New
Regs Clarify Cost Segregation Method Changes
Changes that are accounting method changes:
Changes that are not accounting method changes:
The item being changed generally is each depreciable or amortizable asset.
The Temporary Regulations are effective as of
A copy of TD 9105 may be obtained here. Reproduced below are the preamble to TD 9105 and the temporary regulations, (in blue), with the old final regulations under § 446. The temporary regulations under §§ 167 and 1016 are reproduced verbatim from the Treasury Decision.
* * *
If you have any questions regarding the above article, please contact us. Our in-house CPA’s and cost segregation specialists stand ready to address any needs you or your client may have.
[4830-01-p]
Published
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part
1
TD 9105
RIN: 1545-BC17
Changes in Computing
Depreciation
AGENCY: Internal Revenue
Service (IRS), Treasury.
ACTION: Final and temporary
regulations.
SUMMARY: This document
contains regulations relating to a change in computing depreciation or
amortization as well as a change from a nondepreciable
or nonamortizable asset to a depreciable or
amortizable asset (or vice versa). Specifically, these regulations provide
guidance to any taxpayer that makes a change in depreciation or amortization on
whether such change is a change in method of accounting under section 446(e) of
the Internal Revenue Code and on the application of section 1016(a)(2) in determining whether the change is a change in method
of accounting. The text of these temporary regulations also serves as the text
of the proposed regulations set forth in the notice of proposed rulemaking on
this subject in the Proposed Rules section in this issue of the Federal
Register.
DATES:
Effective
Dates: These regulations are effective
Applicability
Dates: For dates of applicability, see §§1.167(e)-1T(e),
1.446(e)-1T(
e)(4), and 1.1016-3T(j).
FOR FURTHER INFORMATION
CONTACT: Sara Logan or Douglas Kim, (202) 622-3110.
(not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains
amendments to 26 CFR part 1 to provide regulations under sections 167, 446(e),
and 1016(a)(2) of the Internal Revenue Code (Code).
These regulations provide the changes in depreciation or amortization that are,
and are not, a change in method of accounting under §1.446-1(e). Additionally,
these regulations amend §1.167(e)-1 to provide that certain changes in
depreciation method for property for which depreciation is determined only
under section 167 are made without the consent of the Commissioner of Internal
Revenue, and amend §1.1016-3 to provide that section 1016(a)(2)
does not permanently affect a taxpayer’s lifetime income for purposes of
determining whether a change in depreciation or amortization is a change in
method of accounting.
Explanation of Provisions
Section 446 provides in
general that taxable income shall be computed under the method of accounting on
the basis of which the taxpayer regularly computes the taxpayer’s income in
keeping the taxpayer’s books. Section 446(e) provides that, except as otherwise
expressly provided in chapter 1 of the Code, a taxpayer who changes the method
of accounting on the basis of which the taxpayer regularly computes the
taxpayer’s income in keeping the taxpayer’s books shall, before computing the
taxpayer’s taxable income under the new method, secure the consent of the
Secretary.
Section 1.446-1(e)(2)(ii)(a)
provides in pertinent part that a change in method of accounting includes a
change in the overall plan of accounting for gross income or deductions or a
change in the treatment of any material item used in such overall plan. A
material item is any item that involves the proper time for the inclusion of
the item in income or the taking of a deduction. However, '1.446-1(e)(2)(ii)(b) provides in pertinent part that a change in
method of accounting does not include an adjustment in the useful life of a
depreciable asset. Although such adjustment may involve the question of the
proper time for the taking of a deduction, such item is traditionally corrected
by adjustments in the current and future years.
Section 1.167(e)-1(a)
provides that in general, any change in the method of computing the
depreciation allowances with respect to a particular account (other than a
change in method permitted or required by reason of the operation of former
section
167(j)(2) and
§1.167(j)-3(c)) is a change in method of accounting, and such a change will be
permitted only with the consent of the Commissioner, except that certain
changes to the straight line method of depreciation will be permitted without
consent as provided in former section 167(e)(1), (2), and (3). Any request for
a change in method of depreciation shall be made in accordance with section 446
and the regulations under section 446.
In 1996, the IRS issued Rev.
Proc. 96-31 (1996-1 C.B. 714), providing that a change from not claiming the
depreciation or amortization allowable to claiming the depreciation or
amortization allowable is a change in method of accounting for which the
consent of the Commissioner of Internal Revenue is required.
In Kurzet
v. Commissioner, 222 F.2d 830, 842-845 (10th Cir. 2000), the
taxpayer sought to change the classification of property under section 168 from
nonresidential real property to 15-year property thereby resulting in a change
in recovery period from 31.5 years to 15 years. The Tenth Circuit held that a
change in recovery period under section 168 is a change in method of accounting
under section 446(e). In reaching its holding, the Tenth Circuit considered the
taxpayer’s argument that a change in recovery period is analogous to a change
in useful life, but concluded that the Commissioner’s interpretation of
§1.446-1(e)(2)(ii) in Rev. Proc. 96-31 as requiring a
taxpayer to obtain permission for a change in recovery period is not plainly
erroneous or inconsistent with '1.446-1(e)(2)(ii).
In
Brookshire Brothers Holding, Inc. & Subsidiaries v. Commissioner, 320 F.3d
507 (5th Cir. 2003), aff’g. T.C. Memo. 2001-150, reh’g en banc denied, 65 Fed. Appx. 511 (5th
Cir. 2003), the Fifth Circuit held that a change in classification of property
under section 168 is not a change in method of accounting under section 446(e)
because the change is the functional equivalent of a change in useful life
thereby resulting in the change falling under the useful life exception in
§1.446-1(e)(2)(ii)(b). The Eighth Circuit in O’Shaughnessy v. Commissioner, 332
F.3d 1125 (8th
Cir. 2003), rev’g in part 2002-1 U.S.T.C. (CCH) ¶50,235 (D. Minn.
2001), adopted the analysis in Brookshire and held that a change in
classification of property under section 168 falls within the useful life
exception and, thus, does not constitute a change in method of accounting under
section 446(e).
Further, in Green Forest
Manufacturing Inc. v. Commissioner, T.C.Memo.
2003-75, the Tax Court extended its reasoning in Brookshire. The court held
that a change in computing depreciation from the general depreciation system in
section 168(a) to the alternative depreciation system in section 168(g) is a
change in classification that falls within the useful life exception and,
therefore, is not a change in method of accounting.
