263A Question

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UnitarySpace
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263A Question

Postby UnitarySpace » Sun Dec 04, 2011 6:56 pm

263A seems to require capitalization of property that you produce. What if my company produces some piece of capital machinery that has a useful life of 1 month that it then uses. Does that mean that I can't deduct it? Do I have to depreciate it under MACRS which would take 3 years or something? How do I recover the costs that incurred in building the machinery?

gp86
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Re: 263A Question

Postby gp86 » Sun Dec 04, 2011 8:40 pm

A capital expenditure is an outlay that gives the taxpayer a substantial benefit beyond the taxable year, so by definition the costs incurred in your example wouldn't be capital expenditures alone (think about it - a deduction for 100% depreciation is just an expense). If you were to use the machinery in the construction of a building with a 30 year life, however, 263A would require you to add the costs to the basis of the building. This was the exact dispute in Lincoln Savings.

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UnitarySpace
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Re: 263A Question

Postby UnitarySpace » Sun Dec 04, 2011 9:53 pm

gp86 wrote:A capital expenditure is an outlay that gives the taxpayer a substantial benefit beyond the taxable year, so by definition the costs incurred in your example wouldn't be capital expenditures alone (think about it - a deduction for 100% depreciation is just an expense). If you were to use the machinery in the construction of a building with a 30 year life, however, 263A would require you to add the costs to the basis of the building. This was the exact dispute in Lincoln Savings.


That's my precise concern. The machinery is not a capital outlay under the (<= 1 year duration test under the 263 regs) but 263A(b)(1) read literally seems to facially require capitalization - the raw materials and labor being capitalized into the final machine 263A(a) (the Lincoln Savings provision). What I'm worried about is being forced to wait 3 years to recover the costs associated with the machinery.

After thinking about it some more, the only way out I could see would be a 179 deduction (if the value < 250000 or whatever), or a straight up loss deduction if the company just threw the machine away at the end of the year (which wouldn't be a capital loss since it's not a "sale" or "exchange."

gp86
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Re: 263A Question

Postby gp86 » Sun Dec 04, 2011 11:18 pm

I don't think you could toss it out and take a loss under 165 - that'd lead to some interesting tax sheltering.

I'm sort of confused. Are you saying that 1) 263A(b)(1) requires capitalization of all costs incurred in the production of personal, tangible property, 2) this machine with a one-month useful life is personal, tangible property and therefore all costs must be capitalized, and 3) 167(e)(1) dictates that this machinery is 3-year property because it has a class life of 4 years or less?

An outlay is a business expense if it doesn't provide the taxpayer with a substantial benefit beyond the taxable year. That is literally one of the two definitions of "ordinary" in §162. Prop. Reg. §1.263(a)-2 states that a capital expenditure is cost associated with property having a useful life substantially beyond the taxable year. This hypothetical machinery would, if anything, be an expense if it weren't produced in the construction or acquisition of something that did provide substantial benefits beyond the year. I mean, if I baked a cake for my office - all other deductibility issues aside - what you're suggesting is that I would have to capitalize the cake costs because I produced personal property and would have to depreciate it over 3 years because it is a wasting asset.

edit: I mean, you can elect to capitalize expenses under 162, but that's a different matter.

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UnitarySpace
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Re: 263A Question

Postby UnitarySpace » Mon Dec 05, 2011 2:23 am

gp86 wrote:I don't think you could toss it out and take a loss under 165 - that'd lead to some interesting tax sheltering.

I'm sort of confused. Are you saying that 1) 263A(b)(1) requires capitalization of all costs incurred in the production of personal, tangible property, 2) this machine with a one-month useful life is personal, tangible property and therefore all costs must be capitalized, and 3) 167(e)(1) dictates that this machinery is 3-year property because it has a class life of 4 years or less?

An outlay is a business expense if it doesn't provide the taxpayer with a substantial benefit beyond the taxable year. That is literally one of the two definitions of "ordinary" in §162. Prop. Reg. §1.263(a)-2 states that a capital expenditure is cost associated with property having a useful life substantially beyond the taxable year. This hypothetical machinery would, if anything, be an expense if it weren't produced in the construction or acquisition of something that did provide substantial benefits beyond the year. I mean, if I baked a cake for my office - all other deductibility issues aside - what you're suggesting is that I would have to capitalize the cake costs because I produced personal property and would have to depreciate it over 3 years because it is a wasting asset.

edit: I mean, you can elect to capitalize expenses under 162, but that's a different matter.


That is what I'm saying. I read the interplay of 263 and 263A as follows. One part of the 263 UNICAP rules it seems is the capitalization of goods for resale (not including goods that would otherwise be inventory which would be included in inventory costs). Even though I might sell some of those goods in the same taxable year, 263A(b)(2) still requires me to capitalize those. Despite what Reg. §1.263(a)-2 says about capital expenditures, I read 263A to modify that reg to require capitalization of somethings that would otherwise be expenses.

In light of your cake example though, my intuition is that I'm completely reading 263A.

Edit: Is this what 263A is saying? Ok you have to capitalize direct and indirect costs associated with anything you produce or buy from resale. But then if the thing that you produced or reselling has useful life less than or equal to 1 year, you can deduct if it otherwise satisfies 162.

gp86
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Re: 263A Question

Postby gp86 » Mon Dec 05, 2011 2:55 am

Despite what Reg. §1.263(a)-2 says about capital expenditures, I read 263A to modify that reg to require capitalization of somethings that would otherwise be expenses.


It does, but not in the way you're thinking. You're getting too lost in the Code and forgetting the case law: an outlay is a business expense if it's necessary and ordinary. An expense is ordinary if 1) it's accepted by the broader business community and 2) it's not a capital expenditure. That's what I meant when I said that the substantial benefits test is literally the distinction between expenses and capital expenditures. And in response to your edit, yes, that's what I was trying to say in my first post: if you were to capitalize and depreciate an asset in full in one year, that would basically be an expense deduction.

Another way to think about this, in a better way in terms of theory: the outlay would result in a decrease in wealth in a taxable year intended to produce income, and that's the entire theoretical basis under the SHS income tax for allowing a \ deduction in the first place.

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UnitarySpace
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Re: 263A Question

Postby UnitarySpace » Mon Dec 05, 2011 3:10 am

Sorry it should have read:
UnitarySpace wrote:I'm completely misreading 263A.


This makes more sense now, thanks for your help. Let me sleep on it now and see if it still makes sense in the morning.




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