New Repair Regulation Chapter 10 pp. 349 - 409 2015 National Income TAX Workbook™

Rules Proposed and Proposed and Proposed in 2006, 2008, 2011, 2012 AND Finalized in 2014  Notice 2004-6 asked for comments as to what is: ▪ A unit of property? ▪ The starting point to see if value or life are increased? ▪ What is a material increase in value? ▪ Etc….Etc…. Etc…  2006 Proposed Regulations - Withdrawn  2008 Proposed Regulations – Withdrawn  2011 Temporary Regulations – Withdrawn  2012 Temporary Regulations – Withdrawn  Final Regulations effective for tax years beginning on or after January 1, 2014 but can elect for years after 12/31/11

Repairs Regulations Chapter 10 p. 349  Improvements to property.  Unit of Property.  Materials & Supplies.  De Minimis Safe Harbor.  Routine Maintenance Safe Harbor.  Small Taxpayer Safe Harbor.  Election to Capitalize Repair & Maintenance Costs.  Change in Accounting Method.  Decision Tree.

Repair Regulations Introduction p. 349 Final Regulations TD 9636, 2013-43 IRB 331.  Clarify whether costs are currently deductible or need to be capitalized  Provide safe harbor simplifications & implement new rules for small and large businesses.

New Repair Regulations Introduction pp. 349 - 350  All Taxpayers must follow the repair Regulations for years beginning on or after January 1, 2014.  Small taxpayers are not exempt.  For many the new Regulations formalized what they have been doing.  Taxpayers with assets less than $10M or 3-year average gross receipts less than $10M can adopt changes in method beginning 1-1-2014 without filing Form 3115.

Observation: 2012 & 2013 Form 3115 Filing Deadline p. 350  Final Regs require making a formal election to use the safe harbors or to capitalize certain costs.  If the safe harbor or capitalization was claimed in an earlier year and no election was made an amended return with an election is required. ▪ Affects years beginning on or after 01/01/2012 and ending on or before 09/19/2013. ▪ Due within 180-days of due date of return including extensions.  This time may have passed but could still be open to some fiscal year end taxpayers.

Background p. 351  §263 generally requires capitalizing amounts paid to acquire, produce or improve tangible property.  §162 allows a current deduction for ordinary and necessary expenses including materials, supplies, repairs and maintenance.

Background p. 350  Illinois Merchandise Trust Co., 4 BTA 103 (1926) provided the guiding principle:  :To repair is to restore to a sound state or to mend….to keep the property in an operating condition….which are distinguishable from those for replacements, alterations, improvement or additions which prolong the life of property….”

Background and Fig. 10.1 p. 351  Reg. §1.162-3 – Rules for material & supplies.  Reg. §1.162-4 – Addresses repairs & maintenance.  Reg. §1.263(a)-1 – General rules for capital expenditures.  Reg. §1.263(a)-2 – Rules for acquisition & production of tangible property.  Reg. §1.263-(a)-3 – Rules for improvements to tangible property.  Fig 10.1 Summarizes final Regs and Safe Harbors

Background p. 351- 352  In the past deciding whether an expenditure should be expensed or capitalized depended upon all of the facts and circumstances.  These new Regulations attempt to clarify whether an expenditure is to be expensed or capitalized.  In the future deciding whether an expenditure should be expensed or capitalized depends upon all of the facts and circumstances.  Speaker’s Comment: Wait a minute….what’s changed?  Well there are safe havens & some specific rules.

Improvements to Property p. 352  The new Regs provide rules for distinguishing between repairs and capital improvements.  The new Regs rely on past rules & concepts.  There is no bright line and, as in the past, facts and circumstances continue to be the key factor.

Improvements to Property p.352  Improvements include: 1.Betterment to the unit of property, or 2.Restoration of a unit of property, or 3.Adapts a unit of property for a new or different use.  All such improvement costs must be capitalized including: ▪ Direct costs, indirect costs that directly benefit or are incurred for improvement HOWEVER….

Improvements to Property p. 352  The rule now differs from the prior rule that all costs of a general improvement or rehabilitation had to be capitalized.  Now -- Indirect costs of a general improvement plan must be capitalized BUT ▪ Indirect costs (such as repairs & maintenance) not required by the improvement and that do not add to improvement are deductible.

Repairs Completed with Improvements Ex. 10.1 p.352  The engine, cab and petroleum tank of a truck is replaced by new ones.  The company logo is painted on the new cab and a taillight on the tractor is replaced.  Cost of painting the logo is required by the improvement and so must be capitalized.  Replacing the taillight was not part of or required by the improvement and so is a currently deductible repair.

Presenter’s Comment  The chapter is filled with examples to illustrate the various points.  It is important to note that almost all of the examples are taken from the Regulations.  Regulation citations follow those examples in the text.  Thus, those examples can be relied upon.

Practitioner’s Note p. 353  Federal, State, etc regulatory rules requiring repairs and maintenance at certain intervals is not a controlling factor in deciding to deduct or capitalize.

Betterments p. 353 Capitalization required for amounts that: 1.Ameliorate a condition or defect prior to acquisition or production of the unit of property. 2.Are a material addition to the unit of property. 3.Materially increases a unit of property’s capacity such as additional square footage, etc. 4.Materially increases a unit of property’s productivity, efficiency, strength, quality or output of a unit of property.