As a result of these
decisions, there is inconsistent treatment of taxpayers with respect to whether
a change in computing depreciation under section 168 is a change in method of
accounting under section 446(e). These regulations clarify the changes in
depreciation or amortization (depreciation) that are
(and are not) changes in method of accounting under section 446(e).
The regulations provide the
changes in depreciation for property for which depreciation is determined under
section 167, 168, 197, 1400I, 1400L(b), or 1400L(c), or former section 168, of
the Code that are (and are not) changes in method of accounting under section
446(e). The regulations also clarify that the rules in §1.167(e)-1 with respect
to a change in the depreciation method made without the consent of the
Commissioner apply only to property for which depreciation is determined under
section 167 (other than under section 168, section 1400I, section 1400L, or
former section 168).
In general, the regulations
provide that a change in the depreciation method, period of recovery, or
convention of a depreciable or amortizable asset is a change in method of
accounting. This change may be the result of, for example, a change in the classification
of property under section 168(e) or a change in computing depreciation from the
general depreciation system under section 168(a) to the alternative
depreciation system of section 168(g). Further, a change to or from claiming
the additional first year depreciation deduction provided by section 168(k) or 1400L(b) is a change in method of accounting under certain
circumstances.
The regulations clarify that
the useful life exception, which has been moved from
§1.446-1(e)(2)(ii)(b) to
§1.446-1T(e)(2)(ii)(d), applies only to property for which the depreciation is
determined under section 167 (other than under section 168, section 1400I,
section 1400L, or former section 168). However, a change to or from a useful
life (or recovery period or amortization period) that is specifically assigned
by the Code, the regulations under the Code, or other guidance published in the
Internal Revenue Bulletin is a change in method of accounting.
The regulations also provide
that a change in salvage value to zero for a depreciable or amortizable asset
for which the salvage value is expressly treated as zero by the Code, the
regulations under the Code, or other guidance published in the Internal Revenue
Bulletin, is treated as a change in method of accounting. Any other change in
salvage value is not treated as a change in method of accounting.
Further, the regulations
provide that a change in the accounting for depreciable or amortizable assets
from single asset accounting to multiple asset accounting (pooling), or vice versa,
or from one type of multiple asset accounting (pooling) to a different type of
multiple asset accounting (pooling) is a change in method of accounting. Also,
for depreciable or amortizable assets that are mass assets accounted for in
multiple asset accounts or pools, a change in the method of identifying which
assets have been disposed
is a change in method of
accounting (for example, from specific identification to a first-in, first-out
method).
Finally, the regulations
provide that a change in the treatment of an asset from nondepreciable
or nonamortizable (nondepreciable)
to depreciable or amortizable (depreciable), or vice versa, is a change in
method of accounting. For example, a change in the treatment of an asset that
was used entirely in the taxpayer’s trade or business and was never held for
sale from being treated as inventory to being treated as depreciable property
is a change in method of accounting.
The regulations provide that
a change in computing depreciation allowances in the taxable year in which the
use of property changes in the hands of the same taxpayer is not a change in
method of accounting.
The regulations also provide
that the making of a late depreciation election or the revocation of a timely
valid depreciation election generally is not a change in method of accounting.
This rule also applies to the making of a late election or the revocation of a
timely valid election under section 13261(g)(2) or (3)
of the Revenue Reconciliation Act of 1993 (107 Stat. 312, 540) (relating to
amortizable section 197 intangibles). To make a late depreciation election or
to revoke a timely valid depreciation election, a taxpayer must submit a
request for a private letter ruling. Elections made under section 168(b)(2)(C), 168(b)(3)(D), or 168(g)(7) are irrevocable.
Finally, the regulations
provide that any change in the placed-in-service date of a depreciable or
amortizable asset is not treated as a change in method of accounting.
The regulations clarify that
for purposes of changes in depreciation, the item being changed is the
depreciation treatment of each individual depreciable or amortizable asset.
However, the item is the
depreciation treatment of each vintage account with respect to depreciable
assets for which depreciation is determined under §1.167(a)-11 (CLADR
property). Further, a change in computing depreciation under section 167 (other
than a change under section 168, section 1400I, section 1400L, or former
section 168) is permitted only with respect to all assets in a particular
account (as defined in §1.167(a)-7) or vintage account.
The regulations also provide
rules for the following: (1) a change from a declining balance method under
section 168(b)(1) or (2) to the straight line method; (2) changes in certain
depreciation methods under section 167 (other than under section 168, section
1400I, section 1400L, or former section 168); and (3) section 481 adjustments.
With respect to a change
from the 200-percent or 150-percent declining balance method under section
168(b)(1) or (2) to the straight line method, the
regulations provide that this change may be made without the consent of the
Commissioner in the first taxable year in which the depreciation allowance
under the straight line method is greater than the depreciation allowance under
the declining balance method.
With respect to changes in
depreciation methods under section 167 (other than under section 168, section
1400I, section 1400L, or former section 168), the regulations provide
cross-references to regulations under section 167 that allow certain
depreciation method changes to be made without the consent of the Commissioner.
With respect to section 481
adjustments, the regulations also clarify that except as otherwise expressly
provided by the Code, the regulations under the Code, or other guidance
published in the Internal Revenue Bulletin, a change from one permissible
method of computing depreciation to another permissible method of computing
depreciation for a depreciable or amortizable asset is implemented on either a
cut-off method (as described in section 2.06 of Rev. Proc. 97-27 (1997-1 C.B.
680) and in section 2.06 of Rev. Proc. 2002-9 (2002-1 C.B. 327)) or a modified
cut-off method (under which the adjusted depreciable basis of the asset as of
the beginning of the year of change is recovered using the new permissible
method of accounting). Because no items are duplicated or omitted from income
when the cut-off method or the modified cut-off method is used to effect the
change in method of accounting, no section 481 adjustment is required or
permitted. However, a change from an impermissible method of computing
depreciation to a permissible method of computing depreciation results in a
negative or positive section 481 adjustment because the adjusted depreciable
basis of the asset as of the beginning of the year of change is changed as a
result of the change in computing depreciation. Similarly, a change in the
treatment of an asset from nondepreciable to
depreciable (or vice versa) or a change from expensing to depreciating an asset
(or vice versa) will also result in a negative or positive section 481
adjustment.
Section 1016(a)(2) provides that the basis of property is adjusted in
respect of any period since February 28, 1913, for exhaustion, wear and tear,
obsolescence, amortization, and depletion, to the extent of the amount allowed
as deductions in computing taxable income and resulting in a reduction for any
taxable year of the taxpayer’s taxes, but not less than the amount allowable.
