2. summary of the new depreciation rules


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2. summary of the new depreciation rules

  1. 1. Tax Insights:IRS releases long-awaited‘repair’ regulationsOn Dec. 23, 2011, new regulations proposed regulations. The revenue Bettermentswere issued addressing when costs are procedures contain transition rules and The regulations provide specific rules forrequired to be capitalized to tangible procedures for changing to the methods determining whether expenditures resultproperty or may be deducted as repair and described in the regulations. in a betterment of a unit of property andmaintenance costs. The new regulations therefore would result in capitalization ofreplace proposed regulations issued in Units of property costs. Of note, the regulations specificallyMarch 2008. The regulations provide detailed rules for provide that an amount results in a On March 7, 2012, the IRS issued two determining the proper unit of property. betterment to a building if it results inrevenue procedures (Rev. Procs. 2012-19 Although these rules generally provide that a betterment to a structural componentand 2012-20) that provide taxpayers with a building and its structural components or a building system. The regulationsrules for filing method changes under the are a single unit of property, the tests to contain a number of examples to illustratenew “repair” regulations. determine if property has been improved the application of the betterment rules. This document provides a summary of must be applied to the building structure Included in the examples are three factsome of the highlights of the regulations (which is defined as the building and situations involving costs incurred by retailand revenue procedures. its structural components other than stores that the regulations label as: specifically identified building systems) and (1) building refresh,What was issued each of the following building systems: (2) building refresh with limitedTreasury and the IRS issued temporary (1) Heating, ventilation and air improvement, andregulations (regulations) that provide conditioning (HVAC) systems (3) substantial remodel.guidance on amounts paid to improve (2) Plumbing systemstangible property (commonly referred to (3) Electrical systemsas the repair regulations). The regulations (4) Escalatorsalso provide guidance on amounts paid to (5) Elevatorsacquire or produce tangible property, as (6) Fire-protection and alarm systemswell as guidance regarding the disposition (7) Security systemsof property. The regulations are generally (8) Gas distribution systemseffective for taxable years beginningon or after Jan. 1, 2012. The text of the The regulations also provide expandedregulations was simultaneously issued as rules for determining the unit of propertyproposed regulations and the previous in situations where property is leasedproposed regulations were withdrawn. and provide special rules for determiningThe regulations include rules that are improvement costs in lease situations.significantly different from currentregulations and the previously issued
  2. 2. IRS releases long-awaited ‘repair’ regulationsThe examples conclude that: The regulations instead provide a facts- Plan of rehabilitation(1) none of the building costs are required and-circumstances test for determining The regulations do not provide for a plan to be capitalized in the building refresh whether a major component or substantial of rehabilitation doctrine as described example; structural part is replaced. The regulations in case law. Instead, the regulations(2) some of the building costs are required also provide that a major component or incorporate the Section 263A standard for to be capitalized in the building refresh substantial structural part includes: the treatment of repair and maintenance with limited improvement example; (1) a “large portion” of the physical costs performed during an improvement and structure of the unit of property, or and require capitalization of all indirect(3) all of the building costs are required (2) a part or combination of parts costs that directly benefit or are incurred to be capitalized in the substantial that perform a discrete and critical by reason of an improvement. The remodel example. function in the operation of the unit preamble to the regulations providesThese three examples illustrate the general of property that is more than a “minor that the plan of rehabilitation doctrinerule in the regulations that a determination component.” is obsolete to the extent that the court-of whether costs result in a betterment created doctrine provided differentdepends on the facts and circumstances The regulations also contain the standards for determining whether anrelated to the costs. requirement that costs expended for the otherwise deductible indirect cost must be replacement of a component of a unit capitalized as part of an improvement.Restorations of property must be capitalized if theThe regulations also address whether taxpayer has properly deducted a loss for Routine maintenance safe harboran amount is paid to restore a unit of that component. The regulations introduce a routineproperty and therefore would result The regulations contain examples to maintenance safe harbor rule. If, at the timein capitalization of costs. These rules illustrate the restoration rules. Included are the unit of property is placed in service, it isspecifically provide that an amount is examples of costs related to the structural reasonably expected that the maintenancepaid to restore a building if it restores components of a roof, a roof membrane, activities will be performed more than oncea structural component or a building an HVAC system, a fire protection during the class life of the unit of property,system. Unlike the rules in prior proposed system, an electrical system, a plumbing the maintenance is deemed to not improveregulations, the regulations fail to provide system, windows and floors. The examples the unit of property. The regulations,a bright-line test for determining whether illustrate that the determination of whether however, specifically provide that the safethe costs result in a replacement of a major costs are required to be capitalized harbor does not apply to work performedcomponent or a substantial structural part depends on the nature and extent of the on buildings.of a unit of property. The prior proposed costs relative to the property.regulations defined replacement of a majorcomponent or substantial structural part tomean either:(1) costs that comprise 50 percent or more of the replacement costs of the unit of property, or(2) replacement of 50 percent or more of the physical structure of the unit of property. 2
