Implementing the IRS s 2011 Repair Regulations and Transition Guidance

Transcription

1 Implementing the IRS s 2011 Repair Regulations and Transition Guidance Tulane Tax Institute November 1, 2012 Carol Conjura Washington National Tax

2 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BY USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 1

3 Transaction Costs

4 Acquisition of property Capitalize: Costs to facilitate the acquisition of a unit of property Facilitate: Amount paid in the process of investigating or otherwise pursuing the acquisition Exceptions All property: Overhead and/or employee compensation costs deductible Real property only: costs incurred prior to the decision whether to acquire and which property to acquire, unless inherently facilitative Practice Tip If property is produced rather than acquired, section 263A requires the capitalization of employee compensation and overhead 3

5 Acquisition of property Inherently facilitative amounts 1. Transporting the property (for example, shipping fees and moving costs); 2. Securing an appraisal or determining the value or price of property; 3. Negotiating the terms or structure of the acquisition and obtaining tax advice on the acquisition; 4. Application fees, bidding costs, or similar expenses; 5. Preparing and reviewing the documents that effectuate the acquisition of the property (for example, preparing the bid, offer, sales contract, or purchase agreement); 6. Examining and evaluating the title of property; 4

6 Acquisition of property Inherently facilitative amounts 6. Obtaining regulatory approval of the acquisition or securing permits related to the acquisition, including application fees; 7. Conveying property between the parties, including sales and transfer taxes, and title registration costs; 8. Finders' fees or brokers' commissions, including amounts paid that are contingent on the successful closing of the acquisition; 9. Architectural, geological, engineering, environmental, or inspection services pertaining to particular properties; and 10. Services provided by a qualifying intermediary or other facilitator of an exchange under section Practice Tip 100% of a broker s fee contingent on closing is entirely inherently facilitative even if the broker performed pre-decisional due diligence Architectural and engineering fees may have to be allocated to land rather than depreciable assets 5

7 Acquisition property Special rule for real property Whether and which test instead of a bright-line used in the intangibles regulations The acquisition of both real and personal property in a single acquisition (for example, a building with section 1245 property) will require a reasonable allocation of pre-decisional costs Practice Tips The allocation of pre-decisional costs can be made using any reasonable method, such as relative cost or time The application of section 1060 to the purchaser s basis and depreciation recovery periods may affect the allocation of relative cost 6

8 Acquisition of property Treatment of transaction costs Include in basis of property acquired or produced Recovered under section 165, 167, or 168 Practice Tip Any costs capitalized into the basis of the property are not subject to amortization as start up costs under section 195 7

9 Broker fees: Treas. Reg (a)-2(f)(4), Example 1 Facts: TP decides to purchase a building to relocate its offices and hires a real estate broker to find a suitable building. TP pays fees to the broker to find property for TP to acquire. Conclusion: TP must treat 100%of the broker fees as inherently facilitative Question: Should services performed by broker during the process of TP determining whether to acquire property and which property to acquire be eligible for the exception? 8

10 Example 2 Whether and which / inherently facilitative costs A retailer, X, examines the feasibility of opening a new store in city A. In October, Year 1, X investigates two possible sites and incurs costs for a development firm to study city A and perform market surveys, evaluate zoning and environmental requirements, and to provide preliminary recommendations on site selection. In December, Year 1, X hires an appraiser to appraise each of two properties. In March, Year 2, X decides to acquire one of the two properties. 9

11 Example 2 (con t) Conclusions: Cost Year 1 Year 2 Development firm (both properties) Deduct N/A Appraisal acquired property Capitalize Included in basis of property acquired Appraisal property not acquired Capitalize Deduct under section

12 Example 3 Allocation of costs to real and personal property Taxpayer purchases a building, personal property located in the building (e.g., manufacturing equipment, carpet, etc.), and vehicles in an asset acquisition that is not the acquisition of assets that constitute a trade or business. Reasonable method of allocating investigatory costs to real and personal property: Contemporaneous documentation from service providers? Employee time devoted to each? Relative cost? Others? 11

