the green behind going green tms final

1

The Green $ Behind Going Green

Presented by:

Teri M. Samples, CPA

Partner and Director of Real Estate Services

Mueller Prost

Energy and Tax Incentives

� Going Green

� 179D

� 45L

� Cost Segregation

� Repair & Maintenance / TPR’s

The Green Behind Going Green | Month DD, YYYY

©2017 | Mueller Prost | Slide 2

Green is The New Red, White & Blue



Overview

� Extended energy credits and other incentives

� Tax updates and strategies for the industry

� Analyzing your real estate: key financial indicators to consider



Tax Updates & Strategies for the IndustryIncluding: Extended Energy Credits and Other Incentives



Recent Updates

� Protecting Americans From Tax Hikes of 2015 supersedes Economic Stimulus Act

� Energy Policy Act Extended through 12/31/2016 Currently Waiting on New Legislation

− 179D 145L

− Bonus Depreciation

− Qualified Leasehold Improvements / Qualified Improvements Property (QIP)

− Rev. Proc. 2008-52

− Other News or Pending Laws



Energy Related Deductions & Other Strategies

� Accelerated Depreciation – Is there a connection?

− Cost Segregation – Is there a connection?

− LEED Certification – Is there a connection to accelerated depreciation?



179D Program Basics

� Created by the Energy Policy Act of 2005 (EPAct 2005)

� Extended by Economic Stimulus Act of 2008

� Extended by the Protecting Americans From Tax Hikes Act of 2015

� Eligible projects “placed in service” during 2006 until 2016

� Provides Tax Deductions – not Tax Credits

� Deduction can be taken by owner of private project

� Deduction can be taken by designer of public project

� Full deduction is $1.80 psf

� Partial deductions are allowed

� Applies to commercial property, not residential



Protecting Americans From Tax Hikes Act of 2015

� Qualified Leasehold Improvement Property is depreciated over 15 years straight-line. A qualified property includes:

� Improvement to an interior portion of the building

� Non-residential real property, i.e. commercial property

� Pursuant to a lease (lessee or lessor)

� Property must have been in service more than 3 years after building originally placed in service

� Non-structural improvements (not common area or elevators)

� Cannot increase square footage of property



Protecting Americans From Tax Hikes Act of 2015

� Qualifying Restaurant Property and Qualifying Retail Property

− Property is placed in service more than 3 years after the building is originally placed in service

− More than 50% of building’s square footage must be devoted to preparation of and seating for on-premises consumption of prepared meals



Protecting Americans From Tax Hikes of 2015

� Qualified Improvement Property 2016 Onward

− 39 year property eligible for bonus

− No 3 year rule



Protecting Americans From Tax Hikes of 2015

� Bonus Depreciation is a mandatory application unless you choose to elect out

� Bonus Depreciation applies for Alternative Minimum Tax (AMT) purposes

� Adjusted basis of qualified property acquired in a tax-deferred exchange is eligible

� No short-year adjustments for bonus depreciation



Energy EfficientCommercial Building Property

� Owners may be eligible for tax deductions up to $1.80 / square foot for improving existing commercial or designing energy efficiency into new buildings.

� Qualifying Activities Defined:− Installed on or in any building located in the United States that

meet certain standards (new construction and improvements to existing property)

− Depreciation or amortization is allowed

− Installed as part of a qualified system

− Part of a certified plan to reduce total energy costs



Energy EfficientCommercial Building Property

� Installed as part of the interior lighting systems, HVAC, or building envelope

− Reduces total annual energy and power costs by 50% or more in comparison to a reference building (2006-2015-ASHRAE 90.1-2001)(2006-2015-ASHRAE 90.1-2007)

− Must be certified by a qualified individual, generally an engineer, and satisfy the requirements of §179D ( c ) (1)



Qualification of Certified Plan

� Designed to reduce annual energy and power costs by at least 50% over “reference building”

� The “reference building” is a building that is located in the same climate zone and is otherwise comparable or compare to self



The Maximum Tax Deduction Allowed

� $1.80 per square foot for qualifying energy efficient enhancements in all of the three building systems

� $1.20 per square foot for qualifying energy efficient enhancements in two of the three building systems

� .60 per square foot for qualifying energy efficient enhancements in one of the building systems

