Transcript GA Overview Jan 2010 - TPR Tools and Templates

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Capitalization of
Tangible Assets
Understanding the New IRS
Regulations and What [client
name] needs to do in Response
Presented by
xxxxxxx CPAs and Consultants
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xxxxxxxxxx, CPA and
xxxxxxx, CPA
Month Day, 2014
Meeting’s Discussion Topics
Materials and supplies—definitions of materials and
supplies
Discussion of the new de minimis safe harbor rules and
annual elections
Repairs—deductions for amounts paid to repair and
maintain property not required to be capitalized under
263(a)
The expenditures required to be capitalized
 Betterments, Restorations, New Use
Building or component dispositions
Introduction on how to change accounting methods
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Today’s Learning Objectives
Understand the tangible property regulations (TPRs) that
the IRS has changed related to:
 Write offs:
 Repairs and maintenance
 Materials and supplies
 Capitalization Issues:
 Improvements to property
 Acquisitions
What you need to follow up on (changes in accounting
methods related to these regulations)
What is the impact of these TPRs to you (both tax and
financial statement)
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10,000-Feet TPR Observations
Few objective rules
What you have done to date (asset groupings, cost
segregation, depreciation choices) matter
Cost segregation still relevant and needed
Multiple Code Sections changed, not just 263(a),
but also Sections 162, 168
Every taxpayer (TP) is affected, just about every TP
will have to file four to five 3115s (IRS form for
Change in Accounting Method)
We will need a lot of old facts/data from you
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Depreciation Allowable or Taken –
this issue is “huge”.
Points: (1) Suggest that you use the spring
and summer of 2014 to correct any errors in
prior year depreciation, and note that
(2) section 1.1016-3 is part of the TPRs for a
reason – that is the “scary” part – the IRS
will use this in their future audits of TPs to
deny depreciation deductions or items that
could have been written off as R & M in prior
years
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§1.1016-3 Exhaustion, Wear and Tear,
Obsolescence, Amortization, and Depletion
Determination of the amount properly allowable for
exhaustion, wear and tear, obsolescence, amortization, and
depletion must be made on the basis of facts reasonably
known to exist at the end of the taxable year.
A TP is not permitted to take advantage in a later year of the
TP's prior failure to take any such allowance or the TP's taking
an allowance plainly inadequate under the known facts in
prior years.
Caution: In the case of depr., if in prior years the TP has
consistently taken proper deductions under one method, the
amount allowable for such prior years must not be increased
even though a greater amount would have been allowable
under another proper method.
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Warnings for Taxpayers (TP)…if
(1) a TP does not identify all of the tangible property
issue(s),
(2) a TP does not implement the rules correctly, AND
(3) file all of the necessary 3115s under the correct new
method(s),
the TPs could have certain current and future tax
depreciation denied and/or miss the potential write-off
on previously capitalized assets.
This exposure is greatest for errors asset class lives, in
bonus depreciation, and for building issues, since that is
where the greatest dollar amounts exist.
Your exposure for errors is great and the time to
execute is limited.
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“Errors” (are impermissible methods) in
Depreciation Deductions
Must correct most issues/impermissble
methods (class life or bonus errors) by filing
a 3115.
Unless the issues/methods were done only in
the prior tax years, the TP is not permitted
to make these corrections with an amended
return
Cannot fix depreciation errors by “catching
up” on prior year errors
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What TPs Need to Do
Depreciation Schedules: fix them before the IRS
disallows missed depreciation
 Fix based upon the new TPR viewpoints – not why it was done
when it was added to the depreciation schedule
Assess conformity of your current policies and
procedures with these TPRs
 Capitalization policies
 Minimum capitalization thresholds
 Routine maintenance expenditures
 Internal tracking and capturing data
Current method(s) conform to TPRs?
 If not, need to file 3115s
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Depreciation Error Process
1. Find out what ‘activity’ the business is in by
reviewing Rev. Proc. 87-56
a) This will instruct us what the asset guideline class
lives should be, O/T asset classes 00.11 to 00.4.
00.11 to 00.4 are the “common” class lives.
b) Based on the business’ “activity” we may have class
lives that are different from the common class lives.
c) 00.11 to 00.4 state the following: office equipment
is 7 years; computers =5, copiers=5, cars and
trucks=5, land improvements=15
d) But if an activity such as 33.3, land improvements
are 7 years; if 57.0 (distributive trades and services)
equipment assets are 5 years, unless they fit into
00.11 to 00.4.
