IRC 263(a): New Finalized Repair Regulations for Return Preparers Applying Revisions to Accurately Capitalize Costs Under the New Rules WEDNESDAY, NOVEMBER 20, 2013,1:00-2:30 pm Eastern IMPORTANT INFORMATION This program is approved for 1.5 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection and phone line (no sharing) if you need to register additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Strafford accepts American Express, Visa, MasterCard, Discover. Respond to verification codes presented throughout the seminar. If you have not printed out the Official Record of Attendance, please print it now. (see Handouts tab in Conference Materials box on left-hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form. Complete and submit the Official Record of Attendance for Continuing Education Credits, which is available on the program page along with the presentation materials. Instructions on how to return it are included on the form. To earn full credit, you must remain on the line for the entire program. WHOM TO CONTACT For Additional Registrations: -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Program: - On the web, use the chat box at the bottom left of the screen - On the phone, press *0 ( star zero) If you get disconnected during the program, you can simply call or log in using your original instructions and PIN.
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IRC 263(a): New Finalized Repair Regulations for Return Preparers Nov. 20, 2013 Rich Shevak, Grant Thornton rich.shevak@us.gt.com Ellen McElroy, Pepper Hamilton mcelroye@pepperlaw.com
Today s Program General Overview of Regulations Slide 7 Slide 13 [Ellen McElroy] Acquisition and Production of Property Slide 14 Slide 19 [Ellen McElroy] Materials and Supplies Slide 20 Slide 24 [Ellen McElroy] Improvements to Property Slide 25 Slide 70 [Ellen McElroy and Rich Shevak Disposition of Assets Slide 71 Slide 85 [Rich Shevak] Practical Implications and Next Steps Slide 86 Slide 88 [Ellen McElroy and Rich Shevak]
Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 6
General Overview of Regulations Ellen McElroy
General Overview of Regulations Results-driven case law created ambiguous legal standards for capitalization caused decades of disputes IRS attempted patchwork of informal guidance (PLRs/TAMs/RR) but unable to fully address issues In 2004, IRS and Treasury announce intention to issue regulatory guidance to resolve myriad of questions Previously-published regulations include: Proposed Regulations issued in 2006; Proposed Regulations issued in 2008; Temporary and Proposed Regulations issued in 2012 8
General Overview of Regulations Treatment of Materials and Supplies: Treas. Reg. 1.162-3 Dispositions of Tangible Property: Prop. Treas. Reg. 1.168(i)-1 and -8 Acquisition or Production of Tangible Property: Treas. Reg. 1.263(a)-1 /2 Improvement of Tangible Property: Treas. Reg. 1.263(a)-3 9
General Overview of Regulations 2013 Regulations retain much of the 2011 Regulations Improved De Minimis Safe Harbor for Acquisitions Added Routine Maintenance Safe Harbor for buildings Eliminated the mandatory rule for partial disposals; provided clarification regarding General Asset Accounts Limited revisions to Improvements provisions; continued reliance on factual determinations 2013 Regulations reflect significant flexibility but require careful consideration in implementation 10
General Overview of Regulations Generally, changes to the final rules are to be effected with an accounting method change TPs may adopt Final Regulations in 2012, 2013, or 2014 TPs failing to make certain elections available under the final rules on timely-filed returns for 2012 or 2013 are permitted to make elections with amended returns returns must be filed on or before 180 days from the due date (including extensions) 11
General Overview of Regulations 2013 Final Regulations 2013 Proposed Regulations Effective for tax years beginning on or after 1/1/14 2012 and 2013 Tax Years Early adopt 2013 Final Regulations; or Use current methods; or Use the 2011 Temporary Regulations Effective for tax years beginning on or after 1/1/14 May be relied on for 2012 or 2013 Most changes require Form 3115 and Section 481(a) adjustment Certain items required on a cut-off basis Amended returns available for certain elections 12
General Overview of Regulations Procedural guidance expected to be issued in mid-december regarding implementation of 2013 Final Regulations Guidance is expected to provide: Details regarding accounting method change requirements Automatic consent to change Audit protection Section 481(a) adjustment May reduce the number of accounting method changes required for regulations 13
Acquisition and Production of Property Ellen McElroy
Acquisition/Production of Property Treas. Reg. 1.263(a)-1 and 2 Capitalization required for amount paid to: acquire or produce a unit of property, defend or protect title to a unit of property, or facilitate the acquisition or production of a unit of property Does not apply to: amounts subject to the de minimis rule materials and supplies 15
