2. summary of the new depreciation rules
- 1. Tax Insights: IRS releases long-awaited ‘repair’ regulations On Dec. 23, 2011, new regulations proposed regulations. The revenue Betterments were issued addressing when costs are procedures contain transition rules and The regulations provide specific rules for required to be capitalized to tangible procedures for changing to the methods determining whether expenditures result property or may be deducted as repair and described in the regulations. in a betterment of a unit of property and maintenance costs. The new regulations therefore would result in capitalization of replace proposed regulations issued in Units of property costs. Of note, the regulations specifically March 2008. The regulations provide detailed rules for provide that an amount results in a On March 7, 2012, the IRS issued two determining the proper unit of property. betterment to a building if it results in revenue procedures (Rev. Procs. 2012-19 Although these rules generally provide that a betterment to a structural component and 2012-20) that provide taxpayers with a building and its structural components or a building system. The regulations rules for filing method changes under the are a single unit of property, the tests to contain a number of examples to illustrate new “repair” regulations. determine if property has been improved the application of the betterment rules. This document provides a summary of must be applied to the building structure Included in the examples are three fact some of the highlights of the regulations (which is defined as the building and situations involving costs incurred by retail and revenue procedures. its structural components other than stores that the regulations label as: specifically identified building systems) and (1) building refresh, What was issued each of the following building systems: (2) building refresh with limited Treasury and the IRS issued temporary (1) Heating, ventilation and air improvement, and regulations (regulations) that provide conditioning (HVAC) systems (3) substantial remodel. guidance on amounts paid to improve (2) Plumbing systems tangible property (commonly referred to (3) Electrical systems as the repair regulations). The regulations (4) Escalators also provide guidance on amounts paid to (5) Elevators acquire or produce tangible property, as (6) Fire-protection and alarm systems well as guidance regarding the disposition (7) Security systems of property. The regulations are generally (8) Gas distribution systems effective for taxable years beginning on or after Jan. 1, 2012. The text of the The regulations also provide expanded regulations was simultaneously issued as rules for determining the unit of property proposed regulations and the previous in situations where property is leased proposed regulations were withdrawn. and provide special rules for determining The regulations include rules that are improvement costs in lease situations. significantly different from current regulations and the previously issued
- 2. IRS releases long-awaited ‘repair’ regulations The examples conclude that: The regulations instead provide a facts- Plan of rehabilitation (1) none of the building costs are required and-circumstances test for determining The regulations do not provide for a plan to be capitalized in the building refresh whether a major component or substantial of rehabilitation doctrine as described example; structural part is replaced. The regulations in case law. Instead, the regulations (2) some of the building costs are required also provide that a major component or incorporate the Section 263A standard for to be capitalized in the building refresh substantial structural part includes: the treatment of repair and maintenance with limited improvement example; (1) a “large portion” of the physical costs performed during an improvement and structure of the unit of property, or and require capitalization of all indirect (3) all of the building costs are required (2) a part or combination of parts costs that directly benefit or are incurred to be capitalized in the substantial that perform a discrete and critical by reason of an improvement. The remodel example. function in the operation of the unit preamble to the regulations provides These three examples illustrate the general of property that is more than a “minor that the plan of rehabilitation doctrine rule in the regulations that a determination component.” is obsolete to the extent that the court- of whether costs result in a betterment created doctrine provided different depends on the facts and circumstances The regulations also contain the standards for determining whether an related to the costs. requirement that costs expended for the otherwise deductible indirect cost must be replacement of a component of a unit capitalized as part of an improvement. Restorations of property must be capitalized if the The regulations also address whether taxpayer has properly deducted a loss for Routine maintenance safe harbor an amount is paid to restore a unit of that component. The regulations introduce a routine property and therefore would result The regulations contain examples to maintenance safe harbor rule. If, at the time in capitalization of costs. These rules illustrate the restoration rules. Included are the unit of property is placed in service, it is specifically provide that an amount is examples of costs related to the structural reasonably expected that the maintenance paid to restore a building if it restores components of a roof, a roof membrane, activities will be performed more than once a structural component or a building an HVAC system, a fire protection during the class life of the unit of property, system. Unlike the rules in prior proposed system, an electrical system, a plumbing the maintenance is deemed to not improve regulations, the regulations fail to provide system, windows and floors. The examples the unit of property. The regulations, a bright-line test for determining whether illustrate that the determination of whether however, specifically provide that the safe the costs result in a replacement of a major costs are required to be capitalized harbor does not apply to work performed component or a substantial structural part depends on the nature and extent of the on buildings. of a unit of property. The prior proposed costs relative to the property. regulations defined replacement of a major component or substantial structural part to mean either: (1) costs that comprise 50 percent or more of the replacement costs of the unit of property, or (2) replacement of 50 percent or more of the physical structure of the unit of property. 2