13 Unit of Property

14 Unit of Property Overview Functional interdependence Buildings Plant property Network assets Leased property 13

15 Unit of Property Building Unit of Property Each building and its structural components are a unit of property Improvement standards applied to Building systems: heating, ventilation, and air conditioning systems (HVAC) plumbing systems electrical systems all escalators all elevators fire protection and alarm systems security systems gas distribution systems other structural components identified in published guidance Building and its structural components (other than the sub-systems above) 14

16 Unit of Property Building Practice Tips A accurate measurement of the cost and/or value of the discrete building systems will be necessary to properly apply the capitalization tests. Taxpayers should undertake to document this at the time the building is first place in service Taxpayers may aggregate discrete structural components that are part of the same building system. For example, all HVAC units are treated as a single unit of property for applying the capitalization standards 15

17 Unit of Property Plant Property Plant property requires additional analysis beyond the functional interdependence test to determine UoP: Each component or group of components that perform a discrete and major function or operation within the functionally interdependent property is a separate UoP Plant property is functionally interdependent machinery or equipment, other than network assets [defined below], used to perform an industrial process, such as manufacturing, generation, warehousing, distribution, automated materials handling in service industries, or other similar activities 16

18 Unit of Property Network Assets Based on facts and circumstances or as provided in published guidance Functional interdependence test not determinative Network assets are defined as railroad track, oil and gas pipelines, water and sewage pipelines, power transmission and distribution lines, and telephone and cable lines that are owned or leased by taxpayers in those respective industries Industry specific guidance Rev. Proc (wireline assets) Rev. Proc (wireless assets) Rev. Proc (electric T&D) 17

19 Unit of Property Leased Property Each building and its structural components (lessor) or the portion of each building subject to the lease and the structural components associated with the leased portion (lessee) An improvement to a leased building or a leased portion of a building if the amount paid results in an improvement to the leased building structure or building systems Leasehold improvement that is IRC 1250 property and is constructed by a lessee is a separate unit of property Practice Tips Although the unit of property for a lessee will be smaller than for the lessor in most cases, the lessee may aggregate all leased portions of the enumerated building systems and structure 18

20 Betterments

21 Betterment Treas. Reg (a)-3T(h) Betterment: Corrects a material defect existing prior to the taxpayer s acquisition of the UoP or one that arose during the production of the UoP; Results in a material addition (e.g., physical enlargement, expansion or extension) to the UoP; or Results in a material increase in capacity, strength, productivity, efficiency, quality, or output of the UoP 20

22 Improvements Betterments, examples Treas. Reg (a)-3T(h)(4), Examples 1 & 2: Amelioration of pre-existing material condition or defect In this example, the taxpayer purchases a store on a parcel of land that includes underground storage tanks. The taxpayer later learns that the tanks have leaked, and the taxpayer incurs costs to remediate the spillage. The remediation costs result in a betterment to the land parcel because the costs were incurred to ameliorate a material condition that existed prior to the acquisition of the property. In this example, the taxpayer owns a building that was constructed with insulation containing asbestos. Taxpayer determines that certain portions of the insulation were deteriorating and could pose a health risk, and therefore incurs costs to replace the insulation with similar insulation that doesn t pose a health risk. Although the asbestos is determined to be unsafe, the asbestos is not a pre-existing or material defect. Therefore, the removal and replacement of the asbestos insulation does not result in a betterment to the building. 21

23 Improvements Betterments, examples (cont.) Treas. Reg (a)-3T(h)(4), Examples 11 &12: Regulatory requirements In this example, the taxpayer owns a hotel. A new city ordinance requires the taxpayer to replace old parapets and cornices (that are still in good condition) with new ones made of glass fiber reinforced concrete to address earthquake and safety concerns. These new parapets are lighter and stronger, and are attached using welded connections (versus wire supports). The newer features materially increased the structural soundness of the building structure. In this example, the taxpayer owns a meat processing plant. Taxpayer discovers oil seeping through concrete walls of the plant, and federal meat inspectors advise taxpayers to correct the seepage problem or they will shut down the plant. To correct the problem, taxpayer adds a concrete lining to the walls. Since the work was done solely to correct the seepage and the work did not result in a material addition or increase in operational value, the work performed is not a betterment. 22

