Tangible Property Regulations. Crystal Germanese, CPA, MSAT December 18, 2013

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1 Tangible Property Regulations Crystal Germanese, CPA, MSAT December 18, 2013

2 Tax Disclaimer This presentation is for general informational purposes only. No tax advice is intended to be given. The examples contained within this presentation are for illustration purposes only. Under U.S. Treasury Department guidelines, we hereby inform you that (1) any tax advice contained in this communication is not intended or written to be used, and cannot be used by you, for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service or State Tax Authorities, (2) no part of any tax advice contained in this communication is intended to be used, and cannot be used, by any party to market or promote any transaction or matter addressed herein without the express and written consent of Blum Shapiro & Company, P.C. (3) Blum Shapiro & Company, P.C. imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein, and (4) any fees otherwise payable to Blum Shapiro & Company, P.C. in connection with this written tax advice are not refundable or contingent on your realization of tax benefits from the advice contained herein. 2

3 Your Presenter Crystal A. Germanese, CPA, MSAT General Experience Highlights As a tax manager, Crystal serves privately held businesses in a variety of industries, including construction, manufacturing, distribution and real estate. Crystal is also a member of the Real Estate Cost Segregation Services Group. This specialized tax and engineering service identifies and reclassifies property acquisition and construction costs eligible for accelerated depreciation methods cgermanese@blumshapiro.com 3

4 Introduction On September 13, 2013, the IRS and Treasury department released over 200 pages of final regulations on the deduction and capitalization of expenditures related to tangible property The IRS also issued proposed regulations revising the rules on dispositions of tangible property Will affect every taxpayer that acquires, produces or improves tangible property Will generally require a change of accounting forms attached to 2014 business tax returns Waiting for IRS to issue transition guidance 4

5 Effective Dates The Regulations are generally effective for tax years beginning on or after January 1, 2014 or to amounts paid or incurred in tax years beginning on or after January 1, 2014, as applicable Taxpayers may chose to apply the final repair regulations to any tax year beginning on or after January 1, 2012, or to amounts paid or incurred in the tax years beginning on or after January 1, 2012, as applicable. Transition relief to the extent taxpayers failed to make certain elections on their timely filed original federal tax returns for 2012 or 2013 by filing amended tax returns on or before 180 days from the due date (including extensions). Taxpayers may choose to apply the 2011 temporary regulations to tax years beginning on or after January 1, Taxpayers cannot apply the 2011 temporary regulations to tax years beginning on or after January 1,

6 Outline De Minimis Safe Harbor Timing of Deductions of Materials and Supplies Capital Improvement vs. Repair Adjustments for Prior Year Expenditures 6

7 Expenditures Materials and Supplies Deduct when purchased or consumed Special Rules for rotable, temporary and emergency standby spare parts Capitalization of Expenditures Capitalize purchases including transactions costs Improvement or Repair Betterment Restoration New or different use Routine Maintenance De Minimis Rule Applies to materials and supplies as well as Improvements 7

8 De Minimis Rule In general, taxpayers may annually elect to apply the de minimis safe harbor to expense otherwise capital assets, improvements and materials & supplies Under the safe harbor, taxpayers may not capitalize certain acquisitions under $5,000 OR $500 depending on whether or not the taxpayer has an applicable financial statement Annual election is made by attaching a statement to a timely filed original federal tax return 8

9 De Minimis Rule Applicable Financial Statement: A financial statement required to be filed with the SEC A certified audited financial statement used for: Credit purposes Reporting to shareholders, partners or similar persons, or Any other substantial non-tax purpose, or A financial statement required to be provided to the federal or state government or any federal or state agency (other than SEC or IRS) 9

10 De Minimis Rule For taxpayers with an applicable financial statement: Taxpayer must have at the beginning of the taxable year, written accounting policies treating an expense for non-tax purposes: Amounts paid for property costing less than a specified dollar amount; or Amounts paid for property with an economic useful life of 12 months or less Taxpayers must treat the amount paid for the property as an expense on its applicable financial statements Threshold can be any amount under the IRS prescribed amount. Needs to be approved for financial statement purposes. A change in the accounting policy is not an issue for tax. Use what is in place at beginning of year. 10

11 De Minimis Rule Transaction and Other Additional Costs Transaction costs are only considered if included on the same invoice If multiple assets on invoice, transaction costs are allocated to assets on the invoice using a reasonable method Anti-abuse rule If a taxpayer acts to manipulate transactions with the intent to achieve a tax benefit, appropriate adjustments will be made Example: Invoices are created to componentize property that is generally acquired as a single unit of property, and If property is treated as a single unit, would exceed limitations 11

12 De Minimis Rule Consolidated Groups If applicable, financial is for a group of entities The group s applicable financial statement may be treated as the applicable financial statement The written accounting procedures provided for the group and utilized for the group financial statement may be treated as the written accounting procedures Election is made for each member of the consolidated group filing a consolidated income tax return by the common parent The statement must include the name and ID number for each member for which the election is made. 12

