REPAIR V. CAPITALIZATION REGS

Transcription

1 REPAIR V. CAPITALIZATION REGS Copyright Tax Educators' Network, Inc

2 INTRODUCTION & COMMENTS Copyright Tax Educators' Network, Inc

3 Workshop Objectives Knowledge Issue awareness Ability to effectively & efficiently deal with tax return related matters during the upcoming busy season Copyright Tax Educators' Network, Inc

4 QUESTIONS? Copyright Tax Educators' Network, Inc

5 REPAIR V. CAPITALIZATION REGS Copyright Tax Educators' Network, Inc

6 OVERVIEW OF FINAL REGS Copyright Tax Educators' Network, Inc

7 Overview of Reg Proposals To Date Overview 4 th attempt to provide guidance Regs affect many areas in addition to repair or maintenance deductions IRS first issued proposed tangible property regulations in 2006 and subsequently withdrew those regs In 2008, IRS reissued regs in proposed form Generally better accepted than 2006 regs Temporary & proposed regs then issued in 2011 After receiving many comments, final regs released on Sept. 15, 2013 (T.D. 9636) Regs include new concepts as well as reinterpretations of 2008 regs, while also adopting some of the original 2011 proposed regs Copyright Tax Educators' Network, Inc

8 Impact on Taxpayers Taxpayers affected by new regs Generally, regs affect all domestic (and, some foreign taxpayers) that acquire, produce, or improve tangible property Regardless of entity type (C/S corps, partnerships, or proprietorships Copyright Tax Educators' Network, Inc

9 Need to Capitalize Unless expense qualifies as a material or supply cost, or the de minimis safe harbor election applies, taxpayer must capitalize amounts paid to acquire or produce a unit of property (UOP), whether real or personal property, including: Leasehold improvement property Land and land improvements Buildings Machinery and equipment, and Furniture and fixtures Amounts paid to acquire or produce unit of real or personal property include the invoice price as well as transaction costs (Reg 1.263(a) 2(d)) Copyright Tax Educators' Network, Inc

10 Other Items of Interest Regs contained revised rules for: Materials and supplies Spare parts General and mass asset accounting Investigatory and acquisition costs Units of property for leased property Routine maintenance safe harbor Regs also include over 150 examples illustrating how to interpret and apply these rules Copyright Tax Educators' Network, Inc

11 Some Changes in Final Regs Final regs more favorable to taxpayers Provide higher capitalization exemption amount Expansion of the safe harbor rule for routine maintenance Elimination of the ceiling for de minimis expense amounts Effectively a book tax conformity election Will allow many businesses to currently deduct their outlays for lower cost assets, materials, and supplies Building owners permitted to use new safe harbor election allowing a current deduction for routine maintenance Copyright Tax Educators' Network, Inc

12 Some Changes in Final Regs Certain owners of smaller properties get special perbuilding safe harbor election for maintenance expenses Overall cap is so low it might not be worthwhile to use Basically, these final regs attempt to address which expenditures can be treated as current repair deduction v. a capitalized cost Examples include how to treat: Environmental remediation expenses Restaurant flatware expenses Renovation of the facade of a historic hotel Rotable spare parts used in repairs Copyright Tax Educators' Network, Inc

13 New Standards in Regs Significant standards included in regs Revised unit of property (UOP) definitions for real and personal property Improvements to property ( BAR test) Modifications to rules for property dispositions Bottom line: Regs provide general framework for determining whether expenditure is improvement to property requiring capitalization or deductible repair Taxpayers must initially determine UOP and then apply series of tests to determine whether expenditure was capital improvement or deductible repair Copyright Tax Educators' Network, Inc

14 Dispositions Property Components Regs also make significant changes to rules covering dispositions of property Before these regs, a taxpayer not permitted to claim a partial disposition deduction ERTA 81 specifically repealed component depreciation Recovery periods instead enacted Extremely short for real property (15 years) MACRS increased to 27.5 & 39 years Copyright Tax Educators' Network, Inc

15 Dispositions Property Components Taxpayers could still be writing off ghost assets Opportunity to claim Sec losses for remaining undepreciated bases of such assets? Form 4562 should be examined for these assets Taxpayers often capitalized and depreciated multiples of the same item where actually just one item existed Example: Multiple roof upgrades capitalized over time Regs revise disposition rules allowing write offs of the old component if replaced with a capital improvement Copyright Tax Educators' Network, Inc