24 Improvements Betterments, examples (cont.) Treas. Reg (a)-3T(h)(4), Examples 6-8; Retail Remodels Example 6 concludes that performing cosmetic and layout changes and performing general repairs and maintenance does not result in a betterment to the store property. Example 7 builds on example 6, and includes replacing all the bathroom fixtures with upgraded fixtures for the toilets, sinks, plumbing, etc. This also involves tile work to get to the plumbing. In this example, the plumbing work is viewed as a betterment, whereas the remainder of the remodel activities do not constitute a betterment to the store property. Example 8 builds on example 7, and involves altering the appearance and layout of the store. This includes rebuilding and replacing walls, upgrading wiring, and several other improvements. This remodel is viewed as a general betterment to the store property, and because all the work is incurred by reason of the improvement, all the work is viewed as a betterment. 23

25 Improvements Betterments, examples (cont.) Treas. Reg (a)-3T(h)(4), Examples 13-15; Shingle Replacements Example 13 concludes that replacing all the wooden shingles on a roof with new wooden shingles is not a betterment. Example 14 mirrors example 13, but analyzes the replacement of all the wooden shingles with asphalt shingles of similar quality. The example concludes that the shingle replacement is not a betterment. Example 15 mirrors examples 13 & 14, but analyzes the replacement of all the wooden shingles with lightweight composite shingles of improved quality. The example concludes that the shingle replacement is a capitalizable betterment. 24

26 Restorations

27 Restoration Replace a component deducted as loss Replace a component and basis taken into account in sale or exchange Repair after a casualty if basis adjusted Return to operating condition if in a state of disrepair and no longer functional for its intended use Rebuild the property to like-new condition after the end of class life Replace a major component or substantial structural part 26

28 Major Component or Substantial Structural Part Facts and circumstances test Temporary regulations remove 50% bright line test and recovery period threshold Defined as a part or combination of parts that comprises a large portion of the physical structure of the unit of property, or that performs a discrete and critical function in the operation of the unit of property 27

29 Examples: Restoration Improvement Several walk-in freezer components where loss claimed Repair Rebuild freight car to like-new condition before end of class life Storm damage to office building Farm outbuilding in state of disrepair and not functional Rebuild freight car to like-new condition after end of class life 28

30 Examples: Major Component Yes Engine and Cab of Truck Tractor Petroleum tank of trailer Entire roof of retail store Large portion of the decking, insulation and membrane of roof HVAC furnace in single unit HVAC building system Chiller unit in single unit HVAC building system No Power switch assembly of drill press Waterproof membrane of factory roof 30 of 300 windows Wood flooring in hotel lobby Two roof-mounted units in 10-unit HVAC building system 3 of 20 restroom sinks 29

31 Examples: Major Component Yes No Sprinkler-system in building Wiring in building electrical system All restroom fixtures in 3-story building with restrooms on two floors Restroom fixtures in 20 floor hotel where replacement occurs two floors at a time 200 of 300 windows Wood flooring in all hotel public areas 30

32 Routine Maintenance Safe Harbor

33 Routine Maintenance Safe Harbor Temp. Treas. Reg (a)-3T(f) Amount paid is deemed to not improve the unit of property if it is for the recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of the UoP to keep the unit of property in its ordinarily efficient operating condition Safe harbor does not apply to buildings or structural components of buildings (or building systems) Routine maintenance is activities that the taxpayer reasonably expects (at the time the property is placed in service) to perform more than once during the ADS class life of the UoP Excludes certain restorations (i.e., tests 1-4 if replacements treated as disposition events or after casualty or dysfunctional state) and repair and maintenance of rotable and temporary spare parts for which optional method is elected 32

34 Routine Maintenance Safe Harbor Activities are routine and therefore repairs if: They are reasonably expected to occur more than once in an asset s MACRS class life Not applicable To buildings or structural components, or If property restored under tests 1-4 i.e., if replacements are treated as disposition events or after a casualty, or dysfunctional state 33

35 Improvements Routine maintenance with betterments Treas. Reg (a)-3T(g)(5), Example 9 Facts: Taxpayer owns and leases fleet of towboats. Each have 2 diesel-powered engines, and the UOP is the towboat including the engines. Class life for the towboats is 18 years. Taxpayer performs scheduled maintenance on the towboat engines every 3-4 years. In year 9, Taxpayer upgrades the engines to increase their horsepower and propulsion to enable the towboats to tow heavier loads. Taxpayer performs scheduled maintenance at the same time it increases the horsepower of the engines and towing capacity of the towboats. Conclusion: Scheduled maintenance activities directly benefit the upgrades. None of the costs qualify for the routine maintenance safe harbor and must be capitalized. 34

