Hw New Repair Regulatins Affect Real Estate Owners Octber 24, 2012 Jeffrey Wilmes Partner Evansville Office BKD, LLP jwilmesl@bkd.cm Rick Carrier, Jr. Manager Evansville Office BKD, LLP rcarrier@bkd.cm Jim Still Assistant Natinal Tax Directr Natinal Office BKD, LLP jstill@bkd.cm T Receive CPE Credit Participate in entire webinar Answer plls when they are prvided If yu are viewing this webinar in a grup Cmplete grup attendance frm with Title & date f live webinar Yur cmpany name Yur printed name, signature & email address All grup attendance sheets must be submitted t training@bkd.cm within 24 hurs f live webinar Answer plls when they are prvided If all eligibility requirements are met, each participant will be emailed their CPE certificates within 15 business days f live webinar 2 1
Hw New Repair Regulatins Affect Real Estate Owners Octber 24, 2012 Jeffrey Wilmes Partner Evansville Office BKD, LLP jwilmesl@bkd.cm Rick Carrier, Jr. Manager Evansville Office BKD, LLP rcarrier@bkd.cm Jim Still Assistant Natinal Tax Directr Natinal Office BKD, LLP jstill@bkd.cm Why Yu Need t Understand These Rules Fundamentally impacts Supplies deductins Hw minr purchases expensed Bk capitalizatin plicies If replaced, prperty can be written ff When repair needs t be capitalized What happens asset acquisitin csts Tax depreciatin cmputatins Wh needs t knw that? 4 2
Impact f Repair Regs. in General Will ften require bk cnfrmity Many may have mre taxable incme Cmplexity wn t lessen IRS disputes 5 Unit f Prperty Real prperty: building & structural cmpnents are single UOP Building systems are each separate UOP Other prperty: UOP determinatin is based upn functinal interdependence standard Special rules apply Plant prperty Netwrk assets Leased prperty Imprvements 6 3
Structural Cmpnents Defined Reg. 1.48-1(e)(2) Nt changed by new regs. Walls, partitins, flrs, ceilings, tiling, paneling, windws, drs, air cnditining system, heating system, plumbing fixtures, electrical wiring, etc. 7 Building Systems HVAC systems Plumbing systems Electrical systems Escalatrs Elevatrs Fire prtectin & alarm systems Security systems Gas distributin systems Other systems/cmpnents identified in published guidance 8 4
Imprvements Imprvement rules apply t Building & structural cmpnents Building systems Types f imprvements Betterment Restratin Adaptatin t new r different use 9 Plling Questin 1 Which f the fllwing is nt a type f imprvement discussed in the repair regulatins? Betterment Restratin Adaptin Changing a light bulb Nt sure 10 5
Cndminiums UOP = individual unit wned including structural cmpnents Imprvement rules apply t structural cmpnents & building systems that are part f unit Management assciatins als subject t imprvement rules 11 Cperative Husing Crpratin UOP = prtin f building & structural cmpnents taxpayer has pssessry rights Imprvement rules apply t structural cmpnents & building systems fr prtin f building with pssessry rights Cperative husing crpratins apply rules t entire building including structural cmpnents & building systems 12 6
Reg. Example Building Systems Facts X wns ffice building with HVAC system cnsisting f ten rfmunted units servicing different parts f the building Rf-munted units are nt cnnected & have separate cntrls & duct wrk that distribute heated r cled air t different areas f the building X pays labr & material csts fr wrk perfrmed n rf-munted units Amunts paid fr wrk n rf-munted units results in imprvement t HVAC system Cnclusin X must treat HVAC system imprvement as imprvement t building 13 Leased Buildings UOP = leased building & structural cmpnents r leased prtin f building & structural cmpnents Imprvement rules Leasing entire building building, structural cmpnents, building systems Leasing prtin f building structural cmpnents & building systems related t prtin f building leased 14 Office Flr/square ftage 7
Imprvement t Leased Prperty Lessr imprvements Capitalize Amunts paid thrugh cnstructin allwance Lessee imprvements paid as substitute fr rent Amunts capitalized by lessr may nt be capitalized by lessee Imprvements made by lessr are nt separate UOP 15 Imprvement t Leased Prperty Lessee imprvements General rule capitalize imprvements Exceptins cnstructin allwances & substitutes fr rent Separate UOP frm leased prperty imprved Imprvements t imprvement are nt separate UOP fr lessee 16 8
