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 must
depreciate these improvements over:
a. 15 year period with bonus depreciation
b. 15 year period with no bonus depreciation
c. 39 year period with bonus depreciation
d. 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. $ 8,100
b. $ 9,000
c. $ 9,990
d. $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 supplies
oNon-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)$30,000
b)$27,000
c)$22,000
d)$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.
CAPITALIZATION POLICY FOR FIXED
ASSETS

c) Both the tools and equipment can be
expensed.
ASSETS

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

d)$10,000.
ASSETS

Which of the following is true regarding the de
Minimis 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 Rule
for 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.
MAINTENANCE

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.
MAINTENANCE

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

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.

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.

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.
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.
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).
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.
REAL PROPERTY

a) the $25,000 must be capitalized as cost of the
land.
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!
rules?

• 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.
rules?

Questions?
Lora Ament
lament@louisplung.com

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

Recommended

Recommended

More Related Content

What's hot

What's hot (17)

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

Similar to TAX DEPRECIATION AND TANGIBLE PROPERTY REGULATIONS UPDATE without detail_for Presentation slides (2) (20)

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