COST SEGREGATION AND THE Tangible Property Regulations

Transcription

1 COST SEGREGATION AND THE Tangible Property Regulations IMPLEMENTATION FOR PUTTING THE PIECES TOGETHER Good Morning KEVIN JERRY Executive Vice President Cost Segregation Services

2 Eighty percent of success is showing up. WOODY ALLEN AGENDA What you will hopefully understand after this presentation Why the TPR s were issued and why they CANNOT be ignored. What is your risk with non compliance? What must you do to become compliant RIGHT NOW The risk of doing nothing EASY TO UNDERSTAND safe harbors including the DMSH, RMSH, STSH and PADS An EASY TPR formula you can now follow moving forward 7 Cost Segregation basics and examples 2

3 WHO IS CSSI And how did we become the Tangible Property Regulations company? CSSI is the nations premier engineering based cost segregation firm. We have performed over 16,000 studies. We have never had a study overturned by the I.R.S. We have never missed a deadline. The building basis of our projects range from $200,000 to $950,000,000. In 2011 we started receiving calls from CPA s asking us to calculate late partial asset dispositions and building systems evaluations. Because of the complexity, nuances, and a lack of bright lines within the Regulations, we recognized in 2011 that C.P.A. s and building owners were not going to become compliant without help. To become compliant and eliminate Circular 230 risk and risk, CPA s are going to need an engineering firm with construction and tax experience. We are your calculation resource. We are the calculation resource to help you become compliant. In 2015 we partnered with the national authority of TPR implementation and training: Eric Wallace. After nearly a decade in the making, the final tangible property regulations have arrived. These regulations will affect every taxpayer that uses tangible property in its business. JOURNAL OF ACCOUNTANCY 3

4 WHAT YOU NEED TO KNOW TO BE IN COMPLIANCE From the IRS Audit Technique Guide 2016 Over the years, the standards for applying 263(a), as set forth in the regulations, case law, and administrative guidance, have proved to be difficult to discern and apply in practice and have led to considerable uncertainty and controversy. To address this discord, in January of 2004, the IRS and Treasury announced their intention to propose regulations providing guidance in the area. See Notice , ( IRB 308) The final regulations collectively are known as the Tangible Property Regulations. The final regulations provide a general framework for distinguishing capital expenditures from supplies, repairs, maintenance, and other deductible business expenses TANGIBLE PROPERTY REGULATIONS Quotes from the IRS Audit Technique Guide 2016 In anticipation of the final regulations, many taxpayers completed capitalization to repair studies and filed accounting method changes to re-characterize previously capitalized costs to deductible repairs. Taxpayers generally made these method changes for years 2006 through Beginning on or after January 1, 2014, taxpayers are required to comply with the final regulations and are expected to change their accounting methods to implement the final regulations. The examiner should determine whether a repair study was conducted in a prior year, if Forms 3115 were filed to change the tax treatment of repairs, and the amount of the associated 481(a) adjustment(s). 4

5 WHAT YOU NEED TO KNOW TO BE IN COMPLIANCE From the IRS Audit Technique Guide 2016 Section 263(a) generally requires taxpayers to capitalize an amount paid to acquire, produce, or improve tangible property (a)-1 provides general rules for capital expenditures, including an election to utilize a de minimis safe harbor (a)-2 provides rules for amounts paid for the acquisition or production of tangible property; and 1.263(a)-3 provides rules for amounts paid for the improvement of tangible property. (IRS TPR Audit Technique guide page 3) The TPR s also require knowledge of code sections: 168, 263A, 280B, 165. The first problem for all of us, men and women, is not to learn, but to unlearn. Gloria Steinem 5

6 Becoming Compliant and Eliminating Risk Your Number One Goal WHAT YOU NEED TO KNOW TO BE IN COMPLIANCE From the IRS final regulations. Revenue Procedure Every expenditure needs a qualitative and quantitative inquiry. For example, the following are not in the final TPR criterion and as such, may not rise to the level of being capitalization Taxpayer spends $100,000 on a building repair Expenditure extended the life of the asset All new roof shingles or a roof membrane was installed Taxpayer added a new air conditioner unit to the five current ones Taxpayer replaced thirty percent of the exterior windows for $75,000 Taxpayer extended the capacity of a component five percent 6