� Reduction to cost basis of asset



179D Deduction Types

� Full Deduction − Exceed ASHRAE standard 90.1 - 2001 by 50% through 2015

� 90.1-2007 by 50% through 2016

� Partial Deduction – use 1, 2 or all 31. Building Enclosure exceeds ASHRAE by 10%

2. Lighting exceeds ASHRAE by 20% (parking garages)

3. HVAC and Hot Water exceed ASHRAE by 20%

� Use ASHRAE 90.1-2001

� Performance Rating Method− Show “reference building”

− Show “proposed building”

− Based on $ energy cost



Key Points: 179D Tax Deduction (Commercial)

� Deduction is available to the owner of a private project

− Developer owned properties are eligible ****

� Eligible projects are ‘placed in service’ during 2006 through 2016

� Maximum tax deduction of $1.80 per square foot

− Partial deductions ranging from $0.30 - $1.50 per square foot allowed

− Must achieve a 50% reduction in predicted energy use, as built building compared to an ASHAE 90.1-2007 standard building on same site

� Components include:

− Lighting

− HVAC & hot water systems

− Building envelop

� Up to .60 cents per square foot per component



Lighting Considerations

� “Low hanging fruit”− No costly energy prediction model needed

− Credit determined by comparison to energy density chart (W / ft2)

� Partial credit for energy savings less than 50% of standard

� Evaluation can be done space by space OR entire structure

DOs− Mix in LED lighting to reduce energy density

− Occupancy sensors don’t have to be expensive

DON’Ts− Calculation uses connected energy so mere reduction of light bulb

power not enough

− Incidental lighting not considered as space light (eg. Casinos)



HVAC, Hot Water Considerations

� Operational Energy use model of actual to Standard required

� Solar Energy property has additional tax advantages

DOs− Programmable thermostats

− Consider heat mumps, geothermal

− Circulate building air, connect Northeast to Southwest

− Variable frequency drive motors can be cost effective energy savers

DON’Ts− PTAC units notoriously energy inefficient

− Heat it up, to cool it down syndrome



Building Envelope Considerations

� Operational Energy use model of actual to Standard required

� Optimize building orientation on the site

DOs− Insulation is the best pay back

− Tighten those fenestrations

− Window tinting & roof color matter

DON’Ts− Single pane windows

− Aluminum window frames

− Uninsulated doors



179D Government Owned Buildings

� Public entities earn energy efficiency tax benefits, but they cannot monetize them

� Owner may allocate deduction to “designer”− (Notice 2008-40)

� Owner may allocate the deduction to more than one designer

� Designer is defined as the “person that creates the technical specifications for the installation of energy efficient commercial building property”

� Allocation must be in writing



179D Allocation Letter Details

� There is no “standard form” for the allocation

− We have both a letter and form type formats for use

− Notice 2008-40 provides guidance

� There is no definition of “amount of deduction”− Could be a percentage (100% if single designer)

− Could be a $ amount

� Allocation does not accompany tax return but taxpayer must show in an audit

� Deduction must be taken in the year the property is “placed in service”



179D Certification Basics

� Provided by a “qualified individual”

− Not related to taxpayer

− Engineer licensed in project jurisdiction

− Provides written statement of qualifications

− Uses and trained on IRS approved software for calculations

� Certification and Analysis not submitted with return



179D Government Building Types

� Local Government

− Public Schools

− Airport Authorities

− Parking Garages

− Police and Fire Stations

� State Government

− State Colleges and Universities

� Federal Government

− Department of Defense

− Prisons



179D Government Owned Example



Assumptions Results

Square Footage: 200,000 Federal 179D

Deduction:

$360,000

179D Deduction: $1.80/Square Ft. Immediate State

Tax Savings:

$126,000

Federal Tax Rate: 35% Immediate State

Tax Savings:

$18,000

State Tax Rate: 5% Gross Savings: $144,000

Net Savings: TBD

Can 179D Help your Non-Profit?