Imprvement t Leased Prperty Other rules Regulatry requirements fr repairs r maintenance disregarded in determining imprvements Indirect csts that d nt benefit r are nt incurred by reasn f imprvement are nt capitalized 17 Reg. Example Lessee Imprvements; Additins t Building Facts T is retailer f cnsumer prducts & leases building frm L fr use as retail sales facility Leased building cnsists f building structure & varius building systems including plumbing system, electrical system & HVAC system Under lease terms, T is permitted t imprve building at its wn expense Cnclusin If T pays amunt that imprves building structure, plumbing system, electrical system r HVAC system, then T must treat amunt as imprvement t entire leased building 18 9
Capitalizatin f Betterments Betterment f material cnditin r defect that exists prir t acquisitin f prperty Material additin t UOP, i.e., enlargement, expansin, extensin Material increase in capacity Facts & circumstances test Purpse f expenditure Physical nature f wrk perfrmed Effect n UOP Treatment n AFS 19 Reg. Example Betterment f Pre-Existing Cnditin r Defect Facts In Year 1, X purchases stre lcated n parcel f land with undergrund gasline strage tanks left by prir ccupants Parcel f land is unit f prperty Tanks leaked, causing sil cntaminatin X is nt aware f cntaminatin at time f purchase In Year 2, X discvers cntaminatin & incurs csts t remediate sil Cnclusin Remediatin csts result in betterment t land because X incurred csts t amelirate material cnditin r defect that existed prir t X's acquisitin f land 20 10
Capitalizatin f Restratins Amunts are paid t restre UOP if Replacement f UOP cmpnent if taxpayer deducted lss fr cmpnent replaced Replacement f UOP cmpnent if taxpayer included replaced part in basis fr gain lss purpses Repair f damage t UOP frm casualty lss Returns UOP t rdinary efficient perating cnditin if prperty deterirated t state f disrepair & is n lnger functinal Rebuilding UOP t like-new cnditin after end f class life Replacement f part r cmbinatin f parts that cmprmise majr cmpnent f UOP 21 Reg. Example Replacement f Majr Cmpnent r Substantial Structural Part; Rf ). Facts X wns large retail stre & discvers leak in rf X hires cntractr t inspect & fix rf Cntractr discvers that majr prtin f sheathing & rafters has rtted & recmmends replacement f entire rf X pays cntractr t replace entire rf with new rf Cnclusin Replacement f rf is majr cmpnent r substantial structural part f X's building structure X must capitalize amunt paid t replace rf as restratin 22 11
Reg. Example Nt Replacement f Majr Cmpnent r Substantial Structural Part; Rf Membrane ). Facts X manufactures parts & wns factry Factry rf is cmprised f structural elements, insulatin & waterprf membrane Over time, waterprf membrane began t wear & leak X incurs csts t replace rf membrane with similar but new membrane Cnclusin Rf membrane by itself is nt majr cmpnent r substantial structural part f X's building structure X is nt required t treat amunt paid t replace rf membrane as restratin f building structure Taxpayer needs t cnsider Sectin 263A UNICAP rules 23 Reg. Example Nt Replacement f Majr Cmpnent r Substantial Structural Part; Windws ). Facts X wns large ffice building fr emplyees that manage X's peratins Building has 300 exterir windws In Year 1, X replaces 30 exterir windws that had becme damaged At time f replacement X has n plans t replace any ther windws in the near future Cnclusin 30 replacement windws d nt Cmprise large prtin f physical structure f building Perfrm discrete & critical functin in peratin f building Cnstitute majr cmpnents r substantial structural parts f building structure X is nt required t treat amunt paid t replace the windws as restratin f building system 24 12