7 WHAT YOU NEED TO KNOW TO BE IN COMPLIANCE Don t be fooled REV-PROC February 13, 2015: IRS issues RP that modified Rev. Proc to permit a small business taxpayer, (defined as a business with total assets of less than $10 million or average annual gross receipts of $10 million) to automatically opt into the regulations without the filing a Form RP is written for non-profits and taxpayers with N.O.L. s or passive activities to reduce paperwork for Tax Professionals. JUST BECAUSE A 3115 WAS NOT SENT TO THE IRS, DOESN T MEAN A CHANGE OF ACCOUNTING IS NOT ON FILE WITH THE IRS. WHICH MEANS THE REGULATIONS CANNOT BE IGNORED. DEPRECIATION SCHEDULES STILL MUST BE SCRUBBED AND THE REGULATIONS FOLLOWED. WHAT YOU NEED TO KNOW TO BE IN COMPLIANCE What makes the regulations so complicated REV-PROC (a) In general. Except as provided in paragraph 10.11(6)(b) of this APPENDIX, a taxpayer changing to a method of accounting provided in Section of this APPENDIX must apply section 481(a) and take into account any applicable section 481(a) adjustment in the manner provided in sections 5.03 and 5.04 of this revenue procedure. (c) Itemized listing on Form A taxpayer changing to a method of accounting provided in section of this APPENDIX must include on Form 3115, Part IV, line 25, the total section 481(a) adjustment for each change in method of accounting being made. Repairs Final IRS Regulations 9/13/2013 7

8 WHAT YOU NEED TO KNOW TO BE IN COMPLIANCE Game plan for compliance, reduction of risk and moving forward Request permission by filing 3115s for large taxpayers Scrub depreciation schedules Apply the new capitalization rules against existing assets that do not rise to the new level of capitalization. Create section 481a adjustments Repairs and Maintenance, Routine Maintenance Safe Harbor Unit of Property (MC 184) Scrub depreciation schedules for small taxpayers Apply the new capitalization rules against existing capitalized assets Create section 481a adjustments Moving forward (3 annual elections) Partial Asset Disposition Small Tax Payer Safe Harbor De minimis Safe Harbor TPRs Have the Following Effects for GAAP Reporting Issues 8

9 WHAT A&A NEEDS TO KNOW TO BE IN COMPLIANCE The TPRs are highly likely to reduce the taxable income for the current period in which the TPRs are adopted (method changes) or for periods where the annual elections are made. Implementing the TPRs also affects recognition and measurement of deferred taxes related to tangible property and the balance sheet classification of deferred taxes. The TPRs also affect (a) the timing (as opposed to the amount) of deductions and (b) could affect the amount of the deduction of a tax expenditure (if the TPRs are not properly complied with a taxpayer (TP) could lose some tax deductions permanently. Uncertain Tax Positions (UTPs). Taxpayers may take, may miss, may not understand, may misapply, or take tax return positions which are not supportable in comparison to the TPRs WHAT A&A NEEDs TO KNOW TO BE IN COMPLIANCE During 2014 Able Inc. pays $100,000 for many small items, each under $5,000 each The CPA does not ask Able about its capitalization policy for books and whether it has a capitalization policy for tax Because of this, there was an inconsistency in the capitalization or deduction of these items between book and tax The financials were finalized Another CPA firm prepares the tax return for Able months later Ables tax return preparers bring up the issue of the DMSH to the auditors Ables financials are recalled and reissued to include the DMSH considerations 9

10 Scrubbing Depreciation Schedules Step One Eliminating Your Risk for ALL clients 10

11 WORKFLOW FOR BUILDING IMPROVEMENT DECISIONS DETERMINE THE UNIT OF PROPERTY STEP 1 THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS The term building generally means any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is to provide shelter or housing, or to provide working, office, parking, display, or sales space. 168 The larger the unit of property, the more likely the expenditure can be expensed. The larger the unit of property, the more likely the expenditure can be expensed. 11

12 THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS This is about as simple as it gets moving forward If the taxpayer gets the U of P wrong, the application of the new rules could be incorrect A taxpayer cannot make a determination of whether an expenditure should be capitalized or expensed unless he or she determines what component the expenditure will be compared to. That is the purpose of and the importance of the U of P rules. Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS An Example YU owns 45 condo units in a building consisting of 50 total condos YU acquired the condo units over a period of years YU does not have one unit of property which has 45 units YU has 45 separate U of Ps YU acquires the other 5 condo units. YU can change its U of P from 50 condos to one U of P if YU changes its U of P accounting method The larger the unit of property, the more likely the expenditure can be expensed. 12