� On April 3, 2014, the Senate Finance Committee concluded its markup of a tax extenders package. The Section 179D Tax Deduction was included in the markup through 2015 including:

− 2-Year extension retroactive to January 1, 2014 and through December 31, 2015

− In addition to government owned buildings, tribal governments and not-for-profits will be allowed to allocate the deduction to the primary designers



Key Points: 45L Tax Credit (Residential)

� Credit available to an eligible contractor/owner for new construction or substantial renovation of an energy efficient home including:

− Freestanding homes− Townhouses− Apartment units that are three stories or less above grade

� $2,000 credit for qualified new energy efficient home or unit− $1,000 credit for manufactured homes

� Requirements for dwelling units to qualify for the credit:− Located in the United States− Construction substantially completed after August 8, 2005− Meets the energy saving requirements of § 45L ©(1)− Acquired from an eligible contractor after December 31, 2005 for use

as a residence− Certification of improvements required



Rebate Programs

� Many utilities offer rebates and other incentives when buildings include energy efficient components (HVAC, lighting, energy management systems, etc)

� Rebates are available for new construction and remodels/ retrofits

� These rebates are free money that very few firms are aware of or understand how to obtain

� Rebates generally range 20%-50% of the cost of the equipment



What is a Cost Segregation Study?

� A Cost Segregation Study (CSS) is the most significant and yet the most often overlooked opportunity to reduce income tax liability. Cost segregation is an Internal Revenue Service approved method of reclassifying both the components and improvements of a commercial building from real property to personal property. In essence, this process allows the assets to be depreciated on a new 5 -, 7 -or 15 - Year Class Life instead of the traditional 39 - Year Class Life of real property



Key Benefits of Cost Segregation

� Provides significant opportunities for Substantial Reductions in Tax Liabilities

� Immediate increased cash flow through accelerated depreciation

� Enhances your real property’s financial returns

� Corrects misclassified assets and provides the opportunity to claim missed "catch up depreciation" from prior years in the current year

� Renovations, remodeling and replacement will be less costly due to detailed breakdown of building components

� Real estate property taxes may be reduced

� A 30%, 50% or 100% bonus depreciation can be taken when applicable!



Analyzing YourReal Estate



Feasibility Process

� Project goal setting

� Establish overall design criteria

� Align Goals / Criteria with Sustainable and/or Energy Efficient Opportunities

� Evaluate Cost / Benefits



Financial Analysis

� Simple Payback Period (SPP)

� Return on Investment (ROI)

� Net Present Value (NPV)

� Internal Rate of Return (IRR)

� Net Operating Income (NOI)

� Asset Valuation



Financial Analysis (Life Cycle Cost)

� Example: Implement a new energy efficient lighting system



Initial Cost $100,000

Projected Annual Savings $25,000

Capitalization Rate 8%

Analysis Term 10 years

Simple Payback Period

� Definition: Time required to recover the cost of a capital investment

− SPP = Cost/Annual Savings

� Example: $100,000 / $25,000 = 4 years



Return on Investment (ROI)

� Definition: Annual rate of interest earned on an investment

− ROI = Net Savings/Project Cost

� Example: ROI - $25,000 / 100,000 = 25%



Net Present Value (NPV)

� Definition: Present Value (PV) of expected future cash flows less the initial cost

− NPV = PV Savings – PV Project Cost

� Example: NPV = PV $25,000 (8%, 10 years) - $100,000

� NPV = $167,752 - $100,000 = $67,752



Internal Rate of Return (IRR)

� Definition: Interest rate at which NPV = 0 (PV of cash outflows = PV of cash inflows) PV Savings – PV Project Cost = 0

− Example: PV $25,000 (IRR%, 10 years) - $100,000 = 0

− PV $25,000 (IRR%, 10 years) = 100,000

− What is the discount rate? IRR 21%



Net Operating Income (NOI)

� Definition: Income remaining after operating expense subtracted from operating revenues NOI = Total Revenue –Total Operating Expenses

− Example: Increase in NOI by Lowering Operating Costs



Reduce Energy Increase NOI

� Definition:

− Income remaining after operating expenses are subtracted from operating revenues



Asset Valuation

� Definition: Increase in asset value resulting from increases in annual net income (or decreases in annual energy costs), i.e. Increase in NOI