Reg. Example Replacement f Majr Cmpnent r Substantial Structural Part; Windws ). Facts Assume same facts except X replaces 200 f 300 windws n building Damage is incurred during installatin f replacement windws & X repaints interir trim Cnclusin 200 replacement windws Cmprise large prtin f physical structure f building Perfrm discrete critical functin in peratin f building X must capitalize csts incurred as restratin 25 Changes t Depreciatin Rules Under Temprary Regulatins Expand definitin f dispsitin t include retirement f structural cmpnents f building &, in sme cases, cmpnents f nnbuilding prperty Revives cncept f cmpnentizatin Allws recgnitin f lss n retirement f structural cmpnent f building Changes t general asset accunt (GAA) rules Expands definitin f qualifying dispsitin 26 13
Nnbuilding Cmpnentizatin Cmpnentizatin is elective fr prperty ther than buildings Prperty in certain asset classes nt eligible fr cmpnentizatin Office furniture, cmputers & ther equipment Autmbiles, trucks & buses Tractrs & trailers Nncmmercial aircraft Vessels, barges & tugs nt used in marine cnstructin Similar rules apply if elect t cmpnentize prperty 27 Building Cmpnentizatin Cmpnentizatin required n buildings Retirement f cmpnent autmatically triggers restratin rule fr capitalizatin f repair 28 14
Building Cmpnentizatin What if repair is nt betterment under repair regulatins? Must still capitalize repair f building cmpnent under restratin rules T what level f detail is cmpnentizatin required? N guidance prvided by IRS Level f cmpnentizatin must be cnsistent Typically better ff t deduct cst f repair versus recgnizing lss n dispsal f cmpnent Slutin place building in GAA 29 Determining Cmpnent Cst N guidance prvided t determine replaced cmpnent cst Cst segregatin study Engineering-based study supprting cmpnent cst Allws fr accelerated depreciatin f certain cmpnents Other suggested appraches 30 Original cnstructin cst Discunting current cst f replacement cmpnent Replacement cst percentage extraplatin Calculate percentage replaced cmpnent s cst represents f entire building s current replacement cst Multiply percentage by riginal cst f building 15
Plling Questin 2 Cmpnentizatin is required fr buildings True False Nt sure 31 Dispsitin f Building Cmpnent Example Facts Purchased building 6/1/2008 fr $10 millin Cst segregatin study determined cst allcated t rf is $100,000 On 10/1/2012, entire rf was replaced at cst f $150,000 Accumulated depreciatin n riginal rf at 12/31/11 was $9,000 32 16
Dispsitin f Building Cmpnent Example Results Old Rules Old rf cntinued t be depreciated New rf repairs capitalized & depreciated ver 39 years New Rules Recgnize $91,000 lss n dispsal f ld rf New rf repair f $150,000 capitalized & depreciated ver 39 years 33 GAA Gruping Rules Taxpayer must elect t grup assets in GAA Each GAA must include nly assets with same Depreciatin methd Recvery perid Cnventin Year placed in service Assets eligible t be gruped int single GAA may be divided int mre than ne GAA 34 17
Special Rules n Gruping Mid-quarter cnventin assets must be gruped in GAA with assets placed in service in same quarter Mid-mnth cnventin assets must be gruped in GAA with assets placed in service in same mnth Vehicles subject t IRC Sectin 280F luxury aut rules must be gruped int separate GAA Assets nt eligible fr r electing ut f bnus depreciatin must be gruped int separate GAA 35 GAA Dispsitins General Rule General rules N immediate recvery f basis Prceeds are recgnized as rdinary incme t extent unadjusted basis f GAA exceeds amunts previusly recgnized as rdinary incme frm dispsitin f ther assets in GAA Dispsals include sale, exchange, retirement, abandnment, destructin, transfer t supply r scrap accunt Buildings dispsitin includes retirement f structural cmpnent 36 18
Optinal Electin t Terminate GAA Qualifying dispsitins GAA treatment fr assets terminates first day f dispsal tax year Gain/lss determined based upn asset s adjusted depreciable basis at time f dispsal IRC Sectin 1245/1250 gain limited t lessr f Depreciatin allwed fr asset Unadjusted depreciable basis f GAA accunt less cumulative gains previusly recgnized 37 Optinal Electin t Terminate GAA Dispsitin f all assets in GAA GAA terminates Gain/lss determined based upn remaining adjusted depreciable basis remaining in GAA Sectin 1245/1250 recapture is limited t excess depreciatin f GAA allwed ver any rdinary incme previusly recgnized 38 19
