[Federal Register Volume 89, Number 95 (Wednesday, May 15, 2024)]
[Proposed Rules]
[Pages 42404-42408]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-10579]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-133850-13]
RIN 1545-BN93
Interest Capitalization Requirements for Improvements to
Designated Property
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations that would remove
the associated property rule and similar rules from the existing
regulations on the interest capitalization requirements for
improvements to designated property. In addition, this document
contains proposed regulations that would modify the definition of
``improvement'' for purposes of applying those existing regulations.
Lastly, this document contains proposed regulations that would modify
other rules in those existing regulations in light of the proposed
removal of the associated property rule. The proposed regulations would
affect taxpayers making improvements to real or tangible personal
property that constitute the production of designated property.
DATES: Written or electronic comments and requests for a public hearing
must be received by July 15, 2024.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically via the Federal eRulemaking Portal at https://www.regulations.gov (indicate IRS and REG-133850-13) by following the
online instructions for submitting comments. Requests for a public
hearing must be submitted as prescribed in the ``Comments and Requests
for a Public Hearing'' section. Once submitted to the Federal
eRulemaking Portal, comments cannot be edited or withdrawn. The
Department of the Treasury (Treasury Department) and the IRS will
publish for public availability any comments submitted to the IRS's
public docket. Send paper submissions to: CC:PA:01:PR (REG-133850-13),
Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin
Station, Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Livia Piccolo of the Office of Associate Chief Counsel (Income Tax and
Accounting), at (202) 317-7007; concerning submissions of comments or a
public hearing, Vivian Hayes, (202) 317-6901 (not toll-free numbers) or
by email at [email protected] (preferred).
SUPPLEMENTARY INFORMATION:
Background
This document proposes amendments to Sec. 1.263A-11(e)(1)(ii) and
(iii) of the Income Tax Regulations (26 CFR part 1) to remove the
``associated property rule'' and similar rules from the interest
capitalization requirements for improvements that constitute the
production of property under section 263A(f) of the Internal Revenue
Code (Code). In addition, this document proposes amendments to Sec.
1.263A-11(f) to clarify that Sec. 1.263A-11(f) applies only to
property purchased and further produced before it is placed in service.
Finally, this document proposes to amend Sec. 1.263A-8(d)(3) to update
the definition of ``improvement'' so that it is consistent with the
definition of ``improvement'', including the exceptions, safe harbors,
and elections provided under Sec. 1.263(a)-3.
Sections 263A(a) and (b) of the Code generally require the
capitalization of direct and indirect costs of real or tangible
personal property produced by the taxpayer. Under section 263A(g)(1)
and Sec. 1.263A-8(d)(3), the term ``produce'' includes ``improve.''
Section 263A(f) contains rules for capitalizing interest with
respect to certain property produced by the taxpayer and for
determining the amount of interest required to be capitalized. In
general, section 263A(f)(1) limits capitalization to interest that is
paid or incurred during the production period and that is allocable to
real property or certain tangible personal property produced by the
taxpayer, referred to as ``designated property'' in the section 263A
regulations. See Sec. 1.263A-8(b)(1). Under section 263A(f)(2)(A), in
determining the amount of interest required to be capitalized to any
property, (i) interest on any indebtedness directly attributable to
production expenditures with respect to the property is assigned to the
property, and (ii) interest on any other indebtedness is assigned to
the property to the extent that the taxpayer's interest cost could have
been reduced if production expenditures not attributable to
indebtedness described in clause (i) had not been incurred (avoided
cost method).
Section 1.263A-8(a) provides that taxpayers must use the avoided
cost method described in Sec. 1.263A-9 in determining the amount of
interest required to be capitalized with respect to the production of
designated property. Section 1.263A-9(a)(1) explains that, under the
avoided cost method, any interest that the taxpayer theoretically would
have avoided if accumulated production expenditures (as defined in
Sec. 1.263A-11) (APEs) had been used to repay or reduce the taxpayer's
outstanding debt must be capitalized. Under Sec. 1.263A-11(a), APEs
generally mean the cumulative amount of direct and indirect costs
described in section 263A(a) that are required to be capitalized with
respect to a unit of property.
