis of $768). The gain of $232 issubject 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 amountspreviously recognized as ordinary income ($1,232 +$0 - $0 = $1,232). As a result, the entire gain of $232is subject to section 1245.

(iii) Disposition of an asset in a qual-ifying disposition—(A) Optional deter-mination of the amount of gain, loss, orother 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 thisparagraph (e)(3)(iii) (rather than havingparagraph (e)(2) of this section apply).Under this paragraph (e)(3)(iii), generalasset account treatment for the asset ter-minates as of the first day of the taxableyear in which the qualifying dispositionoccurs, and the amount of gain, loss, orother deduction for the asset is determinedunder §1.168(i)–8 or §1.168(i)–8T, as ap-plicable, by taking into account the asset’sadjusted depreciable basis at the time of

the disposition. The adjusted depreciablebasis of the asset at the time of the dispo-sition (as determined under the applicableconvention for the general asset account inwhich the asset was included) equals theunadjusted depreciable basis of the assetless the depreciation allowed or allowablefor the asset, computed by using the de-preciation method, recovery period, andconvention applicable to the general assetaccount in which the asset was includedand by including the portion of the ad-ditional first year depreciation deductionclaimed for the general asset account thatis attributable to the asset disposed of. Therecognition and character of the gain, loss,or other deduction are determined underother applicable provisions of the InternalRevenue Code, except that the amount ofgain subject to section 1245 (or section1250) is limited to the lesser of—

(1) The depreciation allowed or allow-able for the asset, including any expensedcost (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, inthe case of section 1245 property origi-nally included in the general asset account,any expensed cost; over

(ii) The cumulative amounts of gainpreviously recognized as ordinary incomeunder either paragraph (e)(2) of this sec-tion or section 1245 (or section 1250).

(B) Qualifying dispositions. A quali-fying disposition is a disposition that doesnot involve all the assets, or the last asset,remaining in a general asset account andthat is—

(1) A direct result of a fire, storm, ship-wreck, or other casualty, or from theft;

(2) A charitable contribution for whicha deduction is allowable under section 170;

(3) A direct result of a cessation, ter-mination, or disposition of a business,manufacturing or other income producingprocess, operation, facility, plant, or otherunit (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 section168(i)(7)), (v) (pertaining to transactionssubject to section 1031 or section 1033),(vi) (pertaining to technical terminationsof 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 thissection).

(C) Effect of a qualifying disposition ona general asset account. If the taxpayerelects to apply this paragraph (e)(3)(iii) toa qualifying disposition of an asset, then—

(1) The asset is removed from the gen-eral asset account as of the first day of thetaxable year in which the qualifying dis-position occurs. For that taxable year, thetaxpayer accounts for the asset in a singleasset account in accordance with the rulesunder §1.168(i)–7(b) or §1.168(i)–7T(b),as applicable;

(2) The unadjusted depreciable basis ofthe general asset account is reduced by theunadjusted depreciable basis of the asset asof the first day of the taxable year in whichthe 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 depreciationmethod, recovery period, and conventionapplicable to the general asset account inwhich the asset was included and by in-cluding the portion of the additional firstyear depreciation deduction claimed forthe general asset account that is attribut-able to the asset disposed of; and

(4) For purposes of determining theamount of gain realized on subsequent dis-positions that is subject to ordinary incometreatment under paragraph (e)(2)(ii) of thissection, the amount of any expensed costwith 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 servicein 2014. Of the 12 machines, nine machines that costa total of $135,000 are used in Z’s Kentucky plant,and three machines that cost a total of $45,000 areused in Z’s Ohio plant. Assume Z depreciates thisgeneral asset account using the optional depreciationtable that corresponds with the general depreciationsystem, the 200-percent declining balance method, a5-year recovery period, and the half-year convention.Z does not make a section 179 election for any of themachines, and all of the machines are not eligible forany additional first year depreciation deduction. As

October 21, 2013 414 2013–43 I.R.B.

of December 31, 2015, the depreciation reserve forthe account is $93,600.

(ii) On May 27, 2016, Z sells its entire manufac-turing plant in Ohio to an unrelated party. The salesproceeds allocated to each of the three machines atthe Ohio plant is $5,000. This transaction is a quali-fying disposition under paragraph (e)(3)(iii)(B)(3) ofthis 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. Asof December 31, 2015, the depreciation allowed orallowable for the three machines at the Ohio plant is$23,400. Thus, as of January 1, 2016, the unadjusteddepreciable basis of the account is reduced from$180,000 to $135,000 ($180,000 less the unadjusteddepreciable basis of $45,000 for the three machines),and, as of December 31, 2015, the depreciationreserve of the account is decreased from $93,600 to$70,200 ($93,600 less the depreciation allowed orallowable of $23,400 for the three machines as ofDecember 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 ofthe three machines at the Ohio plant is determinedas follows. The depreciation allowed or allowable in2016 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 accountless the depreciation allowed or allowable of $1,440in 2016). As a result, the loss recognized in 2016 foreach 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 officebuilding that cost $20 million and was placed inservice in July 2011. A depreciates this general assetaccount using the optional depreciation table thatcorresponds 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 thebuilding is located and damages the roof of thebuilding. A decides to replace the entire roof. Theroof is replaced in June 2014. The roof is a structuralcomponent of the building. Because the roof wasdamaged as a result of a casualty event describedin section 165, the partial disposition rule providedunder paragraph (e)(1)(ii) of this section applies tothe roof. Although the office building (including itsstructural components) is the asset for dispositionpurposes, the partial disposition rule provides thatthe retirement of the replaced roof is a dispositionunder 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 applyparagraph (e)(3)(iii) of this section for the retirementof 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 allowedor 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), andthe depreciation reserve of the account is decreasedfrom $1,261,000 to $1,197,950 ($1,261,000 less thedepreciation allowed or allowable of $63,050 for theretired 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 roofis $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 lessthe depreciation allowed or allowable of $11,752 in2014). As a result, the loss recognized in 2014 forthe retired roof is $925,198, which is subject to sec-tion 1231.

(vi) If A must capitalize the amount paid for thereplacement roof under §1.263(a)–3, the replacementroof 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 replacementroof is a separate asset for disposition purposes pur-suant to paragraph (e)(2)(viii)(B)(4) of this section. IfA 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 section168(i)(7)—(A) In general. If a taxpayertransfers one or more assets in a gen-eral asset account (or a portion of suchasset) in a transaction described in sec-tion 168(i)(7)(B) (pertaining to treatmentof transferees in certain nonrecognitiontransactions), the taxpayer (the transferor)and the transferee must apply this para-graph (e)(3)(iv) to the asset (or the portionof such asset) (instead of applying para-graph (e)(2), (e)(3)(ii), or (e)(3)(iii) of thissection). The transferee is bound by thetransferor’s election under paragraph (l)of this section for the portion of the trans-feree’s basis in the asset (or the portion ofsuch asset) that does not exceed the trans-feror’s adjusted depreciable basis of thegeneral asset account or the asset (or theportion 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 taxpayertransfers all the assets, the last asset, orthe remaining portion of the last asset, ina general asset account in a transaction de-scribed in section 168(i)(7)(B)—

(1) The taxpayer (the transferor) mustterminate the general asset account on thedate of the transfer. The allowable depre-

ciation deduction for the general asset ac-count for the transferor’s taxable year inwhich the section 168(i)(7)(B) transactionoccurs 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 andthe transferee on a monthly basis. Thisallocation is made in accordance with therules in §1.168(d)–1(b)(7)(ii) for allocat-ing the depreciation deduction between thetransferor and the transferee;

