Final repair regulations: What has changed and how will it impact you?
 

Final repair regulations: What has changed and how will it impact you?

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This webcast will provide you with an overview of the most significant aspects of the recently issued tangible property regulations that provide guidance on how to treat amounts paid to acquire, ...

This webcast will provide you with an overview of the most significant aspects of the recently issued tangible property regulations that provide guidance on how to treat amounts paid to acquire, produce and improve tangible property (“repair regulations”), as well as re-proposed regulations regarding the disposition of depreciable property. The webcast will focus on important differences between the previous and new regulations, including opportunities and challenges relating to repairs, dispositions, asset groupings and the de minimis rules. In addition, we will address the transition rules to make changes in methods of accounting under the new regulations.

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  • Routine maintenance can be performed at anytime during the life of the property

Final repair regulations: What has changed and how will it impact you? Final repair regulations: What has changed and how will it impact you? Presentation Transcript

  • CPE Credit is not available for viewing archived programs. Please visit http://www.grantthornton.com/events for upcoming programs. Final repair regulations: What has changed and how will it impact you? Original Broadcast Date: October 2013 © Grant Thornton LLP. All rights reserved.
  • Presenters David Auclair Jim Wittmer National Managing Principal Washington National Tax Office Washington, D.C. Northeast Region Leader Strategic Federal Tax Services Philadelphia, Pa. Joe Brown Midwest Region Leader Strategic Federal Tax Services Chicago, Ill. © 2013 Grant Thornton LLP. All rights reserved. 2
  • Final repair regulations: What has changed and how will it impact you? Learning objectives • Identify opportunities and challenges in implementing the new rules • Determine action steps for applying the final regulations, temporary regulations or a combination thereof © 2013 Grant Thornton LLP. All rights reserved. 3
  • What was issued? • Final regulations under 162 and 263(a) – Amounts paid to acquire, produce, or improve tangible property • Re-proposed regulations under 168 – General asset accounts and disposition of depreciable property • IRS and Treasury expect to finalize these regulations in 2014 © 2013 Grant Thornton LLP. All rights reserved. 4
  • Practical implications Rules affect any business that owns or leases tangible property. Therefore these rules affect all businesses © 2013 Grant Thornton LLP. All rights reserved. 5
  • Final repair regulations: What has changed and how will it impact you? Agenda • Improvements to tangible property • Dispositions • De Minimis • Materials and supplies • Effective dates • Next steps © 2013 Grant Thornton LLP. All rights reserved. 6
  • Improvements to property General rule A taxpayer (TP) must generally capitalize an amount that IMPROVES a unit of property ("UOP") if the amount: (1) Is for a betterment; (2) Restores the UOP; or (3) Adapts the UOP to a new or different use. © 2013 Grant Thornton LLP. All rights reserved. 7
  • Unit of property • General rule: functional interdependence test • Special rules: buildings, plant property, network assets, and leased property – Improvement standards must be applied separately to building structure and building system • Clarification of unit of property for leasehold improvements – For work done on an addition previously made to a leased building, consider the entire leased structure, not merely the addition © 2013 Grant Thornton LLP. All rights reserved. 8
  • Unit of property Building systems include: - HVAC systems - Plumbing systems - Electrical systems - All escalators - All elevators © 2013 Grant Thornton LLP. All rights reserved. - Fire protection and alarm systems - Security systems - Gas distribution systems - Any other structural components in published guidance 9
  • Betterments • General rule: A TP must capitalize an amount paid for a "betterment" • An amount is paid for 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 to or addition of a major component to the UOP, or a material increase in the capacity of the UOP; – Results in a material increase in productivity, strength, efficiency, or quality of the UOP or the output of the UOP. © 2013 Grant Thornton LLP. All rights reserved. 10
  • Betterments New and revised examples Retail store refresh/remodel Ex. 6 (refresh): No significant changes Ex. 7 (limited improvement): Significantly different facts, clear improvement separate from refresh activities Ex. 8 (major remodel): Significantly different facts, clear improvement impacting most of store Future refresh/remodel guidance in retail Industry Issue Resolution project © 2013 Grant Thornton LLP. All rights reserved. 11
  • Betterments New and revised examples Material increase in capacity/efficiency Ex. 17: 25% increase in depth of channel = material increase in capacity Ex. 20: 10% increase in energy efficiency of 2 out of 10 roof mounted HVAC units = no material increase in efficiency Ex. 21: 50% reduction in energy and power costs from new insulation = material increase in efficiency © 2013 Grant Thornton LLP. All rights reserved. 12