Concurrently with the
issuance of these regulations, the IRS and Treasury Department will issue a
revenue procedure that will allow a taxpayer to change the taxpayer’s method of
determining depreciation for a depreciable or amortizable asset after its
disposition if the taxpayer did not take into account any depreciation
allowance, or did take into account some depreciation but less than the
depreciation allowable, for the asset in computing taxable income in the year
of disposition or in prior taxable years. Because the taxpayer is permitted to
claim the allowable depreciation not taken into account for this asset, the
taxpayer’s lifetime income is not permanently affected by the “allowed or
allowable” rule under section 1016(a)(2). Accordingly,
the regulations provide that section 1016(a)(2) does
not permanently affect a taxpayer’s lifetime income for purposes of determining
whether a change in depreciation is a change in method of accounting under
section 446(e) and the regulations under section 446(e).
The revenue procedure also
will revise the depreciation changes included in Rev. Proc. 2002-9 (2002-1 C.B.
327), the automatic change in method of accounting revenue procedure, to
conform with these regulations and will waive the
application of Rev. Rul. 90-38 (1990-1 C.B. 57) for changes in depreciation
made under Rev. Proc. 97-27 (1997-1 C.B. 680) or Rev. Proc. 2002-9.
Special Analyses
It has been determined that
this Treasury decision is not a significant regulatory action as defined in
Executive Order 12866. Therefore, a regulatory assessment is not required. It
also has been determined that section 553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply to these regulations. For the
applicability of the.Regulatory Flexibility Act (5
U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the
cross-reference notice of proposed rulemaking published in the Federal
Register. Pursuant to section 7805(f) of the Code, these temporary
regulations will be submitted to the Chief Counsel for Advocacy of the Small
Business Administration for comment on its impact on small business.
Drafting Information
The principal author of
these regulations is Sara Logan, Office of Associate Chief Counsel
(Passthroughs and Special Industries). However, other personnel from the IRS
and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Amendments to the
Regulations
Accordingly, 26 CFR part 1
is amended as follows:
PART 1--INCOME TAXES
Paragraph
1. The
authority citation for part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 *
* *
Par. 2. Section 1.167(e)-1 is
amended by:
1. Revising paragraph (a).
2. Adding new paragraph (e).
The addition and revision
read as follows:
§1.167(e)-1 Change in
method.
(a) In general. [Reserved]. For
further guidance, see §1.167(e)-1T(a).
*
* * * *
(e)
Effective date. [Reserved]. For further guidance, see
the first two sentences of §1.167(e)-1T(e).
Par. 3. Section 1.167(e)-1T is
added to read as follows:
§1.167(e)-1T Change in
method (temporary).
(a) In general.
(1)
Any change in the method of computing the depreciation allowances with respect
to a particular account (other than a change in method permitted or required by
reason of the operation of former section 167(j)(2) and §1.167(j)-3(c)) is a
change in method of accounting, and such a change will be permitted only with
the consent of the Commissioner, except that certain changes to the straight
line method of depreciation will be permitted without consent as provided in
former section 167(e)(1), (2), and (3). Except as provided in paragraphs (c)
and (d) of this section, a change in method of computing depreciation will be
permitted only with respect to all the assets contained in a particular account
as defined in §1.167(a)-7. Any change in the percentage of the current straight
line rate under the declining balance method, for example, from 200 percent of
the straight line rate to any other percent of the straight line rate, or any
change in the interest factor used in connection with a compound interest or
sinking fund method, will constitute a change in method of depreciation. Any
request for a change in method of depreciation shall be made in accordance with
section 446(e) and the regulations under section 446(e). For rules covering the
use of depreciation methods by acquiring corporations in the case of certain
corporate acquisitions, see section 381(c)(6) and the regulations under
section.381(c)(6).
(2)
Paragraphs (b), (c), and (d) of this section apply to property for which
depreciation is determined under section 167 (other than under section 168,
section 1400I, section 1400L, or under section 168 prior to its amendment by
the Tax Reform Act of 1986 (100 Stat. 2121)) of the Internal Revenue Code.
(b)
through (d) [Reserved]. For further guidance, see
§1.167(e)-1(b) through (d).
(e)
Effective date. This section applies on or after
§
1.446-1. General rule for methods of accounting as amended by temporary
regulations
(a) General rule.—
(1) Section 446(a) provides that taxable income
shall be computed under the method of accounting on the basis of which a
taxpayer regularly computes his income in keeping his books. The term “method
of accounting” includes not only the over-all method of accounting of the
taxpayer but also the accounting treatment of any item. Examples of such
over-all methods are the cash receipts and disbursements method, an accrual
method, combinations of such methods, and combinations of the foregoing with
various methods provided for the accounting treatment of special items. These
methods of accounting for special items include the accounting treatment
prescribed for research and experimental expenditures, soil and water
conservation expenditures, depreciation, net operating losses, etc. Except for
deviations permitted or required by such special accounting treatment, taxable
income shall be computed under the method of accounting on the basis of which
the taxpayer regularly computes his income in keeping his books. For
requirement respecting the adoption or change of accounting method, see section
446(e) and paragraph (e) of this section.
(2) It is recognized that no uniform method of accounting can be
prescribed for all taxpayers. Each taxpayer shall adopt such forms and systems
as are, in his judgment, best suited to his needs. However, no method of
accounting is acceptable unless, in the opinion of the Commissioner, it clearly
reflects income. A method of accounting which reflects the consistent
application of generally accepted accounting principles in a particular trade or
business in accordance with accepted conditions or practices in that trade or
business will ordinarily be regarded as clearly reflecting income,
provided all items of gross income and expense are treated consistently from
year to year.
(3) Items of gross income and expenditures which are
elements in the computation of taxable income need not be in the form of cash.
It is sufficient that such items can be valued in terms of money. For general
rules relating to the taxable year for inclusion of income and for taking
deductions, see sections 451 and 461, and the regulations thereunder.
(4) Each taxpayer is required to make a return of
his taxable income for each taxable year and must maintain such accounting
records as will enable him to file a correct return. See section 6001 and the
regulations thereunder. Accounting records include the taxpayer’s regular books
of account and such other records and data as may be necessary to support the
entries on his books of account and on his return, as for example, a reconciliation
of any differences between such books and his return. The following are among
the essential features that must be considered in maintaining such records:
(i) In all cases in which
the production, purchase, or sale of merchandise of any kind in an
income-producing factor, merchandise on hand (including finished goods, work in
process, raw materials, and supplies) at the beginning and end of the year
shall be taken into account in computing the taxable income of the year. (For
rules relating to computation of inventories, see sections 263A, 471 and 472,
and the regulations thereunder.)