13 THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Buildings with additions must be specified as one unit of property. THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Unit of Property Declaration to the IRS Present method: The taxpayer owns one building, a commercial strip mall consisting of 120,000 square feet. The building was built in two different stages The first part of the building was built in 1998 consisting of 80,000 square feet and the second part completed in 2004 for 40,000 square feet The taxpayer has been accounting for these as two separate assets. Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property 13

14 THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Unit of Property Declaration to the IRS Proposed method: The taxpayer will account for its building, a commercial strip mall consisting of 120,000 square feet as one unit of property That unit of property will consist of the whole strip mall building, even though built at different times and accounted for on its depreciation schedule as separate assets, as one unit of property and includes the building, its building structures and building systems. If the taxpayer adds additional square footage to the building and that square footage must be capitalized under the rules of 1.263(a)-3, then the additional square footage will be included in the strip mall building and not as an additional unit of property. Additionally, the taxpayer will account for its land improvements consisting of its parking lots, landscaping, and outside lighting as one unit of property, separate from the building unit of property. Unit of property consulting is a great strategy to create incremental consulting revenue. THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Apartment complexes must be broken down into separate units of property. 14

15 THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Unit of Property Declaration to the IRS Proposed method : The taxpayer will account for its apartment complex consisting of twenty five buildings as separate units of property. Each building will be a separate unit of property and will consist of the building, its building structures and building systems. The building structures will also include the carpeting and cabinets installed in the building. The taxpayer will divide its current one line asset on its depreciation schedule into five separate buildings using a reasonable method to divide up that one asset. The reasonable method will employ the square footage of each building compared to the total square footage of all buildings multiplied by the price paid for the apartment complex. Additionally, the taxpayer will account for its land improvements consisting of its parking lots, landscaping, and outside lighting as one unit of property, separate from the building units of property Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Buildings with additions must be specified as one unit of property. 15

16 THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Unit of Property Declaration to the IRS Proposed method: The taxpayer will account for its building, an office complex consisting of 1,000,000 square feet as one unit of property and includes the building, its building structures and building systems. If the taxpayer adds additional square footage to the building and that square footage must be capitalized under the rules of 1.263(a)-3, then the additional square footage will be included in the office building and not as an additional unit of property. Additionally, the taxpayer will account for its land improvements consisting of its parking lots, landscaping, and outside lighting as one unit of property, separate from the building unit of property. Unit of property consulting is a great strategy to create incremental consulting revenue. THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Buildings with additions, no matter how old, should be specified as one unit of property. 16

17 THE UNIT OF PROPERTY FOR A BUILDING IS: THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Carpeting If carpet is permanently attached it is 1250 property and can be viewed as part of the building. U of P carpet in apartments or commercial buildings is difficult to call 1250 property Glued carpet on apartment porches can be If the carpet is 1245 property, it has to be treated as 1245 property. If the carpet is 1245 property you determine its appropriate U of P based upon the functional interdependence test If you determine that the carpet in the bedroom is dependent on the carpet in the hall, which is dependent on the carpet in the living room, which is dependent on the carpet in the hall of the apartment building, etc. you can conclude that the carpet U of P is the whole carpeting in the building Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property WORKFLOW FOR SRUBBING EXISTING SCHEDULES This is about as simple as it gets moving forward WHICH BUILDING SYSTEM APPLIES AND WHICH COMPONENT IN THE SYSTEM IS BEING REPAIRED OR REPLACED STEP 2 17

18 The final regulations address the request for additional clarity regarding the definition of major component for buildings by adding a new definition for major components and substantial structural parts of buildings. In the case of buildings, an amount is for the replacement of a major component or substantial structural part if the replacement: (1) comprises a major component or a significant portion of a major component of the building structure or any building system, or (2) comprises a large portion of the physical structure of the building structure or any building system. Final Regulations The general rule is that major components and substantial portions of a building system will need to be capitalized. AT RISK OR AFFECTED CLIENTS All taxpayers are affected by the TPR s according to the AICPA! Manufacturing facilities Apartment buildings Fast Food Hotels Warehouses Office buildings Restaurants Auto Dealers Strip Centers Medical Buildings Residental Rental Properties Leasehold Improvements The 3 year statute of Limitations DOES NOT APPLY. The class life of the asset will rule. See Suburban and Churchill case cited in Rev. Proc