  • Betterments New and revised examples Material addition Ex. 22: Drive through service area added = material addition (physical expansion, extension, and addition of a major component) © 2013 Grant Thornton LLP. All rights reserved. 13
  • Restorations 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; 2) Is for the replacement of a part or a combination of parts that comprise a major component or a structural part of the UOP; 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; © 2013 Grant Thornton LLP. All rights reserved. 14
  • Restorations An amount restores property if the amount (continued): 4) 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); 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 Grant Thornton LLP. All rights reserved. 15
  • Restorations • Clarification of distinction between major component and substantial structural part Major component Substantial structural part Part or combination of parts that perform a discrete and critical function in the operation of the UOP Part or combination of parts that comprises a large portion of the physical structure of the UOP • Incidental component, even though performs discrete function, is not restoration © 2013 Grant Thornton LLP. All rights reserved. 16
  • Restorations Clarified definitions New definition provided for major component and substantial structural parts of building • The replacement includes a part or combination of parts that comprise a major component or a significant portion of a major component of the building structure or building system, or • The replacement includes a part or combination of parts that comprises a large portion of the physical structure of the building structure or building system © 2013 Grant Thornton LLP. All rights reserved. 17
  • Restorations New favorable casualty loss rule • New casualty loss rule: – TP permitted to take a deduction, if otherwise permissible, in excess of adjusted basis of the property damaged in the casualty event • Still no deduction for replacement property to extent of adjusted basis in destroyed property due to the casualty loss rules in 165 which require the loss to be claimed and basis reduced, which triggers the restoration rules © 2013 Grant Thornton LLP. All rights reserved. 18
  • Restorations New and revised examples Restoration Not a restoration • 1 chiller in HVAC system • 1 of 3 furnaces • Entire sprinkler system • 3 of 10 roof HVAC units • All wiring in building • 30% of electrical wiring • All restroom fixtures • 8 of 20 sinks • 200 of 300 windows • 100 of 300 windows (300 windows cover 25% of building surface area) • 100 of 300 windows (windows cover 90% of building) • 40% of sq ft of flooring • 10% of sq ft of flooring • 1 of 4 elevators © 2013 Grant Thornton LLP. All rights reserved. 19
  • New or different use An amount is paid to adapt a UOP to a new or different use if the adaptation is not consistent with the TP's ordinary use of the UOP at the time originally placed in service © 2013 Grant Thornton LLP. All rights reserved. 20
  • New or different use New and revised examples New or different use: Not a new or different use: • Manufacturing plant to showroom space • 3 leased retail spaces into 1 leased retail space • Develop land used for manufacturing plant as residential housing • Preparing a building for sale • Retail drug store converts area of pharmacy to walk-in medical clinic © 2013 Grant Thornton LLP. All rights reserved. • Grocery store converts existing store space into sushi bar • Hospital modifies emergency room to also provide outpatient surgery clinic 21
  • Other costs incurred during improvement 263A retained; new rule for removal costs • Section 263A standard to be applied: – Costs that directly benefit or are incurred by reason of the improvement should be capitalized • New special rule for removal costs: – If a TP disposes of a depreciable asset (including partial disposition) and has taken into account adjusted basis, costs of removing that asset are not required to be capitalized • Related amounts: – Amounts paid over a period of more than one taxable year © 2013 Grant Thornton LLP. All rights reserved. 22
  • Routine maintenance safe harbor Expanded to buildings • Amount paid for routine maintenance deemed not to improve property if a taxpayer reasonably expects to perform more than once during: – 10 year period from PIS date for building property, or – The ADS class life for all property other than building property • Applied to building structure and each building system, or UOP for non-building property • Routine activities include: inspecting, cleaning, testing and replacement of damaged parts © 2013 Grant Thornton LLP. All rights reserved. 23
  • New election Safe harbor for buildings of small taxpayers • Taxpayers with average annual gross receipts of $10 million or less may elect not to apply the improvement rules to a building with an unadjusted basis of $1 million or less if – Total amount paid during the year for repairs, maintenance, improvements and similar activities on building cannot exceed the lesser of $10,000 or 2% of unadjusted basis of the building and • Elected annually for each building; and • Amounts deducted under de minimis and routine maintenance safe harbors are included. © 2013 Grant Thornton LLP. All rights reserved. 24