(2) The transferee must establish a newgeneral asset account for all the assets,the last asset, or the remaining portionof the last asset, in the taxable year inwhich the section 168(i)(7)(B) transactionoccurs for the portion of its basis in theassets that does not exceed the transferor’sadjusted depreciable basis of the generalasset account in which all the assets, thelast asset, or the remaining portion of thelast asset, were included. The transferor’sadjusted depreciable basis of this gen-eral asset account is equal to the adjusteddepreciable basis of that account as ofthe beginning of the transferor’s taxableyear in which the transaction occurs, de-creased by the amount of depreciationallocable to the transferor for the year ofthe transfer (as determined under para-graph (e)(3)(iv)(B)(1) of this section). Thetransferee is treated as the transferor forpurposes of computing the allowable de-preciation deduction for the new generalasset account under section 168. The newgeneral asset account must be establishedin 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 ofthe last asset, and the greater of the de-preciation allowed or allowable for all theassets, the last asset, or the remaining por-tion of the last asset (including the amountof depreciation for the transferred assetsthat is allocable to the transferor for theyear of the transfer), are included in thenewly established general asset account.Consequently, this general asset accountin the year of the transfer will have a be-ginning balance for both the unadjusteddepreciable basis and the depreciation re-serve of the general asset account; and

(3) For purposes of section 168 and thissection, the transferee treats the portionof its basis in the assets that exceeds the

2013–43 I.R.B. 415 October 21, 2013

transferor’s adjusted depreciable basis ofthe general asset account in which all theassets, 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 thatthe transferee placed in service on thedate of the transfer. The transferee ac-counts for this asset under §1.168(i)–7 or§1.168(i)–7T, as applicable, or may makean election under paragraph (l) of this sec-tion to include the asset in a general assetaccount.

(C) Not all assets remaining in generalasset account are transferred. If a taxpayertransfers an asset in a general asset ac-count in a transaction described in section168(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) mustremove the transferred asset from the gen-eral asset account in which the asset isincluded, as of the first day of the taxableyear in which the section 168(i)(7)(B)transaction occurs. In addition, the ad-justments to the general asset accountdescribed in paragraphs (e)(3)(iii)(C)(2)through (4) of this section must be made.The allowable depreciation deduction forthe asset for the transferor’s taxable yearin which the section 168(i)(7)(B) trans-action occurs is computed by using thedepreciation method, recovery period, andconvention applicable to the general assetaccount in which the asset was included.This allowable depreciation deduction isallocated between the transferor and thetransferee on a monthly basis. This alloca-tion is made in accordance with the rulesin §1.168(d)–1(b)(7)(ii) for allocating thedepreciation deduction between the trans-feror and the transferee;

(2) The transferee must establish anew general asset account for the assetin the taxable year in which the section168(i)(7)(B) transaction occurs for theportion of its basis in the asset that doesnot exceed the transferor’s adjusted depre-ciable basis of the asset. The transferor’sadjusted depreciable basis of this asset isequal to the adjusted depreciable basis ofthe asset as of the beginning of the trans-feror’s taxable year in which the trans-action occurs, decreased by the amountof depreciation allocable to the transferorfor the year of the transfer (as determinedunder paragraph (e)(3)(iv)(C)(1) of this

section). The transferee is treated as thetransferor for purposes of computing theallowable depreciation deduction for thenew general asset account under section168. The new general asset account mustbe established in accordance with the rulesin paragraph (c) of this section, exceptthat the unadjusted depreciable basis ofthe asset, and the greater of the depreci-ation allowed or allowable for the asset(including the amount of depreciation forthe transferred asset that is allocable to thetransferor for the year of the transfer), areincluded in the newly established generalasset account. Consequently, this generalasset account in the year of the transferwill have a beginning balance for boththe unadjusted depreciable basis and thedepreciation reserve of the general assetaccount; and

(3) For purposes of section 168 and thissection, the transferee treats the portionof its basis in the asset that exceeds thetransferor’s adjusted depreciable basis ofthe asset (as determined under paragraph(e)(3)(iv)(C)(2) of this section) as a sep-arate asset that the transferee placed inservice on the date of the transfer. Thetransferee accounts for this asset under§1.168(i)–7 or §1.168(i)–7T, as appli-cable, or may make an election underparagraph (l) of this section to include theasset in a general asset account.

(v) Transactions subject to section1031 or section 1033—(A) Like-kind ex-change or involuntary conversion of allassets remaining in a general asset ac-count. If all the assets, the last asset, orthe remaining portion of the last asset,in a general asset account are transferredby a taxpayer in a like-kind exchange (asdefined under §1.168–6(b)(11)) or in aninvoluntary conversion (as defined under§1.168–6(b)(12)), the taxpayer must ap-ply this paragraph (e)(3)(v)(A) (insteadof applying paragraph (e)(2), (e)(3)(ii),or (e)(3)(iii) of this section). Under thisparagraph (e)(3)(v)(A), the general as-set account terminates as of the first dayof the year of disposition (as defined in§1.168(i)–6(b)(5)) and—

(1) The amount of gain or loss for thegeneral asset account is determined undersection 1001(a) by taking into account theadjusted depreciable basis of the generalasset account at the time of disposition(as defined in §1.168(i)–6(b)(3)). Thedepreciation allowance for the general

asset account in the year of dispositionis determined in the same manner asthe 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 orloss are determined in accordance withparagraph (e)(3)(ii)(A) of this section(notwithstanding that paragraph (e)(3)(ii)of this section is an optional rule); and

(2) The adjusted depreciable basis ofthe general asset account at the time of dis-position is treated as the adjusted depre-ciable basis of the relinquished MACRSproperty.

(B) Like-kind exchange or involuntaryconversion of less than all assets remain-ing in a general asset account. If an assetin a general asset account is transferredby a taxpayer in a like-kind exchange orin an involuntary conversion and if para-graph (e)(3)(v)(A) of this section doesnot apply to this asset, the taxpayer mustapply this paragraph (e)(3)(v)(B) (insteadof applying paragraph (e)(2), (e)(3)(ii), or(e)(3)(iii) of this section). Under this para-graph (e)(3)(v)(B), general asset accounttreatment for the asset terminates as ofthe first day of the year of disposition (asdefined in §1.168(i)–6(b)(5)), and—

(1) The amount of gain or loss for theasset is determined by taking into accountthe asset’s adjusted depreciable basis atthe 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 depreciablebasis of the asset less the depreciationallowed or allowable for the asset, com-puted by using the depreciation method,recovery period, and convention applica-ble to the general asset account in whichthe asset was included and by includingthe portion of the additional first yeardepreciation deduction claimed for thegeneral asset account that is attributable tothe relinquished asset. The depreciationallowance for the asset in the year of dis-position is determined in the same manneras the depreciation allowance for the re-linquished MACRS property (as definedin §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 gainor loss are determined in accordance withparagraph (e)(3)(iii)(A) of this section

October 21, 2013 416 2013–43 I.R.B.

(notwithstanding that paragraph (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 section708(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 ofthe terminated partnership’s general assetaccounts terminate as of the date of itstermination under section 708(b)(1)(B).The terminated partnership computes theallowable depreciation deduction for eachof its general asset accounts for the taxableyear in which the technical terminationoccurs by using the depreciation method,recovery period, and convention applica-ble to the general asset account. The newpartnership is not bound by the terminatedpartnership’s election under paragraph (l)of this section.

(vii) Anti-abuse rule—(A) In general.If an asset in a general asset account isdisposed of by a taxpayer in a transactiondescribed in paragraph (e)(3)(vii)(B) ofthis section, general asset account treat-ment for the asset terminates as of thefirst day of the taxable year in which thedisposition occurs. Consequently, thetaxpayer must determine the amount ofgain, loss, or other deduction attribut-able to the disposition in the manner de-scribed in paragraph (e)(3)(iii)(A) of thissection (notwithstanding that paragraph(e)(3)(iii)(A) of this section is an optionalrule) and must make the adjustments to thegeneral asset account described in para-graphs (e)(3)(iii)(C)(1) through (4) of thissection.

(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 thetransaction is entered into, or made, witha 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 transactionsinclude—

(1) A transaction entered into with aprincipal purpose of shifting income or de-ductions among taxpayers in a manner thatwould not be possible absent an electionunder this section to take advantage of dif-fering effective tax rates among the tax-payers; or

(2) An election made under this sectionwith a principal purpose of disposing of anasset from a general asset account to uti-lize an expiring net operating loss or creditif the transaction is not a bona fide dispo-sition. The fact that a taxpayer with a netoperating loss carryover or a credit carry-over transfers an asset to a related personor transfers an asset pursuant to an arrange-ment where the asset continues to be used(or is available for use) by the taxpayerpursuant to a lease (or otherwise) indicates,absent strong evidence to the contrary, thatthe transaction is described in this para-graph (e)(3)(vii)(B).

