TAX DEPRECIATION AND TANGIBLE PROPERTY REGULATIONS UPDATE without detail_for Presentation slides (2)

TAX DEPRECIATION AND TANGIBLE PROPERTY REGULATIONS UPDATE

• Under the Protecting Americans from Tax Hikes (PATH) Act of 2015, Section 179’s expensing amounts for small businesses have been made permanent at $500,000 level.

• Businesses exceeding $2M purchases in qualifying equipment will have the Section 179 deduction phase out dollar for dollar and completely eliminated above $2.5M.

• Section 179 cap will be indexed to inflation in $10,000 increments in future years.

• For tax years beginning in 2016, the annual cap remains at $500K; however the investment limitation will increase to $2,010,000 from $2,000,000.

• Permanently extended option to treat 3 categories of property (QLIP, QRP and QRIP) as Section 179 property.

• For tax years beginning on or after 1/1/16, the $250,000 limitation on the amount of qualified real property that may be expensed is eliminated.

PATH Act: Section 179 Expensing

• Protecting Americans from Tax Hikes (PATH) Act of 2015 extended 50% bonus depreciation thru the end of 2017.

• 40% bonus depreciation thru 2018.• 30% bonus depreciation thru 2019.• No bonus depreciation available in

2020 or later.

PATH Act: Bonus Depreciation Extension

Straight-Line Cost Recovery Period and 15- year life for the following expenditures made permanent as of 1/1/15:• Qualified leasehold improvements (QLIP)• Qualified restaurant buildings (QRP)• Qualified retail improvements (QRIP)Without this extension, these properties would have reverted to a 39 year recovery period.

15-year Recovery Period Made Permanent for Certain Property

• Rev. Proc 2015-56 Retail/Restaurant Industry Safe Harbor for determining whether expenditures incurred to “remodel” or “refresh” their property can be expensed;

• Retailers and restaurants can immediate deduct 75% of qualified amounts spent to refresh certain property and are required to capitalize remaining 25%.

• Biggest potential downside is that Rev. Proc. 2015-56 requires taxpayers to forego “partial disposition” treatment for building covered by the safe harbor.

Rev. Proc 2015-56

• Qualified Improvement Property –first available for property placed in service after 12/31/15.

• Subject to a 39 year recovery period and qualifies for bonus depreciation.• Available to broader set of taxpayers than QLHI, QRP and QRIP.

Defined as any improvement to an interior portion of a building that is nonresidential real property as long as that improvement is placed in service after building was first placed in service.

All properties that qualify as QLIP, QRP and QRIP also qualify as QIP. However in order to qualify as these three types of properties that are subject to a 15 year recovery period, the property needs to meet certain restrictive tests.

Expenditures for enlarging a building, any elevator or escalator, or the internal structural framework of the building do not qualify as either QIP or QLHI.

New Property Type under PATH Act

• QLHI requires that building be placed in service at least 3 years before the improvement; QIP only requires that property be placed in service before the improvement (no time requirement).

• No lease requirement for QIP. Property can be owned by taxpayer.

• QIP 39 year recovery period vs. 15 year for QLHI

QIP vs. QLHI (DIFFERENCES)

• Both QIP and QLHI qualify for bonus depreciation.

• Expenditures for enlarging a building, any elevator or escalator, or the internal structure framework of the building do not qualify as either QLHI or QIP.

QIP AND QLHI SIMILARITIES

ABC Corporation placed a building in service in 2014 which it leases to various occupants.In 2015, it makes improvements to interior common areas in part of its building. It mustdepreciate these improvements over:a. 15 year period with bonus depreciationb. 15 year period with no bonus

depreciationc. 39 year period with bonus depreciationd. 39 year period with no bonus depreciation

Quiz Question on Life of Improvement Property

D is the correct answer.The improvements do not qualify as QLHI because they were made only one year after the building was placed in service.The improvements also do not qualify as QIP since they were placed in service in 2015. QIP can only be used for expenditures on or after 1/1/16.

