final repair and maintenance regulations: new rules, new ... · final repair and maintenance...

© 2013 Baker Tilly Virchow Krause, LLP

Baker Tilly refers to Baker Tilly Virchow Krause, LLP,

an independently owned and managed member of Baker Tilly International.

1

Final repair and maintenance regulations: New rules, new opportunities

October 1, 2013

Agenda

> Changes to the capitalization standards

> Routine maintenance safe harbor

> Materials and supplies

> De minimis safe harbor

> Safe harbor for small taxpayers

> Proposed partial disposition regulations

> Final thoughts

> Questions

3

4

Timeline

2003 FedEx case

January 2004 Notice 2004-6 (Notice of Proposed Rulemaking)

August 2006 2006 Proposed Regulations

March 2008 2008 Proposed Regulations

December 2011 2011 Temporary Regulations

March 2012• Rev. Proc. 2012-19 and Rev. Proc. 2012-20- Transition Rules for Implementing Temporary Regulations (covering years 2012 and 2013)

• LB&I Exam Stand-Down Directive (covering years 2012 and 2013)

November 2012 Notice 2012-73 (Announcement to modify Temporary Regulations effective date and other aspects of the Temporary Regulations)

December 2012 Technical amendments to the Temporary Regulations (amended effective date)

March 2013 Revised LB&I Stand-Down Directive

September 2013 2013 FINAL REGULATIONS

Background

> The final regulations refine and simplify some of the rules in the 2011 temporary regulations and create a number of new safe harbors.

– Adopt a revised and simplified de minimis safe harbor

– Extend the safe harbor for routine maintenance to buildings

– Add a safe harbor for small taxpayers

– Refine several of the criteria for defining betterments and restorations to tangible property

– Propose new partial disposition rules

Overview

> The final regulations (T.D. 9636) are generally effective for tax years beginning on or after Jan. 1, 2014.

> A taxpayer may choose to apply the final regulations to taxable years beginning on or after Jan. 1, 2012.

> A taxpayer may elect to apply the temporary regulations (T.D. 9564) to tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014.

> Transition relief for 2012 and 2013 tax returns available for certain provisions.

> Revenue procedures with accounting method procedures expected in early November.

Effective date

6

7

Capitalization standards

8

Non-buildingsBuildings

Single UoP

Default rule Plant property Network assets

Functional

interdependence

Discrete and

major function

Industry-specific

facts and

circumstances

Unit of property (UoP)

Building

Building structure

Building systems

HVAC system

Electrical system

Plumbing system

Gas distribution

Fire suppression

Elevators

Escalators

Building security

Pre-regulation law

Final regulations

Capitalization standards must be applied separately to:

9

Unit of property for buildings

Improvement standards

10

Improvement

Betterment Adaptation Restoration

> Betterment

– Ameliorates a material condition or defect at acquisition or production

– Material addition or expansion

– Reasonably expected to materially increase the productivity, efficiency, strength, quality, or output

Improvement standards – betterment

11

Examples:

Betterments; materiality

12

Non-material increase in efficiency Material increase in efficiency

Facts:HVAC system has 10 roof-mounted units

Replaces two units

Increase energy efficiency by 10%

Added new insulation in an existing building

Reasonably expected to reduce energy and power

costs by 50%

Conclusion: 10% efficiency increase is not expected to

materially increase the productivity, efficiency,

strength, quality, or output of the HVAC system

Reasonably expected to materially increase the

efficiency of the building structure (by 50%)

Costs will be capitalized as a betterment

Examples:

Betterments; retail remodels

Retail building refreshRetail building refresh;

limited improvementRetail building remodel

Purpose: Maintain appearance and

functionality

Maintain appearance and

functionality

Increase storage space, add

second loading dock and

overhead door

New market focus

Scope: Cosmetic and layout

changes

Cosmetic and layout changes

Construct an addition to the

back of the building, add a

second loading dock, and add

another overhead door

Substantial renovation of

building structure, electrical

system, and plumbing system

Clean, patch holes, repaint, and

power wash

Conclusion: Not a betterment Store refresh - not a betterment

Additions - betterment

Betterment

13

> Restoration

– Recognition of a loss on component

– Gain/loss on sale of component

– Basis adjustment as a result of a casualty loss

– Return to former operating condition – no longer functioning

– Rebuild the property to like-new condition after class life

– CLARIFICATION: Replacement of a major component/substantial structural part

Improvement standards – restoration

14

> NEW: Major component definition

– Part or combination of parts that performs discrete and critical function in the operation of the unit of property.

