The Final Tangible Property Regulations West Virginia Tax Institute

Transcription

1 The Final Tangible Property Regulations West Virginia Tax Institute October 20, 2014

2 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG or Teresa Castanias, CPA TO BE USED, AND CANNOT BE 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 Long Road to Here January 20, 2004 Notice announces government s plan to develop tangibles regs August 21, 2006 Government issues first set of proposed regulations March 10, 2008 Government withdraws 2006 proposed regulations and issues new proposal December 27, proposed regulations withdrawn and replaced with third proposal (also issued as temporary regulations, so effective immediately) September 19, 2013 Final regulations published for acquisition costs and for repair and maintenance costs; proposed regulations issued for dispositions (effective January 1, 2014) January 24, 2014 Revenue Procedure issued (repair and maintenance) February 28, 2014 Revenue Procedure issued (dispositions) August 18, 2014 Final disposition regulations (effective January 1, 2014) September 18, 2014 Revenue Procedure issued (dispositions) Pending Industry guidance for cable TV, natural gas, retailers Newly opened Industry guidance for restaurants and mining 2

4 Common method changes and elections Election Method Change Area of focus Item Election made with affirmative statement Election made by reporting on the return Method change with 481(a) adjustment Method change with limited 481(a) Book de minimis policy Acquisition Costs Materials and supplies Election to capitalize & depreciate rotable or temporary spares Repairs and Improvements Repairs vs. improvements Book conformity election Partial disposition Dispositions Late partial disposition election Complete asset disposition 3

5 Automatic method changes - Form 3115 Changes qualify for the automatic consent procedures of Rev. Proc Filing requirements Scope limitations waived temporarily (tax years beginning before 2015) After expiration of scope limitation waiver, changes will still be eligible for automatic consent, but scope limitations will apply (i.e., if under exam must consider window periods; only one automatic change within a 5 year period; etc.) Additional requirements The authority for each change must be described in the Form 3115 The unit of property for repairs changes must be described in the Form 3115 Section 263A No requirement that 263A methods be in compliance to file an automatic change Must consider 263A in calculating the 481(a) adjustment Adds additional changes under 263A to the automatic consent procedures Section 481(a) adjustment Generally spread positive (income) 481(a) adjustments over 4 years and negative (deduction) over 1 year Netting not clear 4

6 Acquisition costs

7 Transaction costs Tax Facilitative Costs an amount paid in the process of investigating or otherwise pursuing the transaction Invoice cost Inherently facilitative costs (partial list): Transportation costs Appraisal costs Sales and transfer taxes Architectural Installation costs, etc. Other facilitative costs Whether & which test applies to real property only Employee labor excluded GAAP Historical cost purchase price (less cash discounts); includes sales tax Transportation charges (e.g., freight) Installation & assembly Testing and design Closing costs Attorney fees Title Recording Land grading, filling, draining, and clearing 6

8 De minimis rule - safe harbor 2011 ceiling replaced with a safe harbor Requirements to use the safe harbor Taxpayer has written procedures at the beginning of the taxable year treating as an expense for non-tax purposes amounts paid for property: Costing less than a specified dollar amount; or Having an economic useful life of 12 months or less Taxpayer treats as an expense in AFS Amount eligible for safe harbor may not exceed $5,000 per invoice (or per item on invoice) Additional costs (e.g., delivery and installation) not included if not on the same invoice Requires annual, irrevocable election May amend for 2012 or 2013 unless no written policy Higher amounts allowed if clear reflection of income 7

9 De minimis rule - safe harbor election How to make the annual election Statement attached to the timely filed original income tax return (including extensions) The statement must be titled Section 1.263(a)-1(f) de minimis safe harbor election and include the following: taxpayer's name, address, taxpayer identification number, and a statement that the taxpayer is making the de minimis safe harbor election under 1.263(a)-1(f). Parent must list the name and identification number of each consolidated group member making the election. 8 8