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What After Depreciation Errors?
2. There are other issues that are not
depreciation errors, but rather are TPR issues
that are generated from a review of the
depreciation schedules. There are:
a) Repair items that were capitalized. (items that
were capitalized but viewed now under the TPRs
would have been written off).
b) Prior building write off issues. (new roof was added
but old roof can now be written off
a)
This can be done even if the old roof comes from many
years ago (example: old roof was put on in 1995 – there
is still many years of depreciation remaining that can be
written off as the asset was put on with a 39 year life)
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What you need to address first
on most of the TPR Issues (after
addressing depreciation error
corrections):
- two items –
TPR Issue(s) identification
Unit of Property
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Issue(s) Identification – “the list”
The actions a TP may need to take under these
TRs are not limited to:
 Change in unit of property: do we have buildings
grouped together in the depreciation schedule?
(example: multiple buildings in an apartment
building)
 The need to breakout prior costs for property
capitalized (i.e. what is the detail in that 39 year
asset account where the roof was replaced years
ago?)
 Write off or capitalize current year expenditures (and
if we capitalize, do we have prior to dispose of?
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Issue(s) Identification - 2
If we have to write off prior assets, do they still
have basis that can be written off?
 If fully depreciated, unless we also want to write off the
removal costs of the new asset, we are done with this
asset. Just capitalize the current expenditures and
depreciate them properly over future years
If we have to write off these prior assets (or
removal costs) and they still have basis, we have to
determine whether we are going to write those
assets off in a 3115 filing under the “cost known”
method (such as a cost segregation or being able to
recreate the original costs) or under a “reasonable
allocation” method (such as a CPI “lookback”)
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Issue(s) Identification - 3
Do we need to correct depreciation errors (i.e.
bonus, lives)? Every depreciation schedule will
need to be “scrubbed” for errors. These will
require 3115 filings in order to take the
(typical) negative 481(a) adjustments. We have
decided, in general, that this is fall/winter work
for 2013 and that these changes will be
attached to the 2013 income tax returns.
Adopt new accounting method(s) – (numerous
potential methods!!!)
File 3115(s) (separately or together) for what?
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Unit of Property (UoP)
Is a very important element to these
and other regulations
Do You first need to change any UoP
before you makes a method change
under the new TPRs?
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Unit of Property (UoP) - 1
UoP is a very important issue, why?:
 It is an important criteria in the decision whether a
TP can write off an expenditure
Generally:
 The smaller the UoP the more likely the expenditure
will be required to be capitalized
This issue should almost always be considered in
TPR issues, most of the time, early. If it is a
problem, it must be changed and 3115 filed. If
not, move on.
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Building UoP Examples - 2
Apartment complex with multiple buildings –
all listed as one asset on the depreciation
schedule:
 UoP must be changed to each building (but
capitalization considerations on building
components and/or system are measured in
comparison to that building component that
performs a unique function or specifically
enumerated system)
Retailer complex with multiple buildings:
 UoP is each individual separate building
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Review of the TPR
Main Standards
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What the Tangible Property
Regulations (TPR) Do
TPRs provide guidance on the application of Sections 162(a)
(deduction) and 263(a) (requires capitalization) of the Code to
amounts paid to acquire, produce, or improve tangible property.

Regulations aim to clarify the difference between these two opposites
Final regulations were issued in September of 2013 and only give us
through tax year 2014 in which to make these new method changes
and potential numerous annual elections
Clarify and expand the standards under Sections 162(a) and 263(a)
Provide certain bright-line tests (for example, new de minimis safe
harbor rules for certain acquisitions)
Provide guidance under Section 168 regarding the accounting for, and
dispositions of, building property
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What the ‘Repair’
Regulations Do
TR will affect all taxpayers that acquire,
produce, or improve tangible property
Regulations are effective on January 1, 2014
or for taxable years that begin after 1-12014, but can be applied for tax years 2012
to 2013 (so why not apply the “beneficial”
method changes earlier and get a nice tax
deduction?)