– An incidental component of the unit of property, even though such component performs a discrete and critical function in the operation of the unit of property, generally will not, by itself, constitute a major component.

> NEW: Substantial structural part definition

– Part or combination of parts that comprises a large portion of the physical structure of the unit of property.

Application of restorations to buildings

15

Building structure and systems

16

Systems System major components

Structure Building and structural components other than structural components designated in another building system

HVAC Motors, compressors, boilers, furnace, chillers, pipes, ducts, radiators

Plumbing Pipes, drains, valves, sinks, bathtubs, toilets, water, and sanitary collection equipment, exterior site utility equipment

Electrical Wiring, outlets, junction boxes, lighting fixtures and associated connectors, exterior site utility equipment

Elevators/

escalatorsAll elevators/escalators

Fire

protection

Sensing devices, computer controls, sprinkler heads, sprinkler mains, associated piping and plumbing, pumps, visual and auditable alarms, alarm

control panels, heat and smoke detection devices, fire escapes, fire doors, emergency exit lighting and signage, fire fighting equipment

SecurityFor the protection of the building and its occupants: window and door locks, security cameras, recorders, monitors, motion detectors, security

lighting, alarm systems, entry and access systems, related junction boxes, wiring, and conduit

Gas

distributionAssociated pipes and equipment to distribute gas from and to the property and between buildings and structures

Examples:

Major component or

substantial structural part

17

Roof HVAC

Facts: Replaced roof membrane to fix leaky roof with

a comparable part

HVAC system includes many components including one

chiller unit

The chiller unit is replaced with a comparable unit

Conclusion: The roof, including the membrane, is part of

the building structure

The replacement is not considered a significant

portion of the roof major component

Chiller unit performs a discrete and critical function in the

operation of the HVAC system

Chiller unit is a major component

Treatment: Expense Capitalize

Examples:

Major component or


3 of 10 RTUs replaced,

cost of $15,000

18

Temporary regulations Final regulations

UoP Building Building

Building structure/

systemHVAC HVAC

Building system

replacement cost

new

$150,000 $150,000

Major component

performing discrete

and critical function

N/A RTUs

Analysis

Cost of RTUs $15,000

= 10%

Units replaced 3

= 30%Building system

replacement

cost

$150,000 Total units 10

Treatment DEDUCTIBLE DEDUCTIBLE

30% of electrical wiring replaced in a

building, cost of $30,000


Building Building

Electrical Electrical

$300,000 $300,000

N/A Electrical wiring

Cost of wiring $30,000

= 10% 30%Building system

replacement

cost

$300,000

DEDUCTIBLE DEDUCTIBLE

Examples:

Major component or


20 of 20 sinks replaced, cost of $10,000;

30 of 30 toilets replaced, cost of $30,000

19

8 of the 20 sinks are replaced,

cost of $4,000



Building structure/

systemPlumbing Plumbing

Building system

replacement cost

new

$200,000 $200,000

Major component

performing discrete


N/A Toilets AND sinks

Analysis

Cost of

replacement$40,000

= 20%

Units replaced 20 30


replacement

cost

$200,000 Total units 20 30

Treatment DEDUCTIBLE CAPITALIZE


Building Building

Plumbing Plumbing

$200,000 $200,000

N/A Sinks

Cost of sinks $4,000

= 2%

Units replaced 8


replacement

cost


DEDUCTIBLE DEDUCTIBLE

Examples:

Major component or


100 of 300 exterior windows replaced,

cost of $50,000

20

200 of 300 exterior windows replaced,

cost of $100,000



Building structure/

systemBuilding structure Building structure

Building system

replacement cost

new

$750,000 $750,000

Major component

performing discrete


N/A Windows

Analysis

Cost of

windows$50,000

= 6%

Units replaced 100


replacement

cost


Treatment DEDUCTIBLE DEDUCTIBLE


Building Building

Building structure Building structure

$750,000 $750,000

N/A Windows

Cost of

windows$100,000

= 13%

Units replaced 200


replacement

cost


DEDUCTIBLE CAPITALIZE

> A UoP is improved if the amounts paid result in an:

