What s News in Tax Analysis That Matters from Washington National Tax

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1 What s News in Tax Analysis That Matters from Washington National Tax The Final Disposition Regulations : The Last Installment of the Repair Regs Saga The government issued final regulations and transitional guidance regarding the tax treatment of tangible asset dispositions. This article provides a brief overview of the final disposition regulations and related accounting method changes the accompanying flow charts demonstrate the basic operation of the regulations. Monday, October 13, 2014 by James Atkinson, Washington National Tax, and Lynn Afeman and Peter Baltmanis, Accounting Methods and Credit Services James Atkinson is a principal in WNT s Income Tax and Accounting group. Peter Baltmanis is a principal and Lynn Afeman is a tax managing director in the Accounting Methods and Credits Services practice. James is a former IRS Associate Chief Counsel (Income Tax and Accounting). Treasury and the Internal Revenue Service have issued final regulations regarding the tax treatment of tangible asset dispositions. 1 The regulations finalize without significant change proposed regulations issued in September 2013 in conjunction with the final repair regulations. 2 The changes made to the earlier proposed regulations are relatively minor, and relate mainly to the identification and computation of tax basis for purposes of computing gain or loss resulting from the disposition. The final regulations provide rules for identifying disposed assets, and perhaps more importantly, how to account for any resulting gains or losses upon the disposition of all or a portion of that asset. For property held in a general asset account ( GAA ), losses from dispositions of tangible property held in the GAA must be recognized in limited circumstances (for example, following the technical termination of a partnership or certain nonrecognition transactions). 3 For all other dispositions of property held in a GAA, the taxpayer may elect to recognize a loss either from the disposition of the last asset (or remaining portion of the last asset) contained in a GAA, or from a qualified disposition, such as a disposition due to a casualty event, a charitable contribution, or the cessation of a trade or business, process, or plant. In either case, the GAA s remaining basis and depreciation reserve are adjusted accordingly. Otherwise, dispositions from 1 T.D. 9689, 79 Fed. Reg (Aug. 18, 2014). 2 REG , 78 Fed. Reg (Sept. 19, 2013). 3 See generally section 1.168(i)-1. entity. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.

2 The Final Disposition Regulations : The Last Installment of the Repair Regs Saga page 2 a GAA must be disregarded, with the GAA s pre-disposition tax basis continuing to be depreciated without change. Proceeds received from the disposition generally are treated as ordinary income, with any potential basis offset determined by whether the basis of the GAA remains intact or instead is reduced by the disposition. For assets not held in GAAs so-called single or multiple asset accounts the rules provided by the final disposition regulations are both simpler and more flexible than those for GAAs. 4 Under the final regulations, taxpayers must recognize gain or loss arising from the disposition of an entire asset. Gain or loss also must be recognized for partial dispositions arising from certain events, such as casualty losses or from the sale of a portion of the asset. In other situations, however, the taxpayer may elect to either recognize the gain or loss from the partial disposition, or disregard the disposition and continue depreciating the remaining portion of the asset without change. These rules generally are unchanged from the earlier proposed disposition regulations. 5 The final regulations do make the following relatively minor changes and clarifications: In calculating gain or loss to be recognized upon a disposition, the taxpayer generally must use asset-specific data to determine the remaining tax basis of the replaced asset (or the portion of an asset disposed of), unless doing so is impractical. When obtaining asset-specific data is not practical, the taxpayer instead may use a reasonable method to determine the replaced asset s remaining basis. The regulations provide nonexclusive examples of methods that would be considered reasonable for this purpose. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended (the Code ) or the applicable regulations promulgated pursuant to the Code (the regulations ). 4 See generally section 1.168(i)-8. 5 For a more detailed discussion of the new rules, please see James Atkinson and Lynn Afeman, An Overview of the Tangible Property Disposition Regulations, 143 Tax Notes 819 (April 28, 2014).

3 The Final Disposition Regulations : The Last Installment of the Repair Regs Saga page 3 When the disposition results from a restoration of tangible property (but not from a betterment or adaptation to a new use), the taxpayer may employ reasonable methods, including using the Producer Price Index (but not the Consumer Price Index) to discount the cost of the replacement asset to determine the replaced asset s original cost. Whichever reasonable method the taxpayer uses for this purpose must be applied consistently to all disposed portions of an asset. These requirements apply to assets held in a GAA, as well as those that are not. The final disposition regulations also clarify the application of section 280B to assets held in a GAA. In general, section 280B requires a taxpayer to capitalize into the basis of land any demolition costs and any losses arising from the demolition of a structure. When the structure is held in a GAA, however, the basis of the demolished structure continues to be depreciated as a component of the depreciable basis of the GAA itself (which is the depreciable asset, rather than the structure held in the GAA). The remaining basis of the demolished structure must be capitalized into the basis of the land under section 280B only if the taxpayer elects to terminate the GAA under the rules described above. The use of a GAA thus may provide an important planning opportunity in certain situations. Apart from certain industry-specific guidance that is still pending, the issuance of the final disposition regulations completes the government s overhaul of the capitalization and cost recovery rules for tangible property. Although the final disposition regulations are not mandatory until the taxpayer s first tax year beginning on or after January 1, 2014, taxpayers may early adopt the regulations for either their 2012 or 2013 tax years. 6 The attached flow charts demonstrate the basic operation of the final disposition regulations. Separate charts are provided showing the application of the regulations to tangible property contained in a GAA, and to tangible property held in either a single or multiple asset account. 6 Section 1.168(i)-1(j) & 1.168(i)-8(e).