(ii) Expenditures made during the year shall be
properly classified as between capital and expense. For example, expenditures
for such items as plant and equipment, which have a useful life extending
substantially beyond the taxable year, shall be charged to a capital account
and not to an expense account.
(iii) In any case in which there is allowable with
respect to an asset a deduction for depreciation, amortization, or depletion,
any expenditures (other than ordinary repairs) made to
restore the asset or prolong its useful life shall be added to the asset
account or charged against the appropriate reserve.
(b) Exceptions—
(1) If the taxpayer does not regularly employ a
method of accounting which clearly reflects his income, the computation of
taxable income shall be made in a manner which, in the opinion of the
Commissioner, does clearly reflect income.
(2) A taxpayer whose sole source of income is wages
need not keep formal books in order to have an accounting method. Tax returns,
copies thereof, or other records may be sufficient to establish the use of the
method of accounting used in the preparation of the taxpayer’s income tax
returns.
(c) Permissible methods—
(1) In general. Subject to the provisions of
paragraphs (a) and (b) of this section, a taxpayer may compute his taxable
income under any of the following methods of accounting:
(i) Cash receipts and
disbursements method. Generally, under the cash receipts and disbursements
method in the computation of taxable income, all items which constitute gross
income (whether in the form of cash, property, or services) are to be included
for the taxable year in which actually or constructively received. Expenditures
are to be deducted for the taxable year in which actually made. For rules
relating to constructive receipt, see §1.451-2. For treatment of an expenditure
attributable to more than one taxable year, see section 461(a) and paragraph (a)(1) of §1.461-1.
(ii) Accrual method—
(A) Generally, under an accrual method, income is to
be included for the taxable year when all the events have occurred that fix the
right to receive the income and the amount of the income can be determined with
reasonable accuracy. Under such a method, a liability is incurred, and
generally is taken into account for Federal income tax purposes, in the taxable
year in which all the events have occurred that establish the fact of the
liability, the amount of the liability can be determined with reasonable
accuracy, and economic performance has occurred with respect to the liability.
(See paragraph (a)(2)(iii)(A) of §1.461-1 for examples
of liabilities that may not be taken into account until after the taxable year
incurred, and see §§1.461-4 through 1.461-6 for rules relating to economic
performance.) Applicable provisions of the Code, the Income Tax Regulations,
and other guidance published by the Secretary prescribe the manner in which a
liability that has been incurred is taken into account. For example, section
162 provides that a deductible liability generally is taken into account in the
taxable year incurred through a deduction from gross income. As a further
example, under section 263 or 263A, a liability that relates to the creation of
an asset having a useful life extending substantially beyond the close of the
taxable year is taken into account in the taxable year incurred through
capitalization (within the meaning of §1.263A-1(c)(3)), and may later affect
the computation of taxable income through depreciation or otherwise over a
period including subsequent taxable years, in accordance with applicable
Internal Revenue Code sections and related guidance.
(B) The term “liability” includes any item allowable
as a deduction, cost, or expense for Federal income tax purposes. In addition
to allowable deductions, the term includes any amount otherwise allowable as a
capitalized cost, as a cost taken into account in computing cost of goods sold,
as a cost allocable to a long-term contract, or as any other cost or expense.
Thus, for example, an amount that a taxpayer expends or will expend for capital
improvements to property must be incurred before the taxpayer may take the
amount into account in computing its basis in the property. The term
“liability” is not limited to items for which a legal obligation to pay exists
at the time of payment. Thus, for example, amounts prepaid for goods or
services and amounts paid without a legal obligation to do so may not be taken
into account by an accrual basis taxpayer any earlier than the taxable year in
which those amounts are incurred.
(C) No method of accounting is acceptable unless, in
the opinion of the Commissioner, it clearly reflects income. The method used by
the taxpayer in determining when income is to be accounted for will generally be acceptable if it accords with generally accepted
accounting principles, is consistently used by the taxpayer from year to year,
and is consistent with the Income Tax Regulations. For example, a taxpayer engaged
in a manufacturing business may account for sales of the taxpayer’s product
when the goods are shipped, when the product is delivered or accepted, or when
title to the goods passes to the customers, whether or not billed, depending on
the method regularly employed in keeping the taxpayer’s books.
(iii) Other permissible methods. Special
methods of accounting are described elsewhere in chapter 1 of the Code and the
regulations thereunder. For example, see the following sections and the
regulations thereunder: Sections 61 and 162, relating to the crop method of
accounting; section 453, relating to the installment method; section 460,
relating to the long-term contract methods. In addition, special methods of
accounting for particular items of income and expense are provided under other
sections of chapter 1. For example, see section 174, relating to research and
experimental expenditures, and section 175, relating to soil and water
conservation expenditures.
(iv) Combinations of the foregoing methods.
(a) In accordance with the following rules,
any combination of the foregoing methods of accounting will be permitted in
connection with a trade or business if such combination clearly reflects income
and is consistently used. Where a combination of methods of accounting includes
any special methods, such as those referred to in subdivision (iii) of this
subparagraph, the taxpayer must comply with the requirements relating to such
special methods. A taxpayer using an accrual method of accounting with respect
to purchases and sales may use the cash method in computing all other items of
income and expense. However, a taxpayer who uses the cash method of accounting
in computing gross income from his trade or business shall use the cash method
in computing expenses of such trade or business. Similarly, a taxpayer who uses
an accrual method of accounting in computing business expenses shall use an
accrual method in computing items affecting gross income from his trade or
business.
(b) A taxpayer using one method of accounting
in computing items of income and deductions of his trade or business may
compute other items of income and deductions not connected with his trade or
business under a different method of accounting.
(2) Special rules—
(i) In any case in which
it is necessary to use an inventory the accrual method of accounting must be
used with regard to purchases and sales unless otherwise authorized under
subdivision (ii) of this subparagraph.
(ii) No method of accounting will be regarded as
clearly reflecting income unless all items of gross profit and deductions are
treated with consistency from year to year. The Commissioner may authorize a
taxpayer to adopt or change to a method of accounting permitted by this chapter
although the method is not specifically described in this part if, in the
opinion of the Commissioner, income is clearly reflected by the use of such
method. Further, the Commissioner may authorize a taxpayer to continue the use
of a method of accounting consistently used by the taxpayer, even though not
specifically authorized by the regulations in this part, if, in the opinion of
the Commissioner, income is clearly reflected by the use of such method. See
section 446(a) and paragraph (a) of this section, which require that taxable
income shall be computed under the method of accounting on the basis of which
the taxpayer regularly computes his income in keeping his books, and section
446(e) and paragraph (e) of this section, which require the prior approval of
the Commissioner in the case of changes in accounting method.