Preexisting Material Condition Ex 10.2 p. 353  Fast Food bought a store located on top of gasoline storage tanks left by prior owner.  The gas tanks leaked before the purchase but Fast Fresh did not know this until a year after the purchase.  Costs to deal with damage must be capitalized since incurred to ameliorate a material condition or defect prior to acquisition.

Absence of Material Condition Ex 10.3 pp. 353 - 354  Turner owns a building insulated with asbestos NOT known to be a problem when the building was built.  Insulation began to deteriorate and was replaced years after building was in service.  New Regs follow a Tax Court decision in an old case.  Cost of removing & replacing insulation are a currently deductible repairs because the costs did NOT: 1.Ameliorate a condition or defect prior to acquisition, or 2.Add to the unit of property, or 3.Increase a unit of property’s capacity or size, or 4.Materially increase a unit of property’s productivity, efficiency, strength, quality or output of a unit of property. 

Regulatory Requirement Not a Betterment Ex. 10.4 p. 354  Lamb Chops owns meat processing plant.  Gov’t found that oil was seeping thru concrete floors.  Gov’t required Lamb Chop to stop oil seepage.  Lamb Chop added concrete lining to walls & concrete to floor.  Lamb Chop can currently deduct the costs even though required by the Gov’t.  Walls & floors were functional prior to seepage.  Seepage was not a pre-existing condition.  Costs did not increase effectiveness and were not a material addition to the existing building.

Relocation and Reinstallation of Equipment Ex. 10.5 p. 354  Jazz operates a manufacturing facility in Bldg A.  Jazz decided to expand by relocating a machine to Bldg B.  The new configuration and addition of components increased the capacity of the machine.  Jazz must capitalize the cost of disassembling, moving and reinstalling the machine because capacity was increased.

Relocation and Reinstallation of Equipment Ex. 10.6 pp. 354 - 355  Peek owns bldg. used in its real estate business.  The first floor has a drop ceiling.  Peek removed the drop ceiling and repainted the original ceiling.  Peek can currently deduct the cost of removing the drop ceiling or painting the old ceiling.  No material addition or increase in capacity or efficiency..

Relocation and Reinstallation of Equipment Ex. 10.7 p. 355  Star found it could reduce its energy costs by adding insulation to its building’s attic, walls, and crawl space.  The insulation is expected to lower the energy costs by 50%.  Star must capitalize the costs since they make the building more efficient.  Question #1:  Suppose the insulation was expected to lower energy cost by 30%?

Relocation and Reinstallation of Equipment Ex. 10.7 p. 355  Star found it could reduce its energy costs by adding insulation to its building’s attic, walls, and crawl space.  The insulation is expected to lower the energy costs by 50%.  Star must capitalize the costs since they make the building more efficient.  Question #1:  Suppose the insulation was expected to lower energy cost by 30%?  According to the text this would not be a material increase in efficiency and would be deductible as a repair.

Comparison of Property Condition p. 355  Comparing condition before & after expenditures helps in deciding if there was a betterment that requires capitalization.  There is no betterment if the property’s condition after a repair is either its: ▪ Condition after the last time normal wear and tear were corrected, or its ▪ Condition is the same as when the asset was placed in service, if there were no prior corrections for normal wear & tear.

Comparing the Property Condition Ex. 10.8 pp. 355 - 356  Roover’s bldg. has 10 roof mounted heat & air conditioning units.  The system includes a control system and duct work with the units making up the HVAC system.  After many years two of the units were replaced.  The new units correct climate control problems and are 10% more efficient than the old units.  Replacement is deductible as a repair because replacement of two units in the entire HVAC system and 10% is not a material increase in efficiency.

Damage to Unit of Property p. 356  If a unit of property is repaired as a result of damage to the property its condition for comparison is its condition before the damage occurred.  Practitioner’s Note:  No betterment if damaged property is restored to its condition before damage happened. ▪ Exception: Cost of restoring property damaged by casualty must be capitalized to the extent the property’s basis is reduced for a casualty loss.

Refreshing a Building p. 356  Costs of “refreshing” a building are currently deductible.  Tres. Regs give examples distinguishing repairs from capital expenditures. ▪ Examples 6, 7, 8 from Tres Reg §1.263(a)-3(j)(3) are illustrative of when costs are deductible “refreshing” or “improvements” that must be capitalized. ▪ See 2014 text book pages 328 – 329 on CD

Restorations pp. 356 - 357 Capitalization required for amounts for: 1.Replacements where deduction was properly taken for non-casualty loss of a component. 2.Replacement where gain or loss was properly taken on disposition of the unit of property. 3.Repair of damage where basis was properly adjusted as result of a casualty. 4.Return of property to use after not functional. 5.Rebuilding to like new after end of its class life. 6.Replacement of a major component.

Restore Deteriorated Unit of Propertyp. 357  If a unit of property deteriorates to where it is no longer fit for use: ▪ Cost of returning the unit of property to its ordinary state of operating is a capital cost.

Return to Like-New Condition p. 357  Cost to bring property to “like new” condition after its class life are capital.  Similar work before end of property’s class life can be deductible repair if not a replacement of a major component of a unit of property.  A comprehensive maintenance program does not return a building to “like new”.

Replace a Major Component or Substantial Structural Part pp. 357 -358  Must capitalize as restoration expenses placements of parts that are a major component of a unit of property or a substantial structural part of a unit of property.  To do this use facts and circumstances.  The Regs try to distinguish “major” and “incidental” components….both being parts that perform a critical function of the unit of property.