16 Final Regs Effective Date Apply to tax years beginning on or after Jan. 1, 2014 But, do not finalize (or, remove) temporary regs governing component dispositions of property under Sec. 168 Instead, to address significant changes in this area, revised proposed regulations were issued at the same time as these final regs Copyright Tax Educators' Network, Inc

17 New Regs Bottom Line New regs are interpretative not legislative Taxpayers will ultimately challenge these regs, especially regarding UOP definition being so narrowed Cases such as FedEx cannot simply be ignored especially where an asset is simply being maintained (i.e., not BAR ) In the meantime, though, Form 8275R should probably be filed where taxpayer aggressive in ignoring principles in these new regs Copyright Tax Educators' Network, Inc

18 Specific Client Steps to Consider Make sure client has written capitalization policy in place (effective as of January 1, 2014) if de minimis safe harbor will be elected in 2014 Should changes to any current processes or controls be made to support client s interpretation of new BAR standard? Should partial disposition rule be used to write off any ghost assets that client is still carrying on Form 4562? Copyright Tax Educators' Network, Inc

19 SPECIFIC TYPES OF COSTS Copyright Tax Educators' Network, Inc

20 Facilitative Costs Generally speaking, all costs that facilitate acquisition or production of such property must be capitalized, with exceptions for employee compensation and overhead costs However, investigatory expenses related to acquisition of realty generally do not have to be capitalized unless the expenses are inherently facilitative But, taxpayers will be required to capitalize repairs made to assets before they are placed in service (Reg 1.263(a) 2(d)(1)) Copyright Tax Educators' Network, Inc

21 Costs Incurred Before Asset Placed in Service Example: In Year 1, Ace Corp. buys a building for use as a business office. Before placing the building in service, Ace incurs costs to repair cement steps, refinish wood floors, patch holes in walls, and paint the building s interior and exterior. In January of Year 2, Ace places the building in service and begins using it as its business office. None of the work was an improvement to the building or its structural components. Nevertheless, the amounts paid must be capitalized as costs of acquiring the building because they were for work performed before Ace placed the building in service. (Reg 1.263(a) 2(d)(2), Ex. 10) Note: Taxpayers wishing to minimize these capitalized costs should placed asset into service first and then proceed to make necessary repairs Ascertain whether certificate of occupancy could be obtained Copyright Tax Educators' Network, Inc

22 Facilitative Costs Facilitative (and, inherently facilitative) costs Paid to facilitate acquisition of real or personal property must be capitalized Paid in the process of investigating or otherwise pursuing the acquisition (Reg 1.263(a) 2(f)(3)(i)) Included in the basis of property acquired or produced Based on all of the facts and circumstances But, fact that the amount would (or, would not) have been paid but for the acquisition is relevant but not determinative (Reg 1.263(a) 2(f)(2)(i)) Note: Some facilitative expenses may qualify as amortizable startup expenditures under Code 195 Copyright Tax Educators' Network, Inc

23 Summary of Facilitative Costs 11 inherently facilitative costs Transporting the property (e.g., shipping fees and moving costs) Securing an appraisal or determining value or price of property Negotiating terms or structure and obtaining tax advice Application fees, bidding costs or similar expenses Preparing and reviewing documents that effectuate acquisition (e.g., preparing the bid, offer, sales contract or purchase agreement) Examining and evaluating title Copyright Tax Educators' Network, Inc

24 NEW UNIT OF PROPERTY DEFINITION Copyright Tax Educators' Network, Inc

25 UOP Real Property Real property New rules define a building and its structural components as a single UOP Expenditure treated as capital improvement if it improves building structure or any individual building system Amounts treated as paid for an improvement to a building if they improve: The building structure; or Any designated building system Copyright Tax Educators' Network, Inc

26 UOP Real Property Building structure defined Under Reg (e)(2), term structural components includes such parts of a building as walls, partitions, floors, and ceilings, as well as any permanent coverings therefor such as paneling or tiling, windows and doors, and other components relating to the operation or maintenance of a building If a business improves a building structure by, for example, replacing the entire roof, the expense generally is treated as an improvement to the single UOP consisting of the building Similarly, if it improves a building system, such as an improvement to the heating, ventilation, and air conditioning (HVAC) system, then the expense constitutes an improvement to the building UOP Copyright Tax Educators' Network, Inc