10 Accounting for materials and supplies Options for accounting for materials and supplies: Deduct non-incidental materials and supplies when used or consumed, unless they are used in a capital improvement Deduct incidental materials and supplies in the year purchased Deduct any material and supply in the year purchased if it qualifies under the de minimis rule Capitalize and depreciate only materials and supplies that are rotable, temporary, or emergency standby spare parts (can t go back!) GAAP comparison: Spare parts (replacement items such as motors) are generally capitalized as part of property Insignificant spare parts may be treated as prepaid expense or supplies inventory Spare parts not in use are depreciated over remaining life of equipment/property Tools, dies, patterns, utensils, etc. Expense immediately Amortize over life of product or shorter period if short lived or subject to disappearance 9

11 Materials and supplies Materials and supplies defined: 1. A component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer 2. A unit of property with an economic useful life of 12 months or less 3. A unit of property that has an acquisition or production cost of $200 or less 4. Fuel, lubricants, water and similar items that are reasonably expected to be consumed within 12 months or less, beginning when used in the taxpayer s operations 5. Property identified in published guidance as M&S 6. Rotable, temporary, or emergency stand-by spare parts 10

12 Rotable and Temporary Spare Parts Options for accounting for spares: Me Method 1 Deduct full basis on final disposition Method 2 Capitalize and depreciate starting upon acquisition Method 3 Optional method exchange type treatment. Deducting when placed in service and capitalizing repair costs of broken item If elected, generally applies to entire pool REQUIRED IF USED FOR BOOKS AND RECORDS Important Note MAY deduct under de minimis rule unless optional method is used or election to capitalize and depreciate is made 11

13 Acquisition costs common questions Common questions related to the acquisition cost bucket: My company s minimum capitalization policy is higher than $5,000. Can I still elect the de minimis safe harbor? We have a minimum capitalization policy and we try to follow it, but some plant managers aren t consistent. Can we still elect the de minimis safe harbor? We have different minimum capitalization policies for different categories of costs. Can I still elect the safe harbor? My company currently follows specific guidance for certain costs, such as small wares and truck tires. Can I keep using these if I make the book conformity safe harbor? For any given part, we might repair and reuse it, or we might scrap it, depending on a particular part s condition when it is removed. Are these rotables? How do I determine if I am compliant with the transaction cost rules i.e. facilitative and inherently facilitative costs? With all the optional methods rotable spare parts, I am not sure which option to select. What are the relevant considerations in choosing which method to apply? 12

14 Repair and maintenance or capital improvements?

15 The Second Bucket Repair and Maintenance Costs Book capitalization election Book typically over-capitalizes Applies to amounts capitalized; not expensed No 3115 required for expenses or if book always followed (IRS public statements) File Form 3115 alternatives: 1. Form 3115 to accelerate tax deductions for previously capitalized improvements Requires 481(a) adjustment Statistical sample usually required 2. Form 3115 with zero or minimal 481(a) Practical way to follow book without filing a Form 3115 Prior method change / study 14

16 Election to follow book capitalization policy Taxpayer may elect to capitalize otherwise deductible repairs If incurred in trade or business; and Capitalized in books and records regularly used in computing income. Must be applied to all amounts paid for repair and maintenance of tangible property that taxpayer treats as capital expenditures on its books and records in that taxable year. Note that this doesn t apply to amounts expensed for book purposes, including under the de minimis rule. The annual election is irrevocable 15

17 Book capitalization election How to make the annual election Statement attached to the timely filed original income tax return (including extensions) The statement must be titled Section 1.263(a)-3(n) election and include the following: taxpayer's name, address, taxpayer identification number, and a statement that the taxpayer is making the election to capitalize repair and maintenance costs under 1.263(a)-3(n). Parent must list the name and identification number of each consolidated group member making the election. 16

18 Unit of property Buildings Everything Else Single UOP Default Rule Plant Property Network Assets Functional Interdependence Discrete and major function Facts & circumstances - industry specific 17