Dispsed Assets Identificatin Methds Methds fr identifying dispsed assets Specific identificatin methd can determine asset year placed in service FIFO methd can determine ttal f assets dispsed with same recvery perid but unable t determine basis Mdified FIFO methd determine ttal f assets dispsed & unadjusted depreciable basis Mrtality dispersin table applies t mass assets LIFO methd nt permitted 39 GAA Electin GAA is an electin Irrevcable Made by checking bx n Frm 4562 Applies t each wner Cnslidated grup member Partnership S Crpratin 40 20
Plling Questin 3 Has yur cmpany ever made a general asset accunt electin? Yes N Nt sure 41 Late General Asset Accunt Electin Rev. Prc. 2012-20 Allws taxpayer t make GAA electin fr assets acquired prir t year f change Flexibility t either deduct remaining basis f dispsed cmpnent & capitalize imprvement r cntinue t depreciate ld cmpnent & deduct therwise allwable repair Fr prperty n lnger wned 481(a) adjustment Fr prperty still wned mdified cut-ff methd 42 21
Late GAA Electin Qualifying Dispsitin Allws taxpayer t make late electin t recgnize gain/lss upn dispsitin f item in qualifying dispsitin Advantageus when imprvement t asset was capitalized resulting in cntinued depreciatin f ld & new cmpnent Change implemented with 481(a) adjustment Statistical sampling nt allwed Review depreciatin schedules fr capitalized repairs t identify deductin pprtunities 43 Late GAA Electin Example Facts Purchased building 6/1/2008 fr $20 millin Cst segregatin study determined cst allcated t rf is $100,000 On 10/1/2012, rf was repaired at cst f $125,000 Repair did nt result in betterment r restratin Accumulated depreciatin n riginal rf at 12/31/11 was $9,000 44 22
Late GAA Electin Example Results Late GAA Electin Nt Made Old rf dispsed f with remaining tax basis f $91,000 New rf repairs capitalized & depreciated ver 39 years Late GAA Electin Made Cntinue t depreciate riginal rf The $125,000 repair cst is expensed Additinal deductin f $34,000 by making late GAA electin 45 Acquisitin & Prductin Csts General rule capitalize amunts paid t acquire r prduce UOP Includes transactin cst & defense/perfectin f title Repairs made befre UOP is placed in service are capitalized Interactin with de minimis rule 46 23
Transactin Csts General rule capitalize amunts paid t facilitate acquisitin r prductin f UOP Facilitative cst amunt paid in prcess f investigating r pursuing acquisitin Facts & circumstances Fact amunt wuld have been paid is relevant but nt determinative Emplyee cmpensatin & verhead nt included 47 Overhead & Emplyee Cmpensatin Taxpayer may elect t capitalize verhead & emplyee cmpensatin Electin made separately fr each transactin, applied separately t verhead & labr Made by capitalizing csts n timely filed return in year csts are paid S Crpratin & partnerships file electin Electin may nly be revked by requesting PLR frm IRS 48 24
Inherently Facilitative Cst Transprting prperty Appraisal csts Cst t negtiate terms r structure including tax advice Applicatin fees & bidding Preparing & reviewing transactin dcuments Examining & evaluating title Regulatry apprval & permits Cnveyance csts & sales & transfer taxes Finder s fees & brker s cmmissins Architectural, gelgical, engineering, envirnmental r inspectin csts IRC Sectin 1031 exchange qualified intermediary services 49 Real Prperty Acquisitin Csts Csts t investigate acquisitin f real prperty May be deducted if nt inherently facilitative Inherently facilitative csts must be capitalized Acquisitin f real & persnal prperty in single transactin Csts investigating acquisitin f persnal prperty Reasnable allcatin methd may be used t determine csts relating t real prperty & persnal prperty Amunts paid t defend r perfect title must be capitalized 50 25
Plling Questin 4 Csts incurred t facilitate an acquisitin f prperty shuld generally be capitalized True False Nt sure 51 Reg. Example Real Prperty Transactin Csts Facts X is retailer that wants t acquire land fr purpse f building new distributin facility fr its prducts X cnsiders varius prperties n highway A in state B X incurs fees frm architect fr advice t evaluate suitability f ptential sites Cnclusin X must capitalize architect fees as cst t acquire land because they are inherently facilitative 52 26