(iii) The timing rules of §1.1502-13 are a method of
accounting for intercompany transactions (as defined
in §1.1502-13(b)(1)(i)), to
be applied by each member of a consolidated group in addition to the member’s
other methods of accounting. See §1.1502-13(a)(3)(i). This paragraph (c)(2)(iii) is
applicable to consolidated return years beginning on or after
(d)
Taxpayer engaged in more than one business—
(1) Where a taxpayer has two or more separate and distinct
trades or businesses, a different method of accounting may be used for each
trade or business, provided the method used for each trade or business clearly
reflects the income of that particular trade or business. For example, a
taxpayer may account for the operations of a personal service business on the
cash receipts and disbursements method and of a manufacturing business on an
accrual method, provided such businesses are separate and distinct and the
methods used for each clearly reflect income. The method first used in
accounting for business income and deductions in connection with each trade or
business, as evidenced in the taxpayer’s income tax return in which such income
or deductions are first reported, must be consistently followed thereafter.
(2) No trade or business will be considered separate
and distinct for purposes of this paragraph unless a complete and separable set
of books and records is kept for such trade or business.
(3) If, by reason of maintaining different methods
of accounting, there is a creation or shifting of profits or losses between the
trades or businesses of the taxpayer (for example, through inventory
adjustments, sales, purchases, or expenses) so that income of the taxpayer is
not clearly reflected, the trades or businesses of the taxpayer will not be
considered to be separate and distinct.
(e)
Requirement respecting the adoption or change of accounting method—
(1) A taxpayer filing his first return may adopt any
permissible method of accounting in computing taxable income for the taxable
year covered by such return. See section 446(c) and paragraph (c) of this
section for permissible methods. Moreover, a taxpayer may adopt any permissible
method of accounting in connection with each separate and distinct trade or business,
the income from which is reported for the first time. See section 446(d) and
paragraph (d) of this section. See also section 446(a) and paragraph (a) of
this section.
(2)(i) Except as otherwise expressly provided in chapter 1 of the Code and the regulations thereunder, a taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner. Consent must be secured whether or not such method is proper or is permitted under the Internal Revenue Code or the regulations thereunder.
(ii)(a) A change in the method of
accounting includes a change in the overall plan of accounting for gross income
or deductions or a change in the treatment of any material item used in such
overall plan. Although a method of accounting may exist under this definition
without the necessity of a pattern of consistent treatment of an item, in most
instances a method of accounting is not established for an item without such
consistent treatment. A material item is any item that involves the proper time
for the inclusion of the item in income or the taking of a deduction. Changes
in method of accounting include a change from the cash receipts and disbursement
method to an accrual method, or vice versa, a change involving the method or
basis used in the valuation of inventories (see sections 471 and 472 and the
regulations under sections 471 and 472), a change from the cash or accrual
method to a long-term contract method, or vice versa (see §1.460-4), certain
changes in computing depreciation or amortization (see paragraph (e)(2)(ii)(d)
of this section), a change involving the adoption, use or discontinuance of any
other specialized method of computing taxable income, such as the crop method,
and a change where the Internal Revenue Code and regulations under the Code
specifically require that the consent of the Commissioner must be obtained
before adopting such a change.
(b) A change in method of
accounting does not include correction of mathematical or posting errors, or
errors in the computation of tax liability (such as errors in computation of
the foreign tax credit, net operating loss, percentage depletion, or investment
credit). Also, a change in method of accounting does not include adjustment of
any item of income or deduction that does not involve the proper time for the
inclusion of the item of income or the taking of a deduction. For example,
corrections of items that are deducted as interest or salary, but that are in
fact payments of dividends, and of items that are deducted as business
expenses, but which are in fact personal expenses, are not changes in method of
accounting. In addition, a change in the method of accounting does not include
an adjustment with respect to the addition to a reserve for bad debts. Although
such adjustment may involve the question of the proper time for the taking of a
deduction, such items are traditionally corrected by adjustment in the current
and future years. For the treatment of the adjustment of the addition to a bad
debt reserve (for example, for banks under section 585 of the Internal Revenue
Code), see the regulations under section 166 of the Internal Revenue Code. A
change in the method of accounting also does not include a change in treatment
resulting from a change in underlying facts. For further guidance on changes
involving depreciable or amortizable assets, see paragraph (e)(2)(ii)(d)
of this section and §1.1016-3T(h).
(c) A change in an overall plan or system of
identifying or valuing items in inventory is a change in method of accounting.
Also a change in the treatment of any material item used in the overall plan
for identifying or valuing items in inventory is a change in method of
accounting.
(d) Changes
involving depreciable or amortizable assets—
(1) Scope. This paragraph
(e)(2)(ii)(d) applies to property subject to section 167, 168, 197,
1400I, 1400L(b), or 1400L(c), or to section 168 prior to its amendment by the
Tax Reform Act of 1986 (100 Stat. 2121) (former section 168).
(2) Changes in depreciation or amortization that are a change in method of accounting.
Except as provided in paragraph (e)(2)(ii)(d)(3)
of this section, a change in the treatment of an asset from nondepreciable
or nonamortizable to depreciable or amortizable, or
vice versa, is a change in method of accounting. Additionally, a correction to
require depreciation or amortization in lieu of a deduction for the cost of
depreciable or amortizable assets that had been consistently treated as an
expense in the year of purchase, or vice versa, is a change in method of
accounting. Further, except as provided in paragraph (e)(2)(ii)(d)(3)
of this section, the following changes in computing depreciation or
amortization are a change in method of accounting:
(i) A
change in the depreciation or amortization method, period of recovery, or
convention of a depreciable or amortizable asset.
(ii) A change from not claiming to
claiming the additional first year depreciation deduction provided by section
168(k) or 1400L(b) for, and the resulting change to the amount otherwise
allowable as a depreciation deduction for the remaining adjusted depreciable
basis (or similar basis) of, qualified property, 50-percent bonus depreciation
property, or qualified New York Liberty Zone property, provided the taxpayer
did not make the election out of the additional first year depreciation
deduction (or did not make a deemed election out of the additional first year
depreciation deduction; for further guidance, see Rev. Proc. 2002-33 (2002-1
C.B. 963), Rev. Proc. 2003-50 (2003-29 I.R.B. 119), and §601.601(d)(2)(ii)(b)
of this chapter) for the class of property in which the qualified property, the
50-percent bonus depreciation property, or the qualified New York Liberty Zone
property is included.