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What the ‘Repair’
Regulations Do
Splits the definition of tangible property
into two categories:
 Buildings
 Everything else
For Buildings: a building and its structural
components are treated as a single unit of
property, but when improving “building
systems,” must be separated out
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Building and Structural Components
1.263(a)-3(e)(2) (UoP)
General rule that the UoP for a building is comprised of the
building and its structural components
Requires that a TP apply the improvement standards
separately to the primary components of the building, that is,
the building structure or any of the specifically defined
building systems.
A cost is treated as a capital expenditure if it results in an
improvement to the building structure or to any of the
specifically enumerated building systems.
Defines the building structure as the building (§1.48-1(e)(1))
and its structural components (§1.48-1(e)(2)) other than the
components specifically enumerated as building systems.
A UoP is a method of accounting
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Building and Structural Components
1.263(a)-3(e)(2) (UoP)
Defines building systems to include (1) the heating,
ventilation, and air conditioning systems (“HVAC”);
(2) the plumbing systems; (3) the electrical
systems; (4) all escalators; (5) all elevators; (6) the
fire protection and alarm systems; (7) the security
systems; (8) the gas distribution systems; and (9)
any other systems identified in published guidance
These are considered improvements to the building:
Replacement of an entire roof, improvement to the
HVAC system
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Building and Structural Components
1.263(a)-3(e)(2) (UoP)
Old Rule: Taxpayer was required to depreciate
building improvements over the life of the original
asset (39 years), even if building had been 29 years
into its depreciable life; no write off of the
replaced component
 If one replaced a roof, for example, you depreciated two
roofs—the original one and the replaced one, or three
roofs, etc.
New Rule: replace a roof, you are able to recover
as a loss the remaining basis of the old roof, book
the new roof and depreciate it
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Background
Section 263(a) (relating to the capitalization
requirement) states that no deduction is
allowed for:
(1) Any amount paid out for new buildings or
permanent improvements or betterments made to
increase the value of any property, or
(2) Any amount expended in restoring property or
in making good the exhaustion thereof for which an
allowance has been made.
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Background
263(a) Regulations state that capital expenditures
include amounts paid or incurred to:
 Add to the value, or substantially prolong the useful life,
of property owned by the TP; or,
 Adapt the property to a new or different use.
 Amounts paid or incurred for incidental repairs and
maintenance of property (as defined by 162 and §1.162-4
(relating to the deduction for ordinary and necessary trade
or business expenses) are not capital expenditures under
§1.263(a)-1.
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U.S. Courts on
Capitalization Have
Recognized the highly factual nature of determining whether
expenditures are for capital improvements or for repairs
Articulated a number of ways to distinguish between
deductible repairs and non-deductible capital improvements.
Explained that R and M expenses are incurred for the purpose
of keeping property in an ordinarily efficient operating
condition over its probable useful life for the uses for which
the property was acquired.
Explained that capital expenditures, in contrast, are for
replacements, alterations, improvements, or additions that
appreciably prolong the life of the property, materially
increase its value, or make it adaptable to a different use
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U.S. Courts on
Capitalization Have
Explained that the relevant distinction between capital
improvements and repairs is whether the expenditures were
made to “put” or “keep” property in efficient operating
condition
Stated that if the expenditure merely restores the property to
the state it was in before the situation prompting the
expenditure arose and does not make the property more
valuable, more useful, or longer-lived, then such an
expenditure is usually considered a deductible repair.
Concluded that a capital expenditure is generally considered
to be a more permanent increment in the longevity, utility, or
worth of the property.
Key is that TR have attempted to match or meet these
“elements” outlined in those court cases ….
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TPR Regulations
Do Not Change
§263(a), which requires TPs to capitalize amounts
paid to improve tangible property and
§263A and the regulations under §263A, which
require TPs to capitalize the direct and allocable
indirect costs, including the cost of materials and
supplies, to property produced or to property
acquired for resale
§1.471-1, which requires TPs to include in inventory
certain materials and supplies
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TPR Regulations
Do Adopt and Refine
1.
The definition and treatment of materials and supplies
2.
New de minimis safe harbor rules for the acquisition and
production of property and/or material & supplies
3.
An election to capitalize materials and supplies and/or R & M
4.
Safe harbor for routine maintenance for both tangible personal
property and buildings
5.
Rules for determining a unit of property
6.