− Example: Increase in asset value = annual increase in NOI / cap rate

− Example: $25,000 / 8% = $312,500



Financial Analysis Summary



Ratio Result Proposal

Simple Payback Return 4 years Accept/ Reject

Return on Investment 25% Accept/ Reject

Net Present Value $67,752 Accept/ Reject

Internal Rate of Return 21% Accept/ Reject

Net Operating Income $25,000 Accept/ Reject

Asset Valuation $312,000 Accept/ Reject

Who Benefits

� Tenants / Occupants

� Landlords / Owners

� Property Managers

� Vendors providing expertise and rated products

� Financial & Insurance Community

� Community & Environment



Landlord’s Challenges

� Lease structure and market terms

− Gross lease vs. net lease

− Brokerage community support

� Pass-thru costs

� CAM’s



Capital Expense Pass Throughs

� Often, capital expenditures can be “passed through” to tenants if they meet criteria such as:

− Reduce operating expenses

− Are required by law (as in a new building code requirement)

− Lease terms

� Industry trends are pointing to revised lease agreements that maintain the integrity of green buildings and energy efficient building. May benefit both landlords and tenants alike. (i.e. Green Leases)





People

Bottom LineEnvironment

Green /

Efficiency

Eco – Friendly Economics

� Some studies have shown:

− May raise construction costs by 1-3 percent



“What’s In It For Me?”

And…what will this cost me?



Environmental, Economical and Social Benefits

� Overall energy consumption savings for the property

� Lower maintenance/operational costs over the life of the property

� Increased value of the property

� Marketability/Consumer Motivation

� Income Tax Benefits

� Increased Rents

� Intangible benefits:− Becoming an industry leader

− Tenant/employee satisfaction and productivity

− Improvements in health and safety

− Brightens moods



Why Have an Environmental Program?

“As we add new developments…we’re going to make them LEED certified…we’re going to be environmentally responsible, and socially conscious, but always in a way that provides guests (and owners) with what they want – because that’s the business we’re in.”

- Vail Resorts CEO, Rob Katz



Simple Things to Do:

� It is always cheaper to save energy, than to produce it.

� Lighting

� Appliance

� Recycling

� Use the Climate – (Solar or Wind Power)

� Collect Rainwater – For every one inch of rainfall, a 2,000 sq. ft home will collect 1,250 gallons of water.

� Let the Sun Warm Your Homes – Correct Orientation of Homes = 30% lower heating costs.



What’s Next?

� New Administration?

� New Plan?

� New Policy?

� Potential Code Changes?



Repairs, Maintenance and TPR’s



Tangible Property Regulations (TPRs)

� Applicable to you? Yes – if you own fixed assets, have depreciation, buy fixed assets, improves or disposes of fixed assets, and/or have material and supplies



Background

� In what circumstances are the TPRs applicable to a taxpayer?

− Any taxpayer that previously adopted and employed tax methods over depreciation, asset disposals, materials and supplies, repairs and maintenance, and/or capitalization that are not in accordance with the final TPRs as written and published in September 2013 (for sections 162 and 263(a)) or August 2014 (for section 1.168(i)-8 on MACRS dispositions) and/or their applicable revenue procedures (issued January of 2014 for 162 and 263(a) and in September of 2014 for 1.168(i)-8.)



Summary of Major Changes

� De Minimis Rule Change – Amounts < $5,000 can be expensed for tax as long as they are expensed on applicable financial statements. Taxpayers without Applicable Financial Statements are limited to $2,500 per item.

� Routine Maintenance Safe Harbor rule – extend safe harbor to buildings but require 10 years as the period which a taxpayer must reasonably expect to perform the relevant activities more than once.

� Relief for Small Businesses – small taxpayers can forgo improvement rules in eligible buildings

� Changes to definitions of Betterments and Restorations

� Dispositions – Final Regulations (issued 8/14/14) change rules for partial dispositions of assets. Require making timely elections.



Repair Regulations Items of Note

� Many sections of regs. must be applied retroactively to all prior years where it presents a material difference in tax liability. IRS has not provided clear guidance on how far back to go.

� Must file Form 3115 “Change of Accounting Method” for several sections of the regs.

− Final Regs – most taxpayers 2-3 CAMs

� Cost Segregation Studies are more relevant− For Retirement purposed & Building System identification

− May require more detail than a standard cost segregation study



Effective Dates

� Rules generally apply to tax years beginning on/after 1/1/2014 (but also apply to cost incurred in prior years)

− Costs to repair or improve tangible property in prior years required to conform to the Final Repair Regs

� All taxpayers must conform to the Final Repair Regs for tax years beginning 1/1/2014



Retirement of Structural Components Final Rules

� § Dispositions of MACRS Property (final regs issued 8/14/14)

− Final Regs: Allow for the retirement of structural components of buildings.