– Adaptation of the UoP to a new or different use

Improvement standards – new or different use

21

Examples: Not a new or different use New or different use

Facts: Operating grocery store adds a sushi bar Retail drug store creates a walk-in medical clinic

Conclusion: Consistent with intended, ordinary use of building Not consistent with the intended ordinary use of the building

at the time placed in service


> NEW: May elect to treat amounts paid during the taxable year for repair and maintenance to tangible property as amounts paid to improve that property if the taxpayer incurs these amounts in carrying on the taxpayer’s trade or business and if the taxpayer treats these amounts as capital expenditures on its books and records.

> Applies to all amounts paid for repair and maintenance to tangible property that it treats as capital expenditures on its books and records in that taxable year.

> Annual irrevocable election made by attaching a statement to a timely filed original federal tax return (including extensions) for the taxable year in which the taxpayer pays these amounts.

> Must begin to depreciate the costs of improvements when they are placed in service.

Election to capitalize repair and maintenance costs

22

24

Routine maintenance safe harbor

Extension of routine maintenance

safe harbor to buildings

> NEW: Extend the application of the routine maintenance safe harbor to buildings.

> Recurring activities that a taxpayer expects to perform as a result of the taxpayer’s use of the building to keep the building structure or system in its ordinarily efficient operating condition.

> The taxpayer must reasonably expect to perform the activities more than once during a 10-year period beginning at the time the building structure or building system is placed in service.

> Note: A taxpayer’s expectation will not be deemed unreasonable merely because it does not actually perform the maintenance a second time during the 10-year period—as long as the taxpayer can otherwise substantiate that its expectation was reasonable when the property was placed in service.

> Amounts incurred for activities that do not meet the safe harbor are subject to analysis under the general rules for improvements.

25

Qualifying routine maintenance Non-qualifying routine maintenance

Facts: Reasonably expected that every 4 years

maintenance would be performed on HVAC system

In Year 4, a contractor is paid to perform

maintenance

Maintenance was not performed again until Year 11

Purchased a used machine and expected to

perform maintenance every 3 years

At the time of purchase, the machine was close to

the 3-year scheduled maintenance

Conclusion: Amounts paid for maintenance in Year 4 and

Year 11 are qualified

The costs were incurred as a result of the prior

owner’s use of the property and do not qualify


26

Examples

27

Materials and supplies

Materials and supplies

> MODIFICATION: Expand the definition of materials and supplies to include property that has an acquisition or production cost of $200 or less (previously $100 or less).

> NEW: Provide a definition for standby emergency spare parts.

> Retain the rule permitting a taxpayer to elect to capitalize and depreciate amounts paid for certain materials and supplies.– NEW: Provide that this rule is only applicable to rotable, temporary,

or standby emergency spare parts.

– Election is made by capitalizing amounts paid in the year paid.

– Election must be made on a timely filed original federal tax return (including extensions).

> CLARIFICATION: Provide that a taxpayer that uses the optional method for rotable and temporary spare parts for federal tax purposes must use the optional method for all of the pools of rotable and temporary spare parts used in the same trade or business for which the optimal method is used for book purposes.

28

29

De minimis safe harbor

Old rule

> Ceiling limitation

– The aggregate amount deducted is less than or equal to the greater of

o 0.1 percent of gross receipts for federal income tax purposes

OR

o 2 percent of total book depreciation and amortization expense

– Removed due to many unfavorable taxpayer comments

o Administrative burden – would be required to keep detailed accounts of amounts generally not tracked because such amounts are expensed under financial accounting capitalization policies.

30

New safe harbor

> NEW: May rely on the safe harbor to expense tangible property under a certain dollar threshold.

> Must have a written accounting procedure in place at the beginning of the taxable year with a specified dollar amount and does not exceed a per invoice or per item cost.

– For taxpayers with an applicable financial statement, the dollar amount is not to exceed $5,000 per item.

– For taxpayers without an applicable financial statement, the dollar amount is not to exceed $500 per item.