Certain rule revisions for determining whether there has been an
improvement to a unit of property
7.
Rules revisions for determining whether an amount is paid for an
improvement to a building.
8.
Rule revisions for determining whether an amount is paid for the
replacement of a major component or substantial structural
part of a unit of property
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TPR Regulations
Do Adopt and Refine
9.
Expanded definition of disposition for MACRS to include the
retirement of a structural component (loss recognition
availability for partial building disposals)
10. The general rule that incidental materials and supplies (for
which no inventories or records of consumption are maintained)
are deductible in the year purchased
11. Statements that non-incidental materials and supplies are not
deductible until the year in which they are used or consumed in
the TP's operations, unless the new safe harbor de minimis is
applied)
12. New rules for rotable and temporary spare parts
13. No longer a need for TPs to understand General Asset Groupings
14. Numerous new and revised examples
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Final Regulations (and PRs)
Have Numerous Examples
1.
Examples of 1.162-3 (Materials and Supplies)
2.
(P) Examples of 1.168(i)-1(c) (Establishment of General
Asset Accounts)
3.
(P) Examples of 1.168(i)-1(e)(2) (GAA - General rules for a
disposition)
4.
(P) Examples of 1.168(i)-1T(e)(3)(ii) (GAA – Special rules –
Disposition of all assets remaining in a GAA)
5.
(P) Examples of 1.168(i)-1T(e)(3)(iii) (GAA – Special rules –
Disposition of an asset in a qualifying disposition)
6.
(P) Examples of 1.168(i)-8 (Dispositions of MACRS property)
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Final Regulations (and PRs)
Have Numerous Examples
7.
Examples of Amounts Paid to Sell Property (1.263(a)-1(e))
8.
Examples of De minimis safe harbor election (1.263(a)-1(f)
[NEW SECTION FOR FINAL][Moved from 1.263(a)-2T of the
temporary]
9.
Examples of Amounts Paid to Acquire or Produce Tangible
Property (1.263(a)-2(d))
10. Examples of Amounts Paid for Defense or Perfection of
Title to Tangible Property (§1.263(a)-2(e))
11. Examples of Transaction costs (1.263(a)-2(f)
12. Examples of Recover of capitalized amounts (§1.263(a)-
2(h)) [NEW]
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Final Regulations (and PRs)
Have Numerous Examples
13. Example of Coordination with other provisions of the Code
(§1.263(a)-3(c)) [NEW]
14. Examples of Determining the Unit of Property (1.263(a)-
3(e))
15. Examples of Improvements to Leased Property (1.263(a)-
3(f))
16. Examples of Special rules for determining improvement
costs (1.263(a)-3(g))
17. Examples of Safe harbor for small taxpayers (1.263(a)-3(h))
[NEW]
18. Examples of Safe harbor for routine maintenance on
property (1.263(a)-3(i)) [NEW]
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Final Regulations (and PRs)
Have Numerous Examples
19. Examples of Capitalization of Betterments (1.263(a)-3(j)
20. Examples of Capitalization of Restorations (1.263(a)-3(k)
21. Examples of Capitalization of amounts to adapt property to
a new or different use (1.263(a)-3(l)
22. Example of Optional regulatory accounting method
(§1.263(a)-3(m))
23. Example of Election to capitalize repair and maintenance
costs (§1.263(a)-3(n)) [NEW]
24. Example of §1.1016-3 Exhaustion, wear and tear,
obsolescence, amortization, and depletion
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Material and
Supplies
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Definition of
Material and Supplies
TPRs define and expand the definition of materials and
supplies as tangible property that is used or consumed in the
TP’s operations, not constituting a UoP, not acquired as part
of a single UoP, and is not inventory, and that:
1.
Is a component acquired to maintain, repair, or improve a unit of
tangible property owned, leased, or serviced by the TP and that is
not acquired as part of any single unit of tangible property;
2.
Consists of fuel, lubricants, water, and similar items, that are
reasonably expected to be consumed in 12 months or less, beginning
when used in TP's operations; (New Category)
3.
Is a UoP that has an economic useful life of 12 months or less,
beginning when the property is used or consumed in the TP's
operations;
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Definition of
Material and Supplies
4.
Is a UoP that has an acquisition cost or production cost (under
Section 263A ) of $200 or less (or other amount as identified in
published guidance in the Federal Register or in the IRB; or
5.