− Final Regs: “Partial Dispositions Election” is needed on timely filed tax return including extensions for year portion of asset is disposed.

� Lookback retirement studies are limited



Retirement of Structural Components

� Example: Taxpayer acquired $5M building in 2007

− 2010 they spend $1M to remodel portion of 2nd floor (ceilings, walls, lighting, plumbing, ducting, electrical wiring, etc.

− Cost Segregation was already performed in prior year for the 2007 purchase and the 2010 improvements.

− “Retirement Study” determines the original cost basis of demolished components is $470K (from the original $5M building)

− Recognize a loss of $404K in 2012 tax year by filing Form 3115. (original cost basis less depreciation already taken)

� Final Regs. limited to dispositions in current tax year. Can file a “Late Disposition Election” for a limited time!



Retirements Create Permanent Tax Savings!!

Retirements Convert Recapture tax into Capital Gains

� If you incorrectly continue to depreciate 1245 & 1250 property that was removed from a building, you pay recapture tax upon sale

− 1245 recapture is at ordinary rates (35-41%)

− 1250 recaptured at 25%

− Capital Gains are typically taxed at 20%



Repairs



Introduction

� Repairs = deductions

� Now can be: removal, demolition (but not 280B demolition types), moving and installation costs;

� Not: work performed prior to placing property into service (263A), or transaction costs, or costs that require capitalization under the regs (R.A.B.I. rules)



SUBJECT $$ TO THE R.A.B.I TEST



“Improvement Standards”

� Amounts paid to improved tangible property, i.e., the “improvement standards”, the R.A.B.I. rules



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 this purpose, a unit of property is improved if the amounts paid for activities performed after the property is placed in service by the TP

− Are for a betterment to the unit of property

− Restore the unit of property or

− Adapt the unit of property to a new or different use

− i.e. the new R.A.B.I. tests/criteria/rules



Unit of Property

Note: This is a very important item in the TPRs



Determining the U of P §1.263(a)-3(e)

� The unit of property determination is generally based upon the functional interdependence standard

− Functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayer

� But there are…



Determining the UoP §1.263(a)-3(e)

� Special rules are provided for

− Buildings – each building is a U of P

− Plant property

− Network assets

− Leased property

� Leased buildings and leased property other than buildings

− Improvements to property



Buildings —§1.263(a)-3(e)(2)

� 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 if the amount is paid for an improvement under (R.A.B.) to any of the following:

� Building structure. A building structure consists of the building and its structural components, or…….



Buildings —§1.263(a)-3(e)(2)

� Building Systems:

− HVAC, Plumbing, Electrical

− Escalators, Elevators

− Fire protection and alarm, Security

− Gas distribution

− Other as IRS provides in the future

� Or within the building systems or building structure, any item that performs a major and discrete function

� Or… Any large physical portion of the building,



Unit of Property Issues

� One tangible personal property: no problem, all separate tangible personal property is a separate U of P: Example: TP buys 100 computers. Each computer is a separate U of P

� Apartment complex consisting of several buildings: each separate building must be separate U of P

� Large mall with buildings all connected together: must use facts and circumstances to determine if the U of P is one or separate buildings



Improvement Costs Criteria

� This is the “I in the R.A.B.I. rules



What is Different with the R.A.B.I Rules

� Prior “criteria”, “elements”, or fact patterns that we thought required the expenditure to be capitalized must be set aside

� With the release of the final TPRs, if a “criteria”, “element”, or “principal” is not described, it is not to be considered in the determination of whether an expenditure should be capitalized

� For example…. We will no longer consider if …− The TP spend a lot of money

− It made the property more valuable

� If the new criteria is not met, it is not considered in the

� R & M verses R.A.B.I. testing This is the “I in the R.A.B.I. rules



Special Rules for Determining Improvement Costs—Reg. §1.263(a)-3(g)

� Certain costs incurred during an improvement

− General Rule: A TP must capitalize all the direct costs of an improvement and all the indirect costs (including, for example, otherwise deductible repair costs) that directly benefit or are incurred by reason of an improvement

− Indirect costs arising from activities that do not directly benefit and are not incurred by reason of an improvement are not required to be capitalized under Section 263 (a), regardless of whether the activities are performed at the same time as an improvement



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 a TP disposes of a component of a unit of property, but the disposal of the component is not a disposition ……..