31

Applicable financial statement

> A financial statement required to be filed with the Securities and Exchange Commission (SEC) (the 10-K or the Annual Statement to Shareholders);

> A certified audited financial statement that is accompanied by the report of an independent certified public accountant (or, in the case of a foreign entity, by the report of a similarly qualified independent professional) that is used for:

– Credit purposes;

– Reporting to shareholders, partners, or similar persons; or

– Any other substantial non-tax purpose; or

> A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or the IRS).

32

Election details

> Safe harbor is elected annually by including a statement on a timely filed original federal return (including extensions) for the year elected.

> Must be applied to all amounts paid in the taxable year for tangible property that meet the requirements of the de minimis safe harbor, including amounts paid for materials and supplies.

– Except for materials and supplies that the taxpayer elects to capitalize and depreciate; or

– Except for where the optional method of accounting is used for rotable and temporary spare parts.

> Election may not be revoked.

> An election may not be made by filing an application for change in accounting method.

33

Examples

34

Taxpayer without an AFS Taxpayer with an AFS

Facts: 10 computers purchased for $600 each,

$6,000 total

Accounting policy expenses amounts paid for

property less than $1,000

1,250 computers purchased for $5,000 each,

$6.25 million total

Accounting policy expenses amounts paid for

property costing $5,000 or less

Conclusion: Amount paid for the property exceeds $500

per invoice

Does not meet requirements for the de minimis

safe harbor

Amounts paid meet the requirements for the

de minimis safe harbor

Treatment: Capitalize Expense

35

Safe harbor for “small taxpayers”

General rule

> NEW: A qualifying taxpayer may elect to not apply the capitalization rules 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:

– 2 percent of the unadjusted basis of an eligible building; or

– $10,000.

> If the amounts tested exceed the outlined criteria for the small taxpayer safe harbor:

– Taxpayer must analyze amounts paid using the general improvement rules.

> Attach a statement to a timely filed original federal tax return for the year in which the costs are incurred.

– Elected annually on a building-by-building basis.

– Election may not be revoked.

36

Qualifying taxpayer and eligible

building property

> A taxpayer whose average annual gross receipts for the three preceding taxable years is less than or equal to $10 million.

> Eligible building property

– Must have an unadjusted basis of $1 million or less.

37

Examples:

Small taxpayer safe harbor

Example 1 Example 2

Facts: Building has an unadjusted basis of $750,000

Costs of $5,500 for repairs, maintenance,

improvements, etc.

Two rental properties:

• Building M

• Building N

Both buildings have unadjusted basis of $300,000

Costs for repairs, maintenance, improvements, etc.

• Building M: costs of $5,000

• Building N: costs of $7,000

Conclusion: The aggregate amount paid for repairs and

maintenance does not exceed:

• $15,000 (2% of the building’s unadjusted

basis of $750,000) -or-

• $10,000

Building M:


basis of $300,000) -or-

• $10,000

Building N:


basis of $300,000) -or-

• $10,000

Treatment: ExpenseBuilding M: Expense

Building N: Capitalize

38

40

Proposed partial disposition

regulations

Overview

> Proposed regulations include:

– General asset accounts

– Accounting for MACRS property

– Dispositions of MACRS property

> The 2013 proposed regulations apply to tax years beginning on or after Jan. 1, 2014.

– Taxpayers may apply the proposed regulations early to tax years beginning on or after Jan. 1, 2012.

> The 2011 temporary regulations have not been withdrawn.

41

Old rule

> Under the 2011 temporary regs, taxpayers could elect to recognize a loss upon the disposition of an asset in a general asset account (GAA) if there was a ―qualifying disposition‖ – or –not recognize the loss and continue to depreciate the asset.

> ―Qualifying disposition‖ was defined to include the retirement of a structural component of a building.

– This was an awkward workaround to allow component disposition.

> Taxpayer comments: This approach is too complicated, too burdensome, sets a trap for the unwary.

42

New rule

> NEW RULE: Taxpayers may take a loss on the disposition of a structural component of a building—or a portion of a structural component of a building—without the GAA election.

– Loss must be recognized in the tax year of the disposition.

> Also, taxpayers may forgo a loss on the disposition of a structural component of a building—or a portion of a structural component of a building—without the GAA election.