4 The Final Disposition Regulations : The Last Installment of the Repair Regs Saga page 4 Accounting Method Changes Revenue Procedure , issued on September 18, 2014, provides the procedural requirements for making accounting method changes required to implement the disposition regulations. As has become standard with such transition guidance, the revenue procedure provides automatic consent for taxpayers to make specific accounting method changes, along with a temporary waiver of certain scope limitations, such as restrictions normally placed on taxpayers under examination or who have made similar method changes within the previous five years. Revenue Procedure is detailed and lengthy. The principal elements of the document, however, include IRS consent to: Conform to the disposition regulations new rules governing complete or partial dispositions of property. Immediately recover the remaining basis of property the taxpayer previously disposed of, but is continuing to depreciate over its remaining depreciable life. Method changes to recover such stranded basis related to previous partial asset dispositions will no longer be available after the taxpayer s 2014 tax year. Revoke most GAA elections made under earlier versions of the disposition regulations, under which use of GAAs was more favorable than under the final disposition regulations. This consent is available only through the taxpayer s 2014 tax year. Modify the manner in which the taxpayer identifies the property disposed of, as well as the manner in which the taxpayer groups assets. File concurrent method changes to clean up other depreciation methods (recovery periods, etc.) that may be detected in a review of the taxpayer s fixed asset records. Revenue Procedure also clarifies the manner in which the disposition regulations interact with section 280B, requiring the capitalization of costs incurred to demolish a structure. Taxpayers needing to make method changes to implement the disposition regulations should consider doing so as soon as practical. Although automatic consent generally will remain available for the foreseeable

5 The Final Disposition Regulations : The Last Installment of the Repair Regs Saga page 5 future, the IRS has waived the otherwise applicable scope limitations only for changes implemented no later than the taxpayer s 2014 tax year. This is particularly important for taxpayers currently under examination, or who have made similar method changes within the past five years. Revenue Procedure also may limit the taxpayer s ability to obtain audit protection for prior years depending on its status before IRS Exam, Appeals, or a federal court. As such, taxpayers under examination for whom the items within the scope of Revenue Procedure are not yet an issue pending should file the required method change requests expeditiously, in order to lock in audit protection for prior years. Perhaps most importantly, the IRS has granted consent to use the method change process only through the taxpayer s 2014 tax year to either (1) revoke prior GAA elections, or (2) recover stranded basis relating to prior-year partial dispositions. After 2014, these two modifications will not be treated as method changes, and instead may be changed only using other more onerous procedures (such as requesting a private letter ruling). As such, these two changes in particular should be made no later than the taxpayer s 2014 tax year. Contact Information For additional information regarding the new regulations please contact any of the following KPMG professionals: Lynn Afeman, James Atkinson, Peter Baltmanis, Carol Conjura, Eric Lucas, Colleen O Connor, or John Suttora. KPMG s What's News in Tax is a publication from Washington National Tax that contains thoughtful analysis of new developments and practical, relevant discussions of existing rules and recurring tax issues. 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. This article represents the views of the author or authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

6 FINAL DISPOSITION REGULATIONS: GENERAL ASSET ACCOUNTS What has been disposed of? Has an entire asset held in the GAA been disposed of through: Has a portion of the asset been subject to either: Sale Exchange Retirement MANDATORY TAX EFFECT? Is this disposition from either: A partnership technical termination A step in the shoes transaction under section 168(i)(7)(B) A non-recognition transaction under sections 1031 or 1033 A transaction that IRS has determined to be abusive GAA AFFECTED Abandonment Destruction GO There has been a disposition determine the effect on the GAA and whether basis can be recovered FINAL ASSET? Is this the disposition of the final asset, or final portion of an asset, in the GAA? GAA UNAFFECTED A casualty Section 1031/1033 non-recognition transaction Step in the shoes transaction under section 168(i)(7)(B) Sale of a portion of the asset Transaction determined by IRS to be abusive QUALIFIED DISPOSITION? Did the disposition result from either a: Casualty Charitable contribution Cessation of a trade or business, process, plant, etc. that used the asset A non-recognition transaction other than a section 1031/1033 event or a step in the shoes transaction under section 168(i)(7)(B) Terminate GAA in whole or part Recover/adjust basis as required Adjust remaining depreciation schedule as required No basis adjustment No depreciation adjustment Disposition proceeds taxed as ordinary income without basis offset ELECTION? Did the taxpayer elect to treat this as a disposition of the asset or portion of asset? 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. NDPPS

7 FINAL DISPOSITION RULES FOR SINGLE AND MULTIPLE ASSET ACCOUNTS (N-GAA) What has been disposed of? Entire Asset Portion of Asset Tax Event determine gain or loss and recover/adjust basis under normally applicable rules (section 1001; section 1016, etc.) Was this a: Casualty event Section 1031/1033 non-recognition transaction Step in the shoes transaction under section 167(i)(7)(B) Sale of a portion of the asset Did the taxpayer elect to treat this as a disposition? No tax event no recognition of gain or loss; no adjustment of basis 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. NDPPS