Is identified in published guidance in the Federal Register or in
the IRB as materials and supplies for which treatment is
permitted
6.
Also provide an election to treat certain materials and supplies
under the de minimis safe harbor rule
7.
Allow a TP to elect to capitalize certain materials and supplies.
8.
Redefine the first category of materials and supplies by further
describing the types of components that qualify and by
9.
Eliminating the prior discussion that such property not be a UoP
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Definition of
Material and Supplies
Specified acquisition or production cost threshold
 Final TPRs up the limitation to $200 per item
 Add language, however, that gives the IRS and the
Treasury Department the flexibility to change the amount
of the limitation
 A TPR with either applicable financial statements (AFS) or
at least a written communicated policy will be permitted
to deduct amounts paid for property up to $5,000 and
$500 respectively if it complies with the new method
change requirements and elects annually to write off on
books and tax these amounts.
Adds a new definition for “standby emergency spare parts”
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Election to Capitalize
Material and Supplies
A TP may elect to treat as a capital expenditure and to treat
as an asset, subject to depreciation, the cost of any M and S
Election applies to amounts paid during the taxable year to
acquire or produce any M or S. Any asset for which this
election is made shall not be treated as a M or S.
Exceptions. A TP may not elect to capitalize
i.
Any amount paid to acquire or produce a M or S if:
ii.
The M or S is intended to be used as a component of a unit of
property and
iii. The TP has not elected to capitalize and depreciate that unit of
property; or
ii.
Any amount paid to acquire or produce a rotable or temporary
spare part if the TP has applied its optional method of
accounting
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Election to Capitalize
Material and Supplies
A TP makes the election by capitalizing the
amounts in the taxable year the amounts are
paid and by beginning to depreciate them
If a pass-through entity, the election is
made at the entity level
A TP must apply the de minimis safe harbor to
amounts paid for all M & S, except for those M & S
that the TP elects to capitalize and depreciate
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De minimis
Safe Harbor (DMSH)
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DMSH
 Final - (can apply to 2012 and 2013 but must apply 2014
and after) de minimis safe harbor:
 There is no ceiling as to the amount that can be
deducted if it fits in the DMSH amounts
 Must make an annual election on the tax return
 Safe harbor determined at invoice item level, but same
on policies for books and records
 If you have an audit, TP may rely on DMSH only if the
amount paid for property does not exceed $5,000 per
invoice, or per item as substantiated by the invoice.
 If no audited financials, generally DMSH is $500 per
invoice/items
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DMSH
The de minimis safe harbor has been expanded to
include amounts paid for property having an economic
useful life of less than 12 months.
A $500 per item de minimis rule is also included for
taxpayers without an AFS, but still have to have
accounting procedures in place to deduct amounts paid
for property costing less than a specified amount, or
amounts paid for property with a life of 12 months or
less
If cost exceeds $500 per invoice, no portion will qualify
for the safe harbor
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DMSH
The de minimis safe harbor does not preclude a TP
from reaching an agreement with the IRS that the IRS
examining agents will not review certain items.
Examining agents do not need to revise their
materiality thresholds in accordance with the safe
harbor limitations.
The DMSH is elected annually by including a statement
on the TP's tax return for the year elected.
An election to use the safe harbor may not be made
through the filing of an application for change in
accounting method, it must be made on the return
when filed
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DMSH
If an invoice includes amounts paid for multiple
tangible properties and the invoice includes additional
invoice costs related to the multiple properties, then
the taxpayer must allocate the additional invoice costs
to each property using a reasonable method
The DMSH must be applied to all eligible M & S (other
than rotable, temporary, and standby emergency spare
parts subject to the election to capitalize or to rotable
and temporary spare parts subject to the optional
method of accounting for such parts) if the TP elects
the DMSH
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DMSH
TPs that do not elect the de minimis safe harbor must
treat amounts paid for materials and supplies in
accordance with Reg. §1.162-3.
TPs subject to 263A can not avoid those provisions by
using the DMSH
Safe harbor does not apply to inventory, land, items it
capitalizes, and the optional method of rotable parts
Safe harbor is deducted as ordinary and necessary
expense
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De minimis Rule
Election Details
… of the de minimis safe harbor election:
Note that the TPRs do not state that the
“election” of the safe harbor de minimis
rule is a method of accounting
That means that a TP can elect to apply the
de minimis rule in one year and not the next
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Applicable Financial
Statements
Defined as: TP’s FS that has the highest priority.