Significant Portion of a Major Component Ex 10.9 p. 358  Building has 300 windows making up 25% of its total surface.  Year 1 – 100 windows are damaged and replaced.  The windows are a major component of the building.  But, 100 windows is not a significant portion of the window component.  So the cost of replacing 100 is not capital.  Treas Reg §1.263(a)-3(k)(7), Ex 25.  But….How about if 200 windows are replaced?.....

Significant Portion of a Major Component Ex 10.9, Question 1 p. 358  Building has 300 windows making up 25% of its total surface.  Year 1 – 200 windows are damaged and replaced.  The windows are a major component of the bldg.  200 windows is a significant portion of the window component.  So the cost of replacing 200 is a capital expense.  Treas Reg §1.263(a)-3(k)(7), Ex 26.  But….How about 125 windows? 150? 175? And does the size of the windows make a difference?...

Significant Portion of a Major Component Ex 10.9, Question 2 p. 358  Yes, Size can matter and make a difference.  Building has 300 windows making up 90% of its total surface. Year 1 – 100 damaged and replaced.  The windows are a major component of the building and because they make up 90% of the building surface they are a substantial structural component.  So replacing 100 windows is replacing a substantial structural component of the building and the cost of replacing 100 is a capital expense.  Treas Reg §1.263(a)-3(k)(7), Ex 27. (60%, 70%, ??)

Replacement of Furnace Not a Major Component Ex 10.10 pp. 358 - 359  Master’s bldg.’s HVAC is comprised of 3 furnaces, 3 air conditioning units and duct work.  One furnace breaks down and is replaced.  One furnace unit is not a substantial structural part of the VAC system.  Replacing the one unit is a deductible repair expense.

Replacement of Furnace Not a Major Component Ex 10.11 p. 359  Nimble’s bldg. has an HVAC that is made up on one chiller unit, one boiler, pumps, duct work, diffusers, air-handlers, etc, etc.  The chiller unit includes compressor, evaporator, condenser, & expansion valve.  Replacing the chiller unit is a capital expense.  The chiller unit is a major component of the HVAC system -- It cools the entire system.

Replacement of Plumbing System is a Major Component Ex 10.12 p. 359  Star’s 3 story bldg. has men and women restrooms on two floors.  Star replaces all of the toilets and sinks but not the plumbing pipes.  The restoration must be capitalized because all of the toilets and sinks are a major component of the plumbing system.  Question:  Supposed only 8 of 20 sinks were replaced?

Replacement of Plumbing System is a Major Component Ex 10.12, Q1 p. 359  Star’s 3 story bldg. has men and women restrooms on two floors.  Star replaces all of the toilets and sinks but not the plumbing pipes.  The restoration must be capitalized because all of the toilets and sinks are a major component of the plumbing system.  Question:  Suppose only 8 of 20 sinks were replaced?  8 sinks out of 20 are not a significant portion of a major component of the plumbing system and so the cost is deductible as a repair.

Flooring Replacement Not a Component Ex 10.13 pp. 359 - 360  Victor owns a hotel & decided to refresh the lobby by replacing the lobby floors.  The lobby makes up only 10% of bldg.  The replacement of the flooring is a deductible repair since it is not a significant portion of a major component of the bldg. and not a structural part of the bldg.  Question #1:  What if all public area flooring is replaced?

Flooring Replacement Not a Component Ex 10.13, Q #1 pp. 359 - 360  Question #1:  What if all public area flooring is replaced?  The public areas make up 40% of the hotel flooring.  Changing all public area flooring is a capital expense because it is 40% (a significant portion a major component) of flooring.  Question #2:  Supposed public areas make up 30% of flooring?

Flooring Replacement Not a Component Ex 10.13, Q #2 pp. 359 - 360  Question #2:  Suppose public areas make up 30% of flooring?  The replacement of the flooring would be a deductible repair.  At 30% the public area flooring is not considered a significant portion of a major component.

Partial Disposition Election p. 360  Disposition of an asset can result from a sale or exchange, abandonment, contribution.  A taxpayer can election to report a gain or loss on disposition of a portion of certain assets if the taxpayer classifies the replacement portion of the asset under the same asset class as the disposed portion of the asset. ▪ Taxpayer gets to deduct the portion of an asset abandoned in exchange for capitalizing the replacement portion of the asset.

Partial Disposition Election p. 360  In certain instances the elect must be made: 1.Disposition of a portion of the asset was due to casualty. 2.Disposition where gain is not recognized under 1031. 3.Certain transfers of assets. 4.A sale of a portion of an asset. Thus, under these circumstances the taxpayer reports the gain or loss on disposition and capitalizes the replacement asset.

Partial Disposition Election p. 360  A taxpayer may use any reasonable method to determine the adjusted basis of the disposed portion of the asset.  Permissible methods include: 1.Producer Price Index (PPI) rollback. 2.Cost segregation studies. 3.Factorial comparisons.  Computations are demonstrated on pages 361 and 362.  Page 362 lists changes that cannot use the PPI.

Removal Costs p. 363  Removal cost of a part of a unit of property may be deductible or capital costs if disposal is not a disposition of the unit of property.  Capitalization is not required if removal costs of a capital asset are taken into consideration in gain or loss of the asset.  Ex 10.18, page 363 explains…..