  • New election Election to capitalize repair and maintenance costs • TP's may elect to capitalize amounts incurred during the year as costs of improvements if TP capitalizes the amounts on its books and records • Election applies to all amounts treated as capital for books each year • Election made by attaching a statement to the return each year © 2013 Grant Thornton LLP. All rights reserved. 25
  • Highlights Improvements to real property Significant changes New elections • Addition of a major component and material increase in capacity are betterments • Election to capitalize repair costs • Replacement of significant portion of a major component of a building is restoration • Treatment of removal costs • New and revised examples • Routine maintenance safe harbor now applies to buildings Issues and opportunities • Annual elections need to be considered each year – not available retroactively • New examples under restoration provide increased replacement percentages over prior • §263A applies- no plan of rehabilitation © 2013 Grant Thornton LLP. All rights reserved. 26 What's the effect? • Safe harbor elections made each year = no 481(a) adjustment • Repair or capitalize changes = 481(a) adjustment
  • Final repair regulations: What has changed and how will it impact you? Agenda • Improvements to tangible property • Dispositions • De Minimis • Materials and supplies • Effective dates • Next steps © 2013 Grant Thornton LLP. All rights reserved. 27
  • Dispositions • Re-proposed regulations • Retirement of a structural component no longer mandatory – Need for general asset account election eliminated • Disposition includes sale, exchange, retirement, physical abandonment or destruction of an asset • Disposition also occurs when asset is transferred to a supplies or scrap account or when a portion of an asset is disposed of in sale, casualty event, like-kind exchange, involuntary conversion or tax-free transfer © 2013 Grant Thornton LLP. All rights reserved. 28
  • Dispositions New election • TP may elect to dispose of a portion of an asset. Includes: – Structural components (or components thereof) of a building – Components or portions of 1245 assets • Eliminates the need for TP to determine reasonable and consistent method for 1245 assets • Election is made in year of partial disposal by claiming gain, loss or other deduction on the return © 2013 Grant Thornton LLP. All rights reserved. 29
  • Dispositions New election • Partial disposition (other than required situations) is a not a method of accounting. • Election can only be made in the year of disposition, with the exception of situations where a taxpayer deducts a replacement cost as a repair and later has that item adjusted by the IRS – Method change can be filed after exam to go back and claim partial disposition for the basis of asset that was disposed of in the replacement © 2013 Grant Thornton LLP. All rights reserved. 30
  • Dispositions Determination of asset • General rule = facts and circumstances • Special rules: – Each building is the asset – Each condo/coop unit is the asset – Each item in asset classes 00.11 to 00.4 or §168(e) is the asset – Each addition or improvement to an asset after placed in service is a separate asset © 2013 Grant Thornton LLP. All rights reserved. 31
  • Dispositions Identification of asset disposed • General rule = specific identification • Special rule for mass assets or partial disposition (where impracticable to determine the taxable year the asset was placed in service) – FIFO – Modified FIFO – Mortality dispersion table – Any other method designated in subsequent guidance – LIFO is not allowed © 2013 Grant Thornton LLP. All rights reserved. 32
  • Dispositions Basis of asset disposed of • General rule = adjusted depreciable basis at disposal • Special rule for mass assets or partial disposition = any reasonable method – Discounting the cost of replacement portion of the asset to its placed-in-service year cost using the consumer price index – Pro rata allocation of the unadjusted depreciable basis of the asset based on replacement cost of disposed portion – Study allocating the cost of the asset to individual components © 2013 Grant Thornton LLP. All rights reserved. 33
  • Dispositions New example • TP replaces 60% of roof in 2012- capitalizes replacement and makes partial disposition election • In 2022, TP replaces 55% of the roof of the building- capitalizes replacement makes the partial disposition election for the replaced portion • TP cannot determine from its records whether the 55% is part of the 60% replaced in 2012 or whether it is part of the original 40% of the roof • TP uses the FIFO method to identify the asset disposed of © 2013 Grant Thornton LLP. All rights reserved. 34
  • Dispositions New example - conclusion How is the asset that is disposed of determined when TP replaces 55% of the roof? • Building is asset (including original roof) and 60% of roof replacement in 2012 is a separate asset • TP disposed of the remaining 40% of the original roof and 25% of the 60% of the roof replaced in 2012 © 2013 Grant Thornton LLP. All rights reserved. 35