(f) Assets generating foreign sourceincome—(1) In general. This paragraph(f) provides the rules for determining thesource of any income, gain, or loss recog-nized, and the appropriate section 904(d)separate limitation category or categoriesfor any foreign source income, gain, orloss recognized on a disposition (withinthe meaning of paragraph (e)(1) of thissection) of an asset in a general asset ac-count that consists of assets generatingboth United States and foreign sourceincome. These rules apply only to a dispo-sition to which paragraphs (e)(2) (generaldisposition rules), (e)(3)(ii) (dispositionof all assets remaining in a general assetaccount), (e)(3)(iii) (disposition of an as-set in a qualifying disposition), (e)(3)(v)(transactions subject to section 1031 orsection 1033), or (e)(3)(vii) (anti-abuserule) of this section applies. Solely forpurposes of applying this paragraph (f),the term asset is:

(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 onthe disposition of an asset in a general as-set account must be apportioned betweenUnited States and foreign sources based onthe 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 occursif paragraph (e)(2) of this section appliesto 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 dispositionof all assets, the last asset, or the remain-ing portion of the last asset, in the generalasset account, or if all the assets, the lastasset, or the remaining portion of the lastasset, 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 assetdisposed of for only the taxable year inwhich the disposition occurs if the tax-payer applies paragraph (e)(3)(iii) of thissection to the disposition of the asset in aqualifying 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) ofthis section (anti-abuse rule).

(ii) Formula for determining foreignsource income, gain, or loss. The amountof ordinary income, gain, or loss rec-ognized on the disposition that shall betreated as foreign source income, gain, orloss must be determined under the formulain this paragraph (f)(2)(ii). For purposesof this formula, the allowed depreciationdeductions 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. 417 October 21, 2013

Foreign Source Income, Gain, or Lossfrom the Disposition of an Asset

= Total Ordinary Income, Gain, or Lossfrom the Disposition of an Asset

X Allowed Depreciation DeductionsAllocated and Apportioned toForeign Source Income/Total AllowedDepreciation Deductions for theGeneral Asset Account or for the AssetDisposed of (as applicable)

(3) Section 904(d) separate categories.If the assets in the general asset accountgenerate foreign source income in morethan one separate category under section904(d)(1) or another section of the Inter-nal Revenue Code (for example, incometreated as foreign source income undersection 904(g)(10)), or under a United

States income tax treaty that requires theforeign tax credit limitation to be deter-mined separately for specified types ofincome, the amount of “foreign sourceincome, gain, or loss from the dispositionof 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 categoriesunder the formula in this paragraph (f)(3).For purposes of this formula, the alloweddepreciation deductions are determinedfor the applicable time period providedin paragraph (f)(2)(i) of this section. Theformula is:

Foreign Source Income, Gain, or Lossin a Separate Category

= Foreign Source Income, Gain, or Lossfrom The Disposition of an Asset

X Allowed Depreciation DeductionsAllocated and Apportioned to aSeparate Category Total/AllowedDepreciation Deductions andApportioned to Foreign Source Income

(g) Assets subject to recapture. If thebasis 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 therecapture 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 yearin which the recapture event occurs. Con-sequently, the taxpayer must remove theasset from the general asset account as ofthat day and must make the adjustmentsto the general asset account described inparagraphs (e)(3)(iii)(C)(2) through (4) ofthis section.

(h) Changes in use—(1) Conversion toany personal use. An asset in a generalasset account becomes ineligible for gen-eral asset account treatment if a taxpayeruses the asset in any personal activity dur-ing a taxable year. Upon a conversion toany personal use, the taxpayer must re-move the asset from the general asset ac-count as of the first day of the taxable yearin which the change in use occurs (the yearof change) and must make the adjustmentsto the general asset account described inparagraphs (e)(3)(iii)(C)(2) through (4) ofthis section.

(2) Change in use results in a dif-ferent recovery period or depreciationmethod—(i) No effect on general asset

account election. A change in the usedescribed in §1.168(i)–4(d) (change inuse results in a different recovery periodor depreciation method) of an asset in ageneral asset account shall not cause orpermit the revocation of the election madeunder this section.

(ii) Asset is removed from the generalasset account. Upon a change in the usedescribed in §1.168(i)–4(d), the taxpayermust remove the asset from the general as-set account as of the first day of the yearof 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 changein use is described in §1.168(i)–4(d)(3)(change in use results in a shorter recoveryperiod or a more accelerated depreciationmethod) and the taxpayer elects to treat theasset as though the change in use had notoccurred pursuant to §1.168(i)–4(d)(3)(ii),no adjustment is made to the general assetaccount upon the change in use.

(iii) New general asset account is es-tablished—(A) Change in use results ina shorter recovery period or a more ac-celerated depreciation method. If the re-sult of the change in use is described in§1.168(i)–4(d)(3) (change in use resultsin a shorter recovery period or a moreaccelerated depreciation method) and ad-justments to the general asset account are

made pursuant to paragraph (h)(2)(ii) ofthis section, the taxpayer must establish anew general asset account for the asset inthe year of change in accordance with therules in paragraph (c) of this section, ex-cept that the adjusted depreciable basis ofthe asset as of the first day of the year ofchange is included in the general asset ac-count. For purposes of paragraph (c)(2)of this section, the applicable depreciationmethod, recovery period, and conventionare determined under §1.168(i)–4(d)(3)(i).

(B) Change in use results in a longerrecovery period or a slower depreciationmethod. If the result of the change in use isdescribed in §1.168(i)–4(d)(4) (change inuse results in a longer recovery period or aslower depreciation method), the taxpayermust establish a separate general asset ac-count for the asset in the year of changein accordance with the rules in paragraph(c) of this section, except that the unad-justed depreciable basis of the asset, andthe greater of the depreciation of the assetallowed or allowable in accordance withsection 1016(a)(2), as of the first day of theyear of change are included in the newlyestablished general asset account. Conse-quently, this general asset account as of thefirst day of the year of change will have abeginning balance for both the unadjusteddepreciable basis and the depreciation re-serve of the general asset account. For pur-poses of paragraph (c)(2) of this section,

October 21, 2013 418 2013–43 I.R.B.

the applicable depreciation method, recov-ery period, and convention are determinedunder §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 ageneral asset account is redetermined dueto a transaction other than that describedin paragraph (g) of this section (for exam-ple, due to contingent purchase price ordischarge of indebtedness), the taxpayer’selection under paragraph (l) of this sectionfor the asset also applies to the increase ordecrease in basis resulting from the rede-termination. For the taxable year in whichthe increase or decrease in basis occurs, thetaxpayer must establish a new general as-set account for the amount of the increaseor decrease in basis in accordance with therules in paragraph (c) of this section. Forpurposes of paragraph (c)(2) of this sec-tion, the applicable recovery period for theincrease or decrease in basis is the recov-ery period of the asset remaining as of thebeginning of the taxable year in which theincrease or decrease in basis occurs, the ap-plicable depreciation method and applica-ble convention for the increase or decreasein basis are the same depreciation methodand convention applicable to the asset thatapplies for the taxable year in which theincrease or decrease in basis occurs, andthe increase or decrease in basis is deemedto be placed in service in the same taxableyear as the asset.

(j) Identification of disposed or con-verted asset—(1) In general. The rulesof this paragraph (j) apply when an assetin a general asset account is disposed ofor converted in a transaction describedin paragraphs (e)(3)(iii) (disposition ofan asset in a qualifying disposition),(e)(3)(iv)(B) (transactions subject to sec-tion 168(i)(7)), (e)(3)(v)(B) (transactionssubject to section 1031 or section 1033),(e)(3)(vii) (anti-abuse rule), (g) (assetssubject to recapture), or (h)(1) (conversionto any personal use) of this section.