19 WHAT HAPPENS IF YOU DON T SCRUB? All taxpayers are affected by the TPR s according to the AICPA! CAUTION THERE IS A STICK Under new regulation Section : Should the IRS audit your client and find that you haven t gone back and scrubbed the depreciation schedules and if the Service finds assets on the schedule that should have been expensed under the final regulations it can not only deny your ability to expense the item but can disallow you from continuing to depreciate the item. This is the use it or lose it rule or Accounting 101 allowed or allowable WHAT HAPPENS IF YOU DON T SCRUB? All taxpayers are affected by the TPR s according to the AICPA! CAUTION THERE IS ANOTHER STICK Circular 230 Section of Circular 230 prohibits a preparer from willfully, recklessly, or through gross incompetence, signing a tax return or claim for refund containing a position that the practitioner knows, or reasonably should know, lacks a reasonable basis. Unreasonable tax positions taken on a tax return could also subject taxpayers and their preparers to penalties (e.g., IRC 6662 and 6694). This is the use it or lose it rule or Accounting 101 allowed or allowable 19

20 WHAT HAPPENS IF YOU DON T SCRUB? All taxpayers are affected by the TPR s according to the AICPA It puts the client at risk for potentially significant taxpayer penalties: Taxpayer accuracy penalty (if understatement with negligence or disregard of rules or regulations) - 20% of the amount of the understatement. It puts the firm at risk for potentially significant preparer penalties: Unreasonable return position (if position results in an understatement and the preparer knowingly signed a return with a position lacking substantial legal authority) - Per return, greater of $1,000 or 50% of fees charged to prepare the return. Willful or reckless conduct (if position results in an understatement and the preparer intentionally disregarded the rules or regulations) - Per return, greater of $5,000 or 50% of fees charged to prepare the return. Circular 230 risks are worse than WHAT HAPPENS IF YOU DON T SCRUB? All taxpayers are affected by the TPR s according to the AICPA! CAUTION THERE IS ANOTHER STICK Circular 230 Under the tangible property regulations, if an accounting method change is required and the taxpayer does not take the necessary steps to make the change (e.g., filing Form 3115 with the proper IRS National Office and also with their tax return), that position would presumptively lack a reasonable basis. CAMICO This is the use it or lose it rule or Accounting 101 allowed or allowable 20

21 WHAT HAPPENS IF YOU DON T SCRUB? All taxpayers are affected by the TPR s according to the AICPA! CAUTION THERE IS ANOTHER STICK Your Clients Without audit protection of the previous two years AND - 481a tax saving opportunities that were overlooked or ignored, your client has every right to dis-engage when these facts come to light. This is the use it or lose it rule or Accounting 101 allowed or allowable Scrubbing Depreciation Schedules Let s Keep Moving 21

22 BUILDINGS ARE BROKEN DOWN INTO SYSTEMS Building systems are NOT the unit of property Heating, ventilation, and air conditioning ( HVAC ) systems Plumbing systems Electrical systems All escalators All elevators Fire-protection and alarm systems Security systems for the protection of the building and its occupants Gas distribution system Building structure. The building structure consists of the building and its structural components including exterior doors, windows, roof, foundation etc. ALL building systems must be calculated before moving forward. Building systems must be further broken down into major components that serve a discreet and critical function for comparison. Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property BUILDINGS ARE BROKEN DOWN INTO SYSTEMS Example of an HVAC building system Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property 22

23 COST SEGREGATION STUDY BUILDING ELEMENTS UNITS OF PROPERTY FROM IRS WEBINAR MARCH 2015 Cost segregation studies now serve additional purposes. For example, not only do these studies reclassify a building s components into assets with shorter class lives, but they also identify building systems for purposes of applying the improvement rules. These studies are also used to identify functionally interdependent plant property and to determine individual components or groups of components that perform a discrete and critical function. IRS Audit Technique Guide 9/