Acquisition/Production of Property Treas. Reg. 1.263(a)-1 and 2 Inherently Facilitative Costs Transportation costs (shipping fees and moving costs) Appraisal or valuation services Negotiation fees or tax advice on an acquisition Application, permit and title validation fees Sales and transfer taxes Brokers commissions Architectural, engineering and inspection fees Intermediary or facilitator fees in conjunction with a 1031 exchange 16
Acquisition / Production of Property: De minimis safe harbor Treas. Reg. 1.263(a)-1(f) Rule allows immediate deduction of certain de minimis costs Abandons ceiling from 2011 temporary regulations TP must have a written accounting procedures expensing threshold amounts at the beginning of the year that addresses Amounts paid for property costing less than threshold, and Amounts paid for property with economic useful life of 12 months or less TP must treat the amounts paid during the year as an expense in AFS or accordance procedures TPs with AFS, property cannot exceed $5,000 (per item or per invoice) TPs w/o AFS, property cannot exceed $500 17
Acquisition/Production of Property: De minimis safe harbor Transaction and addition costs (e.g., delivery or installation) are included in de minimis amount if included on the same invoice as the property If elected, then the de minimis safe harbor must be used with respect to M&S Annual election statement required Taxpayers without a stand-alone AFS, but included in the AFS of a group of entities, may use group s AFS and written accounting to meet the de minimis rule 18
Acquisition/Production of Property: De minimis safe harbor Definition of Applicable Financial Statement A financial statement required to be filed with the SEC A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency A certified, audited financial statement that is accompanied by the report of an independent CPA used for : credit purposes reporting to shareholders other substantial nontax purposes 19
Materials & Supplies Ellen McElroy
Treatment of Materials & Supplies Treas. Reg. 1.162-3 Materials & Supplies are defined to include tangible property that is used or consumed in the taxpayer s operations that is not inventory and that: (1) is a component acquired to maintain, repair, or improve a UOP owned, leased, or serviced by the taxpayer and that is not acquired as part of any single unit of tangible property; (2) consists of fuel, lubricants, water, and similar items that are reasonably expected to be consumed in 12 months or less; (3) is a UOP that has an economic useful life of 12 months or less, beginning when the property is used or consumed; (4) is a UOP that has an acquisition or production cost of $200 or less; or (5) is identified in published guidance. 21
Treatment of Materials & Supplies Treas. Reg. 1.162-3 Treatment of M&S are essentially unchanged o Incidental M&S are deductible when paid or incurred o Non-incidental M&S are deductible when used or consumed Definition of M&S increased from $100 to $200 Election to capitalize and depreciate M&S now limited to rotable, temporary, and/or standby emergency spare parts o Annual election that cannot be changed through accounting method application or an amended tax return o Election to capitalize M&S provided in 2011 Regulations for 2012 and 2013; not available under 2013 Regulations 22
Acquisition/Production of Property: Rotable Spare Parts Special rules for Rotable Spare Parts Treat the parts as disposed of upon final disposition Capitalize and depreciate the rotable or temporary spare parts upon acquisition Use the optional method of accounting for rotable spare parts, which permits exchange type treatment in that a deduction is allowed upon the installation of a part installed with a corresponding income inclusion equal to the fair market value of the replaced part (this method must be used for all rotable spare parts) May deduct M&S costs under the de minimis rule unless optional method is used 23
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IMPROVEMENTS TO PROPERTY
Improvements To Property General rule: A taxpayer must generally capitalize an amount that IMPROVES a unit of property (UOP) if the amount: (1) Results in a betterment (2) Restores the UOP or (3) Adapts the property to a new or different use 26
Improvements To Property Unit Of Property Step #1: Apply "functional interdependent test" (except for special rules) Step #2: Apply special rules if applicable (buildings, leased property, plant property, condominiums, co-ops, or network assets 27
Improvements To Property Unit Of Property Regulations retain the general rule - building and its structural components are a single unit of property TP must apply the improvement standards separately to both: The building and its structural components (other than identified building systems); and Each building system Special rule: Buildings and structural components 28
Improvements To Property Unit Of Property Building systems include: HVAC systems Plumbing systems Electrical systems All escalators All elevators Fire protection and alarm systems Security systems Gas distribution systems Any other structural components in published guidance Special rule: Buildings and structural components The 2013 regulations retain these rules 29