Section 1.263A-9(c) provides that, to the extent a taxpayer's APEs
exceed traced debt (that is, debt that is allocated to APEs with
respect to the unit of property), the general formula for determining
the amount of interest that must be capitalized is the average excess
expenditures multiplied by the weighted average interest rate on the
debt during the time the production occurs. A larger base of production
expenditures leads to more interest capitalized.
Section 1.263A-11(e)(1)(i) provides that, if an improvement
constitutes the production of designated property under Sec. 1.263A-
8(d)(3), APEs with respect to the improvement consist of all direct and
indirect costs required to be capitalized with respect to the
improvement. In the case of an improvement to a unit of real property
qualifying as the production of designated property under Sec. 1.263A-
8(d)(3), Sec. 1.263A-11(e)(1)(ii) provides that APEs include an
allocable portion of the cost of land, and for any measurement period,
the adjusted basis of any existing structure, common feature, or other
property that is not placed in service, or must be temporarily
withdrawn from service to complete the improvement (associated
property) during any part of the measurement period if the associated
property directly benefits the property being improved, the associated
property directly benefits from the improvement, or the improvement was
incurred by reason of the associated property (associated property
rule). In the case of an improvement to a unit of tangible personal
property qualifying as the production of designated property under
Sec. 1.263A-8(d)(3), Sec. 1.263A-
[[Page 42405]]
11(e)(1)(iii) provides that APEs include the adjusted basis of the
asset being improved if that asset either is not placed in service or
must be temporarily withdrawn from service to complete the improvement.
Section 1.263A-12(a) explains that under Sec. 1.263A-9, a taxpayer
must capitalize interest for computation periods that include the
production period of a unit of designated property. In the case of
property produced for self-use, Sec. 1.263A-12(d)(1) generally
provides that the production period for a unit of property ends on the
date that the unit is placed in service and all production activities
reasonably expected to be undertaken are completed.
In Dominion Resources, Inc. v. United States, 681 F.3d 1313 (Fed.
Cir. 2012), the Federal Circuit invalidated the associated property
rule of Sec. 1.263A-11(e)(1)(ii)(B) for property temporarily withdrawn
from service. The court concluded that the regulation was not a
reasonable interpretation of the avoided cost rule in section
263A(f)(2)(A)(ii) and that it violated the State Farm requirement that
the Treasury Department and the IRS provide a reasoned explanation for
adopting a regulation. See Motor Vehicles Mfrs. Ass'n of the United
States, Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).
The taxpayer in Dominion Resources was a public utility that
replaced coal burners in two of its electric generating plants. This
action required the taxpayer to temporarily withdraw the two electric
generating plants from service. During that time, Dominion incurred
interest on debt unrelated to the improvements. Dominion deducted some
of that interest, and the IRS disagreed with the taxpayer's
computations. The IRS argued that pursuant to Sec. 1.263A-
11(e)(1)(ii)(B), the taxpayer's APEs should include the cost of the
improvements (that is, the amount spent to replace the coal burners),
as well as the adjusted basis of the property temporarily withdrawn
from service to complete the improvement (that is, the electric
generating plants).
The taxpayer and the IRS ultimately reached a settlement agreement,
pursuant to which Dominion deducted 50 percent and capitalized 50
percent of the disputed amount. The taxpayer subsequently filed a claim
for refund, asserting that the entire amount was deductible. The
taxpayer challenged the validity of Sec. 1.263A-11(e)(1)(ii)(B) as
applied to its improvements. In Dominion Resources, Inc. v. United
States, 97 Fed. Cl. 239 (Fed. Cl. 2011), the United States Court of
Federal Claims upheld the validity of the associated property rule and
denied the taxpayer's claim for refund.