Reroofing an Apartment Complex Ex. 10.18 p. 363  Apple owns 10 separate bldgs.  Roofs on each deteriorated after owned by Apple.  New shingles were put on top of the old in 2 bldgs.  Roof structure needed no work.  Cost are deductible repair and NOT capital exp.  Exceptions:  Taxpayer would have to capitalize costs if work was due to casualty loss or if taxpayer elected to deduct cost of old shingles using the partial asset disposition rules.

Reroofing an Apartment Complex Ex. 10.18, Q1 p. 363  Apple owns 10 separate bldgs.  Roofs on each deteriorated after owned by Apple.  New shingles were put on top of the old in ALL 10 bldgs.  Roof structure needed no work.  Because deterioration occurred while Apple owned the bldgs. there is no adaption, betterment or improvement and cost are still a deductible repair.  Question # 2 -- But suppose deterioration was only after Apple owned bldgs. for 1 or 2 years?

Reroofing an Apartment Complex Ex. 10.18, Q2 p. 363  Apple owns 10 separate bldgs.  Roofs on each deteriorated 1 or 2 years after Apple acquired the bldgs.  New shingles were put on top of the old in ALL 10 bldgs.  Roof structure needed no work.  Because deterioration probably occurred before Apple owned the bldgs. there is “restoration” and cost should be capitalized.  Taxpayer should probably elect partial disposition & deduct adjusted basis of old shingles as a loss.

Reroofing an Apartment Complex Ex. 10.18, Q3 pp. 363 - 364  Apple owns 10 separate bldgs.  Roofs on each deteriorated while after Apple acquired the bldgs.  New shingles were put on top of the old in ALL 10 bldgs.  Roof structure needed no work.  How should removal cost be treated if removal is a repair?  Taxpayer must deduct the removal costs.

Reroofing an Apartment Complex Ex. 10.18, Q4 pp. 363 - 364  Apple owns 10 separate bldgs.  Roofs on each deteriorated while after Apple acquired the bldgs.  New shingles were put on top of the old in ALL 10 bldgs.  Roof structure needed no work.  How should removal cost be treated if removal is a capital cost and taxpayer elected a partial disposition?  Taxpayer must deduct the removal costs of the old shingles.

Component Removed during Improvement Ex. 10.19, Q #1 p.364  Xavior owns bldg. with storage on 2 nd floor.  Replaced columns and girders to support 50% more weight in 2 nd floor storage area.  Replacement is an improvement and a capital cost  How are cost of removing old columns & girders treated?  Because this was an improvement the cost of removing the old and installing the new are capital costs.

Component Removed during Improvement Ex. 10.19, Q #2 p.364  Xavior owns bldg. with storage on 2 nd floor.  Replaced columns and girders to support 50% more weight in 2 nd floor storage area.  Replacement is an improvement and a capital cost  How are cost of removing old columns & girders treated if “partial disposition” treatment is elected?  The cost of removing the old are a deductible repair.  Cost of installing the new are capital costs.

Component Removed during Improvement Ex. 10.19, Q #3 p.364  Xavior owns bldg. with storage on 2 nd floor.  Replaced columns and girders to support 25% more weight instead of 50% in 2 nd floor storage.  Replacement may not be a “material increase” in capacity.  The costs are a deductible repair.  How about 30%, 40%, 49%?

Component Removed during Repair or Maintenance Ex. 10.20 pp. 364 - 365  Shingles cover a retail building’s roof.  The roof begins to leak.  New shingles replaced the old shingles.  The new shingles stop the leaks but are not a betterment or a restoration and do not adapt or change the buildings use.  Cost of removing the old shingles and installing the new are a currently deductible repair.  BUT….Suppose the owner deducts the adjusted basis of the old shingles as a disposition of a unit of property?

Component Removed during Repair or Maintenance Ex. 10.20, Question p. 365  If the owner deducts the adjusted basis of the old shingles as a loss on disposition of a unit of property the replacement costs is considered a restoration which must be capitalized as an improvement of the unit of property.  The cost of removing the old shingles is still treated as a currently deductible expense.

Adaption to a New or Difference p. 365 Cost of adaption to a new or different use must be capitalized.

Combining Three Leased Spaces Ex. 10.21 p.365  Broadstone owns bldg. & leases 20 retail spaces in the bldg.  Bldg was designed so that spaces could be adjusted within the bldg.  A tenant renting one space expanded & wanted the business to have 3 spaces.  Broadstone removed walls and made adjustments to increase tenants space.  Costs are a deductible repair.

Preparing Building for Sale Not an Adaption Ex. 10.22 p.365  Crystal owns bldg. & leases 20 retail spaces in the bldg. and decided to sell the bldg.  To sell bldg. the walls were painted and flooring was refinished.  Costs are not preparing for a different use.  Costs are a deductible repair.

Modifying Part of Building Ex. 10.23 pp. 365 - 366  General Hospital owns a hospital bldg.  General decided to modify the emergency room to also do outpatient surgery.  It moved walls, added wiring & outlets, replaced flooring & doors, repainted, & added equipment.  Ordinary use of building did not change.  Renovation costs a repair.  Cost of new equipment are capital expense.

Unit of Property p. 366  Replacement of a major component or substantial structural part of a unit of property must be capitalized.  Other than buildings use a: ▪ “Functional Interdependence” standard:  Placing one component in service is dependent on placing other components in service.  Functional interdependent components are one single unit of property.