13 De Minimis Rule Examples clarify that you look at the amount per item: A purchases 10 printers at $250 each for a total cost of $2,500 as indicated on the invoice C pays $6,250,000 to purchase 1,250 computers at $5,000 each as the per item price on the invoice Examples clarify that you do not need to consider non-invoice costs: Table costs $500, chairs costs $300 each, design costs $600. Designer billed for his services on separate invoice from the furniture store for the table and chairs. 13

14 Materials and Supplies Materials and supplies are not inventory, and: 1. Components acquired to maintain, repair or improve a unit of tangible property that the taxpayer owns, leases or services that is not part of a unit of property 2. A unit of property with an economic useful life of 12 months or less, beginning when used in the taxpayer's operations 3. A unit of property that has an acquisition or production cost of $200 or less, OR 4. Fuel, lubricants, water and similar items expected to be consumed within 12 months or less 14

15 Materials and Supplies Incidental Deductible in the taxable year in which these amounts are paid, provided taxable income is clearly reflected. Incidental materials and supplies are carried on hand and no record of consumption is kept or no physical inventories at the beginning and end of the taxable year are taken Non-Incidental Deductible in the taxable year in which they are first used or consumed in the taxpayer s operations. 15

16 Materials and Supplies Rotable, Temporary & Emergency Standby Spare Parts Rotable spare parts are defined as: Acquired for installation on a unit of property Removable from that unit of property Generally repaired or improved, and either reinstalled on the same or other property or stored for later installation Temporary spare parts are defined as: Materials and supplies that are used temporarily until a new or repaired part can be installed Then are removed and stored for later (emergency or temporary) installation 16

17 Materials and Supplies Rotable, Temporary & Emergency Standby Spare Parts Emergency standby spare parts Acquired when particular machinery or equipment is acquired (or later acquired and set aside for use in particular machinery or equipment); Set aside for use as replacements to avoid substantial operational time loss caused by emergencies due to particular machinery or equipment failure; Located at or near the site of the installed related machinery or equipment so as to be readily available when needed; Directly related to the particular machinery or piece of equipment they serve; Normally expensive; Only available on special order and not readily available from a vendor or manufacturer; Not subject to normal periodic replacement; Not interchangeable in other machines or equipment; Not acquired in quantity (generally only one is on hand for each piece of machinery or equipment); and not repaired and reused. 17

18 Materials and Supplies Rotable, Temporary & Emergency Standby Spare Parts Default Treatment Deducted in the taxable year in which the taxpayer disposes of the parts (final disposition) Capitalize Can elect to capital and depreciate starting upon acquisition Optional Method for Rotables Deducted when place in service and capitalized when repaired If the elected must be used for all same pool of part used in a T or B Must use if used for books and records 18

19 Materials and Supplies Rotable, Temporary & Emergency Standby Spare Parts Initial installation: Deduct the amount paid for a new part in the year in which it is installed in equipment; Disposal of the Part: Deduct amounts included in the basis to the extent that those amounts have not been previously deducted Optional Method for Rotables Removal from unit of property: Include in income and assign a cost basis equal to the fair market value of the used, non-functioning part and costs paid to remove the part. Reinstallation of the Part: Deduct the basis of the part when re-installed and costs to reinstall Repair: Capitalize Costs to Repair 19

20 De Minimis Rule Application to materials and supplies If de minimis rule is elected it must be used for all materials and supplies that qualify Cannot be used for rotable, temporary and emergency standby parts if election to capitalize and depreciate is made or optional method is used Note: Three options for rotable, temporary and emergency standby parts. Can only deduct under de minimis rule if the default treatment is used which may be the least favorable method for parts that do not qualify as de minimis 20

21 Improvements Unit of Property Special building and plant property rules Apply standards Betterment Restoration Adaption to new or different use Applicable exceptions? Routine maintenance De minimis rule Safe harbor for small taxpayers Election to capitalize repairs & maintenance 21

22 Unit of Property General Rule Buildings Plant Property Functionally interdependent The placing in service of one component is dependent upon placing in service of the other component Buildings is made up of structure and following systems: Heating, ventilation, and air conditioning ( HVAC ) systems Plumbing systems Electrical systems All escalators All elevators Fire-protection and alarm systems Security systems for the protection of the building and its occupants Gas distribution system Functionally interdependent machinery or equipment, used to perform an industrial process, such as manufacturing, generation, warehousing, distribution, automated materials handling in service industries, or other similar activities. The unit of property is further divided into smaller units comprised of each component (or group of components) that performs a discrete and major function or operation 22

23 Improvement A unit of property is improved if the amounts paid for activities performed after the property is placed in service by the taxpayer: Result in a betterment to the unit of property, Restore the unit of property, or Adapt the unit of property to a new or different use 23