36 Dispositions

37 Accounting for MACRS Property Depreciation rules generally have allowed use of single asset accounts (SAAs*) or multiple asset accounts (MAAs*) Still the default rule under the temporary regulations Taxpayers may elect to use general asset accounts (GAAs***) instead Assets may be grouped into a single MAA or GAA, regardless of asset class, if: Same depreciation method (can t combine bonus with non-bonus) Same recovery period Same convention (must be placed in service in same month, quarter, etc.) and Placed in service in the same taxable year *Single Asset Account **Multiple Asset Account ***General Asset Account 36

38 Dispositions of MACRS Property Definition For purposes of both the GAA and SAA/MAA rules, a disposition is a transfer of ownership of the asset or the permanent withdrawal of an asset from the trade or business Includes: Sale or exchange Retirement Physical abandonment Destruction Transfer to a supplies, scrap, or similar account Involuntary conversion Retirement of a structural component of a building 37

39 Dispositions of Structural Components The temporary regulations expand a disposition to include structural components of buildings Intended to lessen the impact of the new capitalization standards on buildings Old rule: replace a roof, depreciate two roofs, or three... New rule: replace a roof, deduct a roof When there is a disposition, taxpayer must stop depreciation unless it elects GAA treatment 38

40 Identification of the Basis of the Asset Disposed Of in a MAA or GAA Generally must use specific identification Other options: FIFO : taxpayer does not know the actual unadjusted basis, and uses basis from the earliest PIS year that has the same recovery period Modified FIFO: taxpayer knows the actual unadjusted basis Any other method deemed appropriate by publication, but not LIFO Adjusted basis After identifying the disposed of asset, A/B is generally the A/B at the time of disposition (use the asset s convention to determine final year depreciation) If impractical to determine adjusted basis, use any reasonable method that is consistently applied 39

41 Comparison of SAA /MAA v. GAA Under New Regs SAA / MAA Default Treatment Depreciate using GDS or ADS; applicable method, applicable convention, applicable recovery period Upon disposition of any unit or component: Must stop depreciation and recognize gain or loss Must claim loss deduction or lose tax basis GAA Must be elected in PIS year; Can be elected for one or more assets. Depreciation determined in the same manner as for SAA / MAA Upon disposition of any unit or component, including last unit: General rule: Continue depreciation; recognize gain = to proceeds; no loss on disposition Election: Recognize gain or loss 40

42 Dispositions Practice Tips Taxpayers will want to carefully consider making GAA elections, at least for buildings, and there appears to be no downside A GAA election can be made by checking the appropriate box on the Form 4562 Determining basis in retired structural components may be difficult for some industries and retroactively, but reasonable methods may be used In most cases, it will be preferable to forego a loss on the disposition of a structural component unless it involves the replacement of a major component 41

43 Identification of the Basis of the Asset Disposed Of in a MAA or GAA Generally must use specific identification Other options: FIFO : taxpayer does not know the actual unadjusted basis, and uses basis from the earliest PIS year that has the same recovery period Modified FIFO: taxpayer knows the actual unadjusted basis Any other method deemed appropriate by publication, but not LIFO Adjusted basis After identifying the disposed of asset, A/B is generally the A/B at the time of disposition (use the asset s convention to determine final year depreciation) If impractical to determine adjusted basis, use any reasonable method that is consistently applied 42

44 Example: Roof Replacement X, a calendar year taxpayer, discovers leaks in a roof on one of its office buildings and decides to replace the entire roof. How do the capitalization and disposition rules apply in the following circumstances: The building is in an SAA The building is the single building in a GAA The building is one of 3 buildings in a GAA Assume the same facts except that X also sells the entire office building subject to the roof repair. How do the capitalization and disposition rules apply in the following circumstances: The building is in an SAA The building is the single building in a GAA The building is one of 3 buildings in a GAA 43

45 Example: HVAC Replacement X, a calendar year taxpayer, replaces one of 20 malfunctioning and worn HVAC units in an office building. How do the capitalization and disposition rules apply in the following circumstances: The building is in an SAA The building is the single building in a GAA The building is one of 3 buildings in a GAA Specifically, how are the costs of removing the existing HVAC treated? 44