(iii) A change from claiming the
30-percent additional first year depreciation deduction to claiming the
50-percent additional first year depreciation deduction for 50-percent bonus
depreciation property (provided the property is not included in any class of
property for which the taxpayer elected the 30-percent, instead of the
50-percent, additional first year depreciation deduction) or a change from
claiming the 50-percent additional first year depreciation deduction to claiming
the 30-percent additional first year depreciation deduction for qualified
property (including property that is included in a class of property for which
the taxpayer elected the 30-percent, instead of the 50-percent, additional
first year depreciation deduction) or qualified New York Liberty Zone property,
and the resulting change to the amount otherwise allowable as a depreciation
deduction for the property’s remaining adjusted depreciable basis (or similar
basis). This paragraph (e)(2)(ii)(d)(2)(iii) does not
apply if a taxpayer is making a late election or revoking a timely valid
election under section 168(k) or 1400L(b) (see paragraph (e)(2)(ii)(d)(3)(iii)
of this section).
(iv) A change from claiming to not
claiming the additional first year depreciation deduction for an asset that is
not qualified property, 50-percent bonus depreciation property, or qualified
New York Liberty Zone property, and the resulting change to the amount
otherwise allowable as a depreciation deduction for the property’s depreciable
basis.
(v) A change in salvage value to
zero for a depreciable or amortizable asset for which the salvage value is
expressly treated as zero by the Internal Revenue Code (for example, section
168(b)(4)), the regulations under the Code (for example, §1.197-2(f)(1)(ii)),
or other guidance published in the Internal Revenue Bulletin.
(vi) A change in the accounting
for depreciable or amortizable assets from a single asset account to a multiple
asset account (pooling), or vice versa, or from one type of multiple asset
account (pooling) to a different type of multiple asset account (pooling).
(vii) For depreciable or
amortizable assets that are mass assets accounted for in multiple asset
accounts or pools, a change in the method of identifying which assets have been
disposed. For purposes of this paragraph (e)(2)(ii)(d)(2)(vii),
the term mass assets means a mass or group of individual items of
depreciable or amortizable assets that are not necessarily homogeneous, each of
which is minor in value relative to the total value of the mass or group,
numerous in quantity, usually accounted for only on a total dollar or quantity
basis, with respect to which separate identification is impracticable, and
placed in service in the same taxable year.
(viii) Any other change in
depreciation or amortization as the Secretary may designate by publication in
the Federal Register or in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter).
(3) Changes in depreciation or
amortization that are not a change in method of accounting—
(i) Useful
life. An adjustment in the useful life of a depreciable or amortizable
asset for which depreciation is determined under section 167 (other than under
section 168, section 1400I, section 1400L, or former section 168) is not a
change in method of accounting. This adjustment in useful life is corrected by
adjustments in the taxable year in which the conditions known to exist at the
end of that taxable year changed thereby resulting in a redetermination
of the useful life under §1.167(a)-1(b) (or if the period of limitation for
assessment under section 6501(a) has expired for that taxable year, in the
first succeeding taxable year open under the period of limitation for
assessment), and in subsequent taxable years. In other situations, the
adjustment in useful life may be corrected by adjustments in the earliest
taxable year open under the period of limitation for assessment under section
6501(a) or the earliest taxable year under examination by the Internal Revenue
Service (IRS) but in no event earlier than the placed-in-service year of the
asset, and in subsequent taxable years. However, if a taxpayer initiates the
correction in useful life, in lieu of filing amended federal tax returns (for
example, because the conditions known to exist at the end of a prior taxable
year changed thereby resulting in a redetermination
of the useful life under §1.167(a)-1(b)), the taxpayer may correct the
adjustment in useful life by adjustments in the current and subsequent taxable
years. This paragraph (e)(2)(ii)(d)(3)(i)
does not apply if a taxpayer is changing to or from a useful life (or recovery
period or amortization period) that is specifically assigned by the Internal
Revenue Code (for example, section 167(f)(1), section 168(c), section 197), the
regulations under the Code, or other guidance published in the Internal Revenue
Bulletin and, therefore, such change is a change in method of accounting
(unless paragraph (e)(2)(ii)(d)(3)(v) of this section
applies).
(ii) Change in use. A change
in computing depreciation or amortization allowances in the taxable year in
which the use of an asset changes in the hands of the same taxpayer is not a
change in method of accounting.
(iii) Elections. Generally,
the making of a late depreciation or amortization election or the revocation of
a timely valid depreciation or amortization election is not a change in method
of accounting, except as otherwise expressly provided by the Internal Revenue
Code, the regulations under the Code, or other guidance published in the
Internal Revenue Bulletin. This paragraph (e)(2)(ii)(d)(3)(iii)
also applies to making a late election or revoking a timely valid election made
under section 13261(g)(2) or (3) of the Revenue Reconciliation Act of 1993 (107
Stat. 312, 540) (relating to amortizable section 197 intangibles). A taxpayer
may request consent to make a late election or revoke a timely valid election
by submitting a request for a private letter ruling.
(iv) Salvage value. Except as
provided under paragraph (e)(2)(ii)(d)(2)(v)
of this section, a change in salvage value of a depreciable or amortizable
asset is not treated as a change in method of accounting.
(v) Placed-in-service date.
Any change in the placed-in-service date of a depreciable or amortizable asset
is not treated as a change in method of accounting. The change in
placed-in-service date may be corrected by adjustments in the earliest taxable
year open under the period of limitation for assessment under section 6501(a)
or the earliest taxable year under examination by the IRS but in no event
earlier than the placed-in-service year of the asset, and in subsequent taxable
years. However, if a taxpayer initiates the change in placed-in-service date,
in lieu of filing amended federal tax returns, the taxpayer may correct the
placed-in-service date by adjustments in the current and subsequent taxable
years.
(vi) Any other change in
depreciation or amortization as the Secretary may designate by publication in
the Federal Register or in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter).
(4) Item being changed. For
purposes of a change in depreciation or amortization to which this paragraph (e)(2)(ii)(d) applies, the item being changed generally
is the depreciation treatment of each individual depreciable or amortizable
asset. However, the item is the depreciation treatment of each vintage account
with respect to a depreciable asset for which depreciation is determined under
§1.167(a)-11 (CLADR property). Further, a change in computing depreciation or
amortization under section 167 (other than under section 168, section 1400I,
section 1400L, or former section 168) is permitted only with respect to all
assets in a particular account (as defined in §1.167(a)-7) or vintage account.
