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Dear Client:

Do you use rotable or temporary spare parts in equipment you use? Alternatively, do you use rotable or temporary spare parts to carry out equipment service contracts or, similarly, to fulfill warranty or maintenance obligations for equipment you lease or sell to others? In all cases, for tax years beginning after Dec. 31, 2013-whether a calendar year or a fiscal year, such as a fiscal year beginning July 1, 2014-IRS gives you choices in your tax treatment of these parts. You also have the option of applying these rules retroactively to tax years beginning after Dec. 31, 2011.

For purposes of these rules, "rotable spare parts" are parts that are acquired for installation on a unit of property, are removed (and, generally, repaired or improved), and are either reinstalled on the same or other property or stored for later installation. "Temporary spare parts" are parts that are used temporarily until a new or repaired part can be installed, and then are removed and stored for later installation.
The choices for the tax treatment of the rotable or temporary spare parts are the following:

  1. "do nothing," in which case the cost of a rotable or temporary spare part is deducted when the part is retired or otherwise disposed of;
  2. elect, on a part-by-part basis, to capitalize, and treat as depreciable property, all or some of the rotable and temporary spare parts;
  3. elect the "optional method," described in more detail below, for all of its pools of rotable and temporary spare parts used in the same trade or business for which it uses the optional method for its books and records; or
  4. deduct the cost of rotable and temporary spare parts that don't exceed a dollar limit per invoice or item under an exception that requires conformity to the company's financial accounting procedures.

Under the optional method, you must, in essence, (A) deduct the amount paid to acquire or produce the part in the tax year that the part is first installed for use on a unit of property (UOP); (B) include in gross income the fair market value of the part in each year in which the part is removed from a UOP in which it was initially or later installed; (C) assign to the removed part a basis equal to the part's value plus the cost of removal; (D) add to basis any costs of maintaining, repairing, or improving the parts; (E) upon a re-installation of the part, deduct the basis determined under (C) and (D); and (F) apply the rules in (A) through (E) until retirement or other disposition of the part, at which time any remaining basis is deducted.

Note that the rules discussed above require weighing many factors. For example, in determining the desirability of capitalizing the cost of a rotable and temporary spare part under option (2) above, you need to take into account the applicable depreciation rules and the election, under Code Sec. 179, to deduct the cost of a limited amount of depreciable property in the year that the depreciable property is placed in service.

I am in a position to evaluate your situation with a view to the most effective way for you to treat rotable and temporary spare parts and to address the tax issues that will arise should you change your current method of treating them. Please give me a call to set up an appointment.

Very truly yours,
Adams Samartino & Co., CPAs