  • Highlights DISPOSITIONS Significant changes New elections • Asset for disposal purposes is no longer building structure and building components- building is the asset (eliminates need for general asset account election) Partial disposition election • Partial disposition election for buildings and personal property • Required partial disposition for casualty, tax-free exchanges and sales What's the effect? Awaiting guidance on availability of retroactive partial disposition election Issues and opportunities • For years starting after 1/1/14, partial disposition election can only be made in the year disposition occurs- requirement for clients to track each year • Regs. provide that reasonable methods can be used to determine basis of assets disposed (i.e. replacement trending, study, allocation methods) © 2013 Grant Thornton LLP. All rights reserved. 36
  • Final repair regulations: What has changed and how will it impact you? Agenda • Improvements to tangible property • Dispositions • De Minimis • Materials and supplies • Effective dates • Next steps © 2013 Grant Thornton LLP. All rights reserved. 37
  • De Minimis • Ceiling limitation eliminated – No need to track expenses • Replaced with safe harbor election which is based on policies used for financial books and records at an invoice or item level • Taxpayers without an applicable financial statement can now deduct reduced de minimis amount • For amounts above safe harbor, taxpayer needs to demonstrate clear reflection of income © 2013 Grant Thornton LLP. All rights reserved. 38
  • De Minimis • Applicable financial statement – A financial statement required to be filed with the Securities and Exchange Commission; – A certified audited financial statement that is accompanied by the report of an independent certified public accountant that is used for credit purposes, reporting to shareholders, partners or similar persons, or any other substantial non-tax purpose; or – A financial statement (other than a tax return) required to be provided to the federal or state government or any federal or state agency © 2013 Grant Thornton LLP. All rights reserved. 39
  • De Minimis New election TP with an applicable financial statement • Written policy in place at beginning of year • Policy to expense property costing less than a certain dollar amount or property with an economic useful life of 12 months or less • Deducts such amounts in applicable financial statements • Amount paid does not exceed $5,000 per invoice (or per item as substantiated by invoice) © 2013 Grant Thornton LLP. All rights reserved. 40
  • De Minimis New election TP without an applicable financial statement • Written policy in place at beginning of year • Policy to expense property costing less than a certain dollar amount or property with an economic useful life of 12 months or less • Deducts such amounts in applicable financial statements • Amount paid does not exceed $500 per invoice (or per item as substantiated by invoice) © 2013 Grant Thornton LLP. All rights reserved. 41
  • De Minimis New election • Safe harbor is elective each year – Must include statement in the return • Election applies to all eligible materials and supplies • Labor, overhead, transaction and other costs of acquisition can be included in de minimis safe harbor provided the invoice includes such costs • Section 263A does still apply to amounts deductible under de minimis if expected to be used in production of other property © 2013 Grant Thornton LLP. All rights reserved. 42
  • De Minimis New election- applicable financial statements With AFS Without AFS • Written policy to deduct $10,000 or less • Written policy to deduct $1,000 or less • Purchase 1,000 computers for $5,000 each-substantiated by invoice • Purchase 10 computers at $600 each • Deduct each computer as de minimis • Cannot use safe harbor because each item is above $500 • Would not be able to use safe harbor if computers over $5,000 • Would be able to deduct if computers were $500 each © 2013 Grant Thornton LLP. All rights reserved. 43
  • De Minimis Example- additional invoice costs • TP w/AFS has written policy to deduct amounts under $5,000 • Purchases wireless routers for office • Invoice includes price per router of $2,500 and $20,000 total for delivery and installation • $20,000 allocated on a pro-rata basis to each of the 10 routers • Total cost for each router is $4,500 and can be deducted under the de minimis rule © 2013 Grant Thornton LLP. All rights reserved. 44
  • Highlights DE MINIMIS Significant changes New elections • No ceiling limit or tracking requirement • Safe harbor based on invoice/item price: – TP w/AFS = $5,000 – TP w/o AFS = $500 • Includes transaction costs and other costs of acquisition (i.e. labor and OH) • If elected, applies to all materials and supplies De Minimis safe harbor What's the effect? Only applies to amounts incurred in the year adopted: no retroactive adjustment Issues and opportunities • Election must be made each year- statement attached to return • Taxpayers without audited financial statements can now take advantage of a de minimis deduction • Written accounting policy must be in place on first day of taxable year to which election applies • Amounts not subject to de minimis must meet clear reflection or capitalize © 2013 Grant Thornton LLP. All rights reserved. 45