24 WORKFLOW FOR BUILDING IMPROVEMENT DECISIONS This is about as simple as it gets moving forward EXPENDITURE REPLACED OR REPAIRED MUST BE COMPARED TO THE ORIGINAL COMPONENT STEP 3 IMPROVEMENT STANDARDS Then put the expenditure through the RABI test EXPENSE IT UNLESS: R - Restoration - Puts unit of property or building system into its original operating condition from a NON-WORKING condition. If it was in a state of disrepair at the time of purchase, the expenditure MUST be capitalized. A Adaptation If the expenditure adapts the unit of property to a new or different use it MUST be capitalized. B Betterment Measurably improves the building, building structure or building system. If it measurably increases capacity, size, productivity, efficiency, quality, or output it MUST be capitalized. I Major Improvement or Expenditure - If the expenditure is more than 33%-40% of the CURRENT REPLACEMENT cost of the building system component it MUST be capitalized. Capitalizing an expenditure is NOT the safe method anymore. When in doubt. Expense Eric Wallace 24

25 BUILDINGS ARE BROKEN DOWN INTO SYSTEMS Restorations example 16 not major component U owns a large office building that it uses to provide office space for employees that manage U's operations The building has 300 exterior windows. In Year 1, U pays an amount to replace 100 of the exterior windows that had become damaged. At the time of these replacements, U has no plans to replace any other windows in the near future 100 windows do not comprise a significant portion of this major component of the building structure Final IRS Regulations 9/13/2013 Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property BUILDINGS ARE BROKEN DOWN INTO SYSTEMS Improvement example 16. Not a measurable improvement (a)-3 (j) Example 20 The replacement of two roofmounted units is not a material addition. The two replacement units is expected to increase the capacity of the HVAC system 10%. R is not required to capitalize the amounts paid for these replacements as betterments. Final IRS Regulations 9/13/2013 Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property 25

26 BUILDINGS ARE BROKEN DOWN INTO SYSTEMS Betterment example 21 A measurable improvement 1.263(a)-3(j) Example 21 S owns a building that it uses in its service business. S conducts an energy assessment and determines that it could significantly reduce its energy costs by adding insulation to its building. S pays to apply a combination of loose-fill, spray foam, and blanket insulation throughout S's building structure, including within the attic, walls, and crawl spaces S reasonably expects the new insulation to make the building 50% more energy efficient. S must capitalize as a betterment the amount paid to add the insulation because the insulation is reasonably expected to materially increase the efficiency of the building structure Final IRS Regulations 9/13/2013 Each building and its structural components (as defined in (e)(2)) is a single unit of property BUT buildings are broken down into 9 systems within the unit of property 26

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28 Questions on Compliance and Eliminating Risk? ASSIST THE CPA IN IMPLEMENTING ALL AREAS OF THE TPR S MOVING FORWARD AND PROVIDE A 20 PERCENT CONSULTING FEE FOR TIME SPENT (REVENUE OPPORTUNITY) IMPLEMENTING THE REGULATIONS CSSI WILL SCRUB EXISTING SCHEDULES LOOKING FOR LINE ITEMS THAT DO NOT RISE TO THE LEVEL OF RABI, PAD S, REMOVAL COSTS AND COST SEGREGATION OPPORTUNITIES COMPLIANCE WE WILL DETERMINE THE BUILDING SYSTEM AND PERFORM THE CALCULATIONS TO DETERMINE THE 481A OPPORTUNITY. POPULATE AND COMPLETE THE -481A SCHEDULE AND THE ENTIRE 3115 PRESENT THE ANALYSIS TO THE CLIENT WITH THE CPA. 28

29 WHAT YOU NEED TO KNOW TO BE IN COMPLIANCE A real life tangible property study Multiple Story Apartment Complex Purchased in 1993 Cost $1.1 million Improvements over years of: $4 million $160k $2.7million $70k $900k Created -481(a) adjustments of 40% Tax rate Resulted in Tax Savings of $554,000 COST SEGREGATION Results of Cost Segregation DENTAL OFFICE #9501 OFFICE CONDO #10,500 OFFICE WAREHOUSE # 9503 Building Cost $ 250,176 (with-out land) Tax Savings Benefit: $32,845 Study Fee Before Tax: $2,420 Study Fee After Tax: $1,549 ROI: 21:1 Building Cost $324,000 (with-out land) Tax Savings Benefit: $52,856 Study Fee Before Tax: $3,400 Study Fee After Tax: $2,176 ROI: 24:1 Building Cost $5,246,908 (with-out land) Tax Savings Benefit: $312,687 Study Fee Before Tax: $14,900 Study Fee After Tax: $9,536 ROI: 33:1 29