The FS are, in descending priority:
A. A FS required to be filed with the SEC;
B. A certified audited FS that is accompanied by the report
of an independent CPA, that is used for:
1)
Credit purposes;
2)
Reporting to shareholders, partners, or similar persons; or
3)
Any other substantial non-tax purpose; or
C. A FS (other than a tax return) required to be provided to
the federal or a state government or any federal or state
agencies (other than the SEC or the Internal Revenue
Service).
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Improvements
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Amounts Paid to Improve Tangible Property
- Reg. §1.263(a)-3(d)
Requirement to capitalize amounts paid for
improvements
A TP generally must capitalize the related amounts paid
to improve a unit of property owned by the TP.
For purposes of this section, a unit of property is
improved if the amounts paid for activities performed
after the property is placed in service by the TP-(1) Are for a betterment to the unit of property
(2) Restore the unit of property or
(3) Adapt the unit of property to a new or different use
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Amounts Paid to Improve Tangible Property
- Reg. §1.263(a)-3(e)
Determining the unit of property—
The unit of property determination is based upon the
functional interdependence standard
Special rules are provided for
 buildings
 plant property
 network assets,
 leased property (leased buildings and leased property other than
buildings), and
 improvements to property
Additional rules are provided if a TP has assigned different
MACRS classes or depreciation methods to components of
property or subsequently changes the class or depreciation
method of a component or other item of property
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Amounts Paid to Improve Tangible Property
- Reg. §1.263(a)-3(e)
Determining the unit of property— Building
Each building and its structural components (as defined in
§1.48-1(e)(2)) is a single unit of property
An amount is paid to improve a building under if the
amount is paid for an improvement to any of the following:
 Building structure (consists of the building and its
structural components
 Building system – Each of the structural components (as
defined in §1.48-1(e)(2)), including the components
thereof, constitutes a building system that is separate
from the building structure, and to which the
improvement rules must be applied (same categories as
temporary TPRs, but defined in more details)
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Special rules for determining improvement
costs— Reg. §1.263(a)-3(g)
Removal Costs—
 If a TP disposes of a depreciable asset,
including a partial disposition under Prop. Reg.
§1.168(i)-1(e)(2)(ix), and has taken into account
the adjusted basis of the asset or component of
the asset in realizing gain or loss, then the
costs of removing the asset or component are
not required to be capitalized
 If the taxpayer wants to deduct removal costs,
it must file a new 3115 for this method
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Special rules for determining improvement
costs— Reg. §1.263(a)-3(g)
Removal Costs—
 If a TP disposes of a component of a unit of
property, but the disposal of the component is
not a disposition, then the TP must deduct or
capitalize the costs of removing the component
based on whether the removal costs directly
benefit or are incurred by reason of a repair to
the unit of property or an improvement to the
unit of property.
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New Building Safe
Harbor for Small
Taxpayers
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Safe harbor for small taxpayers— Reg.
§1.263(a)-3(h) (SHST)
Certain TPs may elect to not apply the capitalization
requirements to an eligible building property if the
total amount paid during the taxable year for repairs,
maintenance, improvements, and similar activities
performed on the eligible building property does not
exceed the lesser of—
(i) 2 percent of the unadjusted basis (as defined
under paragraph (h)(5) of this section) of the eligible
building property; or
(ii) $10,000.
“amount paid” do not include items capitalized under
de minimis safe harbor or those amounts deemed not
to improve under the safe harbor for routine
maintenance
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SHST
Qualifying taxpayer—
(i) In general - the term qualifying TP means a
TP whose average annual gross receipts for the
three preceding taxable years is less than or
equal to $10,000,000.
 Rules for TPs in existence for less than 3
years
 Short year – annualize
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Safe Harbor for
Routine Maintenance
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Safe harbor for routine maintenance- Reg.
§1.263(a)-3(i) (slide 1)
An amount paid for routine maintenance on a unit of
tangible property, or in the case of a building, on any
of the properties is deemed not to improve that unit
of property.