> This PARTIAL DISPOSITION RULE is designed to minimize situations where multiple versions of the same asset (e.g., building structural component) are on the books and being depreciated simultaneously.

43

Mechanics

> Election is made by the due date (including extensions) of the original return for the tax year of the disposition.

> Election is made by reporting the gain or loss on the timely filed original return for the year of the disposition.

> Transition relief for 2012 and 2013 returns.

– Amended return on or before 180 days from the extended due date, or

– Application for change in accounting method for first or second succeeding tax year.

> Election may be revoked only via request for PLR.

44

Reasonable method

> Taxpayers may use any reasonable method to determine the basis of the asset or the portion of the asset disposed of, including but not limited to:

– Discounting the replacement cost to the original placed-in-service year using the Consumer Price Index.

– Allocating the original cost pro rata based on a ratio of the replacement cost of the component to the replacement cost of the entire building.

– Conducting a study to allocate the original cost of the asset to its various components.

45

Example

> Taxpayer D replaces 60 percent of the roof of a retail building.

> Assume D must capitalize the costs incurred for replacing 60 percent of the roof pursuant to §1.263(a)-3(k)(1)(vi).

> D makes the partial disposition election provided under Reg. §1.168(i)-1(d)(2) for the 60 percent of the replaced roof.

> Thus, the retirement of 60 percent of the roof is a disposition.

> Depreciation for 60 percent of the roof ceases at the time of its retirement (taking into account the applicable convention), and D recognizes a loss upon this retirement.

> Further, D must capitalize the amount paid for the 60 percent of the roof pursuant to §1.263(a)-3(k)(1)(i) and (vi) and the replacement 60 percent of the roof is a separate asset.

46

General asset account

> The partial disposition rule also applies to assets in a GAA; however, there is a catch:

– The proposed regulations change the definition of ―qualifying disposition‖ from a GAA to include only casualty events, 1031/1033 exchanges, transactions under 168(i)(7)(B).

– The disposition of a structural component of a building is no longer a qualifying disposition under the GAA rules.

– BUT – you don’t need the GAA anymore to take component dispositions.

– NOTE: GAA elections are irrevocable and cannot be unwound.

47

49

Final thoughts

Impact and considerations

> Capitalization standards

– Major components and substantial structural parts

o Greater level of detail required

o Interaction with facilities required

o Physical counts of:– HVAC units

– Light fixtures

– Toilets

– Etc.

– Annual election to capitalize repair costs

o Taxable income planning

o Ability to implement repair study changes in fixed asset system

o Avoid book/tax differences

50


> Routine maintenance safe harbor for buildings

– Documentation

– Could apply to ―mandatory‖ franchisee refreshes

o But what if not expected twice in 10 years?

– If costs do not meet safe harbor, can still analyze under improvement rules

> De minimis safe harbor

– Do you have a written financial accounting policy in place prior to Jan. 1, 2014?

– Do you have an AFS?

– Does your current financial accounting policy exceed the safe harbor amount?

51


> Safe harbor for ―small taxpayers‖

– Annual testing required:

o Total amount paid during the taxable year for repairs, maintenance, improvements, and similar activities

o Average annual gross receipts

o Unadjusted building basis

> Proposed partial disposition regulations

– No annual GAA election required for buildings!

– Consider only when repair costs cannot be deducted – larger benefit.

– Complexities in identifying basis of partially disposed assets.

– Timing of final regulations:

o Depends on the nature of the comments received.

o Close to final form, aiming for early 2014.

52

The content in this presentation is a resource for Baker Tilly Virchow Krause, LLP clients

and prospective clients. Nothing contained in this presentation shall be construed as

legal advice, opinion, or as an offer to buy or sell any property or services. In conformity

with U.S. Treasury Department Circular 230, tax advice contained in this communication

and any attachments is not intended to be used, and cannot be used, for the purpose of

avoiding penalties that may be imposed under the Internal Revenue Code, nor may any

such tax advice be used to promote, market or recommend to any person any

transaction or matter that is the subject of this communication and any attachments. The

intended recipients of this communication and any attachments are not subject to any

limitation on the disclosure of the tax treatment or tax structure of any transaction or

matter that is the subject of this communication and any attachments.

Disclosure

final repair and maintenance regulations: new rules, new ... · final repair and maintenance...

Documents