19 Plant Property Regulations Examples Electric power plant Structure Boiler Turbine Generator Each coal pulverizer Commercial laundry facility Sorter Boiler Washer Dryer Ironer Folder Waste water treatment system 18

20 Unit of property buildings Determine UOP Apply Capitalization Standards Capitalize Improvements to UOP Entire building Building structure Building systems Entire building HVAC Plumbing system Electrical system All escalators All elevators Fire protection Security system Gas distribution 19

21 GAAP capitalization standards Costs incurred during ownership consist of additions, improvements, alterations, rehabilitations, replacements, repairs, etc. Capitalized cost - appreciably extend the life, increase the capacity, or improve the efficiency or safety of the property Consideration of materiality is always applicable 20

22 File Form capitalization standards - detail Betterment 1. Material condition or defect at acquisition or production 2. Material addition, including a physical enlargement, expansion, extension, or addition of a major component; or a material increase in the capacity 3. Reasonably expected to materially increase the productivity, efficiency, strength, quality, or output Adaptation Restoration 1. Component loss 2. Gain/loss on sale of a component 3. Casualty loss 4. Return to former operating condition no longer functioning 5. Rebuild to like new condition after the class life 6. Replacement of a major component or substantial structural part Showroom to manufacturing Walk-in medical clinic Grocery - sushi Hospital emergency room 21

23 Example major component or substantial structural part Treas. Reg (a)-3(k)(7) Examples 25, 26, and exterior windows represent 25 percent of surface area of building The windows represent a major component of the building structure (discrete and critical) Replacement of 100 of 300 windows is not a significant portion of a major component Replacement of 200 of 300 windows is a significant portion of a major component Assume that 300 windows represent 90 percent of the surface area of the building Again, the windows represent a major component of the building structure (discrete and critical) The windows are also a substantial structural part of the building because they comprise a large portion of the physical structure of the building Replacement of 100 of the 300 windows is considered the replacement of a substantial structural part because the windows represent 30 percent of the surface area of the building 22

24 Building examples (cont.) major component or substantial structural part Not a major component or substantial structural part: Replacement of floors in lobby of hotel (lobby represented 10% of total square footage) Replacement of a major component or substantial structural part: Replacement of all floors in public areas of hotel (represented 40% of total square footage) Replacement of 8 of 20 sinks in retail building (restrooms on 2 of 3 floors) Replacement of all toilets and all sinks in retail building (restrooms on 2 of 3 floors) Replacement of 30% of wiring in building Replacement of 3 of 10 roof mounted HVAC units Replacement of 1 of 3 furnaces in single HVAC system Replacement of entire roof membrane Replacement of all wiring in building Replacement of one chiller unit in single HVAC system Replacement of sprinkler system Replacement of entire roof 23

25 Building examples betterments Not a betterment: Building refresh cosmetic & layout changes; flooring repairs, moving a wall; patching holes, repainting; repairing ceiling tiles; flooring repairs Addition of concrete lining to prevent oil from seeping into meet processing plant Replacement of roof membrane Replacement of 2 of 10 roof mounted HVAC units (10% more energy efficient) Betterment: Building remodel replacement of large sections of walls (with windows); rebuilding interior and exterior facades; replacement ceilings and ceramic flooring; rebuilding walls, etc. Material increase in strength addition of expansion bolts to building foundation regulatory requirement for earthquake safety Material increase in capacity reinforcement of columns and girders 50% greater load carrying capacity Material addition and increase in capacity new stairway and mezzanine to retail building Material increase in efficiency addition of new insulation to building 24

26 481(a) calculations stat sampling permitted - Rev. Proc

27 Example 1 Invoice documentation of HVAC repair Acceptable documentation: Installed new compressor in Trane roof unit. Checked for leaks and changed unit 26

28 Example 2 Incomplete documentation - electrical Incomplete documentation: Per this invoice, the drawings or an interview with facilities would be required Begin installation of electrical as per drawings 27