30 WORKFLOW FOR BUILDING IMPROVEMENT DECISIONS This is about as simple as it gets moving forward DETERMINE THE UNIT OF PROPERTY, AFFECTED BUILDING SYSTEM. DOES IT FAIL ANY OF THE RABI TESTS FILE A 3115 IMMEDIATELY Will a cost segregation study or a PAD and removal calculation save taxes? If so call a cost segregation company for exact calculations. STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 WHAT IS THE VALUE OF THE BUILDING SYSTEM AND THE EXISTING COMPONENT. Does it serve a major and critical function CALCULATE THE -481A ADJUSTMENT Moving Forward into 2017 and Beyond 30

31 Step One: Determine the Unit of Property Step Two: Do any Safe Harbors Apply? 31

32 Step Three: Does it Rise to the Current Level of Capitalization? Step Four: What are the Values for Each Building System 32

33 Step Five: If it Requires Capitalization, Can a PAD or Removal Costs be Utilized Step One: Determine the Unit of Property 33

34 THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS Buildings with additions must be specified as one unit of property. DE-MINIMIS SAFE HARBOR All Safe Harbors over rule RABI DMSH ANNUAL ELECTION De minimis Safe Harbor (Acquire or Produce) tangible property Allows expensing of amounts paid to acquire or produce a unit of real or personal property, including qualified materials and supplies. Calculated on an invoice or item level. An invoice MUST be available Elected annually by including a statement with the taxpayer s tax return for the year elected. Having an Applicable Financial Statement (AFS) makes a big difference on the limits that can be expensed $500 ($2,500 in 2016) vs $5,000 The expenditure MUST have a receipt. Taxes and freight on the invoice must be added to the total if they are on the invoice. Cite 1.263(a)-1(f)) on addendum to return or check the annual election. Book and Tax MUST match. REVENUE OPPORTUNITY If the taxpayer can apply for any Federal or State contract work which requires tax returns to be submitted, the returns become an AFS. 34

35 DE-MINIMIS SAFE HARBOR All Safe Harbors over rule RABI DMSH ANNUAL ELECTION The final regulations provide that, if elected, the de minimis safe harbor must be applied to all amounts paid in the taxable year for tangible property that meet the requirements of the de minimis safe harbor, including amounts paid for materials and supplies that meet the requirements. In addition, the final regulations provide that a taxpayer may not revoke an election to use the de minimis safe harbor. An election to use the de minimis safe harbor may not be made through the filing of an application for change in accounting method. Revenue Procedure REVENUE OPPORTUNITY If the taxpayer can apply for any Federal or State contract work which requires tax returns to be submitted, the returns become an AFS. DE-MINIMIS SAFE HARBOR All Safe Harbors over rule RABI DMSH ANNUAL ELECTION To simplify the application of the de minimis rule to tangible property, the final regulations provide that a taxpayer electing to apply the de minimis safe harbor is not required to include in the cost of the tangible property the additional costs of acquiring or producing such property if these costs are not included in the same invoice as the tangible property. However, the final regulations also provide that a taxpayer electing to apply the de minimis safe harbor must include in the cost of such property all additional costs (for example, delivery fees, installation services, or similar costs) of acquiring or producing such property if these costs are included on the same invoice with the tangible property. REVENUE OPPORTUNITY If the taxpayer can apply for any Federal or State contract work which requires tax returns to be submitted, the returns become an AFS. 35

36 SMALL TAXPAYER SAFE HARBOR STSH ANNUAL ELECTION If your building has an unadjusted cost basis of $1M or less, & less than $10M avg. annual income, a special rule CAN be utilized: Can elect not to apply improvement rules to eligible buildings if the annual amount spent is less than $10,000 or 2% of unadjusted basis on a building-by- building basis. May be written off as repairs. Example: $300k building = $6,000 limit. If limit is exceeded, it does not apply to any amounts. Small taxpayer safe harbor limit is reduced by routine maintenance safe harbor and De Minimis safe harbor. Gross receipts include interest, dividends, rents, royalties, and annuities, regardless of whether such amounts are derived in the ordinary course of the TP s trade of business STSH is an annual election. The box needs to be checked every year. THE LIMIT CANNOT BE EXCEEDED. (PERIOD) THE UNIT OF PROPERTY FOR A BUILDING IS THE BUILDING, BUILDING SYSTEMS AND STRUCTURAL COMPONENTS The STSH is why apartment complexes must be broken down into separate units of property. 36