27 UOP Real Property Building system defined: Each of them (including their sub components) is a building system that is separate from building structure, and to which the improvement rules must be separately applied (Reg 1.263(a) 3(e)(2)(ii)(B)): HVAC systems (including motors, compressors, boilers, furnace, chillers, pipes, ducts, and radiators); Plumbing systems (including pipes, drains, valves, sinks, bathtubs, toilets, water and sanitary sewer collection equipment, and site utility equipment used to distribute water and waste to and from the property line and between buildings and other permanent structures); Copyright Tax Educators' Network, Inc

28 UOP Real Property Electrical systems (including wiring, outlets, junction boxes, lighting fixtures and associated connectors, and site utility equipment used to distribute electricity from the property line to and between buildings and other permanent structures); All escalators; All elevators; Fire protection and alarm systems (including items such as sensing devices, computer controls, sprinkler heads, sprinkler mains, associated piping or plumbing, pumps, visual and audible alarms, and alarm control panels); Copyright Tax Educators' Network, Inc

29 UOP Real Property Security systems that protect the building and its occupants (including items such as locks, security cameras, motion detectors, security lighting, and alarm systems); Gas distribution systems (including associated pipes and equipment used to distribute gas to and from the property line and between buildings or permanent structures); and Other structural components identified in published IRS guidance that are not part of the building structure and are specifically designated as building systems in the regs. (Reg 1.263(a) 3(e)(2)(ii)(B)) Copyright Tax Educators' Network, Inc

30 UOP Elevator Upgrade Building upgrade example 4 separate banks of elevators UOP for assessing whether capital improvement has occurred is entire elevator system in that building, not the entire building itself Significant change from 2008 regs, where UOP was overall building structure Thus, cost of one elevator bank being upgraded is assessed by comparing it to the building s entire elevator system (Reg 1.263(a) 3(e)(6), Ex. (2)) Copyright Tax Educators' Network, Inc

31 Sec Property v. Building Structures or Systems Distinguish Sec as being separate Some assets located in a building are not structural components and therefore do not belong in one of the building systems categories. For example, for depreciation purposes, assets such as decorative canopies, awnings, millwork, and facades have been held to be short lived Code 1245 property (i.e., personal property) rather than long lived Code 1250 property. Thus, these types of assets are not part of a building or its building systems for capitalization purposes. Similarly, that part of the electrical wiring, plumbing, or fire protection equipment directly associated with non building equipment (such as a commercial baking oven) has been held to be a short lived non building asset. Thus, these types of assets would be capitalized to the nonbuilding asset with which they are directly associated. Copyright Tax Educators' Network, Inc

32 NEW SAFE HARBORS FOR ROUTINE MAINTENANCE & SMALL BUILDING OWNERS Copyright Tax Educators' Network, Inc

33 Routine Maintenance and Small Building Owner Safe Harbors Temporary regs included routine maintenance safe harbor only for property other than buildings Final regs include routine maintenance safe harbor for both real and tangible personal property Either type of routine maintenance treated as not improving the UOP it involves (and, therefore is currently deductible) Additionally, final regs create new expensing safe harbor for small building owners Copyright Tax Educators' Network, Inc

34 Routine Maintenance Safe Harbor for Buildings Consists of recurring activities that taxpayers expect to perform as a result of using property to keep building structure or each building system in its ordinarily efficient operating condition Includes inspection, cleaning, and testing of building structure (or, each building system) and replacement of damaged or worn parts with comparable and commercially available replacement parts Routine maintenance may be performed any time during useful life of building structure or building systems Routine only if taxpayer reasonably expects to perform activities more than once during 10 year period beginning when the building structure or building system on which routine maintenance is performed is placed in service by the taxpayer (Reg 1.263(a) 3(i)(1)(i)) Copyright Tax Educators' Network, Inc

35 Routine Maintenance Safe Harbor for Tangible Personal Property Routine maintenance may be performed at any time during UOP s useful life However, safe harbor applies only if, at time UOP is placed in service by taxpayer, it reasonably expects to perform the activities more than once during class life of asset (not MACRS recovery period) Taxpayer s expectation will not be deemed unreasonable merely because the taxpayer does not actually perform the maintenance a second time during the class life of the UOP, if taxpayer can otherwise substantiate that its expectation was reasonable at the time the property was placed in service. Copyright Tax Educators' Network, Inc

36 Per Building Safe Harbor Election for Qualifying Small Taxpayers New safe harbor at Reg 1.263(a) 3(h), permitting qualifying small taxpayers (i.e., those with $10 million or less average annual gross receipts in the three preceding tax years) to elect not to treat as capitalized expenses (i.e., to currently deduct) improvements made to an eligible building property (i.e., one with an unadjusted basis of $1 million or less) Copyright Tax Educators' Network, Inc