Buildings p.366 - 367  A building is a single unit of property.  But, for purposes of improvement rules: ▪ The building structure is a unit of property and ▪ Building systems are each a separate unit of property including:  Heat, ventilation & air conditioning  Plumbing systems (pipes, sinks, etc)  Electrical systems (wiring, outlets, lighting, etc)  Escalators  Elevators  Fire protection systems.  Etc

Building Structure p.367  Except for “building systems” the building structure is the building including: ▪ Walls ▪ Partitions ▪ Floors ▪ Ceilings ▪ Windows and Doors ▪ Components relating to the building’s operation and maintenance.

Leased Buildings p. 367  Only part of a building is leased: ▪ Unit of property is the portion of the building covered by lease.  Where a whole building is leased: ▪ Improvement rule is same as if the building is owned:  Improvement rules apply to building structure and separately to building systems.

Alterations to Restroom Ex. 10.24p. 367 - 368  Lessee rents space in a large office building  If the Lessee pays to have new toilet and sink installed in a restroom for its employees: ▪ Cost is capital expenditure because the work is on a major portion of plumbing system in lessee’s restroom.  If Lessor pays cost: ▪ Cost could be a deductible repair since it only affects a small portion of the buildings entire plumbing system.

Building Improvement by Lessor Ex. 10.25p. 369  Teddy leased a bldg. from Landmark.  Landmark provided to Teddy a construction allowance used to add to warehouse space.  Landmark is owner of addition and: ▪ Must capitalize the “betterment” costs. ▪ The addition is not a separate unit of property but part of the building  Question / Answer:  If Landmark were to remodel 2 of 6 restrooms next year the cost would be a repair.

Property Other Than Buildings & Ex. 10.26 p. 369  Assets used together are not always functionally interdependent. Ex. 10.26  Laptop computer and printer bought for use by employees.  The computer and printer are separate units of property because one can be placed in service without the other.

Functionally Interdependent Components Ex. 10.27 p.369  A train locomotive is comprised of an engine, generators, batteries, chassis, etc.  The locomotive is a single unit of property.  Its parts are functionally interdependent.

Plant Property p. 369  Means functionally interdependent machinery or equipment (not including network assets) used in manufacturing, warehousing, distribution, etc.  The unit of property is divided into smaller units.  Let’s see example 10.28…..

Discrete and Major Functions Ex 10.28pp. 369 - 370  A laundry plant treats and launders rental uniforms.  It has two lines of operation.  Each line has a sorter, boiler, washer, dryer, ironer, folder & waste water treatment system.  General rule – ▪ Each line is a separate unit of property. ▪ Under functional interdependence.  Plant Property rule - ▪ Each line is further divided into units of property. ▪ Each sorter, boiler, washer, dryer, etc is a separate unit of property. ▪ Replacing a dryer in either line is a capital expenditure.

Network Assets p. 370  Functional interdependence test is NOT controlling for Network Assets  Unit of property for Network Assets is determined by fact and circumstances.  Network Assets Include - Railroad track; oil & gas pipelines; water & sewage pipelines; power transmission & distribution lines; and telephone & cable lines......Excluding buildings & building systems.  See what a good lobbyist can do for an industry.

Limit for Lease Property and Improvements and Different Depreciation Schedules p. 370  A unit of property cannot be larger than the property subject to a lease.  Improvements to a unit of property do not become separate units of property.  Components of a unit of property with a different depreciation methods or recovery periods are separate units of property.

Components with Different Depreciation Classes Ex 10.29 p. 370  Truck company bought a tractor.  Treated tractor as 3-year property.  Treated tractor tires as 5-year property.  General rule – Tractor and tires are a unit of property.  BUT – Because tractor and tires are different classes of property they are two separate units of property.

Improvements with the Same Depreciation Method Ex 10.30 p. 371  Additions to buildings are not separate units of property from the building if the same depreciation method & period are used.  Makes no difference that the placed in service dates are different.

Cost Segregation Ex 10.31 p. 371  If the depreciation method for a portion of a building or components of a building changes that portion becomes a separate unit of property.  Ex 10.31  Depreciating building & parking lot as 39-year property and as one unit of property.  Cost segregation study done and as a result parking lot changed to 15-year property.  Parking lot is now a separate unit of property.

Cost Segregation p. 371  Practitioner Note: ▪ Cost segregation change assets into separate units of property. ▪ This is a change in method of accounting requiring Form 3115 and IRS consent.  Planning Pointer: ▪ Cost segregation may provide larger depreciation deductions BUT ▪ Because the unit of property is smaller what might have been a repair later may be a capital expenditure.

Materials and Supplies p. 372  Materials & Supplies are tangible property used or consumed in a business that are not inventory and are either: 1.Costing $200.00 or less, or (Increased from $100.00 under the temporary regs.) 2.A component acquired to maintain or repair tangible property, or 3.Fuel, lubricants, etc to be consumed in 12-months, or 4.A unit of property with useful life less than 12- months, or 5.Any other tangible property so designated by IRS.

Bulk Purchase Ex. 10.32 p. 372  Buys 10 toner cartridges for $500.  8 will be used within 12-months & 2 are stored.  Since each cartridge cost less than $200 those to be used within 12-months are currently deductible.  So $400 can be deducted currently. ▪ 8 cartridges X $50 cost for each.  The remaining $50 for each cartridge can be deducted when each remaining cartridge is used.

Improvements Using Materials and Suppliesp. 372  Costs of material and supplies used to improve a unit of property must be capitalized and depreciated as part of the unit of property. ▪ §1.263-3(h), Ex 10  Costs of material and supplies used to repair a unit of property can be deducted as a repair expense. ▪ §1.162-4 - See Ex 10.33, Text Page 372.