Improvements To Property Unit Of Property Example - Building systems Facts: X owns an office building that contains an HVAC system. The HVAC system incorporates ten roofmounted units that service different parts of the building. The roof-mounted units are not connected and have separate controls and duct work that distribute the heated or cooled air to different spaces in the building s interior. Special rule: Buildings and structural components X pays an amount for labor and materials for work performed on the roof-mounted units. 30
Improvements To Property Unit Of Property Example - Building systems Conclusion: The entire HVAC system, including all of the roofmounted units and their components, comprise a building system Special rule: Buildings and structural components Therefore, if an amount paid by X for work on the roof-mounted units results in an improvement to the HVAC system, X must treat this amount as an improvement to the building 31
Improvements To Property Unit Of Property Generally speaking you look to the portion of the building that you occupy when trying to determine the UOP to which you are applying the repair regulations. Special rules: Condos, co-ops, leasehold interests 32
Improvements To Property Unit Of Property Definition: Functionally interdependent machinery or equipment (other than network assets) used to perform an industrial process. Special rule: Plant property Rule: The unit of property is comprised of each component (or group of components) that performs a discrete and major function within the functionally interdependent machinery or equipment. 33
Improvements To Property Unit Of Property Definition: railroad track, oil and gas pipelines, water and sewage pipelines, power transmission and distribution lines, and telephone and cable lines that are owned or leased by TPs in each of those respective industries. Special rule: Network assets The 2011 Regulations added an operative rule providing that the unit of property is determined by the TP's particular facts and circumstances except as otherwise provided in published guidance. The 2013 regulations retain this rule. 34
Improvements To Property Unit Of Property The Regulations do not alter or invalidate previously published guidance: Rev. Proc. 2011-43 (Safe harbor method for electric utility transmission and distribution property) Rev. Proc. 2011-28 (Network asset maintenance allowance or units of property method for wireless telecommunication) Rev. Proc. 2011-27 (Network asset maintenance allowance or units of property method for wireline telecommunication network assets) Rev. Proc. 2002-65 (Class II and III railroads) Rev. Proc. 2001-46 (Class I railroads) Special rule: Network assets 35
Improvements To Property Unit Of Property Building systems. B owns a building that it uses in its retail business. The building contains two elevator banks in different locations in its building. Each elevator bank contains three elevators. B pays an amount for labor and materials for work performed on the elevators. Under paragraph (e)(2)(i) of this section, B must treat the building and its structural components as a single unit of property. As provided under paragraph (e)(2)(ii) of this section, an amount is paid to improve a building if it is for an improvement to the building structure or any designated building system. Special rule: Examples 36
Improvements To Property Unit Of Property (Cont.) Under paragraph (e)(2)(ii)(b)(5) of this section, all six elevators, including all their components, comprise a building system. Therefore, under paragraph (e)(2)(ii) of this section, if an amount paid by B for work on the elevators is an improvement (for example, a betterment) to the elevator system, B must treat this amount as an improvement to the building. Special rule: Examples 37
Improvements To Property Unit Of Property Example 15. Year 1: P is a retailer of consumer products. In Year 1, P purchases a building from Q, which P intends to use as a retail sales facility. Under paragraph (e)(2)(i) of this section, P must treat the building and its structural components as a single unit of property. Special rule: Examples 38
Improvements To Property Unit Of Property Year 2: P extends the building. The amount to extend the building is treated as an amount paid for an improvement to the entire building. Accordingly, P capitalizes the amount paid as an improvement to the building under paragraph (d) of this section. Special rule: Examples Conclusion: Under paragraph (e)(4) of this section, the extension is not a unit of property separate from the building. Thus, to determine whether any future expenditure constitutes an improvement to the building under paragraph (e)(2)(ii) of this section, P must determine whether the expenditure constitutes an improvement to the building structure, including the building extension, or to any of the designated building systems. 39