37 Per Building Safe Harbor Election for Qualifying Small Taxpayers New safe harbor election applies only if the total amount paid during the tax year for repairs, maintenance, improvements, and similar activities performed on the eligible building does not exceed the lesser: Of $10,000, or 2% of the building s unadjusted basis Note: In other words, the cap on this safe harbor or such expenses can never exceed $10,000 and the building s cost can never exceed $1 million. Otherwise, all repair costs on the building are ineligible for this safe harbor. Copyright Tax Educators' Network, Inc

38 Per Building Safe Harbor Election for Qualifying Small Taxpayers Election made annually on building by building basis (Reg 1.263(a) 3(h)(6)) Done on white paper statement included with that year s return But, once made for a particular tax year cannot be revoked (Reg 1.263(a) 3(h)(7)) Changes to comply with Reg 1.263(a) 3, which includes the routine maintenance safe harbors, is a change in method of accounting to which Code 446 and Code 481 Therefore, Form 3115 must be filed by the taxpayer Copyright Tax Educators' Network, Inc

39 NEW BAR TEST Copyright Tax Educators' Network, Inc

40 BAR Test in New Regs 3 prong BAR test Regs outline three tests to determine if expenditure results in a betterment, restoration, or adaptation to a UOP that requires capitalization (Temp. Regs. Secs (a) 3T(h), (i), and (j)) Copyright Tax Educators' Network, Inc

41 Historical 3 Prong Test Historically, costs have been held to be currently deductible as a repair expense under Code 162 if they are: Is incidental in nature; Does not materially add to the value of the property; Does not appreciably prolong its useful life; or Does not adapt the asset to a new or different use Copyright Tax Educators' Network, Inc

42 50 Years of Case Law & Rulings On the other hand, costs have to be capitalized under Code 263 if they are for: Permanent improvements or betterments that increase the value of the property; Restore its value or use; Substantially prolong its useful life; or Adapt it to a new or different use Note: The IRS felt that prior final regs did not clearly address the repairs v. capitalization issue. As a result, over the years it spawned a host of sometimes conflicting cases and rulings. These new final regs, like the temporary regs before them, are an attempt by the IRS to deal with the issue in a systematic manner. Copyright Tax Educators' Network, Inc

43 ASSET BETTERMENT COSTS Copyright Tax Educators' Network, Inc

44 Capitalizing Betterment Costs Taxpayers must capitalize amounts paid for betterment of a UOP. An amount is treated as being for a betterment only if it: (1) Ameliorates a material condition or defect that either existed before the taxpayer acquired the UOP or arose during its production, whether or not the taxpayer was aware of the condition or defect at the time of acquisition or production; Copyright Tax Educators' Network, Inc

45 Capitalizing Betterment Costs (2) Results in a material addition (including a physical enlargement, expansion, extension, or addition of a major component) to the UOP, or results in a material increase in the capacity, including additional cubic or linear space of the UOP; or (3) Is reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of the UOP. (Reg 1.263(a) 3(j)(1)) Copyright Tax Educators' Network, Inc

46 Property s Before and After Condition Need for an expense may be triggered by normal wear and tear, or damage, that occurred during the taxpayer s use of the property. In such instances, determination of whether expense results in a betterment is made by comparing the condition of the UOP immediately after the expense with its condition immediately before the circumstances necessitating the expense. (Reg 1.263(a) 3(j)(2)(iv)(A)) Note: Another way of stating this test is put v. keep asset in ordinarily efficient operating condition. Copyright Tax Educators' Network, Inc

47 Betterment Examples Betterment examples in final regs: Cleaning up contamination caused by leaking of underground storage tanks installed by prior owner of property results in a betterment to the land. (Reg 1.263(a) 3(j)(3), Ex. 1) (Cf. United Dairy Farmers, Inc., 88 AFTR 2d (6 th Cir., 10/3/2001) Removal and replacement of asbestos installed by a taxpayer in a building before its health hazards were known does not result in a betterment to the structure. (Reg 1.263(a) 3(j)(3), Ex. 2) (Cf. Cinergy Corp v. U.S., 91 AFTR 2d (Ct Fed Cl 3/10/2003)) Copyright Tax Educators' Network, Inc