  3. 3. Tax Insights: IRS releases long-awaited ‘repair’ regulationsDispositions General asset account election New automatic changesThe regulations also provide new rules for The regulations also expand the rules The new revenue procedures modify thedetermining gain or loss on the disposition related to general asset accounts (GAA), comprehensive list of automatic methodof depreciable property. Of significance is which allow taxpayers to group one or changes in Rev. Proc. 2011-14 by deletingthat the regulations expand the definition many assets in a GAA for depreciation several method changes and adding 19 newof disposition of property to include the purposes. Under the general rule, no gain automatic method changes, including theretirement of a structural component of a or loss is recognized upon the disposition following:building. This requirement will cause any of an asset from a GAA. Special elections • Deducting de minimis amountsamount expended to replace a structural allow taxpayers to recover the basis of • Changing to the safe harbor for routinecomponent of a building to be capitalized, disposals from the GAA at their discretion. maintenance on property other thaneven if the component is minor, because buildingsof the restoration rules requiring Amount paid to acquire or • Capitalizing improvements to tangiblecapitalization if a loss on a component is produce property propertyproperly deducted. To avoid burdensome The regulations also contain rules for • Disposing of a building or structuralresults under this rule, taxpayers will need amounts paid to acquire or produce componentto understand and apply new rules relating property. These include rules related to • Disposing of tangible depreciableto general asset accounts as discussed in material and supplies and rotable spare assets (other than a building or itsthe following. The regulations do not parts. In addition, the regulations contain structural components)require componentization of property a de minimis rule that allows a taxpayer • Electing general asset accountother than buildings, but will allow such in certain situations to deduct amounts treatmentcomponentization if the taxpayer is under a certain dollar amount if that isconsistent in identification of the asset. consistent with a written policy used for The new method changes are generally financial accounting purposes, provided made using a Section 481(a) adjustment. that amounts under this rule do not exceed However, the adjustment for method certain annual thresholds. The annual changes relating to the acquisition of threshold amount is the greater of: tangible property is made using a modified (1) 0.1 percent of the taxpayer’s gross cut-off approach, which means that only receipts for the taxable year as amounts paid or incurred after Jan. 1, determined for Federal income tax 2012, are included in the Section 481(a) purposes, or adjustment. In addition, certain of the (2) 2.0 percent of the taxpayer’s total disposal and depreciation changes are depreciation and amortization expense made using a modified cut-off approach. for the taxable year as determined in its The new revenue procedures specifically applicable financial statements. allow statistical sampling for certain method changes. The new revenue procedures do not, however, allow taxpayers to extrapolate data to an earlier taxpayer year. For all of the new method changes, certain scope limitations under the general automatic method change procedures are waived for the taxpayer’s first and second taxable year beginning after Dec. 31, 2011. 3
  4. 4. Tax Insights: IRS releases long-awaited ‘repair’ regulationsGeneral asset account late Next stepselection relief Taxpayers will want to determine howMost taxpayers have not previously made the new rules provided in the regulationsa general asset election under Section 168(i) may affect their current methods of(4) for their assets, including buildings and capitalizing or deducting costs to acquirestructural components. or improve tangible property. Taxpayers will also want to determine the timingUnder these new rules, however, it is for making automatic method changesanticipated that all taxpayers who own to comply with the new rules under the For more information, contact:or lease buildings will want to make such revenue procedures. It is expected that Scott Hamiltonan election for previous and future years. most taxpayers will need to file method Strategic Federal Tax GroupThe revenue procedures allow taxpayers changes to make the late general asset Director, Southern California T 213.596.8426to make a retroactive general asset election account election and to change their E scott.hamilton@us.gt.comfor years prior to Jan. 1, 2012, by filing an methods of accounting for disposition ofautomatic method change, but only for the property and capitalization of amounts Rich Shevak Strategic Federal Tax Grouptaxpayer’s first two taxable years beginning paid to improve property. Although Senior Manager, Seattleafter Dec. 31, 2011. It is important for method changes cannot be filed for years T 206.398.2489taxpayers to be aware of this limited time beginning prior to Jan. 1, 2012, taxpayers E rich.shevak@us.gt.comframe for making the retroactive election will want to understand as soon as possible www.GrantThornton.com/taxthrough the automatic method change. how adjustments relating to methodAfter this time, retroactive elections will changes will affect financial accounting About Grant Thornton LLPnot be allowed as method changes. and estimated payment purposes. The people in the independent firms of Grant Thornton International Ltd provide personalized attention and the highest quality service to public and private clients Please contact Grant Thornton LLP for in more than 100 countries. Grant Thornton LLP is questions or to discuss how the regulations the U.S. member firm of Grant Thornton International Ltd, one of the six global audit, tax and advisory may affect a specific situation. organizations. Grant Thornton International Ltd and its member firms are not a worldwide partnership, as each member firm is a separate and distinct legal entity. The information contained herein is general in nature and basedTax professional standards statement on authorities that are subject to change. It is not intended andThis document supports the marketing of professional services by Grant Thornton should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader.LLP. It is not written tax advice directed at the particular facts and circumstances of This material may not be applicable to or suitable for specificany person. Persons interested in the subject of this document should contact circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or otherGrant Thornton or their tax advisor to discuss the potential application of this subject tax professionals prior to taking any action based upon thismatter to their particular facts and circumstances. Nothing herein shall be construed as information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that couldimposing a limitation on any person from disclosing the tax treatment or tax structure of affect information contained herein. No part of this documentany matter addressed. To the extent this document may be considered written tax advice, may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, includingin accordance with applicable professional regulations, unless expressly stated otherwise, by photocopying, facsimile transmission, recording, re-keying orany written advice contained in, forwarded with, or attached to this document is not using any information storage and retrieval system without written permission from Grant Thornton LLP.intended or written by Grant Thornton LLP to be used, and cannot be used, by anyperson for the purpose of avoiding any penalties that may be imposed under the © Grant Thornton LLP All rights reservedInternal Revenue Code. U.S. member firm of Grant Thornton International Ltd 4