On appeal, the United States Court of Appeals for the Federal
Circuit (Federal Circuit) reversed the lower court decision and
invalidated the associated property rule of Sec. 1.263A-
11(e)(1)(ii)(B) for property temporarily withdrawn from service. The
Federal Circuit explained that the regulation ``unreasonably links''
the interest capitalized when a taxpayer makes an improvement to the
adjusted basis of the property temporarily withdrawn from service to
complete the improvement. The court reasoned that to implement the
avoided cost principle, the interest to be capitalized is the amount
that could have been avoided if funds had not been expended for the
improvement. However, the adjusted basis of the temporarily withdrawn
property does not represent an ``avoided'' amount. The court found that
``[a] property owner does not expend funds in an amount equal to the
adjusted basis [of the temporarily withdrawn property] when making the
improvement. Instead, she expends funds in an amount equal to the cost
of the improvement itself.'' Dominion Resources, 681 F.3d at 1318; see
also S. Rep. No. 99-313, at 144 (1986) (interest to be capitalized is
the amount ``that could have been avoided if funds had not been
expended for construction.''); H.R. Rep. No. 99-426, at 628 (1985)
(same). Thus, the court concluded that the regulation contradicts the
avoided cost rule.
Section 1.263A-8(d)(3) provides that any improvement to property
described in Sec. 1.263(a)-1(b) constitutes the production of
property. Final regulations under sections 162 and 263(a) of the Code
(TD 9636) were published in the Federal Register (78 FR 57686) on
September 19, 2013. The final regulations clarified the definition of
``improvement'' and moved the definition to Sec. 1.263(a)-3. Section
1.263(a)-3 did not change the meaning of the term ``improvement'' but
synthesized applicable case law and prior administrative rules into a
framework to ease determinations of whether a cost must be capitalized
as an improvement cost or deducted as a repair and maintenance expense.
These final regulations also clarified that a cost capitalized as an
improvement cost can include only the cost of activities performed
after the property is placed in service. See Sec. 1.263(a)-3(d).
Explanation of Provisions
The Treasury Department and the IRS have considered the Federal
Circuit's opinion in Dominion Resources and agree with its rationale.
Under this rationale, treating the adjusted basis of any associated
property that is temporarily withdrawn from service to complete the
improvement as a component of APEs contradicts the avoided cost rule
because the adjusted basis of the temporarily withdrawn property does
not represent an ``avoided'' amount. Accordingly, these proposed
regulations would remove the associated property rule at Sec. 1.263A-
11(e)(1)(ii)(B) (for improvements to real property) and Sec. 1.263A-
11(e)(1)(iii) (for improvements to tangible personal property) for
property temporarily withdrawn from service. For similar reasons, these
proposed regulations would remove the rule at Sec. 1.263A-
11(e)(1)(ii)(A) (APEs with respect to an improvement to real property
includes an allocable portion of the cost of land).
In Dominion Resources, the challenge to Sec. 1.263A-
11(e)(1)(ii)(B) applied only to improvements to property ``temporarily
withdrawn from service'' and not to improvements to property that is
``not placed in service.'' However, the Treasury Department and the IRS
have determined that the associated property rule at Sec. Sec. 1.263A-
11(e)(1)(ii)(B) and 1.263A-11(e)(1)(iii) for improvements to property
``not placed in service'' also should be removed because under Sec.
1.263(a)-3(d), the definition of ``improvement'' is limited to amounts
paid for activities performed after the property is placed in service.
Amounts paid for activities performed prior to the date that property
is placed in service are characterized as acquisition or production
costs (rather than improvement costs) and are generally capitalized
under Sec. 1.263(a)-2 and section 263A. See Sec. Sec. 1.263(a)-2(d)
and (c)(1). In addition, the APE rules in Sec. 1.263A-11(f) already
address a situation in which a taxpayer incurs production costs with
respect to property that has not been placed in service. Accordingly,
these proposed regulations would remove the associated property rule at
Sec. Sec. 1.263A-11(e)(1)(ii)(B) and 1.263A-11(e)(1)(iii) for
improvements to property not placed in service.