(2) Identifying which asset is disposedof 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 methodof accounting. Under this method of ac-counting, the taxpayer can determine theparticular taxable year in which the dis-

posed of or converted asset was placed inservice 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 dispositionsof assets with the same recovery periodduring the taxable year but the taxpayercannot readily determine from its recordsthe unadjusted depreciable basis of the dis-posed of or converted asset. Under thismethod of accounting, the taxpayer iden-tifies the general asset account with theearliest placed-in-service year that has thesame recovery period as the disposed of orconverted asset and that has assets at thebeginning of the taxable year of the dis-position or conversion, and the taxpayertreats the disposed of or converted asset asbeing from that general asset account. Todetermine which general asset account hasassets at the beginning of the taxable yearof 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 inany prior taxable year in a transaction towhich this paragraph (j) applies;

(C) A modified first-in, first-outmethod of accounting if the taxpayer canreadily determine from its records the to-tal dispositions of assets with the samerecovery period during the taxable yearand the unadjusted depreciable basis ofthe disposed of or converted asset. Underthis method of accounting, the taxpayeridentifies the general asset account withthe earliest placed-in-service year that hasthe same recovery period as the disposedof or converted asset and that has assetsat the beginning of the taxable year ofthe disposition or conversion with thesame unadjusted depreciable basis as thedisposed of or converted asset, and thetaxpayer treats the disposed of or con-verted asset as being from that generalasset account. To determine which generalasset account has assets at the beginningof the taxable year of the disposition orconversion, the taxpayer reduces the num-ber of assets originally included in theaccount by the number of assets disposedof or converted in any prior taxable yearin a transaction to which this paragraph (j)applies;

(D) A mortality dispersion table if theasset is a mass asset accounted for in a sep-arate general asset account in accordancewith paragraph (c)(2)(ii)(H) of this section

and if the taxpayer can readily determinefrom its records the total dispositions ofassets 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 actualdisposition and conversion experience formass assets or other acceptable statisticalor engineering techniques. To use a mor-tality dispersion table, the taxpayer mustadopt recordkeeping practices consistentwith the taxpayer’s prior practices and con-sonant with good accounting and engineer-ing practices; or

(E) Any other method as the Secretarymay designate by publication in the Fed-eral Register or in the Internal RevenueBulletin (see §601.601(d)(2) of this chap-ter) on or after September 19, 2013. Seeparagraph (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 portionof an asset and paragraph (e)(1)(ii) of thissection applies to that disposition, the tax-payer may identify the asset by using anyapplicable 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 methodof accounting may not be used. Under alast-in, first-out method of accounting, thetaxpayer identifies the general asset ac-count with the most recent placed-in-ser-vice year that has the same recovery periodas the disposed of or converted asset andthat has assets at the beginning of the tax-able year of the disposition or conversion,and the taxpayer treats the disposed of orconverted asset as being from that generalasset account.

(3) Basis of disposed of or converted as-set. Solely for purposes of this paragraph(j)(3), the term asset is the asset as deter-mined under paragraph (e)(2)(viii) of thissection or the portion of such asset that isdisposed of in a disposition described inparagraph (e)(1)(ii) of this section. Afteridentifying which asset in a general assetaccount is disposed of or converted, thetaxpayer may use any reasonable methodthat is consistently applied to all assets inthe 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. 419 October 21, 2013

asset in that general asset account. Exam-ples of a reasonable method include, butare not limited to, discounting the cost ofthe replacement asset to its placed-in-ser-vice year cost using the Consumer PriceIndex, a pro rata allocation of the unad-justed depreciable basis of the general as-set account based on the replacement costof the disposed asset and the replacementcost of all of the assets in the general assetaccount, and a study allocating the cost ofthe asset to its individual components.

(k) Effect of adjustments on prior dis-positions. The adjustments to a generalasset 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 dispositionssubject to paragraph (e)(2) of this section.

(l) Election—(1) Irrevocable election.If a taxpayer makes an election under thisparagraph (l), the taxpayer consents to, andagrees to apply, all of the provisions ofthis section to the assets included in a gen-eral asset account. Except as provided inparagraphs (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 electionmade under this section is irrevocable andwill be binding on the taxpayer for com-puting taxable income for the taxable yearfor which the election is made and for allsubsequent taxable years. An election un-der this paragraph (l) is made separatelyby each person owning an asset to whichthis section applies (for example, by eachmember of a consolidated group, at thepartnership level (and not by the partnerseparately), or at the S corporation level(and not by the shareholder separately)).

* * * * *(m) Effective/applicability date—(1) In

general. This section applies to taxableyears 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 1edition revised as of April 1, 2011, appliesto taxable years beginning before January1, 2014.

(2) Early application of this section. Ataxpayer 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 regulationproject REG–110732–13. A taxpayer mayrely on the provisions of this section inregulation project REG–110732–13 fortaxable years beginning on or after Jan-uary 1, 2012. However, a taxpayer maynot rely on the provisions of this sectionin regulation project REG–110732–13 fortaxable years beginning on or after Jan-uary 1, 2014.

(4) Optional application of TD9564. A taxpayer may choose to apply§1.168(i)–1T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears beginning on or after January 1,2012. However, a taxpayer may not apply§1.168(i)–1T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears beginning on or after January 1,2014.

(5) Change in method of accounting.A change to comply with this section fordepreciable assets placed in service in ataxable year ending on or after December30, 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 maytreat a change to comply with this sectionfor depreciable assets placed in service ina taxable year ending before December 30,2003, as a change in method of accountingto 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 thissection.

Par. 4. Section 1.168(i)–7 is amendedby:

1. Adding a new sentence at end ofparagraph (b).

2. Revising paragraph (e).The addition and revision read as fol-

lows:

§1.168(i)–7 Accounting for MACRSproperty.

* * * * *(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 mustaccount for the disposed portion in a sin-gle asset account beginning in the taxableyear in which the disposition occurs. See§1.168(i)–8(h)(3)(i).

* * * * *

(e) Effective/applicability date—(1) Ingeneral. This section applies to taxableyears beginning on or after January 1,2014.

(2) Early application of this section. Ataxpayer 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 regulationproject REG–110732–13. A taxpayer mayrely on the provisions of this section inregulation project REG–110732–13 fortaxable years beginning on or after Jan-uary 1, 2012. However, a taxpayer maynot rely on the provisions of this sectionin regulation project REG–110732–13 fortaxable years beginning on or after Jan-uary 1, 2014.

(4) Optional application of TD9564. A taxpayer may choose to apply§1.168(i)–7T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears beginning on or after January 1,2012. However, a taxpayer may not apply§1.168(i)–7T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears beginning on or after January 1,2014.

(5) Change in method of accounting. Achange 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 accountingto which the provisions of section 446(e)and the regulations under section 446(e)apply. A taxpayer also may treat a changeto comply with this section for deprecia-ble assets placed in service in a taxableyear ending before December 30, 2003, asa change in method of accounting to whichthe provisions of section 446(e) and theregulations under section 446(e) apply.

Par. 5. Section 1.168(i)–8 is added toread as follows:

§1.168(i)–8 Dispositions of MACRSproperty.

(a) Scope. This section provides rulesapplicable to dispositions of MACRSproperty (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 MACRSproperty but for an election made by thetaxpayer either to expense all or someof 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, 2013 420 2013–43 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 dispositionsdescribed in paragraph (d)(1) of this sec-tion of a portion of such property. Exceptas provided in §1.168(i)–1(e)(iii), thissection does not apply to dispositions ofassets 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, asapplicable.

(b) Definitions. For purposes of thissection—

(1) Building has the same meaning asthat term is defined in §1.48–1(e)(1).