Incidental Materials and Supplies pp. 372 - 373  If no record is kept the costs are deductible in the year paid if income is clearly reflected.  Planning Pointer:  Under a “Safe Haven” an election can be made to deduct material and supply costs limited by a safe harbor amount.  To be covered next.

De Minimis Safe Harbor p. 373  Deduction allowed for units of property that are normally capitalized if: ▪ Useful life is less than 12 months OR ▪ Cost does not exceed a ceiling amount.  < $500.00 where Applicable Financial Statements are not prepared and  < $5,000 where Applicable Financial Statements are prepared.

De Minimis Safe Harbor Rules p. 373 - 374  Amounts deducted under Safe Harbor are an ordinary §162 deduction.  A later sale of a Safe Harbor item results in ordinary income.  If elected Safe Harbor applies to all applicable cost items.  Exceptions to the De Minimis Rule: ▪ Certain rotable, temporary or emergency spare parts that are capitalized and depreciated. ▪ Property intended for inventory. ▪ Land.

De Minimis Safe Harbor Applied to Materials and Supplies Ex. 10.34 p.374  TPs financial system requires a taxpayer to treat items costing $500 or less as an expense.  TP bought 1,000 calculators costing $100 each.  Life expectancy is more than 12-months.  Since each calculator cost less than $200 they can be treated as materials and supplies and deducted in the year used or consumed.  OR  Since the calculators cost less than $500 the cost can be deducted under the De Minimis Safe Harbor in the year the taxpayer paid or incurred the cost.

De Minimis Safe Harbor Applied to Materials and Supplies p. 375  Planning Pointer: ▪ A §179 deduction could be taken instead of the Safe Harbor deduction. ▪ Under §179 a later gain on disposition could be a capital gain.

De Minimis Safe Harbor Ex 10.35 p. 375  TP does not have AFSs but does have a policy of expensing property costing $500 or less.  Buys 100 heifers that cost $400 each.  Each heifer is a separate unit of property costing less than $500.  TP can deduct the $40,000.  Practitioner Note:  Subsequent sale of the heifers would be ordinary income instead of capital gain.

Qualifications for Election p. 375  To use the De Minimis Safe Harbor the business must have a policy in place for expensing units of property costing a certain amount.  Policy must be in writing if have AFSs.  Text suggests having a written policy even if don’t have AFSs.  Fig 10.2, page 377 provides a sample format to establish an accounting practice.

Useful Life p. 375  In determining whether an item will last more or less than 12-months consider all of the facts, circumstances, experiences, etc.  Class life and recovery period of an asset are not determinative.

Applicable Financial Statement p. 376  Applicable Financial Statements (AFS) ▪ Those filed with the SEC. ▪ CPA Certified statements ▪ Those required by a Federal or State or an agency other than the SEC or the IRS.  The Safe Harbor limits are lower if the TPs accounting procedures set a lower limit.  Fig 10.2 provides a sample format to establish an accounting practice.

Taxpayers With and Without an AFS Ex 10.36 and 10.37 p. 377  Ex. 10.36: TP has AFSs and written policy to expense amounts up to $5,000.  Buys 1,250 computers for $6.25M.  Each is a separate unit of property & each cost no more than the $5,000 limit.  TP can deduct the $6.25M.  Ex. 10.37: TP does not have AFSs but does have a policy of expensing property costing $500 or less.  Buys 10 printers for $2,500.  Each printer is a separate unit of property costing less than $500.  TP must deduct the $2,500

Economic Useful Life Ex 10.38 p.377 - 378  No AFS but policy is to deduct property costing $300 or less AND expense any property with a useful life of 12-months or less.  Bought a $400 device & a $600 computer both having a useful life of less than 12-months.  Can expense both items for accounting purposes AND  Can deduct the $400 for tax purposes BUT  Must capitalize & depreciate the $600 for tax purposes because it exceeds the safe harbor limitation.

Transaction & Other Additional Costs p. 378 In determining if $500 or $5,000 safe harbor limit is met or exceeded:  Costs of acquiring property are included in the cost of a unit of property ONLY if the additional costs and property cost are on same invoice.  If invoice includes multiple units of property and the additional costs (shipping, etc) is on the invoice the additional costs must be allocated to the different units or property.  See Exs. 10.39 and 10.40, text page 378.

De Minimis Rules Annual Election p. 379 Elect to come under safe harbor using the De Minimis Rule:  Irrevocable election is made for each year.  Attach statement to original tax return. ▪ See Fig 10.3, text page 379.  Must be filed by due date including extensions.  Need to state: “Section 1.263(a)-1(f) de minimis safe harbor election.”  S Corps and P/Ss make election on their return… Not SH or Partner’s return.

Antiabuse Rule p. 379  If an invoice is divided for abuse of the rule the safe harbor does not apply.  If you purchase a truck that exceeds the safe harbor limitation you cannot come under the safe harbor by asking for and getting separate invoices for the motor, cab, tires, transmission, seats, etc.  IRS can make adjustments to correct.

Routine Maintenance Safe Harbor Nonelctive p. 380 - 381 Deductible Routine Maintenance includes:  Inspecting, cleaning, testing and replacing damaged or worn parts.  Other than buildings & structural components: ▪ Activities to be performed more than once during the assets ADS class life.  Building & structural components: ▪ Activities to be performed more than once in a 10-year period.