Removal Costs

� Ex. Landlord owns 3 unit commercial building.

− Pays $200k for improvements in each space in year 1.

− In year 5, one tenant leaves and a new tenant requires landlord to gut and renovate the space.

− Landlord pays a contractor $340k to renovate space to new tenant’s specs.

� Contractor cost detail shows $40k to demolish old improvements and $300k to renovate space.

− Landlord can expense the $40k demolition costs if they take the retirement loss deduction for remaining basis of $200k year 1 cost of that space



Determining the Basis of Removed Building Component

New: Final Disposition Regulations:

� Can use a cost segregation study

� Can discount the cost of a replacement component to its placed-in-service year using he Producer Price Index (PPI)

− While this approach can be used for certain restorations, the final regulations do not allow this method to be used for betterments or adaptations.

− The Consumer Price Index (CPI) under the proposed regulations it no longer allowed.



Safe Harbor For Small Taxpayers

� Can elect not to apply improvement rules to eligible buildings if:

− Small taxpayer = $10 million or less average annual gross receipts in three preceding tax years.

− Eligible building = unadjusted basis of $1 million or less

− Annual amount spent is <or= $10,000 or 2% of unadjusted basis of the building

− Elected annually on building-by-building basis

− Includes amounts not capitalized under the de minimis safe harbor and under routine maintenance safe harbor for buildings

− If annual amount is great than $10k, safe harbor does not apply to any amounts (not even the first $10k)



Routine Maintenance

� Different rules for buildings and tangible personal property



Building Routine Maintenance §1.263(a)-3(i)

� RM = the recurring activities that a TP expects to perform as a result of the TP's use to keep the building structure or each building system in its ordinarily efficient operating condition

� 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



Building RM

� However, the activities are routine only if the taxpayer reasonably expects to perform the activities more than once during the 10-year period beginning at the time the building structure or the building system upon which the routine maintenance is performed is placed in service by the taxpayer

� RM = recurring nature of the activity, industry practice, manufacturers' recommendations, and the taxpayer's experience with similar or identical property



Routine Maintenance for Property o/t Buildings

� The activities are routine only if, at the time the unit of property is placed in service by the taxpayer, the taxpayer reasonably expects to perform the activities more than once during the ADS class life of the asset

� Want to be able to do the RMSH? Must file method #184 and cite 1.263(a)-3(i)



Betterments



Checklist of Improvements

� Betterment Considerations (Before we consider, can you get out of applying the rules? i.e. do SHST, RMSH, or DMSH apply?, if so write off, if not do the RABI)

− 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 …



Betterments to Buildings and Refreshments or Remodels

� Analysis of whether costs incurred to refresh or remodel a building result in a betterment requires an examination of all the facts and circumstances including, but not limited to

− The purpose of the expenditure,

− The physical nature of the work performed,

− The effect of the expenditure on the UoP, and

− No longer - the TP’s treatment of the expenditure on its AFS



Biggest Issue that is Uncertain?

� The biggest issue to consider in the betterment rules is what does the phrase “material betterment” mean?

� If a TP adds 2% to its warehouse space, is that a “material betterment”?

� If a TP adds 10% efficiency to its HVAC system is that a “material betterment”?



Restorations

� This is the part of the R.A.B.I. rules that deals with items such as roof replacements



Restorations Criteria 1.263(a)-3(k)

� It returns the U of P 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; OR

� It is rebuilding to like-new condition− Results in the rebuilding of the U of P 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)



More Restoration Criteria 1.263(a)-3(k)

� Replaces a Major Component or Substantial Structural Part of the U of P

− In determining whether an amount is paid for the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of the U of P, the TP must consider all the facts and circumstances, including the quantitative or qualitative significance of the part or combination of parts in relation to the U of P or, in the case of a building, in relation to the building structure or the relevant building system



What is a Major Component or Substantial Structural Part?