(2) Disposition occurs when ownershipof the asset is transferred or when the as-set is permanently withdrawn from use ei-ther in the taxpayer’s trade or business orin the production of income. A dispo-sition includes the sale, exchange, retire-ment, physical abandonment, or destruc-tion of an asset. A disposition also occurswhen an asset is transferred to a supplies,scrap, or similar account, or when a portionof an asset is disposed of as described inparagraph (d)(1) of this section. If a struc-tural component (or a portion thereof) of abuilding is disposed of in a disposition de-scribed in paragraph (d)(1) of this section,a disposition also includes the dispositionof such structural component (or such por-tion thereof).

(3) Mass assets is a mass or group ofindividual items of depreciable assets—

(i) That are not necessarily homoge-nous;

(ii) Each of which is minor in valuerelative to the total value of the mass orgroup;

(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) Portion of an asset is any part of

an asset that is less than the entire asset asdetermined under paragraph (c)(4) of thissection.

(5) Structural component has thesame meaning as that term is defined in§1.48–1(e)(2).

(6) Unadjusted depreciable basis of themultiple asset account or pool is the sumof the unadjusted depreciable bases (as de-

fined in §1.168(b)–1(a)(3)) of all assetsincluded in the multiple asset account orpool.

(c) Special rules—(1) Manner of dis-position. The manner of disposition (forexample, normal retirement, abnormal re-tirement, ordinary retirement, or extraordi-nary retirement) is not taken into accountin determining whether a disposition oc-curs or gain or loss is recognized.

(2) Disposition by transfer to a suppliesaccount. If a taxpayer made an electionunder §1.162–3(d) to treat the cost ofany rotable spare part, temporary sparepart, or standby emergency spare part(as defined in §1.162–3(c)) as a capitalexpenditure subject to the allowance fordepreciation, the taxpayer can dispose ofthe rotable, temporary, or standby emer-gency spare part by transferring it to asupplies account only if the taxpayer hasobtained the consent of the Commissionerto 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 madean improvement to that property for thelessee of the property, has a depreciable ba-sis in the improvement, and disposes of theimprovement 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 thatmade an improvement to that property, hasa depreciable basis in the improvement,and disposes of the improvement beforeor upon the termination of the lease.

(4) Determination of asset disposedof—(i) General rules. For purposes ofapplying this section, the facts and circum-stances of each disposition are consideredin determining what is the appropriateasset disposed of. The asset for dispo-sition purposes may not consist of itemsplaced in service by the taxpayer on dif-ferent dates. For purposes of determiningwhat is the appropriate asset disposed of,the unit of property determination under§1.263(a)–3(e) or in published guidancein 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 purposesof applying this section:

(A) Each building (including its struc-tural components) is the asset exceptas provided in §1.1250–1(a)(2)(ii) orin 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 (includingits structural components) is the asset ex-cept as provided in §1.1250–1(a)(2)(ii) orin paragraph (c)(4)(ii)(D) of this section.

(C) If a taxpayer properly includesan item in one of the asset classes 00.11through 00.4 of Rev. Proc. 87–56 (1987–2C.B. 674) (see §601.601(d)(2) of thischapter) or properly classifies an itemin one of the categories under section168(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 qualifiedretail improvement property), each item isthe asset provided paragraph (c)(4)(ii)(D)of this section does not apply to the item.For example, each desk is the asset, eachcomputer is the asset, and each qualifiedsmart electric meter is the asset.

(D) If the taxpayer places in service animprovement or addition to an asset afterthe taxpayer placed the asset in service,the improvement or addition is a separateasset.

(d) Disposition of a portion of an as-set—(1) In general. For purposes of ap-plying this section, a disposition includesa disposition of a portion of an asset asa result of a casualty event described insection 165, a disposition of a portion ofan 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), ora sale of a portion of an asset, even if thetaxpayer does not make the election underparagraph (d)(2)(i) of this section for thatdisposed portion. For other transactions, adisposition includes a disposition of a por-tion of an asset only if the taxpayer makesthe election under paragraph (d)(2)(i) ofthis section for that disposed portion.

(2) Partial disposition election—(i) Ingeneral. A taxpayer may make an elec-tion under this paragraph (d)(2) to applythis section to a disposition of a portion ofan asset. If the asset is properly included

2013–43 I.R.B. 421 October 21, 2013

in one of the asset classes 00.11 through00.4 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 thisparagraph (d)(2) to apply this section to adisposition of a portion of such asset onlyif the taxpayer classifies the replacementportion of the asset under the same assetclass 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) orparagraph (d)(2)(iv) of this section, a tax-payer must make the election specified inparagraph (d)(2)(i) of this section by thedue date (including extensions) of the orig-inal Federal tax return for the taxable yearin which the portion of an asset is disposedof by the taxpayer.

(B) Manner of making election. Ex-cept as provided in paragraph (d)(2)(iii) orparagraph (d)(2)(iv) of this section, a tax-payer must make the election specified inparagraph (d)(2)(i) of this section by ap-plying the provisions of this section for thetaxable year in which the portion of an as-set is disposed of by the taxpayer, by re-porting the gain, loss, or other deductionon the taxpayer’s timely filed (includingextensions) original Federal tax return forthat taxable year, and, if the asset is prop-erly included in one of the asset classes00.11 through 00.4 of Rev. Proc. 87–56(1987–2 C.B. 674) (see §601.601(d)(2) ofthis chapter), by classifying the replace-ment portion of such asset under the sameasset class as the disposed portion of theasset in the taxable year in which the re-placement portion is placed in service bythe taxpayer. Except as provided in para-graph (d)(2)(iii) or paragraph (d)(2)(iv)(B)of this section, the election specified inparagraph (d)(2)(i) of this section may notbe made through the filing of an applica-tion for change in accounting method.

(iii) Special rule for subsequent In-ternal Revenue Service adjustment. Thisparagraph (d)(2)(iii) applies when a tax-payer deducted the amount paid or in-curred for the replacement of a portionof an asset as a repair under §1.162–4,the taxpayer did not make the electionspecified in paragraph (d)(2)(i) of thissection for the disposed portion of thatasset within the time and in the mannerunder paragraph (d)(2)(ii) or paragraph(d)(2)(iv) of this section, and as a result ofan examination of the taxpayer’s Federal

tax return, the Internal Revenue Servicedisallows the taxpayer’s repair deductionfor the amount paid or incurred for thereplacement of the portion of that assetand instead capitalizes such amount under§1.263(a)–2 or §1.263(a)–3. If this para-graph (d)(2)(iii) applies, the taxpayer maymake the election specified in paragraph(d)(2)(i) of this section for the dispositionof the portion of the asset to which theInternal Revenue Service’s adjustmentpertains by filing an application for changein accounting method, provided the assetof which the disposed portion was a part isowned by the taxpayer at the beginning ofthe year of change (as defined for purposesof section 446(e)).

(iv) Special rules for 2012 or 2013returns. If, under paragraph (j)(2) or para-graph (j)(3) of this section, a taxpayerchooses to apply the provisions of thissection to a taxable year beginning on orafter January 1, 2012, and ending on orbefore September 19, 2013 (applicabletaxable year), and the taxpayer did notmake the election specified in paragraph(d)(2)(i) of this section on its timely filedoriginal Federal tax return for the applica-ble taxable year, including extensions, thetaxpayer must make the election specifiedin paragraph (d)(2)(i) of this section for theapplicable taxable year by filing either—

(A) An amended Federal tax returnfor the applicable taxable year on or be-fore 180 days from the due date includingextensions of the taxpayer’s Federal taxreturn for the applicable taxable year,notwithstanding that the taxpayer may nothave extended the due date; or

(B) An application for change in ac-counting method with the taxpayer’stimely filed original Federal tax return forthe first or second taxable year succeedingthe 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 revokethe election. The Commissioner may granta request to revoke this election if the tax-payer acted reasonably and in good faith,and the revocation will not prejudice theinterests of the Government. See generally§301.9100–3 of this chapter. The electionspecified in paragraph (d)(2)(i) of this sec-tion may not be revoked through the filing

of an application for change in accountingmethod.