Because these proposed regulations would remove the associated
property rule at Sec. 1.263A-11(e)(1)(ii)(B), the de minimis rule of
Sec. 1.263A-11(e)(2) would be irrelevant. Accordingly, these proposed
regulations also would remove this de minimis rule.
As a result of the proposed amendments to Sec. 1.263(a)-11(e) to
remove from APEs the adjusted basis of associated real property, the
adjusted
[[Page 42406]]
basis of associated tangible personal property, and an allocable
portion of the cost of the land when the taxpayer makes an improvement,
a taxpayer would be required to include in APEs only the direct and
indirect costs of the improvement itself.
The proposed regulations would not change the substance of the
rules in Sec. 1.263A-11(f) concerning interest capitalized with
respect to property purchased and further produced before it is placed
in service. Section 1.263A-11(f) provides that if a taxpayer purchases
a unit of property for further production, the taxpayer's APEs include
the full purchase price of the property plus additional direct and
indirect costs incurred by the taxpayer.
The Treasury Department and the IRS considered whether the rules in
Sec. 1.263A-11(f) should be modified to exclude the purchase price of
such property from the taxpayer's APEs in light of the holding in
Dominion Resources. That is, the Treasury Department and the IRS
considered whether the rationale of Dominion Resources should apply to
situations in which a taxpayer purchases property for further
production prior to placing the property in service. As noted
previously in the Background and this Explanation of Provisions, the
holding in Dominion Resources was limited to improvements to property
``temporarily withdrawn from service'' and did not address situations
in which a taxpayer purchases property for further production prior to
placing the property in service. Further, unlike the cost of property
that is temporarily withdrawn from service to be improved, the cost of
property purchased for further production prior to being placed in
service represents an ``avoided'' amount under avoided cost principles
because the cost of such property is a component cost of the original
production activity. In contrast, the cost of property that is
temporarily withdrawn from service to be improved is not a component
cost of the subsequent production activity. Accordingly, these proposed
regulations would retain the substantive rules in Sec. 1.263A-11(f).
However, these proposed regulations would modify Sec. 1.263A-11(f) to
clarify that Sec. 1.263A-11(f) applies only to situations in which
property is purchased and further produced before the property is
placed in service.
The Treasury Department and the IRS recognize that the proposed
amendments to remove from APEs the adjusted basis of associated real
property, the adjusted basis of associated tangible personal property,
and an allocable portion of the cost of the land when the taxpayer
makes an improvement may increase the potential for abuse. For example,
a taxpayer may attempt to treat property produced for self-use as
having been placed in service (even though the placed-in-service
requirements have not yet been met) and then attempt to characterize
subsequent production activities as an improvement, thereby improperly
excluding relevant costs from APEs. Section 1.263A-12(d)(1) provides
that in the case of property produced for self-use, the production
period for a unit of property does not end until the taxpayer places
the property in service and all production activities reasonably
expected to be undertaken are completed. The proposed regulations
contain a cross-reference to Sec. 1.263A-12(d)(1) to emphasize that
taxpayers must comply with the rules of that section when determining
whether the production period has ended and therefore whether the
taxpayer's production activities constitute an improvement.
The final regulations under sections 162 and 263(a), published in
2013, clarify the definition of ``improvement'' and change the specific
citations for the definition. Specifically, Sec. 1.263(a)-3 now
governs the definition of ``improvement'' for purposes of section
263(a). In addition, Sec. 1.263(a)-3 includes certain exceptions, safe
harbors, and elections that may be applied in determining whether
certain amounts must be treated as improvement costs. The treatment
afforded by the application of Sec. 1.263(a)-3, including these
exceptions, safe harbors, and elections, should also apply in
determining whether costs must be treated as improvements for the
computation of APEs for section 263A interest capitalization purposes.