46 Example: Manufacturing Equipment X manufactures commercial products and uses lined containers to convert chemicals into a finished product. The class life of the container, which is the unit of property, is 12 years and X has to replace the lining (which is a major component) of each container approximately every three years. X also maintains a pool of spare lining which it elects to depreciate. If X replaces the lining of one container with lining from the pool of spares what are the consequences in the following circumstances: The container is in an SAA The container is the only asset in a GAA The container is one of 30 containers in a GAA Does it matter whether the removed lining was previously taken from the spare parts pool? Does it matter whether X has treated the lining as a separate unit for disposition purposes? 45

47 Materials & Supplies

48 Materials & Supplies Overview Under existing Treas. Reg Costs of incidental Materials and Supplies for which no inventories or records are kept are deductible in year purchased Costs of non-incidental Materials and Supplies are not deductible until year the Materials and Supplies are used or consumed in taxpayer s operations Existing regulation provides no definition of Materials and Supplies 47

49 Materials & Supplies Treas. Reg T Temporary regulations substantially modify existing regulations (e.g., provides definition of Materials and Supplies), while keeping general framework (i.e., incidental v. non-incidental Materials and Supplies) General rules under the temporary regulations Costs of acquired or produced incidental Materials and Supplies are deductible as paid or incurred if no consumption records or no inventories are maintained, provided taxable income is clearly reflected Costs of acquired or produced non-incidental Materials and Supplies are deductible as used or consumed Consider impact of 263A (see examples 9 and 11) Temporary regulations allow taxpayers to elect to capitalize and depreciate Materials and Supplies Taxpayers may elect to apply a de minimis rule to Materials and Supplies 48

50 Materials & Supplies -- Definition Materials and Supplies mean tangible property that is used or consumed in taxpayer s operations, that is not inventory, and that (i) is a component acquired to maintain, repair, or improve a unit of tangible property ( UOP ) owned, leased, or serviced by the taxpayer and that is not acquired as part of any single UOP (ii) consists of fuel, lubricants, water, and similar items reasonably expected to be consumed in 12 months or less, beginning when used in taxpayer s operations (iii) is a UOP that has an economic useful life of 12 months or less, beginning when used or consumed in the taxpayer s operations, (iv) is a UOP that has an acquisition cost or production cost of $100 or less (see examples 7 and 8), or (v) is identified in published guidance (see, e.g., Rev. Proc (small wares)) 49

51 Economic Useful Life of Property The period over which the property may reasonably be expected to be useful to the taxpayer (in its trade or business) Not necessarily useful life inherent in the property Useful life in applicable financial statements ( AFS ) controls Otherwise, factors are considered 50

52 Election to Capitalize and Depreciate Materials & Supplies Election available year-by-year and asset-by-asset Assets for which election is made are not treated as materials and supplies See example 12 (election for rental items) Election is not available for any materials and supplies intended to be used as a component of a UOP that is a materials and supplies under (iii), (iv), or (v) Election is not available for any Rotables or Temporaries for which taxpayer has applied the Optional Method 51

53 Election to Capitalize and Depreciate Materials & Supplies Election is made by capitalizing amounts paid/incurred for Materials and Supplies and beginning to amortize the Materials and Supplies on a timely filed return (including extensions) for tax year the Materials and Supplies asset is placed in service Election may be revoked by showing good cause and filing a private letter ruling Election/revocation cannot be made on a Form 3115 or an amended return Is this election/revocation a change in accounting method ( CAM )? 52

54 Rotable Spare Parts ( Rotables ) or Temporary Spare Parts ( Temporaries ) Special types of Materials and Supplies with some special rules Rotables are Materials and Supplies acquired for installation on a UOP, removable from that UOP, generally repaired or improved, and either Reinstalled on the same or other property, or Stored for later installation Temporaries are Materials and Supplies used temporarily until a new or repaired part can be installed and then are removed and stored for later (emergency or temporary) installation Rotables and Temporaries (collectively, Rotables ) are used or consumed in taxpayer s operations in year in which taxpayer disposes of the Rotables 53