48 Betterment Examples Amounts paid to bring an assisted living facility up to a higher standard (e.g. repair of damaged drywall, repainting and re wallpapering, repairing and replacing windows, doors and roof, and replacement of furniture, window treatments and cabinets) result in a betterment to the facility. But, see PLR where taxpayer allowed current deduction for mold remediation in a nursing home. Copyright Tax Educators' Network, Inc

49 Betterment Examples Periodic refresh of retail stores in a nationwide chain (cosmetic and layout changes, repair and general maintenance, moving a wall to allow reconfiguration of retail space, new painting, etc.) keeps the stores in an ordinarily efficient operating condition and did not result in a betterment. However, the replacement of Code 1245 property (display tables and racks) would have to be capitalized. If the refresh was made at the same time as limited improvements (increasing storage space, adding loading dock and second overhead door, upgrades to electric system) that do not affect and are not otherwise related to the refresh, then only the limited improvements must be capitalized as betterments. Bottom line: The refresh costs (other than the Code 1245 costs) do not result in a betterment. Copyright Tax Educators' Network, Inc

50 Betterment Examples Substantial remodeling of retail stores to upgrade them in order to reach higher end customers (e.g., replacing large part of walls with windows, replacing escalators, adding elevators, rebuilding facades) would be a betterment. Amounts paid by a building to meet new city earthquake standards (addition of expansion bolts to foundation) are betterments because the expense materially increases the building s strength. Note: The regs clarify that the fact that work is undertaken to satisfy a regulatory requirement is not relevant in determining whether the amount is paid to improve a property. And, this is the same result prescribed by the courts before the final regs were issued. But, needing to make required improvements to a building before a certificate of occupancy is issued would be a clear indication of having to put the asset into ordinarily efficient operating condition with such cost having to be capitalized. Copyright Tax Educators' Network, Inc

51 Betterment Examples Replacement of 2 of the 10 roof mounted HVAC units on a building to solve a climate control problem is not a betterment (even if the replacement units are 10% more energy efficient than the units they replaced). The small efficiency increase does not amount to a material increase in the efficiency, output, etc., of the HVAC system. Copyright Tax Educators' Network, Inc

52 Betterment Examples Summary 23 examples in Reg (a) 3(j)(3) Not a betterment Replacement of asbestos insulation with similar nonasbestos insulation (Ex. 2) Minor repairs and maintenance shortly after purchase (Ex. 3 & 4) Retail refresh limited to cosmetic and layout changes (Ex. 6 & 7) Relocate cash registers (Ex. 9) Add concrete lining to meat plant (Ex. 12) Roof membrane (Ex. 13) Removal of drop ceiling (Ex. 18) Replace 2 out of 10 HVAC units with ones that are 10% more efficient (Ex. 20) Copyright Tax Educators' Network, Inc

53 Betterment Examples Summary 23 examples in Reg (a) 3(j)(3) Are betterments requiring capitalization Remediation of soil contaminated by previous owner (Ex. 1) Bringing assisted living building up to higher standards (Ex. 5) Retail refresh along with increased storage and second loading dock (Ex. 7) Major remodel of retail (Ex. 8) Relocate machines to increase capacity (Ex. 10) Doubling depth of channel (Ex. 15) 25% increase in depth of channel (Ex. 17) 50% reduction in energy or power costs (Ex. 21) Adding restaurant drive through window (Ex. ) Copyright Tax Educators' Network, Inc

54 ASSET RESTORATION COSTS Copyright Tax Educators' Network, Inc

55 Capitalizing Restoration Costs Costs to restore a UOP, including making good the exhaustion for which an allowance is made, must be capitalized. An amount is treated as a restoration cost only if it falls in one of five categories: Category 1: Replaces a component of a UOP where the taxpayer has: (1) Properly deducted a loss for that component (other than a casualty loss under Reg ), or (2) Properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component. However, this rule does not apply if the UOP is fully depreciated and the loss is attributable only to remaining salvage value for federal tax purposes. (Reg 1.263(a) 3(k)(1)(i) & (ii)) Example: Taxpayer replaces inoperable components of a walk in freezer that is Code 1245 property and is not part of the building structure or HVAC system, and either abandons the old components and claims a loss or sells the old components and recognizes a loss. The cost of buying and installing the new components must be capitalized. (Reg 1.263(a) 3(k)(7), Ex. 1 and 2) Copyright Tax Educators' Network, Inc