Accordingly, these proposed regulations would amend Sec. 1.263A-
8(d)(3) to update the definition of ``improvement'' so that it is
consistent with the definition of ``improvement'', including the
exceptions, safe harbors, and elections provided under Sec. 1.263(a)-
3. Note, however, the de minimis safe harbor election, as provided by
Sec. 1.263(a)-1(f), is not an election under Sec. 1.263(a)-3 and
generally does not apply to amounts paid for tangible property subject
to section 263A if these amounts comprise the direct or allocable
indirect costs of other property produced by the taxpayer. See Sec.
1.263(a)-1(f)(3)(v). Accordingly, the de minimis safe harbor election
under Sec. 1.263(a)-1(f) generally would not apply in determining
whether amounts should be included in the computation of APEs for
interest capitalization under section 263A.
Proposed Applicability Dates
These regulations are proposed to apply to taxable years beginning
after the date that final regulations are published in the Federal
Register. However, taxpayers may choose to apply these proposed
regulations for taxable years beginning after May 15, 2024 and on or
before the date that final regulations are published in the Federal
Register.
Special Analyses
I. Regulatory Planning and Review
Pursuant to the Memorandum of Agreement, Review of Treasury
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory
actions issued by the IRS are not subject to the requirements of
section 6 of Executive Order 12866, as amended. Therefore, a regulatory
impact assessment is not required.
II. Paperwork Reduction Act
1. Collections of Information
These proposed regulations do not impose additional recordkeeping
or reporting burden related to section 263A for taxpayers. A change in
a taxpayer's treatment of interest to a method consistent with
Sec. Sec. 1.263A-8(d)(3) and 1.263A-11(e) and (f), as applicable, is a
change in method of accounting to which sections 446 and 481 apply.
Taxpayers change methods of accounting by filing Form 3115 (OMB 1545-
2070). For purposes of the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)) (PRA), the reporting burden associated with Form 3115 will be
reflected in the PRA submission for OMB 1545-2070, so no estimate is
provided here.
2. Burden Estimates
These regulations impose 0 hours and $0 of additional recordkeeping
or reporting burden related to section 263A for taxpayers. Taxpayers
who change their accounting method based on the revised requirements do
so by filing Form 3115 (OMB 1545-2070). For purposes of the PRA, the
reporting burden associated with Form 3115 will be reflected in the PRA
submission for OMB 1545-2070, so no estimate is provided here.
Because businesses with gross receipts of up to $25 million (as
adjusted for inflation pursuant to sections 263A(i) and 446(c)) are
exempted from the requirement to capitalize costs, including interest,
under section 263A, businesses with
[[Page 42407]]
gross receipts in excess of $25 million (as adjusted for inflation) are
impacted by these proposed regulations. Approximately 30,000 taxpayers
with gross receipts in excess of $25 million (as adjusted for
inflation) reported that they were subject to section 263A during the
past five years. This number is based upon the number of taxpayers who
reported that they were subject to section 263A on Forms 1120, 1125-A,
and 4562.
It is estimated that no more than 1 percent of these businesses
will make improvements to real or tangible personal property that
constitute the production of designated property for which a change in
accounting method will be made in any one year. Therefore, it is
estimated that approximately 300 taxpayers may be impacted by the
changes in these proposed regulations.
III. Regulatory Flexibility Act
Small business taxpayers, those with gross receipts of up to $ 25
million (as adjusted for inflation), are exempted from the requirement
to capitalize costs, including interest, under section 263A. Therefore,
very few, if any, small business taxpayers will be affected by these
proposed regulations. It is hereby certified that these proposed
regulations will not have a significant economic impact on a
substantial number of small entities within the meaning of section
601(6) of the Regulatory Flexibility Act (5 U.S.C. chapter 6). The
Treasury Department and the IRS invite comments about the potential
impacts of this proposed rule on small entities.