55 Optional Method for Rotables Temporary regulations provide an Optional Method for Rotables Optional Method is a method of accounting Taxpayer using Optional Method must use it for all Rotables in same business Taxpayer using Optional Method must apply Optional Method to each Rotable 54

56 Under Optional Method for Rotable and Temporary Spare Parts In year Rotable is first installed (or later reinstalled), on a UOP for use in taxpayer s operations, taxpayer must deduct amount paid to acquire or produce the Rotable (or, if reinstalled, basis of the Rotable) In year Rotable is removed from a UOP, taxpayer must include Rotable s fair market value ( FMV ) in gross income and must include in Rotable s basis the same FMV + costs of removal In year Rotable is disposed of, taxpayer must deduct basis 55

57 De Minimis Rule Under the De Minimis Rule, amounts paid/incurred to acquire or produce tangible property (including facilitative costs) are not required to be capitalized Applies to materials and supplies and other fixed assets Only applies to a taxpayer if-- The taxpayer has AFS The taxpayer has written accounting procedures treating as an expense amounts paid for property costing less than a specified dollar amount, and The taxpayer treats the amounts paid during the tax year as an expense on its AFS in accordance with the written procedures 56

58 De Minimis Rule Total amounts paid and not capitalized under De Minimis Rule for tax year cannot exceed the greater of.1% of the taxpayer s gross receipts for the tax year as determined for federal income tax purposes, or 2% of the taxpayer s total depreciation and amortization expense for the tax year as determined in its AFS A taxpayer may elect not to have the De Minimis Rule apply 57

59 Election to Apply De Minimis Rule to Materials & Supplies Election is separate from rule that a UOP that costs $100 or less is a Materials and Supplies A taxpayer may elect to apply De Minimis Rule to any Materials and Supplies by complying with De Minimis Rule The Materials and Supplies for which an election is made is not treated as a Materials and Supplies 58

60 Election to Apply De Minimis Rule to Materials & Supplies Election is made by deducting amount paid/ incurred to acquire or produce the Materials and Supplies on a timely filed return (including extensions) in tax year amount is paid/incurred Election may be revoked by showing good cause and obtaining a PLR Election/revocation cannot be made on a Form 3115 or an amended return Practice Tips De minimis ceiling is not a cliff and taxpayer may selectively apply the rule to longer lived fixed assets and apply the ceiling to shorter lived assets such as supplies 59

61 Effective Date and Transition Rules

62 Effective date Generally effective for tax years beginning on or after January 1, 2012 However, for certain amounts, e.g., materials and supplies and the de minimis rule, regulations are applicable to amounts paid or incurred in taxable years beginning on or after January 1, 2012 Fiscal year taxpayers must apply these provisions to the first tax year ending after December 31,

63 Paid or incurred exceptions Portions of the temporary regulations applicable to amounts paid or incurred in taxable years beginning on or after January 1, Materials and supplies (Treas. Reg T); 2. The special rule for costs related to the acquisition of real property (Treas. Reg (a)-2T(f)(2)(iii)); 3. Employee compensation and overhead costs related to the acquisition or production of property (Treas. Reg (a)-2T(f)(2)(iv)); 4. The treatment of inherently facilitative amounts related to the acquisition or production of property (Treas. Reg (a)-2T(f)(3)(ii)); 5. The de minimis rule or "capitalization threshold" related to the acquisition or production of property (Treas. Reg (a)-2T(g)). 62

64 Paid or incurred exceptions (con t) Portions of the temporary regulations applicable to amounts paid or incurred in taxable years beginning on or after January 1, Production costs of property subject to the acquisition of property de minimis rule or capitalization threshold (Treas. Reg A-1T(b)(14)); 7. The recovery of costs capitalized under section 263A (Treas. Reg A-1T(c)(4)); 8. Section 263A direct material costs (Treas. Reg A-1T(e)(2)(i)(A)); 9. Section 263A indirect material costs (Treas. Reg A-1T(e)(2)(ii)(E)); and 10. Changes in method of accounting for costs subject to the de minimis rule or capitalization threshold (Treas. Reg A-1T(l)). 63

