Tangible Property CapitalizationRegulations
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Transcript of Tangible Property CapitalizationRegulations
Tangible Property Capitalization
Regulations
Angelina Milo, CPA, MT Parnter, Cohen & Company
History & Effective Dates
Ten years in the making – Advance Notice: 2004
– Proposed regulations issued: 2006 & 2008
– Temporary regulations issued: December 2011 • Effective beginning on or after January 1, 2012
– Public hearing in May 2012
– Final regulations repair & proposed disposition regulations issued: September 2013
• Effective beginning on or after January 1, 2014
“The Repair Regulations”: A Misnomer
Applies to all costs incurred in connection with tangible property
(1) acquiring
(2a) improving
(2b) repairing
(2c) maintaining
(3) disposing
Why is it Important?
• Explains how to classify costs: deduct vs. capitalize – No longer based on facts & circumstances – Provides new definitions – Set new standards
• Introduces new “disposition” rules – Allows taxpayers to claim a loss on disposition vs.
double depreciation ** Mixed Results – may be beneficial and/or unfavorable **
Acquiring Property
• Material & Supplies – Tangible property that is used or consumed in the
operations that is not inventory
– Consumed in 12 months or less
– Has economic life of 12 months or less
– Costs of $200 or less
– Annual election to capitalize & depreciate spare parts
Acquiring Property
• De minimis Safe Harbor – Book conformity:
• Costs classified as expenses • Capitalization policy
– Capitalization policy: • In place at beginning of the year • Cost per item less than threshold • Item has an economic useful life of less than 12
months
Acquiring Property
• De minimis Safe Harbor – Two thresholds:
• $5,000 per-item or per-invoice with Applicable Financial Statements (AFS)
• $500 per-item or per-invoice without AFS
– Example: Bulk purchase of 10 computers for cost $40,000. Computers invoiced in aggregate, not individually. De minimis safe harbor applies.
Acquiring Property
• De minimis Safe Harbor – Applicable Financial Statement is:
1. A financial statement required to be filed with the Securities & Exchange Commission (SEC)
2. A certified audited financial statement
3. A financial statement (other than a tax return) required to be provided to the federal or state government (agency) other than SEC or IRS
Acquiring Property
• De minimis Safe Harbor – What if book policy is less than threshold?
• Limited to amount expensed per book
– What if book policy is more than threshold? • Limited to $5,000 to qualify for the safe harbor
• May deduct larger amount: upon audit must demonstrate amount is immaterial or clearly reflects income
Acquiring Property
• De minimis Safe Harbor – Annual Election – made with tax return
• Election is irrevocable
• Not an accounting method
– Election applies to all qualifying expenses • Cannot exclude certain expenses
• Applies to all repair & maintenance costs capitalized for book
Unit of Property (UOP)
• Building, structural components & roof – Single unit of property
• Building systems – Each a separate unit of property
• Other property – Generally a UOP consists of a group of functionally
interdependent components
Unit of Property (UOP)
• Building componentization
• Significant change
• Prior law: building & building systems were likely one UOP
• Each component viewed as a separate asset
• Required on buildings
Unit of Property: Building Each building system = a separate unit of property:
– HVAC – Plumbing systems – Electrical systems – Escalators – Elevators – Fire protection & alarm systems – Security systems – Gas distribution systems – Other systems identified in future published guidance
Unit of Property: Leased Building
• Lessee leases a portion of a building – The portion of the building structure subject to
the lease is the unit of property
– The portion of any building system associated with that portion of the leased property is a unit of property
Improving Property: Capitalize
• A unit of property is improved if amounts are paid for activities performed after the unit of property is placed in service by the taxpayer resulting in: – Adaptation of the unit of property to a new or
different use
– Betterment to the unit of property
– Restoration of the unit of property
Adaptation: Capitalize
• Adapt a UOP to a new or different use • Adaptation is inconsistent with intended use • Analyze facts & circumstances • Examples:
– Capital: Expansion in retail drug store for a walk-in medical clinic
– Deductible: expansion in grocery store for a sushi bar that already includes counters for prepared food & deli meats
Betterment: Capitalize
• Alleviates a material condition or defect that existed prior to the acquisition of property
• Results in a material addition or expansion
• Is expected to materially increase in productivity, efficiency, strength, output or quality of the unit of property
Betterment: Example
• ABC Corp. purchases a parcel of land. The soil was contaminated by leaking underground storage tanks left by a previous owner
• ABC Corp.’s remediation costs to remove the contaminants result in a capitalized betterment to the land because ABC Corp. incurs the costs to ameliorate a material condition or defect that existed prior to its acquisition of the land
Restoration: Capitalize
• Replaces a component, and adjusted basis has been taken into account in realizing gain/loss
• Returns a UOP to its ordinary efficient operating condition if the property is no longer functional
• Rebuilds a UOP to a like-new condition after end of its useful class life
• Replaces a part that comprises a major component or a substantial structural part of a UOP
Restoration: Example
• ABC Corp. replaces the waterproof membrane of the roof
• Not a major component or substantial structural part of the building structure
• Improvement or repair? Depends if ABC Corp. will recognize a loss on the replaced membrane
Restoration: Example (Cont.)
• Will ABC Corp. recognize a loss on the replaced membrane? – Yes: Improvement = Capitalize
– No: Repair = Expense
Restoration: Example (Cont.)
• ABC Corp. rebuilds a manufacturing machine with a seven-year class life: – After eight years: Restoration = Capitalize
– After five years: No Restoration = Repair = Expense
Safe Harbor: Routine Maintenance
• Current deduction for certain on-going, routine maintenance expenditures
• Applies only if: – Activity is performed more than once over the property’s life
– The maintenance keeps the property in an efficient operating condition
– The need for the maintenance results from the taxpayer’s use of the property
Safe Harbor: Routine Maintenance
• Also applies to buildings & structural components
• For buildings: – Maintenance is expected to be completed more
than once in a 10-year period
Safe Harbor: Small Taxpayers
• Applies to buildings
• Average gross receipts: less than $10,000,000
• Average unadjusted basis (cost) of building: less than $1,000,000
• Deduct costs of improvements: – that do not exceed the lesser of $10,000 or
– 2% of the unadjusted basis of the property
Proposed Disposition Regulations
• Temporary regulations were issued
• 2011 regulations too complex
• New proposed regulations issued in 2013
• Final regulations to be issued in 2014 – Effective for tax years beginning on or after
January 1, 2014
Proposed Disposition Regulations
• Prior to 2011 temporary regulations – Retirement of a structural component of a
building could not be treated as a disposition
– Continue depreciating retired component and begin depreciating replacement component
– Example: Replacing a roof – if capitalize new roof cannot write off old roof
Proposed Disposition Regulations
Revised Rule: • May recognize a loss on the retirement of a
portion of an asset
• Created a “partial disposition” election
• If election is made: recognize a loss on retirement
• If no election is made: continue to depreciate the basis of the retired asset
Proposed Disposition Regulations
Revised Rule: – Special rules for General Asset Accounts (GAA)
– Partial disposition rule is elective except for certain cases including
• Casualty event
• Like-kind exchange
• Involuntary conversion
Proposed Disposition Regulations
Tax basis of asset retired – May use any reasonable method to determine
value of retired asset including: • Cost segregation studies
• Replacement cost percentage extrapolation
• Original construction costs
Proposed Disposition Regulations
• Rev Proc 2014-17
• Change in accounting method
• Recognize a loss on assets that were physically retired in prior years
• “Ghost” or “phantom” assets
• No later than due date of 2013 return
• Consider GAAP treatment
Questions?
Thank you!