24 Improvement Betterment Restoration Adaption to new or different use Ameliorates a material condition or defect that existed prior to the taxpayer's acquisition, A material addition (physical enlargement, expansion, extension, or addition of a major component) or a material increase in the capacity, or Materially increases the productivity, efficiency, strength, quality or the output of the unit of property Returns the property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair; Rebuilding of the property to a like-new condition after the end of its class life; or Replacement of a part or a combination of parts that comprise a major component or a substantial structural part. Three other standards relating to when a loss or basis adjustment is taken into account for the old property that was restored If the adaptation is not consistent with the taxpayer's ordinary use of the unit of property at the time originally placed in service by the taxpayer 24

25 Examples - Betterment Betterment Building remodel Relocation and reinstallation along with an improvement Improvement as a result of a regulatory requirement Dredge of a channel to increase depth Replacement of columns and girders supporting second floor storage to increase load carrying capacity Adding a staircase and mezzanine to a retail space to add selling space (capacity) New insulation resulting in 50% reduction in energy costs Physical extension to add a drive through Not a Betterment Building refresh Relocation and reinstallation of property Repair as a result of an event discovered by inspector Re-dredge of channel to bring back to prior depth New roof membrane (top layer) Removal of a drop ceiling and repainting of the original ceiling (not capacity) 2 out of 10 Roof Top Units resulting in 10% efficiency increase 25

26 Examples - Restoration Major Component/Substantial Part Replacement of cab and engine of a petroleum hauling truck New Underground Storage Tanks Replacement of entire or large portion of the roof including decking, insulation and membrane after discovery of rotted sheathing and rafters Replacement of chiller unit (major component) that provides cooling mechanism for entire system Replacement of wiring throughout the entire building Replacement of the entire sprinkler system Replacement of all toilets and sinks in all bathroom in a retail location Replacement of 200 out of 300 windows Replacement of 100 out of 300 windows where the 300 windows represent 90% of the building structure (comprise substantial structural part) Replacement of all wood floors in public areas of hotel (40% square footage) Not a Major Component/Substantial Part Replacement of power switch assembly which controls supply of electric power to a drill press Replacement of roof waterproof membrane after wear and leakage gain to occur on membrane Replacement of 1 of 3 furnaces which combined are a major component Replacement of 3 out of 10 roof top units which combined are a major component Replacement of 30% of the wiring throughout the building Replacement of 8 out of 20 bathroom sinks Replacement of 100 out of 300 windows with no plans to replace the other windows Replacement of lobby floor in hotel (10% square footage) 26

27 Examples New or Different Use New or different use Not new or different use Conversion of manufacturing building into a showroom Cleanup of land so that is can be used for residential, current commercial Conversion of a portion of a retail drug store (pharmacy building) to walk in clinic Reconfiguring retail spaces Preparing a building for sale Cleanup of contaminated land Add sushi bar to grocery store 27

28 Other Exceptions Routine maintenance Safe Harbor Recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of the unit of property to keep the unit of property in its ordinarily efficient operating condition The activities are routine if at the time the unit of property is placed in service the taxpayer reasonably expects to perform the activities more than once during the class life of the unit of property. For buildings activities are routine only if reasonably expected to be performed more than once during the 10-year period Safe harbor for small taxpayers Taxpayer whose average gross receipts for the three preceding taxable years is less than or equal to $10,000,000. Each unit of property that has an unadjusted basis of $1,000,000 or less If repairs are less than: 2 percent of the unadjusted basis of the eligible building; or $10,000 Election to capitalize repairs and maintenance costs A taxpayer may elect to capitalize repair and maintenance costs as improvements and depreciate if the taxpayer treats the amounts as capital on it books and records Applies to amounts capitalized by books, not expensed 28

29 Adjustments for Prior Year Expenditures Waiting on transition guidance Most taxpayers will likely have to file change in accounting method Form(s) 3115 with 2014 tax returns IRS will most likely require taxpayers to review prior year repairs and improvements to determine treatment under the new rules. If something should have been treated differently than how it was treated in prior years an adjustment would be made on the 2014 tax return if favorable or split between if unfavorable If a taxpayer was conservative in the past then the adjustment may be favorable or if aggressive in the past the adjustment may be unfavorable. If a repair study was done in the past it should be revisited. If a taxpayer did not undergo a repair study in the past and was not aggressive is there a need to review prior year? 29

30 Wrap-up Generally decisions will need to be made by the filing (including extensions) of the 2014 tax returns. However if electing De Minimis Safe Harbor and have an audited financial statement must have your policy in writing on January 1, 2014 Has to be applied to both book and tax Review policies around materials and supplies now so that you do not have to retroactively adjust (time consuming) and determine best treatment based on the businesses specific facts and circumstances Decide what types of routine maintenance occur so they can be identified as expenses up front Use BSC as a resource during the year when determining if you have repairs or improvements 30

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