Routine maintenance for a building is the recurring
activities that a TP expects to perform as a result of
the use to keep the building structure/system in its
ordinarily efficient operating condition. Routine
maintenance activities include, the inspection,
cleaning, and testing of the building structure or each
building system, and the replacement of damaged or
worn parts with comparable and commercially
available replacement parts. Routine maintenance
may be performed any time during the useful life of
the building structure or building systems.
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Safe harbor for routine maintenance- Reg.
§1.263(a)-3(i) (slide 2)
The activities are routine only if the TP reasonably
expects to perform the activities more than once
during the 10-year period beginning when placed in
service
Factors to be considered in determining whether
maintenance is routine and whether a taxpayer’s
expectation is reasonable include the recurring nature
of the activity, industry practice, manufacturers’
recommendations, and the taxpayer’s experience with
similar or identical property. With respect to a
taxpayer that is a lessor of a building or a part of the
building, the taxpayer’s use of the building unit of
property includes the lessee’s use of its unit of
property.
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Betterments
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Capitalization of betterments - Reg.
§1.263(a)-3(j) (slide 1)
An amount is paid for a betterment to a unit of
property only if it--
 Ameliorates a material condition or defect that
either existed prior
 Is for a material addition, including a physical
enlargement, expansion, extension, or addition of a
major component to the unit of property or a
material increase in the capacity
 Is reasonably expected to materially increase the
productivity, efficiency, strength, quality, or output
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betterments
Application of betterment rules:
The applicability of each quantitative and qualitative
factors depends on the nature of the unit of property.
For example, if an addition or an increase in a
particular factor cannot be measured in the context of
a specific type of property, that factor is not relevant
in the determination
An amount is paid to improve a building if it is paid for
an increase in the efficiency of the building structure
or any one of its building systems (for example, the
HVAC system).
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betterments
Appropriate comparison - In cases in which an
expenditure is necessitated by normal wear and tear or
damage to the unit of property that occurred during
the TP’s use of the unit of property, the determination
of whether an expenditure is for the betterment of the
unit of property is made by comparing the condition of
the property immediately after the expenditure with
the condition of the property immediately prior to the
circumstances necessitating the expenditure.
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Restorations
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Restorations 1.263(a)-3(k)
An amount is paid to restore, and therefore
improve, a UoP if it:
1.
It returns the UoP to its ordinarily efficient operating
condition if the property has deteriorated to a state of
disrepair and was no longer functional for its intended
use;
2.
It is rebuilding to like-new condition: results in the
rebuilding of the UoP to a like-new condition after the
end of its class life (brought to the status of new,
rebuilt, remanufactured, or similar status under the
terms of any federal regulatory guideline or the
manufacturer’s original specifications); or
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Restorations
 Returns the unit of property 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;
 rebuilding of the unit of property to a likenew condition after the end of its class life
 Is for the replacement of a part or a
combination of parts that comprise a major
component or a substantial structural part
of a unit of property
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Summary of Examples
Restorations
Examples where items were written off:
Rebuild freight cars before the end of their class
life
Repair a broken taillight, replace a power switch
assembly
Waterproof roof membrane
Two out of eight HVAC units, two out of twenty
sinks, and 30 out of 300 windows, wood flooring in
hotel lobby
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Summary of Examples
Restorations
Examples where items were capitalized:
Shore up the walls and replace siding, 200 of 300 windows
Rebuild freight cars after the end of their class life
New engine and cab of a tractor, also paint the tractor cab
Underground tank removal and replace
Entire roof, and significant portion of a roof
Furnace replacement, the one HVAC system, also sprinkler system in
a building
Wiring throughout the building; plumbing fixtures in all of the
restrooms; all of the floors in the public areas of the hotel
Remodel hotel over several-year period
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Amounts to Adapt Property to a New or
Different Use 1.263(a)-3(l)
TP must capitalize amounts paid to adapt a unit of
property to a new or different use.
Amount is paid to adapt a unit of property to a new or
different use if the adaptation is not consistent with the
TP’s intended ordinary use of the unit of property at the
time originally placed in service by the TP.
In the case of a building, an amount is paid to adapt the
UoP to a new or different use if it adapts to a new or
different use any of the properties designated in
paragraphs (e)(2)(ii)(building structure and systems),
(e)(2)(iii)(B)(condominium), (e)(2)(iv)(B)(cooperative),
or (e)(2)(v)(B) (leased building) of this section.
