Facts
Disposal Management intends to expand its operations further by purchasing a large tract of land at a cost of $420,000 to be used as a landfill located near Flint, MI. The property consists of large ‘holes’ that would be ideal for waste disposal. The company forecasts that the salvage value of the property upon termination of its use for landfill will be nearly $180,000.
Issue
Disposal Management is concerned about how the expenditure for the land should be treated for tax purposes.
Authorities
IRC §263 and 263A
IRC § 162
Rev. Rul. 2004-18, 2004-1 C.B. 509
Woodward v. Commissioner, 397 U.S 572, 574-75 (1970)
Cinergy Corp. v. United States, 55 Fed. Cl. 489, 516 (2003)
Analysis
The parcel of land bought is classified as a capital asset, and it would benefit Disposal Management for more than a single year. The expenditures incurred on the land are classified as capital expenditures because it is most likely that the company would not exhaust the benefits gained within one year. In addition, they may be non-recurring expenditures leading to permanent acquisition of the land.
For tax reasons, capital expenditures are not deductible during the fiscal year they are paid or incurred and therefore must be capitalized. In this regard, Disposal Management must capitalize capital expenditures because the useful life of the land would exceed one year. The company will then have to “depreciate or amortize the expenditures over the life” (Taxpayer Advocate Service 348) of the land.
Capital expenditures will result in add basis to the land, which the company will have to adjust and use to assess tax liability by the time the land would be sold.
IRC §263 and 263A identify capital expenditures as expenses incurred on asset purchase, repairing an asset to enhance it functional life, improvements, preparation for trade use, asset restoration, alteration for use, or acquiring new business (Kiplinger 1-15).
The fundamental question for Disposal Management is determined whether all expenses incurred are expensed or capitalized.
IRC § 162 allows firms to deduct necessary or ordinary expenses incurred or paid within the taxable period. Hence, Disposal Management will have to list expensed costs on its financial statement for a given month while capitalized costs will be depreciated or amortized for several years within the balance sheet. In addition, it is imperative to recognize that some expenditures could be capitalized or expensed based on the company preferences.
Disposal Management will have to prove, under IRC § 162(a), that business expenses incurred were both necessary and ordinary in relation to the business in order to benefit from deductible. A matter of fact will arise to determine deductible under IRC § 162(a) or show capital expenditure under IRC § 263 (Taxpayer Advocate Service 347-353). For instance, Rev. Rul. 94-38, 1994-1 C.B. 35 will provide for deductibles (see Cinergy Corp. v. United States, 55 Fed. Cl. 489, 516 (2003)) while Rev. Rul. 2004-18, 2004-1 C.B. 509 (see Woodward v. Commissioner, 397 U.S 572, 574-75 (1970)) will be applied to clarify capital expenditure under IRC § 263(a) (Kiplinger 1-15). Most importantly, the Courts normally use “a case-by-case model for the principles of deductibility and capitalization” (Taxpayer Advocate Service 348). Thus, the company will provide credible evidence, ensure compliance with deductible, maintain proper records, and cooperate with IRS.
Conclusion
Disposal Management must realize that capital expenditure used to improve or acquire the land that will be used for more than a year is not deductible under business expense.
References
Kiplinger. Significant Advice Reviewed – I.R.C. § 162 – Tax Year. 2012. Web.
Taxpayer Advocate Service. 2013 Annual Report to Congress — Volume One. 2013. Web.