37 ROUTINE MAINTENANCE SAFE HARBOR AMAZING OPPORTUNITY The 2011 temporary regulations provided that the costs of performing certain routine maintenance activities for property other than a building or the structural components of a building are not required to be capitalized as an improvement. Under the routine maintenance safe harbor, an amount paid was deemed not to improve a unit of property if it was for the recurring activities that a taxpayer (or a lessor) expected to perform as a result of the taxpayer s (or the lessee s) use of the unit of property to keep the unit of property in its ordinarily efficient operating condition. IRS Revenue Procedure REVENUE OPPORTUNITY RMSH is the most overlooked aspect of the TPR s. Clients will benefit from your expertise and knowledge. Use the RMSH to create additional consulting time. Or call me ROUTINE MAINTENANCE SAFE HARBOR AMAZING OPPORTUNITY Deductible if you reasonably expect (at time UOP is placed in service) to perform more than once during the 10 year period from when the building system was placed in service Routine Maintenance Safe Harbor does not apply to betterments, adaptations, or some restorations. Consider the recurring nature of activity, industry practice, replacement history, manufacturer s recommendations, and TP s business needs The final regulations clarify that amounts incurred for activities falling outside the routine maintenance safe harbor are not necessarily expenditures required to be capitalized under 1.263(a)3. Amounts incurred for activities that do not meet the routine maintenance safe harbor are subject to analysis under the general rules for improvements. Revenue Procedure REVENUE OPPORTUNITY RMSH is the most overlooked aspect of the TPR s. Clients will benefit from your expertise and knowledge. Use the RMSH to create additional consulting time. Or call me

38 IMPROVEMENT STANDARDS What are the general rules of improvement? EXPENSE IT UNLESS: R - Restoration - Puts unit of property or building system into its original operating condition from a NON-WORKING condition. The expenditure must ameliorate a current condition to be capitalized. A Adaptation If the expenditure adapts the unit of property to a new or different use it MUST be capitalized. B Betterment Measurably improves the building, building structure or building system. If it measurably increases capacity, size, productivity, efficiency, quality, or output of the UOP it must be capitalized. I Major Improvement or Expenditure - If the expenditure is more than 35%-40% of the CURRENT REPLACEMENT. Capitalizing an expenditure is NOT the safe method anymore. When in doubt. Expense Eric Wallace RABI CRITERIA FOR TENANTS AND LANDLORDS The second step in the compliance process prior to 2015 LEASEHOLD IMPROVEMENTS In the case of a taxpayer that is a lessee of all or a portion of a building (such as an office, floor, or certain square footage), the unit of property ( leased building property ) is each building and its structural components or the portion of each building subject to the lease and the structural components associated with the leased portion LEASEHOLD IMPROVEMENTS An amount is paid to improve a leased building property under 1.263(a)-3 if the amount is paid for an improvement, betterment, restoration or adaptation to any of the following: an entire building the building structure any building system that is part of the leased building 38

39 RABI CRITERIA FOR TENANTS AND LANDLORDS The second step in the compliance process prior to 2015 LEASEHOLD IMPROVEMENTS LEASEHOLD IMPROVEMENTS 110 The following all have to be capitalized: Landlord spends funds on new TIs in its new building Landlord spends funds on new TIs for a space that it did not lease until years after the other spaces had leased Tenant spends funds on TI space that is new space to the tenant Lessor improvements Requirement to capitalize A taxpayer lessor must capitalize the related amounts, that it pays directly, or indirectly through a construction allowance to the lessee, to improve, a leased property when the lessor is the owner of the improvement or to the extent that Section 110 applies to the construction allowance RABI CRITERIA FOR TENANTS AND LANDLORDS The second step in the compliance process prior to 2015 LEASEHOLD IMPROVEMENTS CODE SECTION 110 If the amounts are not an improvement then the lessor (landlord) does not have to capitalize the expenditure If the lease has 110 language in it, the lease expenditures must be capitalized, even if is not an improvement If the lease refers specifically to 110 in the lease it must be capitalized A lease, with renewals cannot be longer than 15 years (renewal at fair market value are not renewals ) or it is not a 110 lease no matter what it says Generally, if the amounts paid are not an improvement then the lessor does not have to capitalize the expenditure BUT if the lease has 110 language in it, the lease expenditures must be capitalized, even if the expenditures are not an improvement 39