65 Transition rules In general, a method change with a full 481(a) adjustment is required to implement changes resulting from the new regulations Section 481(a) adjustment prevents duplication or omission of amounts upon change from old to new method and is computed notwithstanding period of limitations However, the items noted above, e.g., materials and supplies and the de minimis rule, require a cut-off adjustment Under cut-off method items in year of change and future years are determined under new method and items for prior years continue to be determined under the old method. Item-by-item elections going forward Capitalize and depreciate supplies Not apply de minimis rule Capitalize otherwise deductible transaction costs GAA 64

66 Automatic Consent Procedures Modify the automatic consent procedures in Rev. Proc Rev. Proc Method changes for costs to repair, maintain or improve tangible property Method changes for costs to acquire tangible property Transaction costs De minimis rule Materials and supplies Rev. Proc Rules for accounting for MACRS property, including general asset account (GAA) elections and dispositions Add 18 new automatic accounting method changes 65

67 General Terms and Conditions Waiver of scope limitations in Rev. Proc for two years Don t need to be in a window and may change, even if issue under consideration or pending in exam, appeals, or court Taxpayers generally receive audit protection unless issue pending when Form 3115 is filed (i.e., NOPA) However, LB&I Directive instituting a standoff of examination activity for two years effectively provides audit protection if taxpayer correctly complies with temporary regulations Automatic consent conditioned on compliance with 263A Three categories of implementation methods, depending on type of change 481(a) adjustment Cut-off method Modified cut-off method Statistical sampling procedures set forth in Rev. Proc permitted for calculation of section 481(a) adjustment) 66

68 Filing Procedures 18 distinct changes, but taxpayers may combine related and similar changes on a single Form 3115 Duplicate filing requirement Original with timely tax return by extended due date Copy to Ogden, Utah May be filed early to obtain audit protection Positive and negative 481(a) adjustments may be taken into account separately 4-year spread of positive adjustment (increase to income) No spread of negative adjustment (deduction) No user fees 67

69 Rev. Proc

70 Changes for Repair and Maintenance Expenditures Change #162 applies to a change from capitalizing costs under 263(a) to deducting as repairs under 162 Includes changes to the unit of property under 1.263(a)-3T Change #171 applies to a change to deduct costs under the routine maintenance safe harbor under 1.263(a)-3T(g) Change #174 applies to a change from deducting as repairs under 162 to capitalizing costs under 263(a) 69

71 Materials and Supplies and De Minimis Rule Change #164 applies to a change To deduct non-incidental materials and supplies in taxable year in which they are actually used or consumed Change #165 applies to a change To deduct incidental materials and supplies in a taxable year in which they are pair or incurred Change #169 applies to a change To apply the de minimis rule 70

72 Other Automatic Changes under Rev. Proc Deduct amounts paid or incurred to repair or maintain property under regulatory safe harbor (#163) Deduct non-incidental rotables and temporary spare parts upon disposal (#166) Apply optional method for rotables and temporary spare parts (#167) Deduct dealer expenses that facilitate sale of property (#168) Deduct investigatory costs of acquiring real property (#170) Capitalize non-dealer expenses that facilitate sale of property (#172) Capitalize acquisition or production costs (#173) 71

73 Rev. Proc

74 Dispositions of Assets and Components in General Change #177 applies to taxpayer that wants to recognize gain or loss on dispositions of buildings or structural components Applies to Single Asset Account (SAA) or Multiple Asset Account (MAA (no GAA election) 481(a) adjustment Change # 178 applies to taxpayer that wants to recognize gain or loss on dispositions of tangible depreciable assets (i.e., 1245 property) in a SAA or MAA 481(a) adjustment Change # 179 applies to a taxpayer that wants to recognize gain or loss on dispositions of tangible depreciable assets (i.e., 1245 property) in a GAA 481(a) adjustment 73

75 Late General Asset Account (GAA) Elections and Dispositions Change # 180 applies to taxpayer that wants to make a late GAA election Change must be made for the taxpayer s first or second taxable year beginning after December 31, (a) adjustment limited to property no longer owned by taxpayer (i.e., loss may be recaptured for prior dispositions) Change #180 applies to taxpayer that wants to make a late election to recognize gain or loss in a GAA Upon disposition of all of the assets or the last asset Upon disposition of an item in a qualifying disposition 481(a) adjustment 74