56 Capitalizing Restoration Costs Category 2: Restores damage to a UOP for which the taxpayer has properly taken a basis adjustment as a result of a casualty loss or casualty event under Code 165. (Reg 1.263(a) 3(k)(1)(iii)) Example: Owner of an office building with an adjusted basis of $500,000 spends $50,000 to repair storm damage (repair roof, remove storm debris) and reduces its basis in the building to $450,000. The $50,000 must be capitalized as an improvement. If the owner is compensated for the $50,000 loss by insurance, but makes the necessary basis adjustment to $450,000, it still must capitalize the $50,000 as an improvement since it properly took a basis adjustment on account of a Code 165 casualty event. (Reg 1.263(a) 3(k)(7), Exs. 3 and 4) Note: See CCA where repairs made to restore property to pre flood conditions were currently deductible. Copyright Tax Educators' Network, Inc

57 Capitalizing Restoration Costs Category 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. (Reg 1.263(a) 3(k)(1)(iv)) Example: A farm s outbuilding, formerly used for storage, falls into a state of disrepair and is not structurally sound. The farm owner has the outbuilding s walls shored up and its siding replaced. The amounts are treated as restoring the outbuilding and must be capitalized as an improvement. (Reg 1.263(a) 3(k)(7)) Copyright Tax Educators' Network, Inc

58 Capitalizing Restoration Costs Category 4: Results in the rebuilding of the UOP to a like new condition (i.e., it is brought to the status of a new, rebuilt, remanufactured, or similar status under federal regulatory guidelines or manufacturer s original specifications) after the end of its class life under Code 168 for alternative depreciation system (ADS) purposes. Note: Generally, a comprehensive maintenance program, although substantial, does not return a UOP to a like new condition. Example: Overhauling an airplane after the end of its class life did not restore it to a like new condition. Therefore, the costs did not have to be capitalized. (Reg 1.263(a) 3(k)(7), Ex. 9) But, see Rev. Rul where some costs of overhauling airplane did have to be capitalized. Copyright Tax Educators' Network, Inc

59 Capitalizing Restoration Costs Category 5: Replaces a part or a combination of parts that comprise a major component or a substantial structural part of a UOP. (Reg 1.263(a) 3T(i)) This test relies heavily on the particular facts and circumstances of the specific situation. Copyright Tax Educators' Network, Inc

60 Restoration Cost Examples Summary Not a restoration Replace power switch (Ex. 13) Replace roof membrane (Ex. 15) Replace 1 of 3 furnaces in HVAC system (Ex. 16) Replace 3 of 10 roof top HVAC units (Ex. 18) Replace 30% of electrical system (Ex. 21) Replace 8 of 20 sinks (Ex. 23) Replace 100 of 300 exterior windows comprising 8.3% of total surface area (Ex. 25) Replace lobby floors which comprise 10% of total square footage (Ex. 28) Replace 1 of 4 elevators (Ex. 30) Copyright Tax Educators' Network, Inc

61 Restoration Cost Examples Summary Are restorations requiring capitalization Replace entire roof (Ex. 14) Replace single chiller in HAVC system (Ex. 17) Replace sprinkler system (Ex. 19) Replace entire electrical system (Ex. 20) Replace all toilets and sinks with similar quality and function (Ex. 22) Replace 200 of 300 exterior windows comprising 16.67% of total surface area (Ex. 26) Replace 100 of 300 exterior windows comprising 30% of total surface area (Ex. 27) Replace floors in all public areas comprising 40% of square footage (Ex. 29) Replace 1 of 4 elevators while claiming partial disposition loss (Ex. 31) Copyright Tax Educators' Network, Inc

62 COSTS TO ADAPT ASSET TO NEW OR DIFFERENT USE Copyright Tax Educators' Network, Inc

63 Amounts to Adapt Property to New or Different Use Cost of adapting a UOP to a new or different use must be capitalized (Reg 1.263(a) 3(l)) Example: Costs of converting commercial warehouse space to residential condos would have to be capitalized. Example: Costs of converting open retail store space into subdivided professional office space for doctor/dentist would have to be capitalized. Example: Costs of converting 3 out of 20 retail spaces into one larger space would not have to be capitalized. Copyright Tax Educators' Network, Inc

64 Change in Use Examples Summary (Reg (a) 3(l)(3) Not a change in use: Combine 3 leased retail spaces into 1 space (Ex. 2) Minor refresh of building in anticipation of sale (Ex. 3) Clean up contamination after closing plant (Ex. 4) Convert portion of grocery store space into sushi bar (Ex. 6) Convert portion of hospital emergency room to outpatient surgery center (Ex. 7) Copyright Tax Educators' Network, Inc

