irc 263(a): new finalized repair regulations for return...

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

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IRC 263(a): New Finalized Repair Regulations for Return Preparers

Ellen McElroy, Pepper Hamilton

[email protected]

Nov. 20, 2013

Rich Shevak, Grant Thornton

[email protected]

Todays 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


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


Treatment of

Materials and

Supplies:

Treas. Reg. 1.162-3

Improvement of

Tangible Property:

Treas. Reg.

1.263(a)-3

Acquisition or

Production of

Tangible Property:

Treas. Reg.

1.263(a)-1 /2

Dispositions of

Tangible Property:

Prop. Treas. Reg.

1.168(i)-1 and -8

9


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


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

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

Most changes require Form 3115 and Section 481(a) adjustment

Certain items required on a cut-off basis

Amended returns available for certain elections

Effective for tax years beginning on or after 1/1/14

May be relied on for 2012 or 2013

2013 Final Regulations 2013 Proposed Regulations


12


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 groups 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 taxpayers 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

Slide Intentionally Left Blank

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


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


Building systems include:

HVAC systems

Plumbing systems

Electrical systems

All escalators

All elevators

The 2013 regulations retain these rules

Special rule:

Buildings and

structural

components

Fire protection and

alarm systems

Security systems

Gas distribution systems

Any other structural

components in published guidance

29


Example - Building systems

Facts:

X owns an office building that contains an HVAC

system. The HVAC system incorporates ten roof-

mounted 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 buildings interior.

X pays an amount for labor and materials for work

performed on the roof-mounted units.

Special rule:

Buildings and

structural

components

30


Example - Building systems

Conclusion:

The entire HVAC system, including all of the roof-

mounted units and their components, comprise a

building system

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

Special rule:

Buildings and

structural

components

31


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


Definition: Functionally interdependent machinery or equipment (other than network assets) used to perform an industrial process.

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.

Special rule:

Plant property

33


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.

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.

Special rule:

Network assets

34


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


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


(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


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


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.

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.

Special rule:

Examples

39

Improvements To Property Betterment

No change from prior regulations

General rule: A TP must capitalize amounts that result in a "betterment"

41


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


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


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


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


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


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


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


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


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


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


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


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


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.

Substantial structural part refers to size.

"Part or combination of parts that comprises

a large portion of the physical structure of

the UOP."

Replacement of a

major component/

substantial

structural part

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


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


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

Results in increased capacity, productivity,

efficiency, strength or quality?

Results in a material addition?

Improvement prior to property being placed in

service?

Improvement to ameliorate pre-existing condition?

Adaptation to new or different use?

Section 263A applies?

Basis in replaced component recovered in sale or

exchange?

Basis in replaced component properly deducted as a

loss?

Major component or substantial structural part

replaced?

UOP rebuilt to like-new condition after its class life?

BETTERMENT RESTORATION

UOP in state of disrepair returned to ordinary efficient

operating condition?

Repair to UOP for which a casualty loss was taken?

Does routine maintenance safe harbor apply? Yes

No

C

A

P

I

T

A

L

I

Z

E

Do Not

Capitalize

No

No

No

No

No

No

No

No

No

No

No

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Improvement Flow Chart

69

DISPOSITION OF ASSETS Rich Shevak, Grant Thornton

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.

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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.

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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.

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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.

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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.

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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

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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.

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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?

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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)

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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.

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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

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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

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irc 263(a): new finalized repair regulations for return...

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