Routine Maintenance plus Upgrades Ex 10.41 p. 381  Boats class life is 18 years.  Routine repairs & maintenance done every 4 years.  At 8 th year boats were also upgraded.  The routine repairs and maintenance done at 8 th year directly benefitted the upgrades.  None of the costs in the 8 th year qualify as routine maintenance and repairs and must be capitalized.

Maintenance for Prior Owner’s Use Ex 10.42, Q #1 pp. 381 - 382  Bell bought a machine with 10 ADS life.  Routine maintenance set for every 3-years by mfr.  When the machine was bought it was due for 3-years maintenance work.  Q#1 -- Do the costs qualify for the routine maintenance safe harbor?  No. Work was due to prior owner’s use.  Costs must be capitalized if resulted in betterment, improvement or ameliorated a defect.

Maintenance for Prior Owner’s Use Ex 10.42, Q #2 p. 382  Bell bought a machine with 10 ADS life.  Routine maintenance set for every 3-years by mfg.  When the machine was bought it was due for 3-years maintenance work.  3-years later Bell did the next mfg suggested work.  Q#2 -- Do these subsequent costs qualify for the routine maintenance safe harbor?  Yes and the costs are a deductible.

Escalator System Ex. 10.43 p. 382  40 escalators in a mall.  Estimate replacing handrails every 4 years.  At 4 th year the handrails were replaced.  The cost is a currently deductible expense.  Done to keep the escalator system in operating condition.  Reasonably expected to change the steps during the 10 year period.  How about if steps are replaced in 9 th year?

Escalator System Ex. 10.43, Question p. 382  Again, we have 40 escalators in a mall.  Estimate replacing steps every 18-20 years.  At 9 th year the steps of the escalators need to be replaced.  Replacement not eligible for routine maintenance safe harbor & must be capitalized IF replacement improves the building system.  BUT, may be deducted as a repair if replacement does not result in building system improvement.

HVAC System (Heat, Ventilation & Air Conditioning) Ex. 10.44 p. 383  Estimated work every 4 years to keep HVAC systems running properly.  Work done in 4 th year but not done again until year 11.  If TP can show that expectation of work every 4 years was reasonable it can deduct the work that was postponed until year 11.  Planning Pointer – Need to document maintenance plan.

Small Taxpayer Safe Harbor Eligible Building Property pp. 383 - 384  Small qualifying taxpayers (including renters): ▪ Those with 3-year average receipts < $10M.  Can elect (annually) to deduct building repairs, maintenance, improvements & similar activities if the cost of these is the lesser of:  $10,000 or 2% of property’s unadjusted basis for an eligible building property which is:  One owned or leased by small qualifying TP.  With unadjusted basis < 1M.  If the expenses exceed the safe harbor limit the general rules apply to the expenses….Capitalize improvements.  If the expenses exceed the above limit the general rules apply.

Observation P. 384  2% x $500,000= $10,000  So if a buildings unadjusted basis is: ▪ More than $500,000 the lower limit is $10,000. ▪ Less than $500,000 the 2% limit will be lower and apply.

Safe Harbor Applied to Lessor Ex. 10.45 p. 385  Rita owns rental house.  Her 3-year average gross receipts are less than $10,000,000.  She elected no safe harbor.  Let’s look at the facts and what happens….

Safe Harbor Applied to Lessor Ex. 10.45, Fig 10.4 p. 385 Unadjusted basis Land$10,000 Building Unadjusted Basis 99,500 Prior Bldg Improvements 20,100 Lawn Mower 1,450 Appliances 1,700 Total Unadjusted Basis$132,750 Current Yr Improvements$ 2,000 Current Yr Repairs & Main 3,275 Current Yr Expenses$ 5,275 Has she met the safe harbor? Can she deduct the improvements?

Safe Harbor Applied to Lessor Ex. 10.45, Fig 10.4 p. 385 Unadjusted basisBldg Only Result Land$10,000Repairs, Maintenance, Building Unadjusted Basis 99,500$ 99,500and Improvements are Prior Bldg Improvements 20,100 less than $10,000 BUT Lawn Mower 1,450they exceed the 2% of Appliances 1,700________the Buildings Total Unadjusted Basis$132,750$119,600Unadjusted basis. So, X 2%the Small TP Safe Limitation$ 2,392Harbor is NOT met. Current Yr Improvements$ 2,000 =Must be Capitalized Current Yr Repairs & Main 3,275 =Can Currently Deduct Current Yr Expenses$ 5,275

Safe Harbor Applied by Lessee Ex 10.46 pp. 385 - 386  Unadjusted basis for the small taxpayer safe harbor in a lease situation is the rent to be paid over the life of the lease.  Monthly rent of $4,000 over a 20-year lease gives unadjusted basis of $960,000 ($4,000 x 240 Mos).  Unadjusted basis is therefore less than $1M so property qualifies as an eligible building.  Current yearly maximum repair, maintenance & improvement deduction under the building safe harbor is the lesser of $10,000 or 2% X $960,000.  Taxpayer may be able to deduct $10,000.