(5) Special rules. For
purposes of a change in depreciation or amortization to which this paragraph (e)(2)(ii)(d) applies--
(i) Declining
balance method to the straight line method for MACRS property. For
tangible, depreciable property subject to section 168 (MACRS property) that is
depreciated using the 200-percent or 150-percent declining balance method of
depreciation under section 168(b)(1) or (2), a taxpayer may change without the
consent of the Commissioner from the declining balance method of depreciation
to the straight line method of depreciation in the first taxable year in which
the use of the straight line method with respect to the adjusted depreciable
basis of the MACRS property as of the beginning of that year will yield a
depreciation allowance that is greater than the depreciation allowance yielded
by the use of the declining balance method. When the change is made, the
adjusted depreciable basis of the MACRS property as of the beginning of the
taxable year is recovered through annual depreciation allowances over the
remaining recovery period (for further guidance, see section 6.06 of Rev. Proc.
87-57 (1987-2 C.B. 687) and §601.601(d)(2)(ii)(b) of this chapter).
(ii) Depreciation method
changes for section 167 property. For a depreciable or amortizable asset for
which depreciation is determined under section 167 (other than under section
168, section 1400I, section 1400L, or former section 168), see §1.167(e)-1T(b),
(c), and (d) for the changes in depreciation method that are permitted to be
made without the consent of the Commissioner. For CLADR property, see
§1.167(a)-11(c)(1)(iii) for the changes in
depreciation method for CLADR property that are permitted to be made without
the consent of the Commissioner. Further, see §1.167(a)-11(b)(4)(iii)(c)
for how to correct an incorrect classification or characterization of CLADR
property.
(iii) Section 481 adjustment. Except as otherwise expressly provided by
the Internal Revenue Code, the regulations under the Code, or other guidance
published in the Internal Revenue Bulletin, no section 481 adjustment is
required or permitted for a change from one permissible method of computing
depreciation or amortization to another permissible method of computing
depreciation or amortization for an asset because this change is implemented by
either a cut-off method (for further guidance, see section 2.06 of Rev. Proc.
97-27 (1997-1 C.B. 680), section 2.06 of Rev. Proc. 2002-9 (2002-1 C.B. 327),
and §601.601(d)(2)(ii)(b) of this chapter) or a modified cut-off method
(under which the adjusted depreciable basis of the asset as of the beginning of
the year of change is recovered using the new permissible method of
accounting), as appropriate. However, a change from an impermissible method of
computing depreciation or amortization to a permissible method of computing
depreciation or amortization for an asset results in a section 481 adjustment.
Similarly, a change in the treatment of an asset from nondepreciable
or nonamortizable to depreciable or amortizable (or
vice versa) or a change in the treatment of an asset from expensing to
depreciating (or vice versa) results in a section 481 adjustment.
(iii) Examples. The rules of this
paragraph (e) are illustrated by the following examples:
Example 1. Although the
sale of merchandise is an income producing factor, and therefore inventories
are required, a taxpayer in the retail jewelry business reports his income on
the cash receipts and disbursements method of accounting. A change from the
cash receipts and disbursements method of accounting to the accrual method of
accounting is a change in the overall plan of accounting and thus is a change
in method of accounting.
Example 2. A taxpayer in
the wholesale dry goods business computes its income and expenses on the
accrual method of accounting and files its Federal income tax returns on such
basis except for real estate taxes which have been reported on the cash
receipts and disbursements method of accounting. A change in the treatment of
real estate taxes from the cash receipts and disbursements method to the
accrual method is a change in method of accounting because such change is a
change in the treatment of a material item within his overall accounting
practice.
Example 3. A taxpayer in
the wholesale dry goods business computes its income and expenses on the
accrual method of accounting and files its Federal income tax returns on such
basis. Vacation pay has been deducted in the year in which paid because the
taxpayer did not have a completely vested vacation pay plan, and, therefore,
the liability for payment did not accrue until that year. Subsequently, the
taxpayer adopts a completely vested vacation pay plan that changes its year for
accruing the deduction from the year in which payment is made to the year in
which the liability to make the payment now arises. The change for the year of
deduction of the vacation pay plan is not a change in method of accounting but
results, instead, because the underlying facts (that is, the type of vacation
pay plan) have changed.
Example 4. From 1968 through
1970, a taxpayer has fairly allocated indirect overhead costs to the value of
inventories on a fixed percentage of direct costs. If the ratio of indirect
overhead costs to direct costs increases in 1971, a change in the underlying
facts has occurred. Accordingly, an increase in the percentage in 1971 to
fairly reflect the increase in the relative level of indirect overhead costs is
not a change in method of accounting but is a change in treatment resulting
from a change in the underlying facts.
Example 5. A taxpayer
values inventories at cost. A change in the basis for valuation of inventories
from cost to the lower of cost or market is a change in an overall practice of
valuing items in inventory. The change, therefore, is a change in method of
accounting for inventories.
Example 6. A taxpayer in
the manufacturing business has for many taxable years valued its inventories at
cost. However, cost has been improperly computed since no overhead costs have
been included in valuing the inventories at cost. The failure to allocate an
appropriate portion of overhead to the value of inventories is contrary to the
requirement of the Internal Revenue Code and the regulations under the Code. A
change requiring appropriate allocation of overhead is a change in method of
accounting because it involves a change in the treatment of a material item
used in the overall practice of identifying or valuing items in inventory.
Example 7. A taxpayer has
for many taxable years valued certain inventories by a method which provides
for deducting 20 percent of the cost of the inventory items in determining the
final inventory valuation. The 20 percent adjustment is taken as a “reserve for
price changes.” Although this method is not a proper method of valuing
inventories under the Internal Revenue Code or the regulations under the Code,
it involves the treatment of a material item used in the overall practice of
valuing inventory. A change in such practice or procedure is a change of method
of accounting for inventories.
Example 8. A taxpayer has
always used a base stock system of accounting for inventories. Under this
system a constant price is applied to an assumed constant normal quantity of
goods in stock. The base stock system is an overall plan of accounting for
inventories which is not recognized as a proper method of accounting for
inventories under the regulations. A change in this practice is, nevertheless,
a change of method of accounting for inventories.