29 Capitalization standards Common questions on application of the capitalization standards Revenue procedure requires taxpayers to provide a detailed description of unit(s) of property and/or building system(s) under its current and proposed methods of accounting. How detailed does this need to be? How do I describe the UOP s under my present method? Can I use a cost or percentage based standard to compute repair costs? How do I treat periodic refreshes of our buildings, especially for non-retail space where we don t have (and aren t expecting) an IIR? We don t have a companywide capitalization policy plant managers make the decisions and send the info to company HQ so there isn t 100% consistency. What do I do? 28

30 Capitalization standards (cont.) Common questions on application of the capitalization standards (cont) When would expenditures to satisfy a regulatory requirement be treated as a betterment? For example, emission control equipment, ADA compliance? When is the use of upgraded or superior materials when replacing worn out components considered a material increase in quality? While there are no safe harbors, what general % guidelines can I apply to define a major component or substantial structural part? What do I need to be concerned about with respect to the application of section 263A to our selfconstructed assets? How do past transactions (asset acquisitions, stock acquisitions, etc.) impact the analysis under the tangible property regulations? Can my section 481(a) adjustment for method changes I file take into account costs incurred prior to a transaction? 29

31 Dispositions

32 Dispositions 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 A portion of an asset Including elective treatment for building structural components Involuntary conversion 31

33 Partial Dispositions under 2013 Proposed Regulations Default Treatment General Asset Account Election General rule: Depreciation stops Gain or loss recognized on disposition of entire asset, or Partial disposition from casualty, sale, certain non-recognition transactions Partial disposition - optional annual election* any portion of an asset *Amended return or method change for 2012 or 2013 General rule: Depreciation continues - no immediate recovery of basis Exceptions: Disposition of all or last asset in the account Qualifying dispositions: Casualty Charitable Contribution Termination or sale of business Non-recognition transactions 32

34 Highlights of final disposition regulations Few changes from regulations proposed in September 2013 Clarify application of demolition rules under section 280B in GAAs Determination of UOP disposed of Reasonable methods permitted if taxpayer does not have accurate information Discounted cost approach for partial dispositions limited to restorations Producer price index required for discounting Correction of election to capitalize materials and supplies Election made by capitalizing and beginning to depreciate in year placed in service Election not applicable to property acquired and disposed of in same year Applies to elections under temporary regulations, even though regulations withdrawn 33

35 Observations Planning considerations: If the priority is the ability to claim losses on partial dispositions, including building structural component dispositions, the partial disposition election may be preferable If the objective is flexibility to create additional income in a future year disposition, consider making the GAA election Typically use one GAA per item to maximize flexibility Effective for managing NOLs Ghost assets try to file method change in

36 Example dispositions method change Roof replacement X, a calendar year taxpayer, acquired and placed in service a building and its structural components in 1990 In 2000, X replaced the entire roof of the building X did not recognize a loss on the retirement of the original roof and continues to depreciate the original roof. X also capitalized and depreciated the cost of the replacement roof X may file an automatic change to make a late partial disposition election for the original roof to recognizing a loss upon its retirement. The 481(a) adjustment is the adjusted basis of the roof as of the beginning of the year of change. 35

37 Dispositions and Retirements Common questions on the disposition rules How does the unit of property differ under the improvement standards and for purposes of retirements? Which procedures are used if a change in either is needed? Can I use the book aging/trending study to discount replacements to acquisition date for purposes of identifying the basis of partial disposition? When is it proper to currently expense removal costs, and when are they capital? If using an industry % safe harbor for repairs, do I need to be concerned with retirement losses and partial dispositions? Under the final regulations, when is it advisable to elect GAA treatment for assets? We elected General Asset Accounts for all assets under the temporary regulations. Should some or all of the elections now be revoked? 36

38 Contact information Eric Lucas, Principal KPMG LLP (202)

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