Pursuant to section 7805(f) of the Code, this notice of proposed
rulemaking has been submitted to the Chief Counsel of the Office of
Advocacy of the Small Business Administration for comment on its impact
on small business.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated costs and benefits and take
certain other actions before issuing a final rule that includes any
Federal mandate that may result in expenditures in any one year by a
State, local, or Tribal government, in the aggregate, or by the private
sector, of $100 million (updated annually for inflation). This proposed
rule does not include any Federal mandate that may result in
expenditures by State, local, or Tribal governments, or by the private
sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (Federalism) prohibits an agency from
publishing any rule that has federalism implications if the rule either
imposes substantial, direct compliance costs on State and local
governments, and is not required by statute, or preempts State law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. This proposed rule does not have
federalism implications and does not impose substantial direct
compliance costs on State and local governments or preempt State law
within the meaning of the Executive order.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS, as prescribed in this preamble under the ADDRESSES heading.
The Treasury Department and the IRS request comments on all aspects of
the proposed regulations. Any comments will be made available at
https://www.regulations.gov or upon request.
A public hearing will be scheduled if requested in writing by any
person who timely submits electronic or written comments. Requests for
a public hearing are also encouraged to be made electronically. If a
public hearing is scheduled, notice of the date and time for the public
hearing will be published in the Federal Register.
Drafting Information
The principal author of these regulations is Livia Piccolo of the
Office of the Associate Chief Counsel (Income Tax and Accounting).
However, other personnel from the Treasury Department and IRS
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, the Treasury Department and the IRS propose to amend
26 CFR part 1 as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805 * * *
* * * * *
Sec. 1.263A-0 [Amended]
0
Par. 2. Section 1.263A-0 is amended by removing the entries for Sec.
1.263A-11(e)(1) and (2).
0
Par. 3. Section 1.263A-8 is amended by revising paragraph (d)(3)(i) to
read as follows:
Sec. 1.263A-8 Requirement to capitalize interest.
* * * * *
(d) * * *
(3) Improvements to existing property--(i) In general. Any
improvement to property owned by the taxpayer that is treated as an
improvement under Sec. 1.263(a)-3 constitutes the production of
property. Generally, any improvement to designated property constitutes
the production of designated property. An improvement is not treated as
the production of designated property, however, if the de minimis
exception described in paragraph (b)(4) of this section applies to the
improvement. Paragraph (d)(3)(iii) of this section provides an
exception for certain improvements to tangible personal property. In
addition, improvements to designated property under this paragraph
(d)(3)(i) do not include repairs and maintenance described in Sec.
1.162-4(a).
* * * * *
0
Par. 4. Section 1.263A-11 is amended by revising paragraphs (e) and (f)
to read as follows:
Sec. 1.263A-11 Accumulated production expenditures.
* * * * *
(e) Improvements. If an improvement constitutes the production of
designated property under Sec. 1.263A-8(d)(3), accumulated production
expenditures with respect to the improvement consist of all direct and
indirect costs required to be capitalized with respect to the
improvement. See Sec. 1.263A-12(d)(1) to determine when the production
period for a unit of property has ended.
(f) Mid-production purchases. If a taxpayer purchases a unit of
property for further production before the purchased unit of property
is placed in service, the taxpayer's accumulated production
expenditures include the full purchase price of the purchased unit of
property plus all the additional direct and indirect production costs
incurred by the taxpayer that are required to be capitalized with
respect to the purchased unit of property.
* * * * *
[[Page 42408]]
0
Par. 5. Section 1.263A-15 is amended by adding paragraph (a)(6) to read
as follows:
Sec. 1.263A-15 Effective dates, transitional rules, and anti-abuse
rule.
(a) * * *
(6) Sections 1.263A-8(d)(3) and 1.263A-11(e) and (f) apply to
taxable years beginning after [DATE OF PUBLICATION OF FINAL RULE]. A
change in a taxpayer's treatment of interest to a method consistent
with Sec. Sec. 1.263A-8(d)(3) and 1.263A-11(e) and (f), as applicable,
is a change in method of accounting to which sections 446 and 481
apply.
* * * * *
Douglas W. O'Donnell,
Deputy Commissioner.
[FR Doc. 2024-10579 Filed 5-14-24; 8:45 am]
BILLING CODE 4830-01-P