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Improvements To Property Betterment No change from prior regulations General rule: A TP must capitalize amounts that result in a "betterment" 41
Improvements To Property Betterment An amount results in a betterment if it: Ameliorates a material condition or defect that either existed prior to the TP's acquisition of the property or arose during production of the UOP (regardless of whether the TP was aware of the condition) Results in a material addition (including physical enlargement, extension or addition of a "major component") of the UOP; or Is reasonably expected to results in a material increase in capacity, productivity, strength, efficiency, or quality of the UOP or the output of the UOP 42
Improvements To Property Betterment Betterment is a facts and circumstances determination Special rule for part replacement: "Comparable parts" Appropriate comparison test (look to the condition of the property last time you did that type of repair) 43
Improvements To Property Betterment Plan of rehabilitation doctrine obsoleted (2011) Instead Section 263A rules apply Removal costs (new in 2013) If you deduct the component removed then deduct the removal cost If you don't write off the removed part then apply 263A (benefit test) 44
Improvements To Property Betterment - Examples Amelioration of pre-existing material condition or defect. In Year 1, A purchases a store located on a parcel of land that contains underground gasoline storage tanks left by prior occupants. Assume that the parcel of land is the unit of property. The tanks had leaked prior to A's purchase, causing soil contamination. A is not aware of the contamination at the time of purchase. In Year 2, A discovers the contamination and incurs costs to remediate the soil. Conclusion: The remediation costs are for a betterment because A incurred the costs to ameliorate a material condition or defect that existed prior to A's acquisition of the land. 45
Improvements To Property Betterment - Examples Not the Amelioration of pre-existing material condition or defect. C purchased a used machine for use in its manufacturing operations. C placed the machine in service in January of Year 1. At that time C expected to perform manufacturer recommended scheduled maintenance on the machine every three years. At the time C purchased the machine, it was approaching the end of a three-year scheduled maintenance period. As a result, in February, Year 1, C pays an amount to perform the manufacturer recommended scheduled maintenance to keep the machine in its ordinarily efficient operating condition. 46
Improvements To Property Betterment - Examples Not the Amelioration of pre-existing material condition or defect. (continued). C acquired the machine just before it had received its three-year scheduled maintenance. Accordingly, the amount that C pays for the scheduled maintenance results from the prior owner's use of the property and ameliorates conditions or defects that existed prior to C's ownership of the machine. Nevertheless, considering the purpose and minor nature of the work performed, this amount does not ameliorate a material condition or defect in the machine under paragraph (j)(1)(i) of this section. 47
Improvements To Property Betterment - Examples Betterment examples 6, 7, and 8: Example 6: Minor repairs (painting, etc.) DEDUCT ALL Example 7: Minor repairs PLUS addition to back of building (overhead doors, loading dock, etc.) DEDUCT PART. 48
Improvements To Property Betterment - Examples Example 8: Major remodel In addition to the minor items, C replaced large parts of the exterior walls with windows, replaced the escalators with a monumental staircase, added a new glass enclosed elevator, rebuilt the interior and exterior facades, replaced vinyl floors with ceramic flooring, replaced ceiling tiles with acoustical tiles, and removed and rebuilt walls to move changing rooms and create specialty departments; electrical upgrades; HVAC upgrades. Conclusion: Capitalize 49
Improvements To Property Betterment - Examples Removal Cost : Component removed during improvement; no disposition. X pays an amount to remove the original columns and girders and replaces them with stronger columns and girders. The addition of new columns and girders is an improvement and must be capitalized. Assume that X disposes of the original columns and girders and the disposal of these structural components is not a disposition under the new proposed regulations (i.e., no loss on partial disposition). Treatment of removal costs: Under the regulations, the removal costs must be capitalized as a cost of the improvement, because it directly benefits and is incurred by reason of the improvement to the building. 50
Improvements To Property Betterment - Examples Removal Cost : Example 2. Assume the same facts as Example 1, except X disposes of (writes-off) the original columns and girders under the proposed regulations as a loss on partial disposition. Conclusion: Removal costs paid to remove the columns and girders are NOT required not required to be capitalized as part of the cost of the improvement regardless of their relation to the improvement. 51