65 Change in Use Examples Summary (Reg (a) 3(l)(3) Change in use requiring capitalization Convert manufacturing plant into showroom space (Ex. 1) Regrade land to accommodate sale of land for residential development (Ex. 4) Reconfigure part of retail pharmacy to walk in clinic (Ex. 5) Copyright Tax Educators' Network, Inc

66 REPAIRS MADE DURING GENERAL PLAN OF RENOVATION Copyright Tax Educators' Network, Inc

67 Repairs Undertaken at Same Time as Other Improvements Under judicially developed plan of rehabilitation doctrine, taxpayers must capitalize otherwise deductible repair costs if they are incurred as part of a general plan of renovation or rehabilitation The final regs modify this doctrine and specifically provide that indirect costs made at the same time as an improvement, but that do not directly benefit or are not incurred by reason of the improvement, do not have to be capitalized under Code 263(a). (Reg 1.263(a) 3(g)) Example: A company takes a truck out of service to overhaul its engine. During the overhaul, the truck s broken taillights are replaced and tears in the driver s seat are mended. These expenses are currently deductible as repairs. Copyright Tax Educators' Network, Inc

68 DE MINIMIS SAFE HARBOR Copyright Tax Educators' Network, Inc

69 De Minimis Safe Harbor Election Allows taxpayers to elect to currently deduct their outlays for lower cost business assets that they also expense for book purposes under a written policy To be eligible for this book tax conformity election, a unit of property: Cannot cost >$5,000 if a business has an Applicable Financial Statement (AFS) Cannot cost >$500 if the business has no AFS. Copyright Tax Educators' Network, Inc

70 De Minimis Safe Harbor Election If the taxpayer is eligible for the de minimis safe harbor election, and actually elects to use it: Amount paid to acquire or produce any eligible UOP (or any eligible material or supply) is deducted in year paid under Code 162 (assuming the item otherwise qualifies as an ordinary and necessary business expense), and May not be capitalized or treated as a material or supply (Reg 1.263(a) 1(f)(1), Reg 1.263(a) 1(f)(3)(iv)) Copyright Tax Educators' Network, Inc

71 De Minimis Safe Harbor Election De minimis safe harbor applies to an amount paid during the tax year to acquire or produce a UOP, or acquire a material or supply, if: Taxpayer has at the beginning of tax year written accounting procedures treating as an expense for non tax (i.e., book) purposes amounts paid for property Costing less than a specified dollar amount; or With an economic useful life of 12 months or less Note: As to the latter requirement, why would the acquired asset have to be capitalized in the first place? Note: The written requirement is technically only for those businesses without an AFS. Copyright Tax Educators' Network, Inc

72 De Minimis Safe Harbor Election Taxpayer treats amount paid for property as an expense on its AFS (if it has one), or on its books and records (if it does not) in accordance with its accounting procedures; and If the taxpayer has an AFS, amount paid for property does not exceed $5,000 per invoice (or, per item as substantiated by the invoice), or if the taxpayer does not have an AFS, does not exceed $500 per invoice (or, per item as substantiated by the invoice), or other amount as identified in published IRS guidance. (Reg 1.263(a) 1(f)(1)(i), Reg 1.263(a) 1(f)(1)(ii)) Copyright Tax Educators' Network, Inc

73 De Minimis Safe Harbor Election Note: Companies that do not already have such procedures in place should consider revising accounting procedures before the end of their current year to bring their non tax (i.e., book) expensing limit up to (or, down to) the $5,000/$500 limit. This compliance step, such as changing the expensing amount from $250 to $500, is not considered to be a change in method of accounting requiring any prior IRS approval But, once again, if the economic life is 12 months or less, wouldn t this fact alone justify taking a current expense? Copyright Tax Educators' Network, Inc

74 De Minimis Safe Harbor Example Example: Able Company does not have an AFS. In Year 1, it buys 10 printers at $250 each for a total cost of $2,500 as indicated by the invoice. Each printer is a UOP, and Able has accounting procedures in place at the beginning of Year 1 to expense amounts paid for property costing less than $500. Able treats the amounts paid for the printers as an expense on its books and records. Able may deduct the $2,500 in the tax year the amounts are paid, provided the amounts otherwise constitute deductible ordinary and necessary expenses incurred in carrying on a trade or business. (Reg 1.263(a) 1(f)(7), Ex. 1) Note: An invoice price that is even a few dollars over the $5,000 or $500 threshold will cause the purchased item to be ineligible for the de minimis safe harbor election. Copyright Tax Educators' Network, Inc