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Checklist of Improvements
Betterment Considerations:
Does routine maintenance safe harbor apply?
Does it ameliorate a pre-existing material condition or defect?
Does it ameliorate a material condition or defect prior to
placing the property in service?
Does it result in a material increase in capacity, productivity,
efficiency, quality, etc. of UoP?
Does it adapt to a new or different use?
Does Section 263A apply to the expenditure(s)?
If the answer to any of the above questions is YES, then the
expenditure has to be capitalized …
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Checklist of Improvements
Restoration Considerations:
Is the UoP no longer functional and did you return it to ordinary
efficient or operating condition?
Did you rebuild the UoP to a like-new condition after its useful life?
Did you replace a major component or substantial structural part?
Was the component previously deducted as a loss, before you
replaced it?
Was the component previously sold or exchanged before
replacement?
Was the expenditure to the UoP previously taken as a casualty loss?
If the answer to any of the above questions is YES, then the expenditure
has to be capitalized …
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Accounting Method
Change Rules
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Accounting Method Changes for Reg. §1.263(a)-3
Other than the new annual elections (such as for DMSH or
SHST) taxpayers must file IRS form 3115 to comply with
these new choices.
The new regulations generally require a change in method
of accounting to which the provisions of sections 446 and
481 and the accompanying regulations apply.
Changes generally apply to taxable years on or after 1-1-14,
except for (h) the safe harbor for small taxpayers, (m) the
optional regulatory method, and (n) the election to
capitalize R & M apply to amounts paid on or after 1-1-14
A TP may choose to apply DMSH and/or SHST to amounts
paid in taxable years beginning on or after January 1, 2012.
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Disposition Rules
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Disposition Rules for MACRS
Structural Components.
The proposed regulations (PR) change the rule in
Temp Reg. §§1.168(i)-1T and 1.168(i)-8T that each
structural component of a building, condominium,
or cooperative is the asset for tax disposition
purposes.
The PR provide that a building (including its
structural components), a condominium (including
its structural components), or a cooperative
(including its structural components) is the asset for
disposition purposes.
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Disposition Rules for MACRS –
slide 2
Structural Components.
This rule change allows TPs to chose to take or forgo
a loss upon the disposition of a structural
component of a building without making a general
asset account (GAA) election as required under the
temporary regulations.
A TP desiring to claim a loss on a retired structural
component outside of a GAA is now required to
make a “partial disposition election” (this is a new
term).
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Partial Dispositions - Assets Not
Included in GAAs
The PRs allow a TP to claim a loss upon the
disposition of a structural component (or a portion
thereof) of a building of any other asset (a "partial
disposition" of an asset) without identifying the
component as an asset before the disposition event
by making a partial disposition election.
While the partial disposition rule is generally
elective, the rule is required to be applied to:
 Disposition due to casualty event
 Disposition of a portion of an asset for which gain is not
recognized in whole or part under 1031 or 1033
 Sale or transfer of a portion of an asset
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MACRS
Definition of Disposition
Occurs when ownership of the asset is transferred; or,
Asset is permanently withdrawn from use either in the
taxpayer’s trade or business or in the production of
income;
Includes the sale, exchange, retirement, physical
abandonment, or destruction of an asset;
Also includes the retirement of a structural component
of a building (defined by 1.48-1); and,
Finally, when an asset is transferred to a supplies, scrap,
or similar account.
Manner of Disposition—does not matter.
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Basis and Identification of Disposed or
Converted Asset (slide 1)
Where it is impracticable from the TP’s
records to determine the unadjusted
depreciable basis of the disposed-of asset, the
TP may use any reasonable method that is
consistently applied to the taxpayer’s general
asset accounts, multiple asset accounts, or
larger assets.
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Basis and Identification of Disposed or
Converted Asset (slide 2)
The PRs provide some comprehensive examples of
reasonable methods, including:
(1) discounting the cost of the replacement asset to its
placed-in-service year cost using the CPI;
(2) a pro rata allocation of the unadjusted depreciable
basis based on the replacement cost of the disposed-of
asset and the replacement cost of all of the assets, as
applicable; and/or
(3) a study allocating the cost of the asset to its
individual components.
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838
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CONCLUSION
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