� TR Define a major component or substantial structural part to include a part or combination of parts that:

− Comprise a large portion of the physical structure of the U of P, OR

− Perform a discrete and critical function in the operation of the U of P



Adapt Property to a New orDifferent Use 1.263(a)-3(I)



Amounts to Adapt Property to a New or Different Use 1.263(a)-3(l)



De Minimis Safe Harbor



The DMSH Is a Final TPR New Annual Election - Rules

� DMSH §1.162-3(f)(1)

− If a TP elects to apply the DMSH under §1.263(a)-1(f) to amounts paid for the production or acquisition of tangible property, then the TP must apply the DMSH to amounts paid for all M & S and supplies that meet the requirements of §1.263(a)-1(f) (except for M & S capitalized and use of optional method of accounting for rotableand temporary spare parts)

− DMSH is not an accounting method change filing



De Minimis Safe Harbor Manner of the Election

� TP makes the election by attaching a statement to the TP's timely filed original tax return (including extensions) for the taxable year in which these amounts are paid

� Statement must be titled “ Section 1.263(a)-1(f) de minimissafe harbor election” and include the TP’s name, address, TP identification number, and a statement that the TP is making the de minimis safe harbor election under §1.263(a)-1(f)

� The election cannot be made on a Form 3115 nor on an amended tax return (there is another “out” under §§301.9100-1 through 301.9100-3)



DMSH – Annual Election Example

� De minimis Safe Harbor Election Under 1.263(a)-1(f):

− ABC Business, Inc., EIN 12-34567890, 123 Main Street, St Louis, MO

− ABC hereby elects the De minimis Safe Harbor Election Under 1.263(a)-1(f) for tax year 2014

� We do not tell the IRS what our DMSH amount is or any other capitalization policy details



Get a DMSH Policy in Place Before the Beginning of the Tax Year (by 12-31-17?)



� To take advantage of either of these, a TP must have an accounting policy in place

before January 1, 2014, if calendar year TP who wants to do the DMSH for 2014

First Element of the DMSH

� An accounting policy in place response is required for all separate trades or businesses and any separate legal entities, such as single-member LLC

� If no accounting policy in place, TP will be limited to $200 per item/invoice for U of P ONLY, (BUT only if the TP has a method #186 or #187 3115 filed by 1-1-14)



DMSH Policy in Place Elements Non-AFS DMSH



DMSH Policy in Place Elements Non-AFS DMSH



Have an invoice

DMSH Policy in Place Elements Three More for AFS DMSH



Note: With an AFS a TP will be writing the amounts off for financial

statement purposes, not for “books”

DMSH and Per Item, Per Invoice Issues

� “Applies the DMSH to amounts substantiated with invoices..”

� 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



Final Main TPR DMSH IRS Preamble Statements

� DMSH is not intended to prevent a taxpayer from reaching an agreement with its IRS examining agents that, as an administrative matter, based on risk analysis or materiality, the IRS examining agents will not review certain items

� However, a taxpayer that seeks a deduction for amounts in excess of the amount allowed by the safe harbor has the burden of showing that such treatment clearly reflects income



Conclusions of IRS Preamble Statements

� Although the preamble words are not in the “regulation” we can have confidence in conclusion that the DMSH is NOT a ceiling nor a limit

� It is only a “safe harbor”

� That means a taxpayer can have a policy to exceed the safe harbor

� Again, the burden under the safe harbor dollar amounts is the IRS’s – over the safe harbor? On the taxpayer



The Final Main TPRNew Annual Elections



What the Annual Elections Require to Implement

� The final regulations ways to implement the elections:



TPR Method Changes



Understand What Happens When a TP Files a 3115

� The purpose of a 3115 filing is to

− First: Change a TP’s particular tax method of accounting

� These are automatic if they have been assigned a method number by the IRS

− Second: Catch up for the accounting method change difference between the prior method and the proposed method that the TP is changing to (this is the 481(a) adjustment)

� You have to know which TPR method changes are mandatory and which ones are optional



The Potential Typical TPR Method Required Filings

� #184, 186, 192 combined, concurrent Form 3115 filing on R & M, R.A.B.I. test, RMSH, Unit of Property and proper cost capitalization (R)

� #7 for impermissible depreciation methods (R)

� #21 for removal costs (O)