Quiz Question on Life of Improvement Property

• The taxpayer entered into a 7 year nonrenewable lease of a commercial building on 1/1/10. In 2015, as a tenant, he made $18,000 of improvements which qualify as QLHI. When the lease terminates on 12/31/16, how much of the unrecovered balance can he claim as an abandonment loss?a. $ 8,100b. $ 9,000c. $ 9,990d. $15,000

Quiz Question on Recovering Cost of Leasehold Improvements

A is the correct answer, $8,100.In 2015, 50% bonus of $9,000 can be claimed and regular depreciation of $300 (9,000/15 x ½ year) for a total of $9,300 can be claimed.In 2016, regular depreciation of $600 (9,000/15) can be claimed.18,000- 9,300-600 = 8,100 unrecovered basis

Quiz Question on Recovering Cost of Leasehold Improvements

• The TPR regulations had an effective date of 1/1/14; however they could be used retroactively for taxable years beginning on or after 1/1/12.

• Clarify when taxpayers should capitalize and when they should expense amounts that are paid to acquire, maintain, repair or replace tangible property.

• The regulations are close to 200 pages long and very complex!

Tangible Property Regulations Update

• The final regulations define material and supplies as tangible property used or consumed in a taxpayer’s operations that is not inventory, have a cost of $200 or less, and are reasonably expected to be consumed within one year. Supplies can be segregated in two categories:oIncidental suppliesoNon-incidental supplies

TYPES OF MATERIALS AND SUPPLIES

• The regulations provide an election to substitute a taxpayer’s capitalization threshold in place at the beginning of the year. Whether the taxpayer has an applicable financial statement (AFS) which is generally an audited financial statement determines the amount of the threshold.

• If the taxpayer has an AFS and written capitalization procedures, the maximum threshold is $5,000.

• If the taxpayer does not have an AFS but does have capitalization procedures, the maximum threshold was $500. For tax years beginning on or after 1/1/16, it was raised to $2,500.

DE MINIMUS RULE UNDER REG. SECTION 1.263(a)-1(f)

A delivery company services its own trucks. They maintain on hand various belts to be used in the operating of the trucks. The belts cost $20 each. The company purchased a total of $30,000 of belts during the year. Belts were on hand at the beginning and end of the year of $5,000 and $8,000 respectively. For financial accounting purposes the company reported $30,000 as expense for the belts. Assuming the delivery company does not elect to use the de minimus rules, what is the company’s deduction for tax purposes?

a)$30,000b)$27,000c)$22,000d)$35,000

QUIZ QUESTION RELATED TO MATERIALS AND SUPPLIES

The correct answer would be (B) $27,000 computed as follows: 5,000 Beginning Inventory 30,000 Purchases

35,000 8,000 Ending

Inventory 27,000 Cost of Belts to be Deducted as Expense


Assuming the same circumstances in the question above, what would be the company’s deduction for tax purposes if it elects the de minimus rules?


Assuming the taxpayer qualifies for the de minimis rules election, the correct answer would be A. $30,000.Under this election, a taxpayer follows its written capitalization policy for both book and tax purposes.


The significance of the distinction between “incidental” supplies and “non-incidental” supplies is that:

a) Incidental supplies and materials are carried on hand but no records are maintained as to the flow of goods.

b) Incidental supplies can be deducted in the year of purchase.

c) Incidental supplies are always an indirect cost of production.

d) Incidental supplies always cost less than non-incidental supplies.


The correct answer is:a) Incidental supplies and materials

are carried on hand but no records are maintained as to flow of goods.


• The de minimis safe harbor election can also be made for fixed assets as well as supplies.

• Businesses must have accounting procedures in place on the first day of the tax year.

• The minimum capitalization policy must be

followed for both book and tax purposes.

• Taxpayers that elect the de minimis safe harbor must apply it to all qualifying amounts paid (including materials and supplies) that meet the de minimis requirements.