(e) Gain or loss on dispositions. Solelyfor purposes of this paragraph (e), the termasset is an asset within the scope of thissection or the portion of such asset that isdisposed of in a disposition described inparagraph (d)(1) of this section. Except asprovided by section 280B and §1.280B–1,the following rules apply when an asset isdisposed of during a taxable year:

(1) If an asset is disposed of by sale, ex-change, or involuntary conversion, gain orloss must be recognized under the appli-cable provisions of the Internal RevenueCode.

(2) If an asset is disposed of by physi-cal abandonment, loss must be recognizedin 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 applicableconvention). However, if the abandonedasset 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 thisparagraph (e)(2), the taxpayer must intendto discard the asset irrevocably so that thetaxpayer will neither use the asset againnor retrieve it for sale, exchange, or otherdisposition.

(3) If an asset is disposed of other thanby sale, exchange, involuntary conversion,physical abandonment, or conversion topersonal use (as, for example, when the as-set is transferred to a supplies or scrap ac-count), gain is not recognized. Loss mustbe recognized in the amount of the ex-cess of the adjusted depreciable basis ofthe asset at the time of the disposition (tak-ing into account the applicable conven-tion) over the asset’s fair market value atthe time of the disposition (taking into ac-count the applicable convention).

(f) Basis of asset disposed of—(1) Ingeneral. The adjusted basis of an asset dis-posed of for computing gain or loss is itsadjusted depreciable basis at the time ofthe asset’s disposition (as determined un-der the applicable convention for the as-set).

(2) Assets disposed of are in multipleasset accounts. If the taxpayer accountsfor 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, 2013 422 2013–43 I.R.B.

mine the unadjusted depreciable basis (asdefined in §1.168(b)–1(a)(3)) of the assetdisposed of, the taxpayer may use any rea-sonable method that is consistently appliedto 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 reasonablemethod include, but are not limited to, dis-counting the cost of the replacement assetto its placed-in-service year cost using theConsumer Price Index, a pro rata alloca-tion of the unadjusted depreciable basis ofthe multiple asset account or pool based onthe replacement cost of the disposed assetand the replacement cost of all of the assetsin the multiple asset account or pool, and astudy allocating the cost of the asset to itsindividual components. To determine theadjusted depreciable basis of an asset dis-posed of in a multiple asset account, thedepreciation allowed or allowable for theasset disposed of is computed by using thedepreciation method, recovery period, andconvention applicable to the multiple assetaccount or pool in which the asset disposedof was included and by including the ad-ditional first year depreciation deductionclaimed for the asset disposed of.

(3) Disposition of a portion of an asset.This paragraph (f)(3) applies only when ataxpayer disposes of a portion of an assetand paragraph (d)(1) of this section appliesto that disposition. For computing gainor loss, the adjusted basis of the disposedportion of the asset is the adjusted depre-ciable basis of that disposed portion at thetime 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 determiningthe unadjusted depreciable basis (as de-fined in §1.168(b)–1(a)(3)) of the disposedportion of the asset. If a taxpayer disposesof more than one portion of the same assetand paragraph (d)(1) of this section appliesto more than one of those dispositions, thetaxpayer may use any reasonable methodthat is consistently applied to all portionsof the same asset for purposes of deter-mining the unadjusted depreciable basis ofeach disposed portion of the asset. Exam-ples of a reasonable method include, butare not limited to, discounting the cost ofthe replacement portion of the asset to itsplaced-in-service year cost using the Con-sumer Price Index, a pro rata allocation ofthe unadjusted depreciable basis of the as-

set based on the replacement cost of thedisposed 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 adjusteddepreciable basis of the disposed portionof 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 isattributable to the disposed portion.

(g) Identification of asset disposedof—(1) In general. Except as providedin paragraph (g)(2) or paragraph (g)(3) ofthis section, a taxpayer must use the spe-cific identification method of accountingto identify which asset is disposed of bythe taxpayer. Under this method of ac-counting, the taxpayer can determine theparticular taxable year in which the assetdisposed of was placed in service by thetaxpayer.

(2) Asset disposed of is in a multipleasset account. If a taxpayer accounts forthe asset disposed of in a multiple assetaccount or pool and the total dispositionsof assets with the same recovery periodduring the taxable year are readily deter-mined from the taxpayer’s records, but it isimpracticable from the taxpayer’s recordsto determine the particular taxable year inwhich the asset disposed of was placed inservice by the taxpayer, the taxpayer mustidentify the asset disposed of by using—

(i) A first-in, first-out method of ac-counting if the unadjusted depreciablebasis of the asset disposed of cannot bereadily determined from the taxpayer’srecords. Under this method of account-ing, the taxpayer identifies the multipleasset account or pool with the earliestplaced-in-service year that has the samerecovery period as the asset disposed ofand that has assets at the beginning of thetaxable year of the disposition, and thetaxpayer treats the asset disposed of asbeing from that multiple asset account orpool;

(ii) A modified first-in, first-out methodof accounting if the unadjusted depreciablebasis of the asset disposed of can be readilydetermined 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-serviceyear that has the same recovery period asthe asset disposed of and that has assets atthe beginning of the taxable year of the dis-position with the same unadjusted depre-ciable basis as the asset disposed of, andthe taxpayer treats the asset disposed of asbeing from that multiple asset account orpool;

(iii) A mortality dispersion table if theasset disposed of is a mass asset. Themortality dispersion table must be basedupon an acceptable sampling of the tax-payer’s actual disposition experience formass assets or other acceptable statisticalor engineering techniques. To use a mor-tality dispersion table, the taxpayer mustadopt recordkeeping practices consistentwith the taxpayer’s prior practices and con-sonant with good accounting and engineer-ing practices; or

(iv) Any other method as the Secretarymay designate by publication in the Fed-eral Register or in the Internal RevenueBulletin (see §601.601(d)(2) of this chap-ter) on or after September 19, 2013. Seeparagraph (g)(4) of this section regardingthe 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 whichthe asset was placed in service, the tax-payer must identify the asset by using anyapplicable 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) ofthis section, a last-in, first-out method ofaccounting may not be used. Under a last-in, first-out method of accounting, the tax-payer identifies the multiple asset accountor pool with the most recent placed-in-ser-vice year that has the same recovery periodas the asset disposed of and that has assetsat the beginning of the taxable year of thedisposition, and the taxpayer treats the as-set disposed of as being from that multipleasset account or pool.

(h) Accounting for asset disposedof—(1) Depreciation ends. Depreciationends for an asset at the time of the asset’sdisposition (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. 423 October 21, 2013

of is in a single asset account initiallyor 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’sdisposition (as determined under the ap-plicable convention for the asset). If ataxpayer disposes of a portion of an assetand paragraph (d)(1) of this section appliesto that disposition, depreciation ends forthat disposed portion of the asset at thetime of the disposition of the disposed por-tion (as determined under the applicableconvention for the asset).

(2) Asset disposed of in a multiple assetaccount or pool. If the taxpayer accountsfor the asset disposed of in a multiple assetaccount or pool, then—

(i) As of the first day of the taxable yearin which the disposition occurs, the assetdisposed of is removed from the multipleasset account or pool and is placed into asingle asset account. See §1.168(i)–7(b) or§1.168(i)–7T(b), as applicable;

(ii) The unadjusted depreciable basis ofthe multiple asset account or pool must bereduced by the unadjusted depreciable ba-sis of the asset disposed of as of the firstday of the taxable year in which the dispo-sition occurs. See paragraph (f)(2) of thissection for determining the unadjusted de-preciable basis of the asset disposed of;

(iii) The depreciation reserve of themultiple asset account or pool must bereduced by the depreciation allowed orallowable for the asset disposed of as ofthe end of the taxable year immediatelypreceding the year of disposition, com-puted by using the depreciation method,recovery period, and convention applica-ble to the multiple asset account or pool inwhich the asset disposed of was includedand by including the additional first yeardepreciation deduction claimed for theasset disposed of; and

(iv) In determining the adjusted depre-ciable basis of the asset disposed of at thetime of disposition (taking into accountthe 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 disposedof was included and by including the ad-ditional first year depreciation deductionclaimed 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 assetand paragraph (d)(1) of this section appliesto that disposition. In this case—

(i) As of the first day of the taxable yearin which the disposition occurs, the dis-posed portion is placed into a single assetaccount. See §1.168(i)–7(b);

(ii) The unadjusted depreciable basis ofthe asset must be reduced by the unad-justed depreciable basis of the disposedportion of the first day of the taxable yearin which the disposition occurs. See para-graph (f)(3) of this section for determiningthe 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 depreciationmethod, recovery period, and conventionapplicable to the asset in which the dis-posed portion was included and by includ-ing the portion of the additional first yeardepreciation 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 thetime of disposition (taking into account theapplicable convention), the depreciationallowed or allowable for the disposed por-tion is computed by using the depreciationmethod, recovery period, and conventionapplicable to the asset in which the dis-posed portion was included and by includ-ing the portion of the additional first yeardepreciation deduction claimed for the as-set that is attributable to the disposed por-tion.