� #205 for certain building asset dispositions (PADs) and #206 for certain dispositions or PADs o/t buildings (O); and/or #196 for the late PAD elections that are voluntary (O)



184, 186, 192 Combination

� #186 is the method that enables a taxpayer to adopt:

− The write off of units of property $200 and under

− The Non-incidental material and supplies method change

− This one is for transactions 1-1-14 and after (or 1-1-12), so typically will not have a section 481(a) adjustment

− #187 is the incidental M & S rule



184, 186, 192 Combination

� #192 is the method that enables a taxpayer to adopt:

− The proper capitalization of 1.263(a)-2 for assets purchased or produced

− Example: you must capitalize all facilitative and inherently facilitative costs

− Inherently facilitative costs are specifically defined in 1.263(a)-2(f)(ii)



Next Required Method = #7

� Method #7 for any impermissible to permissible depreciation changes for:

− Class lives that are not correct

− Bonus that was done right

− Assets that were depreciated that should not have been and vice versa

� See RP 87-56 for common class lives to assets employed in various Activities

� Risk of not filing? IRS use of the “use it or lose it” rule, as now authorized by 1.1016-3



First Optional is #21

� A method #21 filing enables a taxpayer (TP) not to have to capitalize any prior or future removal costs associated with an improvement (i.e. a R.A.B.I.) – why not file for all TPs?

� A TP must also have a PAD on the prior asset disposed of (whether current year or prior)

� Can choose each time to employ not

� Not due by 2014 but if a TP wants not to have to capitalize removal costs, it must file this method change



PAD for Buildings for Prior Years

� The particular method will depend on what the TP situation is, but could be #196, #205/206

� TP can use any “reasonable method” to calculate the basis of those assets including:

− PPI roll back method

− Factorial comparison

− Cost segregation



PAD for Buildings for Prior Years

� Example of a PPI roll back method:

− XYZ purchased a building 10 years ago for $1,000,000 and 5 years ago put on a new roof for $100,000. Using a PPI rollback method, the “recasted” basis of the roof from the original purchase approximates $80,000 and depreciation on that to date is $20,000. Therefore, the 481(a) for the #196 or #205 prior roof “write off” approximates $60,000



Recommendations:



The Goal – Determine TPR Issues, Calculate 481(a)s

� Repairs and Maintenance (R & M) (R), #184 with a citation to regulation section 1.162-4

� Material and Supplies (M & S), #186 and/or #187, with a citation to 1.162-3 (R)

� Unit of Property, #184, with a citation to 1.263(a)-3(e) (R)

� Restoration, adaption, betterment and improvement (the R.A.B.I. rules), #184 with a citation to the particular part of 1.263(a)-3(g), -3(j), -3(l), -3(k), as applicable (R)



Regulation Requirements

� Beyond certain parts of the requirements requiring method changes:

− Parts of the TPRs are elections (DMSH, PAD, SHST***)

− Parts of the TPRs are done for transactions after 1-1-14 (or 2012) (M & S, DMSH, SHST)

− Parts of the TPRs are optional for prior, current or future year issues (Removal costs, PADs)

*** de minimis safe harbor, partial asset dispositions, safe harbor for small taxpayers***



The TPR Method Changes are 99.9% Automatic

� If the method change has a number assigned to it by the IRS, it is an automatic method change

� All TPR methods have automatic method #s (#21, 184 to 194, 175 to 180, 195 to 207)

� Automatic method changes do not require a filing fee to file

� Can be done by the due date of the tax return, including extensions

� Be careful, once the scope limitations are done (i.e. expire for tax years after 2014) only advance consent method change may be available



Use It or Lose It Rules

� Applies to R & M and depreciation



New Regulation 1.1016-3

� A taxpayer is not permitted to take advantage in a later year of the taxpayer's prior failure to take any such allowance or the taxpayer's taking an allowance plainly inadequate under the known facts in prior years

� In the case of depreciation, if in prior years the taxpayer has consistently taken proper deductions under one method, the amount allowable for such prior years may not be increased, even though a greater amount would have been allowable under another proper method

� Consequences



TPR Issue Identification by Client –Process, Universal 3115s

� The final and proposed regulations have six potential annual elections – how to implement each?



the green behind going green tms final

Documents