Improvements To Property Restoration An amount restores property if the amount: 1) Results in the rebuilding of the UOP to a like-new condition after the end of its class life (2013 regulations made one clarification related to comprehensive maintenance programs not bringing UOP back to new condition) 2) Is for the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of the UOP 52
Improvements To Property Restoration 3) Returns the UOP to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use 4) It is for the replacement of a component of a UOP and the TP has properly deducted a loss for that component (other than a casualty loss) 53
Improvements To Property Restoration 5) Is for the replacement of a component of a UOP and the TP has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component; or 6) Is for the repair of damage to a UOP for which the TP has taken a basis adjustment as a result of a casualty loss (2013 regulations allow you to deduct amounts paid in excess of adjusted basis prior to any 165 deduction) 54
Improvements To Property Restoration Change from 2008 to 2011 regulations: Major component or a substantial structural part: A part or combination of parts that comprise a large portion of the physical structure of a UOP, or A part or combination of parts that perform a discrete and critical function in the operation of the UOP that is not a minor component in the UOP. (2013 building rule adds "significant portion of a major component") Replacement of a major component/ substantial structural part 55
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Improvements To Property Restoration 2013 rules distinguish between "major component" and "substantial structural part" Major = "Part or combination of parts that performs a discrete and critical function." Not "incidental" parts. Replacement of a major component/ substantial structural part Substantial structural part refers to size. "Part or combination of parts that comprises a large portion of the physical structure of the UOP." 57
Improvements To Property Restoration Examples (Casualty Loss) Example 5. Restoration after casualty loss; limitation. A storm destroys a building at a time when the building has an adjusted basis of $500,000. C determines that the cost of restoring its property is $750,000, deducts a casualty loss under section 165 in the amount of $500,000, and properly reduces its basis in the building to $0. C pays the contractor $750,000 for the work. The work involves replacing the entire roof structure of the building at a cost of $350,000 and pumping water from the building, cleaning debris from the interior and exterior, and replacing areas of damaged dry wall and flooring at a cost of $400,000. Although resulting from the casualty event, the pumping, cleaning, and replacing damaged drywall and flooring, does not directly benefit and is not incurred by reason of the roof replacement. 58
Improvements To Property Restoration Examples (Casualty Loss) Amount for roof: Replacement of major component: C must capitalize as an improvement the $350,000 amount paid to the contractor to replace the roof structure because the roof structure constitutes a major component and a substantial structural part of the building unit of property. 59
Improvements To Property Restoration Examples (Casualty Loss) Remaining costs: C must capitalize SOME of the remaining costs. The capitalized amount is limited to the building basis minus other capitalizable costs ($500,000 minus $350,000 roof costs). Accordingly, C must treat as a restoration $150,000 of the $400,000 paid for the portion of the costs related to repairing and cleaning the building structure under paragraph (k)(1)(iii) of this section. Thus, in addition to the $350,000 to replace the roof structure, C must also capitalize the $150,000 as an improvement to the building unit of property under paragraph (d)(2) of this section. C is not required to capitalize the remaining $250,000 repair and cleaning costs under paragraph (k)(1)(iii) of this section. 60
Improvements To Property Restoration Examples (Incidental Part) Incidental component: In Year 1, J purchased a drill press. In Year 3, J discovers that the power switch assembly has become damaged and cannot operate. J pays amounts to replace the power switch assembly with comparable and commercially available replacement parts. Assume the power switch assembly is a small component of the drill press that may be removed and installed with relative ease. The power switch assembly is not a major component of the unit of property under paragraph (k)(6)(i)(a) of this section because, although the power assembly may affect the function of J's drill press by controlling the supply of electric power, the power assembly is an incidental component of the drill press. Therefore this repair is deductible. 61