(i) Examples. The application of thissection is illustrated by the following ex-amples. For purposes of these examples,assume that section 168 as in effect onSeptember 19, 2013, applies to taxableyears beginning on or after January 1,2014.

Example 1. A owns an office building with fourelevators. 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 doesnot 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 nota disposition. As a result, depreciation continues forthe 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 paidfor 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) ofthis section and for depreciation purposes pursuant tosection 168(i)(6).

Example 2. The facts are the same as in Exam-ple 1, except A accounts for each structural compo-nent of the office building as a separate asset in itsfixed asset system. Although A treats each structuralcomponent as a separate asset in its records, the of-fice building (including its structural components) isthe asset for disposition purposes in accordance withparagraph (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 in Example1, except A makes the partial disposition electionprovided under paragraph (d)(2) of this section forthe elevator. Although the office building (includingits structural components) is the asset for disposi-tion purposes, the result of A making the partialdisposition election for the elevator is that the re-tirement of the replaced elevator is a disposition.Thus, depreciation for the retired elevator ceasesat the time of its retirement (taking into accountthe applicable convention), and A recognizes a lossupon this retirement. Further, A must capitalize theamount paid for the replacement elevator pursuantto §1.263(a)–3(k)(1)(i), and the replacement elevatoris a separate asset for disposition purposes pursuantto paragraph (c)(4)(ii)(D) of this section and fordepreciation purposes pursuant to section 168(i)(6).

Example 4. B, a calendar-year commercial air-line company, owns several aircraft that are used inthe commercial carrying of passengers and describedin asset class 45.0 of Rev. Proc. 87–56. B replacesthe existing engines on one of the aircraft with newengines. Assume each aircraft is a unit of property asdetermined under §1.263(a)–3(e)(3) and each engineof an aircraft is a major component or substantialstructural part of the aircraft as determined under§1.263(a)–3(k)(6). Assume also that B treats eachaircraft as the asset for disposition purposes in ac-cordance with paragraph (c)(4) of this section. Bmakes the partial disposition election provided underparagraph (d)(2) of this section for the engines inthe aircraft. Although the aircraft is the asset fordisposition purposes, the result of B making thepartial disposition election for the engines is that theretirement of the replaced engines is a disposition.Thus, depreciation for the retired engines ceasesat the time of their retirement (taking into accountthe applicable convention), and B recognizes a lossupon this retirement. Further, B must capitalize theamount paid for the replacement engines pursuantto §1.263(a)–3(k)(1)(i), and the replacement enginesare a separate asset for disposition purposes pursuantto paragraph (c)(4)(ii)(D) of this section and fordepreciation purposes pursuant to section 168(i)(6).

Example 5. The facts are the same as in Example4, except B does not make the partial disposition elec-tion provided under paragraph (d)(2) of this sectionfor the engines. Thus, the retirement of the replacedengines on one of the aircraft is not a disposition. Asa result, depreciation continues for the cost of the air-craft (including the cost of the retired engines), and Bdoes not recognize a loss for these retired engines. IfB must capitalize the amount paid for the replacement

October 21, 2013 424 2013–43 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 fordepreciation purposes pursuant to section 168(i)(6).

Example 6. C, a corporation, owns several trucksthat are used in its trade or business and describedin asset class 00.241 of Rev. Proc. 87–56. C re-places the engine on one of the trucks with a newengine. Assume each truck is a unit of property asdetermined under §1.263(a)–3(e)(3) and each engineis a major component or substantial structural part ofthe truck as determined under §1.263(a)–3(k)(6). Be-cause the trucks are described in asset class 00.241 ofRev. Proc. 87–56, C must treat each truck as the assetfor disposition purposes. C does not make the partialdisposition election provided under paragraph (d)(2)of this section for the engine. Thus, the retirement ofthe replaced engine on the truck is not a disposition.As a result, depreciation continues for the cost of thetruck (including the cost of the retired engine), and Cdoes not recognize a loss for this retired engine. If Cmust capitalize the amount paid for the replacementengine 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 fordepreciation purposes pursuant to section 168(i)(6).

Example 7. D owns a retail building. D replaces60 percent of the roof of this building. In accordancewith paragraph (c)(4)(ii)(A) of this section, the retailbuilding (including its structural components) is theasset for disposition purposes. Assume D must cap-italize the costs incurred for replacing 60 percent ofthe roof pursuant to §1.263(a)–3(k)(1)(vi). D makesthe partial disposition election provided under para-graph (d)(2) of this section for the 60 percent of thereplaced roof. Thus, the retirement of 60 percent ofthe roof is a disposition. As a result, depreciation for60 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 percentof 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 depreciationpurposes pursuant to section 168(i)(6).

Example 8. (i) The facts are the same as in Ex-ample 7. Ten years after replacing 60 percent of theroof, 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 aseparate asset. Assume D must capitalize the costsincurred for replacing 55 percent of the roof pursuantto §1.263(a)–3(k)(1)(vi). D makes the partial dispo-sition election provided under paragraph (d)(2) of thissection 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 recordswhether the replaced 55 percent is part of the 60 per-cent of the roof replaced ten years ago or whether thereplaced 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 ofby 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 percentof 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 the applicable convention),and D recognizes a loss upon this retirement. Further,depreciation for 25 percent of the 60 percent of theroof 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 55percent of the roof pursuant to §1.263(a)–3(k)(1)(i)and (vi), and the replacement 55 percent of the roofis a separate asset for disposition purposes pursuantto 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 servicea 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 thebuilding in its records as a single asset with acost of $20,000,000. E depreciates the building asnonresidential real property and uses the optionaldepreciation table that corresponds with the gen-eral depreciation system, the straight-line method, a39-year recovery period, and the mid-month conven-tion. As of January 1, 2014, the depreciation reservefor 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 anyother 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 dispositionelection for the elevator is that the retirement of thereplaced elevator is a disposition. Because E cannotidentify the cost of the structural components of theoffice building from its records, E determines the costof 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 reasonablemethod, E determines the cost of the retired elevatorby discounting the cost of the replacement elevatorto its cost in 2011 (the placed-in-service year) usingthe Consumer Price Index, resulting in $150,000 ofthe $20,000,000 purchase price for the building to bethe 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-yearrecovery period, and the mid-month convention, thedepreciation 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 forthe retired elevator is determined as follows. The de-preciation allowed or allowable for 2014 for the re-tired elevator is $1,763 ((unadjusted depreciable basisof $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 adjusteddepreciable basis of $140,542.50 removed from thebuilding cost less the depreciation allowed or allow-able of $1,763 for 2014). As a result, E recognizes aloss 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 computedas follows. As of January 1, 2014, the unad-justed depreciable basis of the building is reducedfrom $20,000,000 to $19,850,000 ($20,000,000less the unadjusted depreciable basis of $150,000for the retired elevator), and the depreciation re-serve of the building is reduced from $1,261,000to $1,251,542.50 ($1,261,000 less the depreciationallowed or allowable of $9,457.50 for the retiredelevator as of December 31, 2013). Consequently,the depreciation allowance for the building for 2014is $508,954 ($19,850,000 x depreciation rate of2.564% for 2014).