40 Questions on Unit of Property? RABI? Next Step Do Any Safe Harbors Apply 40

41 DISPOSITION OF AN ASSET Partial Asset Disposition PAD ANNUAL ELECTION Determination of basis of disposed asset IN THE CURRENT TAX YEAR Calculate the value of the asset using the current value then PPI rollback to the original year. This assumes the replacement expenditure is not a betterment or restoration. If it is, then a pro rate allocation is the method but the process is the same. Once the value is determined, calculate the RDB by using the same method and convention as the building. Including bonus. Engineered cost segregation is a CERTAIN METHOD for calculating PAD s MC 205 for the disposition of a whole (separately stated) asset can used anytime, not just during the year of removal. Did everyone take late partial dispositions in 2014?? REVENUE OPPORTUNITY Call CSSI for the calculation of a PAD Add this to your consulting fees DISPOSITION OF AN ASSET Partial Asset Disposition PAD ANNUAL ELECTION Method Change 198 If a taxpayer misses a PAD for the replacement of a portion of an asset, the taxpayer may make the PAD election DURING AN AUDIT by filing an application for change in accounting method 198, provided the original asset of which the disposed portion was a part, was owned by the taxpayer at the beginning of the year of change. REVENUE OPPORTUNITY Call CSSI for the calculation of a PAD Add this to your consulting fees 41

42 REMOVAL COSTS DCN 21 NOT REQUIRED TO BE CAPITALIZED Determination of basis of disposed asset The calculation must be an IRS approved method The IRS and the Treasury Department have determined that the Producer Price Index for Finished Goods more accurately reflects inflation for capital expenditures. The removal costs can be written down but a 3115 with MC 21 must be filed with the return Allow CSSI to calculate this for you REVENUE OPPORTUNITY Advise clients to separate ALL removal costs all the time. Use CSSI to do the calculation if necessary. Questions Regarding the Safe Harbors 42

43 A Recap Moving Forward 43

44 WORKFLOW FOR BUILDING IMPROVEMENT DECISIONS This is about as simple as it gets moving forward DETERMINE THE UNIT OF PROPERTY, AFFECTED BUILDING SYSTEM. Does it serve a major and critical function? DECIDE Does the expenditure make the component better, faster, bigger or better in a measurable way or ameliorate an existing condition. No? Expense it. Yes, move to Step 4 DETERMINE Will a cost segregation study or a PAD and removal calculation save taxes? If so call CSSI for exact calculations. STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6 SAFE HARBORS Does the expenditure fall under the clients DMSH,RMSH or STSH? If yes, write it down. If not move to Step 3 MAJOR IMPROVEMENT Is the expenditure more than 30% - 40% of the replacement cost? If no write it down. If yes to either 3 or 4 capitalize it and move to Step 5 DECIDE Which 3115 s need to be filed? Call CSSI and we will generate the entire -481a schedule and complete the 3115 We cannot change the cards we are dealt, just how we play the hand. 44

45 ASSIST THE CPA IN IMPLEMENTING ALL AREAS OF THE TPR S MOVING FORWARD AND PROVIDE A 20 PERCENT CONSULTING FEE FOR TIME SPENT (REVENUE OPPORTUNITY) IMPLEMENTING THE REGULATIONS CSSI WILL SCRUB EXISTING SCHEDULES LOOKING FOR LINE ITEMS THAT DO NOT RISE TO THE LEVEL OF RABI, PAD S, REMOVAL COSTS AND COST SEGREGATION OPPORTUNITIES LET S PARTNER WE WILL DETERMINE THE BUILDING SYSTEM AND PERFORM THE CALCULATIONS TO DETERMINE THE 481A OPPORTUNITY. POPULATE AND COMPLETE THE -481A SCHEDULE AND THE ENTIRE 3115 PRESENT THE ANALYSIS TO THE CLIENT WITH THE CPA. KEVIN JERRY Executive Vice President Cost Segregation Services jerryk@costsegserv.com CSSIstudy.com 45