75 De Minimis Safe Harbor Election Property ineligible for de minimis safe harbor election: Property that is or is intended to be included in inventory Land Rotable, temporary, and standby emergency spare parts that the taxpayer elects to capitalize and depreciate under Reg (d); and Rotable and temporary spare parts that the taxpayer accounts for under the optional method of accounting for rotable parts under Reg (e). (Reg 1.263(a) 1(f)(2)) Note: Sec. 179, especially with a $500,000 would easily absorb most of the tangible personal property a taxpayer might purchase and place in service in a given tax year. But, if this de minimis exception applied, such asset costs would not be included in the overall limit for Sec. 179 purposes. And, if there is a $25,000 limit for 2014, then the $500/item exception might be worthwhile. Copyright Tax Educators' Network, Inc

76 De Minimis Safe Harbor Election Making de minimis safe harbor election This Reg 1.263(a) 1(f) election, which is irrevocable, is made by attaching a statement to the taxpayer s timely filed original Federal tax return (including extensions) for the tax year in which amounts eligible for the election are paid The statement must be titled Section 1.263(a) 1(f) de minimis safe harbor election and include the taxpayer s name, address, taxpayer identification number (TIN), and a statement that the taxpayer is making the de minimis safe harbor election under Reg 1.263(a) 1(f). Election is not made by applying for a change in accounting method (on Form 3115) or by filing an amended Federal tax return (Reg (a) 1(f)(5)) Copyright Tax Educators' Network, Inc

77 REPAIR V. CAPITALIZATION FINAL REGS ELECTIONS TO BE MADE Copyright Tax Educators' Network, Inc

78 Form 3115 v. Statements in Returns De minimis safe harbor (Reg (a) 1(f)) Statement required (not Form 3115 for change in method of accounting) Make sure that client has written policy in place treating such costs as current expenses for nontax purposes Amounts paid for property costing less than specified dollar amount; or Amounts paid for property with economic useful life of 12 months or less Copyright Tax Educators' Network, Inc

79 Elections v. Statements in Returns Capitalize and depreciate rotable, temporary or emergency spare parts (Reg (d)) Election made by simply capitalizing the amount paid and beginning to recover costs through depreciation Capitalize all repair and maintenance costs for both book and tax purposes (Reg (n)) Statement required (not Form 3115 for change in method of accounting) Copyright Tax Educators' Network, Inc

80 Elections v. Statements in Returns Safe harbor for small taxpayers Reg (a) 3(h)(6)) Statement required Component disposition write offs Reg (i) 8(d)(2)(i) Election made by reporting the gain, loss or other deduction on timely filed (including extensions) original tax return Copyright Tax Educators' Network, Inc

81 COMPONENT DISPOSITION RULES Copyright Tax Educators' Network, Inc

82 MACRS Property Disposition Rules Prop. Reg Included among the changes are rules that no longer treat structural components of a building as separate from the rest of the building So called component dispositions But, still permit partial disposition write offs Departure from temporary regs where you were required to write off undepreciated basis of a building component at the time that it was replaced Note: This still flies in the face of ERTA 81 regarding the prohibition of component depreciation Copyright Tax Educators' Network, Inc

83 MACRS Property Disposition Rules Prop. Reg In fact, replacement of a single window under the temporary regs required you to deduct its undepreciated basis (assuming you could determine it) while capitalizing the cost of the new window If partial disposition rules used, made simply by reporting Sec ordinary loss resulting from the disposition on the Form 4797 But, would result in related replacement costs being capitalized Copyright Tax Educators' Network, Inc

84 MACRS Property Disposition Rules Prop. Reg Partial disposition rule Could present valuable opportunity for taxpayers to go back and review their depreciation schedules to determine what "ghost assets" remain on their depreciation schedule Where improvements were required to be capitalized, there could be significant deductions for undepreciated basis of assets disposed of If taxpayer opts not to take this clean up approach, IRS has indicated that they will not imposed the allowed or allowable mandate, thus permitting the taxpayer to continue deducting the remaining unadjusted basis of the disposed of asset (e.g., old roof, HVAC, etc.) Copyright Tax Educators' Network, Inc

85 THANK YOU FOR ATTENDING TODAY S SESSION!