Improvements To Property - Restoration Summary Of Conclusions From Examples 31 Total Restoration Examples Not Major Component Power switch on machine Roof membrane only 1/3 furnaces in HVAC system 3/10 roof top units Entire sprinkler system All wiring in a building 8/20 sinks 100/300 windows (depends) Floors in lobby Major Component Truck cab, engine, & petroleum tank Underground storage tanks Entire roof Replacement of only HVAC chiller 30 percent of the wiring All sinks/all toilets 200/300 windows Floors in all public areas 62
Improvements To Property New Or Different Use No change from 2008 Proposed Regulations Must capitalize amounts paid to adapt UOP to new or different use "New or different use": if the adaptation is not consistent with the TP's intended ordinary use of the UOP at the time it was originally placed in service 2013 added examples 63
Improvements To Property New Or Different Use Examples Conversion of manufacturing facility into showroom is a "new or different use." Reconfiguration of retail building removing a wall is NOT a new or different use. Adding a sushi counter in a grocery store is NOT adaptation to new or different use (but might be an improvement). Conversion of part of a pharmacy into clinic is an adaptation to a new or different use. 64
Improvements To Property Safe Harbor For Routine Maintenance 2013 regulations: Safe harbor now applies to buildings as well as 1245 property 10 year window to determine "routine" nature of the activity Routine maintenance deemed not to improve the unit of property Routine maintenance: Recurring activities to keep the unit of property in its ordinarily efficient operating condition "Routine" only if you expect to do it more than once over the asset's life 65
Improvements To Property Safe Harbor For Routine Maintenance - Exceptions Routine maintenance does not include: Replacement of a component of a UOP if TP has taken a loss deduction on that component Replacement of a component of a UOP if the TP has taken into account the adjusted basis of the component in realizing gain or loss from the sale or exchange Repair of damage to a unit of property for which the TP has taken a basis adjustment as a result of a casualty loss under section 165 Returning a unit of property to its formerly ordinarily efficient operating condition, if the property has deteriorated to a state of disrepair and is no longer functional for its intended use 66
Improvements To Property Safe Harbor For Routine Maintenance - Exceptions New exclusions from RMSH: Routine maintenance does not include: Betterment situations Adaptation to new or different use Work done to network assets 67
Improvements To Property Optional Regulatory Accounting Method No change in 2013 regulations Only applies to "regulated taxpayers" Federal Energy Regulatory Commission, Federal Communications Commission, or Surface Transportation Board Eligible TPs can use the Optional Regulatory Accounting Method to determine whether there is an "improvement" to property Follow method of accounting used for regulatory accounting purposes If capitalized for regulatory purposes then capitalized for federal income tax purposes 68
Improvement Flow Chart BETTERMENT RESTORATION Yes Does routine maintenance safe harbor apply? No Improvement to ameliorate pre-existing condition? No Improvement prior to property being placed in service? No Results in a material addition? No Yes Yes Yes C A P I T A L I Z E Yes Yes Yes Yes UOP in state of disrepair returned to ordinary efficient operating condition? No UOP rebuilt to like-new condition after its class life? No Major component or substantial structural part replaced? No Basis in replaced component properly deducted as a loss? Results in increased capacity, productivity, efficiency, strength or quality? Adaptation to new or different use? Section 263A applies? No No Yes Yes Yes Do Not Capitalize Yes Yes No Basis in replaced component recovered in sale or exchange? No Repair to UOP for which a casualty loss was taken? No 69
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Rich Shevak, Grant Thornton DISPOSITION OF ASSETS
DISPOSITION OF ASSETS Historically a taxpayer could not "dispose" of only part of an asset. Therefore the definition of the "asset" for disposition purposes has always been critical. The disposal rules in both the prior and most recent versions of the proposed "partial disposition" regulations provide rules for when a TP may or must claim a loss on partial disposition of an asset. 72
DISPOSITION OF ASSETS PRIOR REGULATIONS Under the prior (pre- September 2013) disposition rules: Each structural component (including all components thereof) of a building was the asset for disposition purposes. Result: If a building component is removed, then the adjusted basis of the component must be recovered. Impact: Because the adjusted basis of the building component is recovered as a loss, the replacement cost must be capitalized under the restoration rules. 73
DISPOSITION OF ASSETS PRIOR REGULATIONS Under the prior (Pre-September 2013) regulations, a component includes such small assets as the following: windows doors sinks paneling tiling electrical wiring lighting fixtures wall 74