More Than One Building Ex 10.47 p. 386  If a taxpayer has more than one building the Safe Harbor limitations are applied to each building, separately.  Taxpayer owns 2 buildings with unadjusted basis of $300,000.  Repairs, maintenance and improvements to one are $5,000 and are $7,000 to the second building.  Let’s see if the Safe Harbor applies……

More Than One Building Ex 10.47 p. 386 Leased BldgsBldg #ABldg #B Unadjusted Basis$300,000 Limitation % X 2% 2% Limitation$ 6,000 Maximum $ Limitation$ 10,000 Lesser of 2% or $10,000 =$ 6,000 Repairs & Improvements$ 5,000 $ 7,000 Repairs areCurrently Deductible Currently Deductible Improvements areCurrently Deductible To Be Capitalized

Annual Election Eligible Building Safe Harbor p. 386 To elect to come under safe harbor using the Eligible Safe Harbor for a Building:  Attach statement to original tax return. ▪ See Fig 10.5, text page 386.  Must be filed by due date including extensions.  Need to state: “Section 1.263(a)-3(h) Safe Harbor Election for Small Taxpayers.”  S Corps and P/Ss make election on their return… Not SH or Partner’s return.

Election to Capitalize Repair & Maintenance Costs p. 387  Can elect to capitalize and depreciate repairs and maintenance. See sample Fig 10.6, page 388.  Known as “Book Conformity”.  Attach statement to original tax return.  Must be filed by due date including extensions.  Need to state: “Section 1.263(a)-3(n) Election”.  S Corps and P/Ss make election on their return… Not SH or Partner’s return.  Can still use De Minimis Safe Harbor; Safe Harbor for Small Taxpayers; and deduct Routine Maintenance that are not capitalized on the return.

Change in Method of Accounting pp. 388 - 389  Here is where the confusion has been.  When does a change in method Form 3115 need to be filed.  IRS issued Rev Proc 2014-16 to clarify.  IRS then issued Rev Proc 2014-54 to further clarify  IRS then issued Rev Proc 2015-13 to help.  Finally, IRS issued Rev Proc 2015-20 stating that “small taxpayers” could adopt the final regulations on a prospective basis without filing a Form 3115, or attaching a disclosure statement to the return……………SO…….

Change in Method of Accounting p. 389 Revenue Procedure 2015-20, 2015-9 IRB 694:  Taxpayers with less than either: ▪ $10M in assets OR ▪ $10M in a 3-year average of gross receipts  Do NOT have to file Form 3115 to use the final repair regulations for tax years starting on or after January 1, 2014 and  Do NOT need to attach a disclosure statement to the tax return.  Small taxpayers are “deemed “ to have filed a 3115

Section 481(a) Adjustment & Practitioner Note p. 389  The Section 481(a) adjustment usually made with a change in method of accounting is -0- for small taxpayers using the new repair Regulations on or after tax years beginning January 1, 2014.

Separate Trade or Business p. 389  If the trades and businesses are separate and distinct the assets and incomes of the businesses do not need to be combined for purposes of the $10M tests for being a small taxpayer.

Consequences of Deemed Filing of Form 3115 Under Rev Proc 2015-20 pp. 390 - 391  Pages 390 – 391 list the accounting changes that: ▪ Can be made without filing Form 3115 for small taxpayers “Deemed” to have file Form 3115, and ▪ Cannot be made without filing Form 3115 for small taxpayers “Deemed” to have file Form 3115.

To File or Not To File Form 3115 pp. 392 - 393  Form 3115 is not required by “Small Taxpayers”.  The potential missed opportunities and recommendations for when the Form 3115 should be filed are listed on pages 392 - 393.

Concurrent Automatic Changes and Signing & Filing the Form 3115 pp. 395 - 396  One Form 3115 can be filed for several changes to the new rules.  Original goes with tax return.  A signed copy must be sent to IRS, 1973 Rulon White Blvd., Mail Stop 4917, Ogden, UT 84201-1000. ▪ Address in several Rev Procs is incorrect.  Signing instructions are on Form 3115 instructions and in Rev Proc 2015-13.

Extension of Time to File Form 3115 p. 396  There is an automatic 6-month extension to file Form 3115.  Must file 3115 within 6-months of due date excluding extensions.  In addition, taxpayer must: ▪ Timely file return for change year (including extensions), ▪ Attach a statement that the Form 3115 is being: “Filed Pursuant to 301.9100-2(b) of Procedure and Administrative Regulations” ▪ See page 396 for further details.

Sample of a Completed Form 3115 pp. 396 - 402  Sample of a Form 3115 completed for a small business taxpayer choosing to formally file accounting method changes with a zero section 481(a) adjustment.

List of Changes Not Considered a Change in Method p. 403 Safe HarborForm 3115 NOT Required Election Required De Minimis Safe Harbor: < $500 & < $5,000 NoYes Small Taxpayer Building: Lesser of $10,000 or 2% NoIf Exceed Limits For Others See Text Page 403

Summary of Method Changes Reported on Form 3115 pp. 404 - 407  These pages provide a summary of the accounting method changes that may be made as a result of the new repair regulations.

Decision Tree pp. 408 - 409 New Regs have a lot of twists and turns But there is HELP! The Decision Tree on pages 408 & footnotes on page 409 walk you through the maze in deciding whether an expenditure can be deducted or should be capitalized.

New Repair Regulation Chapter 10 pp. 349 - 409 2015 National Income TAX Workbook™

Similar presentations

Presentation on theme: "New Repair Regulation Chapter 10 pp. 349 - 409 2015 National Income TAX Workbook™"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

New Repair Regulation Chapter 10 pp. 349 - 409 2015 National Income TAX Workbook™

Similar presentations

Presentation on theme: "New Repair Regulation Chapter 10 pp. 349 - 409 2015 National Income TAX Workbook™"— Presentation transcript:

Similar presentations

About project

Feedback