(v) E also must capitalize the amountpaid for the replacement elevator pursuant to§1.263(a)–3(k)(1)(i). The replacement elevator is aseparate asset for tax disposition purposes pursuantto paragraph (c)(4)(ii)(D) of this section and fordepreciation purposes pursuant to section 168(i)(6).

Example 10. (i) Since 2005, F, a calendar yeartaxpayer, has accounted for items of MACRS prop-erty that are mass assets in pools. Each pool includesonly the mass assets that have the same depreciationmethod, recovery period, and convention, and areplaced in service by F in the same taxable year. Noneof the pools are general asset accounts under section168(i)(4) and the regulations under section 168(i)(4).F identifies any dispositions of these mass assets byspecific identification.

(ii) During 2014, F sells 10 items of mass assetswith a 5-year recovery period each for $100. Underthe specific identification method, F identifies thesemass assets as being from the pool established by Fin 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 balancemethod, a 5-year recovery period, and the half-yearconvention. F elected not to deduct the additionalfirst year depreciation provided by section 168(k) for5-year property placed in service during 2012. As ofJanuary 1, 2014, this pool contains 100 similar itemsof mass assets with a total cost of $25,000 and a to-tal depreciation reserve of $13,000. Because all theitems of mass assets in the pool are similar, F allo-cates the cost and depreciation allowed or allowablefor the pool ratably among each item in the pool. Us-ing this reasonable method (because all the items ofmass assets in the pool are similar), F allocates a costof $250 ($25,000 x (1/100)) to each disposed of massasset 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 foreach disposed of mass asset is $24 (($250 x 19.2%)/ 2). As a result, the adjusted depreciable basis ofeach disposed of mass asset under section 1011 is $96($250 - $130 - $24). Thus, F recognizes a gain of $4for each disposed of mass asset in 2014, which is sub-ject to section 1245.

(iii) Further, as of January 1, 2014, the unadjusteddepreciable basis of the 2012 pool of mass assets witha 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 ofitems as of December 31, 2013). Consequently, as

2013–43 I.R.B. 425 October 21, 2013

of January 1, 2014, the 2012 pool of mass assetswith a 5-year recovery period has 90 items with atotal cost of $22,500 and a depreciation reserve of$11,700. Thus, the depreciation allowance for thispool for 2014 is $4,320 ($22,500 x 19.2%).

Example 11. (i) The facts are the same as in Ex-ample 10. Because of changes in F’s recordkeep-ing in 2015, it is impracticable for F to continue toidentify 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 inAccounting Method, to change to a first-in, first-outmethod beginning with the taxable year beginning onJanuary 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 taxableyear are deemed to be from the pool with the earliestplaced-in-service year that has assets as of the begin-ning of the taxable year of the disposition with thesame recovery period as the asset disposed of. TheCommissioner of Internal Revenue consents to thischange in method of accounting.

(ii) During 2015, F sells 20 items of mass assetswith a 5-year recovery period each for $50. As ofJanuary 1, 2015, the 2008 pool is the pool with theearliest placed-in-service year for mass assets witha 5-year recovery period, and this pool contains 25items of mass assets with a total cost of $10,000 anda 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. Asa result, the adjusted depreciable basis of each dis-posed of mass asset is $0. Thus, F recognizes a gainof $50 for each disposed of mass asset in 2015, whichis subject to section 1245.

(iii) Further, as of January 1, 2015, the unadjusteddepreciable basis of the 2008 pool of mass assets witha 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 x20)), and the depreciation reserve of this 2008 pool isreduced from $10,000 to $2,000 ($10,000 less the de-preciation allowed or allowable of $8,000 for the 20disposed of items as of December 31, 2014). Conse-quently, as of January 1, 2015, the 2008 pool of massassets with a 5-year recovery period has 5 items witha total cost of $2,000 and a depreciation reserve of$2,000.

(j) Effective/applicability date—(1) Ingeneral. This section applies to taxableyears beginning on or after January 1,2014.

(2) Early application of this section. Ataxpayer 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 regulationproject REG–110732–13. A taxpayer mayrely on the provisions of this section inregulation project REG–110732–13 fortaxable years beginning on or after Jan-uary 1, 2012. However, a taxpayer maynot rely on the provisions of this sectionin regulation project REG–110732–13 fortaxable years beginning on or after Jan-uary 1, 2014.

(4) Optional application of TD9564. A taxpayer may choose to apply§1.168(i)–8T as contained in TD 9564 (76FR 81060) December 27, 2011, to taxableyears 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 taxableyears beginning on or after January 1,2014.

(5) Change in method of accounting.A change to comply with this section fordepreciable assets placed in service in ataxable year ending on or after December30, 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 maytreat a change to comply with this sectionfor depreciable assets placed in service ina taxable year ending before December 30,2003, as a change in method of accountingto 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 providedin paragraph (d)(2)(iii) or (d)(2)(iv)(B) ofthis 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 FederalRegister for September 19, 2013, 78 F.R. 57547)

October 21, 2013 426 2013–43 I.R.B.

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as “rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe the ef-fect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position is be-ing extended to apply to a variation of thefact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds that thesame principle also applies to B, the earlierruling is amplified. (Compare with modi-fied, below).

Clarified is used in those instanceswhere the language in a prior ruling is be-ing made clear because the language hascaused, or may cause, some confusion.It is not used where a position in a priorruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previously pub-lished ruling and points out an essentialdifference between them.

Modified is used where the substanceof a previously published position is beingchanged. Thus, if a prior ruling held that aprinciple applied to A but not to B, and thenew ruling holds that it applies to both A

and B, the prior ruling is modified becauseit corrects a published position. (Comparewith amplified and clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly used ina ruling that lists previously published rul-ings that are obsoleted because of changesin laws or regulations. A ruling may alsobe obsoleted because the substance hasbeen included in regulations subsequentlyadopted.

Revoked describes situations where theposition in the previously published rulingis not correct and the correct position isbeing stated in a new ruling.

Superseded describes a situation wherethe 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 the1986 Code and regulations the same po-sition published under the 1939 Code andregulations. The term is also used whenit is desired to republish in a single rul-ing a series of situations, names, etc., thatwere previously published over a period oftime in separate rulings. If the new rul-ing does more than restate the substance

of a prior ruling, a combination of termsis used. For example, modified and su-perseded describes a situation where thesubstance of a previously published rulingis being changed in part and is continuedwithout change in part and it is desired torestate the valid portion of the previouslypublished ruling in a new ruling that is selfcontained. In this case, the previously pub-lished ruling is first modified and then, asmodified, is superseded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling and thatlist is expanded by adding further names insubsequent rulings. After the original rul-ing has been supplemented several times, anew ruling may be published that includesthe list in the original ruling and the ad-ditions, and supersedes all prior rulings inthe series.

Suspended is used in rare situations toshow that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome of casesin litigation, or the outcome of a Servicestudy.

AbbreviationsThe following abbreviations in current useand formerly used will appear in materialpublished in the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.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—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contributions Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—Grantor.IC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.

PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statement of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D. —Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z —Corporation.

2013–43 I.R.B. i October 21, 2013

Numerical Finding List1

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, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2013–1 through 2013–26 is in Internal Revenue Bulletin2013–26, dated June 24, 2013.

October 21, 2013 ii 2013–43 I.R.B.

Finding List of Current Actions onPreviously Published Items1

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. iii October 21, 2013

Internal Revenue ServiceWashington, DC 20224Official BusinessPenalty for Private Use, $300

INTERNAL REVENUE BULLETINThe Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue

Bulletins are available at www.irs.gov/irb/.

CUMULATIVE BULLETINSThe contents of the weekly Bulletins were consolidated semiannually into permanent, indexed, Cumulative Bulletins through the

2008–2 edition.

INTERNAL REVENUE BULLETINS ON CD-ROMInternal Revenue Bulletins are available annually as part of Publication 1796 (Tax Products CD-ROM). The CD-ROM can be

purchased from National Technical Information Service (NTIS) on the Internet at www.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 INTERNALREVENUE BULLETIN

If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, wewould be pleased to hear from you. You can email us your suggestions or 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.