  • Final repair regulations: What has changed and how will it impact you? Agenda • Improvements to tangible property • Dispositions • De Minimis • Materials and supplies • Effective dates • Next steps © 2013 Grant Thornton LLP. All rights reserved. 46
  • Materials and supplies • Materials and supplies include: • Components acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer that is not acquired as part of any single unit of property • Fuel, lubricants, water and similar items expected to be consumed in 12 months or less • Property with economic useful life of 12 months or less • Property with acquisition cost of $200 or less © 2013 Grant Thornton LLP. All rights reserved. 47
  • Materials and supplies • Rules largely the same as temporary regulations • Some changes – Definition now includes property that has an acquisition or production cost of $200 or less (increased from $100) – Definition of standby emergency spare parts included – Election to capitalize certain materials and supplies now only applicable to rotable, temporary or standby emergency spare parts © 2013 Grant Thornton LLP. All rights reserved. 48
  • Materials and supplies • Non-incidental supplies – Deductible in the year in which the materials are first used or consumed in the taxpayer's operations • Incidental supplies – Deductible in the year in which amounts are paid Incidental supplies are those for which no record of consumption is kept or physical inventories at beginning and end of year are not taken © 2013 Grant Thornton LLP. All rights reserved. 49
  • Highlights MATERIALS AND SUPPLIES Significant changes New elections • Definition now includes property with acquisition or production cost of $200 or less (increased from $100) Election to capitalize now only applies to rotable, temporary or emergency spare parts • Definition of emergency spare parts What's the effect? Final regulations only apply to amounts incurred on or after 1/1/14, unless early adopt. No retroactive adjustment Issues and opportunities • Clear definition of materials and supplies • Can elect to deduct under de minimis, applies to all eligible materials and supplies © 2013 Grant Thornton LLP. All rights reserved. 50
  • Final repair regulations: What has changed and how will it impact you? Agenda • Improvements to tangible property • Dispositions • De Minimis • Materials and supplies • Effective dates • Next steps © 2013 Grant Thornton LLP. All rights reserved. 51
  • Effective dates • Final and re-proposed regulations effective for years beginning on or after January 1, 2014 • TP may choose to apply the final, reproposed, temporary or any combination thereof for 2012 and 2013 • Transitional relief for elections in 2012 and 2013 © 2013 Grant Thornton LLP. All rights reserved. 52
  • Transitional rules • Revenue procedures expected to be issued in November • Expected to provide for late partial disposition election for 2012, 2013, and 2014 tax years • Will provide guidance on changes made under the temporary regulations © 2013 Grant Thornton LLP. All rights reserved. 53
  • Final repair regulations: What has changed and how will it impact you? Agenda • Improvements to tangible property • Dispositions • De Minimis • Materials and supplies • Effective dates • Next steps © 2013 Grant Thornton LLP. All rights reserved. 54
  • Next Steps • Compare current policies – Acquisition policy (de minimis) – Capitalization policy (repairs) • Consider modification to current procurement process – Capital expenditures request (CER) – Capital appropriations request (CAR) • Consider current method change opportunities • Consider annual elections going forward © 2013 Grant Thornton LLP. All rights reserved. 55
  • Next Steps • Consider state and local tax impact – Possible sales and property tax differences • Consider financial statement impact © 2013 Grant Thornton LLP. All rights reserved. 56
  • Method change opportunities • Deduct repair and maintenance costs – Use the routine maintenance safe harbor to deduct routine costs • Possible late partial disposition election to recoup costs from pre-2012 dispositions • Materials and supplies • Depreciation methods and lives • Possible tax reform impact © 2013 Grant Thornton LLP. All rights reserved. 57
  • New annual elections • Partial disposition • De Minimis safe harbor (statement required) • Capitalize repair and maintenance costs (statement required) • Safe harbor for small taxpayers (statement required) • Capitalize and depreciate any rotable, temporary or emergency spare part © 2013 Grant Thornton LLP. All rights reserved. 58
  • Comments? Questions? © 2013 Grant Thornton LLP. All rights reserved. 59
  • Contact Information David Auclair Jim Wittmer National Managing Principal Washington National Tax Office David.Auclair@us.gt.com Northeast Region Leader Strategic Federal Tax Services Jim.Wittmer@us.gt.com Joe Brown Midwest Region Leader Strategic Federal Tax Services Joseph.Brown@us.gt.com © 2013 Grant Thornton LLP. All rights reserved. 60
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