Reg. Example Real Prperty Transactin Csts Facts Assume same facts as previus example, except X incurs fees frm architect t prepare preliminary flr plans fr building t cnstruct n ne f the ptential sites Cnclusin Architect s fees are Nt inherently facilitative t acquisitin f land Allcable as cnstructin csts f building under Sectin 263A X des nt capitalize architect fees as amunts paid t acquire land, but instead must capitalize these csts under Sectin 263A UNICAP rules 53 Reg. Example Facts Real Prperty Acquisitin Csts Facts X wns several retail stres & decides t examine feasibility f pening a new stre in city A In Octber f Year 1, X hires develpment cnsulting firm t study city A which includes perfrmance f market surveys, evaluatin f zning & envirnmental requirements, preparatin f preliminary reprts & recmmendatins fr areas X shuld cnsider as lcatin fr new stre In December f Year 1, X cntinues t cnsider whether t purchase real prperty in city A & which prperty t acquire. X hires appraiser t perfrm appraisals n tw different sites t determine fair ffering price fr each site In March f Year 2, X decides t acquire ne f the sites fr lcatin f its new stre. At the same time, X determines nt t acquire ther site 54 27
Reg. Example Cnclusin Real Prperty Acquisitin Csts Cnclusin X is nt required t capitalize amunts paid t develpment cnsultant in Year 1 because they Relate t activities perfrmed in the prcess f determining whether t acquire real prperty & which real prperty t acquire Are nt inherently facilitative X must capitalize amunts paid t appraiser in Year 1 because appraisal csts are inherently facilitative csts In Year 2, X must include appraisal csts allcable t prperty acquired in basis f prperty acquired & may recver appraisal csts allcable t prperty nt acquired 55 Transitin Rules t Implement Repair Regs Revenue Prcedures 2012-19 Materials & supplies Repairs & maintenance Capital expenditures Tangible prperty acquisitin & imprvement csts De minimis rule Revenue Prcedure 2012-20 Dispsitins f tangible prperty Late GAA electin Late GAA qualifying dispsitin electin 56 28
Transitin Rules t Implement Repair Regs All autmatic changes Applicable fr tax years beginning n r after January 1, 2012 Nrmal scpe restrictins d nt apply fr first tw tax years beginning after December 31, 2011 Taxpayer receives audit prtectin fr prir years Certain changes implemented with 481(a) adjustment while thers use cut-ff methd r mdified cut-ff methd Statistical sampling allwed fr certain 481(a) adjustment calculatins Dn t frget abut 263A impact! 57 What Yu Need t D Nw Meet with BKD tax advisr Tailr rules t yu Discern written capitalizatin plicy Are nnqualified items expensed? Determine accunts repairs expensed t Dcument decisin prcesses Are threshlds exceeded? Scrub depreciatin schedules Ptential additinal tax write-ffs Evaluate benefits cst segregatin Prepare strategy accunting methd changes 58 29
Jeffrey Wilmes Partner 812.428.6500 jwilmes@bkd.cm Rick Carrier Manager 812.428.6500 rcarrier@bkd.cm Jim Still Senir Manager 417.831.7283 jstill@bkd.cm Cntinuing Prfessinal Educatin (CPE) Credits BKD, LLP is registered with the Natinal Assciatin f State Bards f Accuntancy (NASBA) as a spnsr f cntinuing prfessinal educatin n the Natinal Registry f CPE Spnsrs. State bards f accuntancy have final authrity n the acceptance f individual curses fr CPE credit. Cmplaints regarding registered spnsrs may be submitted t the Natinal Registry f CPE Spnsrs thrugh its website: www.learningmarket.rg. The infrmatin in BKD webinars is presented by BKD prfessinals, but applying specific infrmatin t yur situatin requires careful cnsideratin f facts & circumstances. Cnsult yur BKD advisr befre acting n any matters cvered in these webinars. 60 30
CPE Credit Up t 1 CPE credit will be awarded upn verificatin f participant attendance; hwever, credits may vary depending n state guidelines Fr questins, cmplaints r cmments regarding CPE credit, please email the BKD Learning & Develpment Department at training@bkd.cm 61 31