BUSINESS CAPITALIZATION POLICIES FOR FIXED ASSETS

The taxpayer elected to expense all items costing $500 or less in the year the item was put into use. During the year, the taxpayer placed in service small tools that cost $250 each and equipment items that cost $450 each. The financial conformity requirement was satisfied. For the current year:

a)The tools and equipment must be capitalized.b)The tools must be capitalized but the equipment

must be expensed.c)Both the tools and the equipment can be expensed.d)The equipment must be capitalized but the tools

can be expensed.

QUIZ QUESTION RELATED TO CAPITALIZATION POLICY FOR FIXED ASSETS

The correct answer is: c) Both the tools and equipment

can be expensed.


A taxpayer has AFS and a $5,000 written capitalization policy in place at the beginning of the year. The taxpayer pays for 5 copiers at $2,000 each per the invoice. If the taxpayer decides to elect the de minimus safe harbor election, how much may he deduct as expense in the current year?

a)Nothing; they must be capitalized and depreciated.

b)$2,000c)$5,000d)$10,000


The correct answer is: d)$10,000.


Which of the following is true regarding the deMinimis rule for tangible property?

a)It only applies to depreciable property.b)It only applies to taxpayers who have

audited financial statements.

c)The maximum deduction is a percentage of depreciation for the year.

d)The deduction cannot exceed $5,000 per unit of property.

Quiz Question - De Minimis Rule for Tangible Property

• The correct answer is:

d) the deduction cannot exceed $5,000 per unit of property (for taxpayers with an AFS).• A is incorrect – it applies to all tangible property

including materials & supplies.• B is incorrect – taxpayers without an AFS can

qualify but they are limited to items costing $2,500 or less

• C is incorrect – a percentage of depreciation not used

Quiz Question – De Minimis Rulefor Tangible Property

• The regulations introduce the concept “unit of property” (UOP) for purposes of evaluating when repairs must be capitalized.

• A UOP is defined as one that can function independently. When a UOP fails and must be replaced, the failed asset must be retired and a gain or loss recognized. However, if the failed item is deemed a component of a larger UOP, its replacement may be deemed a repair.

REPAIRS AND MAINTENANCE

The regulations take a similar approach with real property. A building is considered to be comprised of the building itself and the following component systems:

a. Heating, ventilation and air conditioning (HVAC).b. Plumbing System.c. Electrical System.d. Escalators and Elevators.e. Fire Protection and Alarms.f. Security System.g. Gas Distribution System.h. Structural components such as the roof, windows,

door and exterior walls.

REPAIRS AND MAINTENANCE

The breakdown into a building’s component systems was purposely created for testing repair costs against the cost of the component system itself rather than against the cost of the total building.

The small the UOP, the more likely the expenditure will need to be capitalized.

WHY IS THIS SIGNIFICANT?

• A taxpayer may recognize a loss on the retirement of a structural component of a building or a component of any other asset.

• This election allows treating the retirement of any portion of an asset as a disposition.

• Election must be made by the due date of the original federal tax return in which the taxpayer disposes of the portion of the asset.

• A taxpayer who has made this election also has the option to deduct removal costs associated with the partial disposition.

Partial Asset Disposition Election

Routine repairs and maintenance are defined as work that is expected to be performed more than once in the life of the asset. This category includes inspecting, cleaning, testing and replacement of damaged parts. Routine maintenance is expensed as paid.

However, certain non-routine repairs are required to be capitalized and may be categorized in one of the following three categories based on the action or the result of the repair.

ROUTINE VS. NON-ROUTINE MAINTENANCE

1. Betterments must be capitalized which would include:• Fixing material defects known at time of

acquisition.• Repairs that result in a material addition

to the property.• Repairs that result in a material

increase in productivity, strength, efficiency, quality or output.

• Change in value standard must be met.

TYPES OF NON-ROUTINE MAINTENANCE

2. A restoration brings the property back up to its intended use. Repairs in this category are capitalized when:• Property is rebuilt at the end of its

depreciable life.• Replacement of a major component or

structural part of the property occurs.• Property is remediated to efficient operating

condition after it reaches a state of disrepair.• Restoration of a property after a loss/basis

adjustment occurs.