Example 9. In 2000, A1, a
calendar year taxpayer engaged in the trade or business of manufacturing
knitted goods, purchased and placed in service a building and its components at
a total cost of $10,000,000 for use in its manufacturing operations. A1
classified the $10,000,000 as nonresidential real property under section
168(e). A1 did not make any elections under section 168 on its 2000 Federal tax
return. As a result, on its 2000, 2001, and 2002 federal tax returns, A1
depreciated the $10,000,000 under the general depreciation system of section
168(a), using the straight line method of depreciation, a 39-year recovery
period, and the mid-month convention. In 2003, A1 completes a cost segregation
study on the building and its components and identifies items that cost a total
of $1,500,000 as section 1245 property. As a result, the $1,500,000 should have
been classified in 2000 as 5-year property under section 168(e) and depreciated
on A1’s 2000, 2001, and 2002 Federal tax returns under the general depreciation
system, using the 200-percent declining balance method of depreciation, a
5-year recovery period, and the half-year convention. Pursuant to paragraph (e)(2)(ii)(d)(2)(i)
of this section, A1’s change to this depreciation method, recovery period, and
convention is a change in method of accounting. This method change results in a
section 481 adjustment. The useful life exception under paragraph (e)(2)(ii)(d)(3)(i)
of this section does not apply because the assets are depreciated under section
168.
Example 10. In 1996, B, a
calendar year taxpayer, purchased and placed in service new equipment at a
total cost of $1,000,000 for use in its plant located outside the United
States. The equipment is 15-year property under section 168(e) with a class
life of 20 years. The equipment is required to be depreciated under the alternative
depreciation system of section 168(g). However, B incorrectly depreciated the
equipment under the general depreciation system of section 168(a), using the
150-percent declining balance method, a 15-year recovery period, and the
half-year convention. In 2003, the IRS examines B’s 2000 Federal income tax
return and changes the depreciation of the equipment to the alternative
depreciation system, using the straight line method of depreciation, a 20-year
recovery period, and the half-year convention. Pursuant to paragraph (e)(2)(ii)(d)(2)(i)
of this section, this change in depreciation method and recovery period made by
the IRS is a change in method of accounting. This method change results in a
section 481 adjustment. The useful life exception under paragraph (e)(2)(ii)(d)(3)(i)
of this section does not apply because the assets are depreciated under section
168.
Example 11. In May 2001, C,
a calendar year taxpayer, purchased and placed in service equipment for use in
its trade or business. C never held this equipment for sale. However, C
incorrectly treated the equipment as inventory on its 2001 and 2002 Federal tax
returns. In 2003, C realizes that the equipment should have been treated as a
depreciable asset. Pursuant to paragraph (e)(2)(ii)(d)(2)
of this section, C’s change in the treatment of the equipment from inventory to
a depreciable asset is a change in method of accounting. This method change
results in a section 481 adjustment.
Example 12. Since 2001, D, a
calendar year taxpayer, has used the distribution fee period method to amortize
distributor commissions and, under that method, established pools to account
for the distributor commissions (for further guidance, see Rev. Proc. 2000-38
(2000-2 C.B. 310) and §601.601(d)(2)(ii)(b) of
this chapter). A change in the accounting of distributor commissions under the
distribution fee period method from pooling to single asset accounting is a
change in method of accounting pursuant to paragraph (e)(2)(ii)(d)(2)(vi)
of this section. This method change results in no section 481 adjustment
because the change is from one permissible method to another permissible
method.
Example 13. Since 2000, E, a
calendar year taxpayer, has accounted for items of MACRS property that are mass
assets in pools. Each pool includes only the mass assets that are placed in
service by E in the same taxable year. E is able to identify the cost basis of
each asset in each pool. None of the pools are general asset accounts under
section 168(i)(4) and the
regulations under section 168(i)(4). E identified any
dispositions of these mass assets by specific identification. Because of
changes in E’s recordkeeping in 2003, it is impracticable for E to continue to
identify disposed mass assets using specific identification. As a result, E wants
to change to a first-in, first-out method under which the mass assets disposed
of in a taxable year are deemed to be from the pool with the earliest
placed-in-service year in existence as of the beginning of the taxable year of
each disposition. Pursuant to paragraph (e)(2)(ii)(d)(2)(vii)
of this section, this change is a change in method of accounting. This method
change results in no section 481 adjustment because the change is from one
permissible method to another permissible method.
Example 14. In August 2001,
F, a calendar taxpayer, purchased and placed in service
a copier for use in its trade or business. F incorrectly classified the copier
as 7-year property under section 168(e). F made no elections under section 168
on its 2001 Federal tax return. As a result, on its 2001 and 2002 Federal tax
returns, F depreciated the copier under the general depreciation system of
section 168(a), using the 200-percent declining balance method of depreciation,
a 7-year recovery period, and the half-year convention. In 2003, F realizes
that the copier is 5-year property and should have been depreciated on its 2001
and 2002 Federal tax returns under the general depreciation system using a
5-year recovery period rather than a 7-year recovery period. Pursuant to paragraph
(e)(2)(ii)(d)(2)(i)
of this section, F’s change in recovery period from
Example 15. In 1998, G, a
calendar year taxpayer, purchased and placed in service an intangible asset
that is not an amortizable section 197 intangible and that is not described in
section 167(f). G amortized the cost of the intangible asset under section
167(a) using the straight line method of depreciation and a useful life of 13
years. In 2003, because of changing conditions, G changes the remaining useful
life of the intangible asset to 2 years. Pursuant to paragraph (e)(2)(ii)(d)(3)(i)
of this section, G’s change in useful life is not a change in method of
accounting because the intangible asset is depreciated under section 167 and G
is not changing to or from a useful life that is specifically assigned by the
Internal Revenue Code, the regulations under the Code, or other guidance
published in the Internal Revenue Bulletin.
Example 16. In July 2001, H,
a calendar year taxpayer, purchased and placed in service “off-the-shelf” computer
software and a new computer. The cost of the new computer and computer software
are separately stated. H incorrectly included the cost of this software as part
of the cost of the computer, which is 5-year property under section 168(e). On
its 2001 Federal tax return, H elected to depreciate its 5-year property placed
in service in 2001 under the alternative depreciation system of section 168(g).
The class life for a computer is 5 years. As a result, because H included the
cost of the computer software as part of the cost of the computer hardware, H
depreciated the cost of the software under the alternative depreciation system,
using the straight line method of depreciation, a 5-year recovery period, and
the half-year convention. In 2003, H realizes that the cost of the software
should have been amortized under section 167(f)(1),
using the straight line method of depreciation, a 36-month useful life, and a
monthly convention. H’s change from 5-years to 36-months is a change in method
of accounting because H is changing to a useful life that is specifically
assigned by section 167(f)(1). The change in
convention from the half-year to the monthly convention also is a change in
method of accounting. Both changes result in a section 481 adjustment.
Example 17.</