DISPOSITION OF ASSETS- EXAMPLE PRIOR REGULATIONS TP owns a building with 300 windows. TP replaces one broken window in the building with a new window. Under the pre-september 2013 disposition rules, unless certain elections are made, the TP is required to recover the adjusted basis in the window upon replacement. TP must determine basis of window that was replaced. 75
DISPOSITION OF ASSETS- EXAMPLE PRIOR REGULATIONS Because the adjusted basis is required to be recovered as a loss, the cost of the new window must be capitalized under the restoration rules. No deduction for new window. Write off basis of old window. Solution: Under the prior version of the regulations, a taxpayer could avoid this result if the TP elects to place the building in a general asset account. 76
GENERAL ASSET ACCOUNT RULES PRIOR REGULATIONS General Asset Account General rule: Generally - no loss is recognized upon the disposition of an asset (including casualty losses). However, TPs may elect upon a qualifying disposition of an asset to remove the asset from the general asset account which would allow the TP to recover the adjusted basis of the asset upon disposition. Assets may be grouped into one or more general asset accounts based on certain criteria. 77
GENERAL ASSET ACCOUNT- EXAMPLE PRIOR REGULATIONS In the above example where one window was replaced, if the building is in a general asset account, the taxpayer would generally choose not to recover the basis of the old windows so that the TP could treat the replacement costs as a deductible repair. 78
GENERAL ASSET ACCOUNT- EXAMPLE PRIOR REGULATIONS What if the new project would be capitalized anyway as a betterment or restoration? For example, if a TP replaced a major component of a building, for example replacing 200 out of 300 windows, the TP can elect to remove the 200 windows from the general asset account and recover the adjusted basis (loss on disposition) in the windows. Therefore, under the prior regulations rules, TP would most likely want to elect to place buildings in general asset accounts. 79
GENERAL ASSET ACCOUNT RULES PRIOR REGULATIONS How to make a general asset account election: Check the box on Form 4562 for the year the asset is placed in service Keep records of property included in each general asset account Limited ability to make a late general asset account election under the prior regulations. 80
IMPROVEMENTS TO PROPERTY DISPOSITION OF ASSETS NEW REGULATIONS The new (Post-September 2013) proposed regulations significantly changes the rules that were in the 2011 regulations 2011 regulations would require taxpayers to write off all partial disposals of building components (absent a GAA election). The 2013 rules change the definition of "property" for purposes of the disposal rule (making the building the property) which means the disposal of a component would not require basis recovery However, the new rules give a taxpayer the option to write off a partial disposition at the taxpayer's election 81
IMPROVEMENTS TO PROPERTY DISPOSITION OF ASSETS Determination of asset being disposed Must determine the component that you are writing off (the prior roof, prior HVAC, etc.). Must determine the basis of the component you are writing off. If impractical to determine basis use any reasonable method. 82
IMPROVEMENTS TO PROPERTY DISPOSITION OF ASSETS Examples of reasonable methods: discounting cost of the replacement to its PIS year using consumer price index information Some pro rata allocation of the prior asset (for example allocation of costs of the building to which the disposal relates). Cost segregation techniques reconstructing the original cost of the component being disposed of. What if the replacement asset is different or better? 83
IMPROVEMENTS TO PROPERTY DISPOSITION OF ASSETS New partial disposition rule is generally elective, but must be applied in certain circumstances: disposition of the portion of an asset in a casualty event (as described in section 165) disposition of the portion of an asset in a transaction in which gain / loss is not recognized (1031/1033) Transfer of the portion of an asset in a "step in the shoes" transaction under section 167(i)(7) 84
IMPROVEMENTS TO PROPERTY DISPOSITION OF ASSETS Observations: Under the new regulations, you could get the same result you would have if you made a General Asset Account election under the prior regulations. Disposition rules represent a huge opportunity for some companies to recover basis when components are replaced. Unclear whether ability to take 481(a) (catch-up) adjustment will be limited under the new regulations. 85
PRACTICAL IMPLICATIONS AND NEXT STEPS
PRACTICAL IMPLICATIONS Effects all business TPs The regulations are effective 1/1/2014 Unlike proposed regulations, you need to comply Tax provision impact Ability to accelerate deductions 87
NEXT STEPS Review method of accounting for repairs in light of new rules possible method changes Decide whether you'd want to apply the Temporary or Final Regulations Evaluate elections under asset grouping and disposition rules Address challenges posed by the de minimis rules (make sure you have a written policy in place by 1/1/2014!) Assess opportunities under the routine maintenance safe harbor 88