3. An adaptation is the cost to convert property to a new different use not consistent with its normal use. Examples include:• Converting manufacturing space into a

showroom.• Developing land in the original

manufacturing site into land now plotted for individual residential housing.

• A retail pharmacy adapting a portion of the pharmacy floor space into a walk-in clinic.


The taxpayer periodically performs heavy duty maintenance on its equipment. In which of the following is the work routine maintenance (to be expensed)?

a. The work is done every 4 years and the class life is 10 years.

b. The work is done at the end of the 6th year and the class life is 7 years.

c. Work is done in the 5th year of an 18 year asset and increases the asset capacity.

d. The work was done only once, in its 7th year of use when its guideline life was 5 years.

QUIZ QUESTIONS REGARDING REPAIRS & MAINTENANCE

The correct answer is:

A) the work is done every 4 years and the class life is 10 years.• B is incorrect – if work is done only once in the

class life of an asset, it may be considered a restoration rather than routine maintenance.

• C is incorrect – if it increases asset capacity, it is a betterment.

• D is incorrect – if property is rebuilt at the end of its depreciable life, it is a restoration.


The company had to uncover and repair a leaky underground storage tank.

a) The cost of uncovering and repairing the tank must be capitalized.

b) The cost of uncovering the tank is deductible but the cost of repairing the tank must be capitalized.

c) The cost of uncovering the old tank is a capital expenditure, but the cost of repairing the tank is deductible.

d) The cost of uncovering and repairing the tanks are deductible.


The correct answer is:d) the cost of uncovering and repair the tanks are deductible. Since faulty parts need to be replaced, this qualifies as routine maintenance and is currently deductible. No portion of the repair is required to be capitalized.


The company had to replace a leaky underground storage tank and took the partial disposition election.

a) The cost of removing the old tank and installing a new tank must be capitalized.

b) The cost of removing the old tank is deductible as a loss and the cost of installing a new tank must be capitalized.

c) The cost of removing the old tank is a capital expenditure, but the cost of installing the new tank is deductible.

d) The cost of removing and installing the tanks are deductible.


The correct answer is:b) The cost of removing the old tank is

deductible as a loss and installing a new tank must be capitalized. This would qualify as non-routine maintenance in the “restoration” category since a major component of the property is being replaced.


In determining whether an expenditure should be capitalized because it resulted in an improvement in the asset, the correct comparison is:

a. The condition of the property immediately before the expenditure and immediately after the expenditure.

b. The condition of the property immediately after the expenditure as compared to its condition had the expenditure not been made.

c. The condition of the property compared to other similar property.

d. The condition of the property immediately after the expenditure as compared to the condition of the property before the use which made the expenditure necessary.

Quiz Question Regarding Change in Value Standard


d)If the value of the property after the expenditure is greater than it was prior to the use which made the expenditure necessary, the value increased and the expenditure should be capitalized.

However, if the value of the property after the expenditure is no greater than the value of it prior to the use which made it necessary, the expenditure can be expensed as routine maintenance.

Quiz Question Regarding Change in Value Standard

There is a special small business safe harbor election that permits a small business to expense certain building improvements instead of capitalizing the cost.• Available if taxpayer has average gross

receipts for the last three years of $10 million or less.

• Qualified taxpayers may elect to be excluded from the improvement rules for any building with an unadjusted basis of $1 million or less.

SMALL TAXPAYER SAFE HARBOR FOR BUILDING REPAIRS

This exclusion allows the taxpayer to:• Expense all repairs, maintenance and

improvements for the lesser of $10,000 or 2% of the unadjusted basis of the building.

• Apply the election on a building-by-building basis.

SMALL TAXPAYER SAFE HARBOR FOR BUILDING REPAIRS

Expenses which are related to the questions “whether to acquire a business” and “which business to acquire” are deductible when incurred.

Once the final decision is made to acquire a business, then any further investigatory expenses become expenses attributable to facilitating consummation of the acquisition and must be capitalized along with the cost of the property acquired.