76 Other Automatic Changes under Rev. Proc Depreciate/amortize leasehold improvements from improper method to proper method (#175) Permissible to permissible method of accounting for MACRS property (#176), including: SAA to MAA, or vice versa MAA grouping to different MAA grouping or GAA grouping to different GAA Grouping MAA change in identifying asset disposed of or GAA change in identifying asset disposed of 75

77 Additional Details on Terms and Exam Activity

78 Scope Limitation Waiver and Taxpayers Under Exam Scope limitations under section 4.02 of Rev. Proc are generally waived for taxpayer s first or second taxable year beginning after December 31, 2011 In general, subject to limited exceptions in section 6, section 4.02 of Rev. Proc precludes taxpayers from filing under the automatic change procedures if the taxpayer: Is under exam, in appeals, or before a court Has engaged in a 381(a) transaction in the year of change, Is in its final year of trade or business, or Has changed its method of accounting for same item within past 5 years 77

79 LB&I Directive on Examination Activity (LB&I ) Issued March 15, 2012 from Commissioner, LB&I, to Industry Directors, Director, Field Specialists, and Director, International Compliance Scope Exam activity relating to original return positions regarding whether costs of tangible property are deductible repairs or capital improvements Correlative issues involving dispositions of tangible property Does not apply to issues before appeals, court, or SBSE division However, the government is likely to follow suit in these forums 78

80 LB&I Directive on Examination Activity (LB&I ) For tax years beginning before Jan. 1, 2012 All exam activity should cease and no new activity should commence Exam should withdraw all IDRs, and NOPAs Exam should develop and issue a Form 5701 with a Form 886-A containing the following language: The Service neither accepts nor rejects the position taken in the tax return related to the method to determine the proper treatment of amounts incurred to repair tangible property. [Insert taxpayer name] will be allowed a two-year period to adopt the appropriate method of accounting provided in Rev. Proc and If an appropriate method is adopted, a change in method of accounting can be made in accordance with Section 4 or 5 of the applicable revenue procedure for all assets. If [Insert taxpayer name] has not changed its accounting method consistent with Revenue Procedures and in its first or second taxable year beginning after December 31, 2011, then the repair expense will be subject to risk assessment and possible examination for tax years ending on or after January 1,

81 LB&I Directive on Examination Activity (LB&I ) For tax years beginning on or after January 1, 2012 but before January 1, 2014 When you begin examining a return for a taxable year beginning on or after January 1, 2012 but before January 1, 2014, you should determine: If the taxpayer filed a Form 3115; If yes, perform a risk assessment regarding the method change; If no, and the scope waiver period to file such change is still open, do not examine the issues and allow the taxpayer the appropriate time period to file a method change; If no, and the waiver period to file such change has passed, perform a risk assessment regarding the issues 80

82 LB&I Directive on Examination Activity (LB&I ) In performing risk assessment to examine 481(a) adjustment, exam should: Consider if the adjustment properly accounts for amounts paid to acquire, produce, or improve tangible property that were computed under the taxpayer's prior method and previously deducted under section 162 Determine if the section 481(a) adjustment(s) resulting from any prior year change was taken into account Consider the accuracy of the section 481(a) adjustment 81

83 263A Compliance For most changes under Rev. Proc and , taxpayers subject to UNICAP must be appropriately capitalizing costs under 263A Changes requiring 263A compliance generally allow taxpayers to make concurrent automatic changes to comply with 263A Resellers (#22) Producers (#23) Note that even if a taxpayer is in compliance with 263A, the 481(a) adjustment must take into account the amount of costs subject to capitalization with respect to 263A For example, if a taxpayer properly capitalizes repairs to a manufacturing plant into inventory costs, and changes its method to capitalize more repairs as improvements, the positive 481(a) adjustment from change # 174 will be reduced by the amount of repair expenses included in beginning inventory for the year of change 82

84 Pre-2012 Accounting Method Changes Rev. Proc provides automatic changes for Repairs and improvements Materials and supplies Dispositions Rev. Proc and Rev. Proc render the above changes obsolete for tax years beginning on or after Jan. 1, 2012 Automatic changes may still be made under Rev. Proc for pre tax years for these items, provided the change is made under preexisting law and not the temporary regulations Note, however, that the LB&I directive to stand down on exam activity and scope restrictions does not apply 83

85 Contact Information Carol Conjura

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