ACQUISITION COSTS OF REAL PROPERTY

Some costs the regulations consider “inherently facilitative” are:

• Transporting the property.• Determining value of real property.• Negotiating terms or structure of the acquisition and obtaining tax

advice on the acquisition.• Application fees, bidding costs or similar expenses.• Preparing and reviewing documents for the acquisition of the property.• Obtaining regulatory approval or securing permits.• Finders’ fees or brokers’ commissions.• Architectural or inspection services.

If any of these costs are capitalized under these rules, but the property is not acquired, the costs can become a deductible loss.

However, inherently facilitative costs are capitalized even if paid during the “whether and which” process.

ACQUISITION COSTS OF REAL PROPERTY

• The regulations, consistent with prior court decisions, require the capitalization of the cost of defending title to property.

• However, costs of defending the particular use of business property can be expensed.

COST OF DEFENDING TITLE

ABC Corporation hired a consultant to help decide whether to open a new branch office. The consultant concluded that it would be cost effective to open a new branch in either of two locations. The consultant’s charge for his services was $25,000. ABC Corp. paid an appraiser $2,500 each to determine the market value of the two properties. The company offered the appraisal price for one of the properties, $250,000, which was accepted. As a result, ABC :

a) May expense $30,000.b) May expense $25,000 and take a loss for $2,500.c) May expense $5,000 appraisal fees.d) Must capitalize $280,000.

QUIZ QUESTION RELATED TO ACQUISITION COSTS OF REAL PROPERTY


b) May expense $25,000 and take a loss for $2,500.

• A is incorrect because ABC Corp. may not expense appraisal fees because they are considered an “inherently facilitative” expense.

• C is incorrect because ABC Corp. must capitalize the $2,500 appraisal fee related to the property it actually acquires.

• D is incorrect because ABC Corp must capitalize $252,500 (the $250,000 fair market value of the property and the $2,500 appraisal fee related to this property).

QUIZ QUESTION RELATED TO ACQUISITION COSTS OF REAL PROPERTY

The taxpayer purchased land and used it in the business for the next 3 years before a relative of the person who sold the land to the company filed a lawsuit claiming that the company did not have good title to the property. The company spent $25,000 successfully defending its title to the land.

a) The $25,000 must be capitalized as a cost of the land.

b) The $25,000 can be deducted as a Section 1231 loss.

c) The $25,000 can be deducted as an expense.d) The $25,000 must be amortized over 3 years.

QUIZ QUESTION RELATED TO REAL PROPERTY

The correct answer is:a) the $25,000 must be capitalized as cost of the land.

QUIZ QUESTION RELATED TO REAL PROPERTY

• Does client have written capitalization procedures? If not, should these be adopted? Does client wish to elect de minimis expensing rules for tangible property?

• Tax needs to be aware of what type of engagement the Audit staff has completed since this affects the amount of de minimis deduction.

• If client has a large amount in “repair expense” or “supplies expense”, tax may need to complete further investigation to see if expenditures qualify as repair/supplies expense for tax purposes.

• Is the client involved in any projects in which the partial disposition election could be elected?

• Does client qualify for small business safe harbor for building repairs?

• Determination of repair v. capitalization is highly factual.• Must analyze each cost in the context of “unit of property”.

How do we apply these rules?

• For example, a taxpayer incurs $30,000 cost for 5 new plumbing fixtures in a small 5,000 square foot building; likely a capital improvement.

• However, the same $30,000 cost for 5 new plumbing fixtures in a large 50,000 square foot building is more likely a repair.

• Same items replaced, but facts and circumstances require different treatment!


• Communication with the client is key to successfully implementing these rules to derive the greatest tax benefit from them.

• Also, communication between the Audit and Tax staff is needed so that Audit is aware of the information that Tax needs in order to determine what elections/positions will benefit the client’s situation.


Questions?

Lora Ament [email protected]

TAX DEPRECIATION AND TANGIBLE PROPERTY REGULATIONS UPDATE without detail_for Presentation slides (2)

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