- 3. Tax Insights: IRS releases long-awaited ‘repair’ regulations Dispositions General asset account election New automatic changes The regulations also provide new rules for The regulations also expand the rules The new revenue procedures modify the determining gain or loss on the disposition related to general asset accounts (GAA), comprehensive list of automatic method of depreciable property. Of significance is which allow taxpayers to group one or changes in Rev. Proc. 2011-14 by deleting that the regulations expand the definition many assets in a GAA for depreciation several method changes and adding 19 new of disposition of property to include the purposes. Under the general rule, no gain automatic method changes, including the retirement of a structural component of a or loss is recognized upon the disposition following: building. This requirement will cause any of an asset from a GAA. Special elections • Deducting de minimis amounts amount expended to replace a structural allow taxpayers to recover the basis of • Changing to the safe harbor for routine component of a building to be capitalized, disposals from the GAA at their discretion. maintenance on property other than even if the component is minor, because buildings of the restoration rules requiring Amount paid to acquire or • Capitalizing improvements to tangible capitalization if a loss on a component is produce property property properly deducted. To avoid burdensome The regulations also contain rules for • Disposing of a building or structural results under this rule, taxpayers will need amounts paid to acquire or produce component to understand and apply new rules relating property. These include rules related to • Disposing of tangible depreciable to general asset accounts as discussed in material and supplies and rotable spare assets (other than a building or its the following. The regulations do not parts. In addition, the regulations contain structural components) require componentization of property a de minimis rule that allows a taxpayer • Electing general asset account other than buildings, but will allow such in certain situations to deduct amounts treatment componentization if the taxpayer is under a certain dollar amount if that is consistent in identification of the asset. consistent with a written policy used for The new method changes are generally financial accounting purposes, provided made using a Section 481(a) adjustment. that amounts under this rule do not exceed However, the adjustment for method certain annual thresholds. The annual changes relating to the acquisition of threshold amount is the greater of: tangible property is made using a modified (1) 0.1 percent of the taxpayer’s gross cut-off approach, which means that only receipts for the taxable year as amounts paid or incurred after Jan. 1, determined for Federal income tax 2012, are included in the Section 481(a) purposes, or adjustment. In addition, certain of the (2) 2.0 percent of the taxpayer’s total disposal and depreciation changes are depreciation and amortization expense made using a modified cut-off approach. for the taxable year as determined in its The new revenue procedures specifically applicable financial statements. allow statistical sampling for certain method changes. The new revenue procedures do not, however, allow taxpayers to extrapolate data to an earlier taxpayer year. For all of the new method changes, certain scope limitations under the general automatic method change procedures are waived for the taxpayer’s first and second taxable year beginning after Dec. 31, 2011. 3
- 4. Tax Insights: IRS releases long-awaited ‘repair’ regulations General asset account late Next steps election relief Taxpayers will want to determine how Most taxpayers have not previously made the new rules provided in the regulations a general asset election under Section 168(i) may affect their current methods of (4) for their assets, including buildings and capitalizing or deducting costs to acquire structural components. or improve tangible property. Taxpayers will also want to determine the timing Under these new rules, however, it is for making automatic method changes anticipated that all taxpayers who own to comply with the new rules under the For more information, contact: or lease buildings will want to make such revenue procedures. It is expected that Scott Hamilton an election for previous and future years. most taxpayers will need to file method Strategic Federal Tax Group The revenue procedures allow taxpayers changes to make the late general asset Director, Southern California T 213.596.8426 to make a retroactive general asset election account election and to change their E scott.hamilton@us.gt.com for years prior to Jan. 1, 2012, by filing an methods of accounting for disposition of automatic method change, but only for the property and capitalization of amounts Rich Shevak Strategic Federal Tax Group taxpayer’s first two taxable years beginning paid to improve property. Although Senior Manager, Seattle after Dec. 31, 2011. It is important for method changes cannot be filed for years T 206.398.2489 taxpayers to be aware of this limited time beginning prior to Jan. 1, 2012, taxpayers E rich.shevak@us.gt.com frame for making the retroactive election will want to understand as soon as possible www.GrantThornton.com/tax through the automatic method change. how adjustments relating to method After this time, retroactive elections will changes will affect financial accounting About Grant Thornton LLP not be allowed as method changes. and estimated payment purposes. The people in the independent firms of Grant Thornton International Ltd provide personalized attention and the highest quality service to public and private clients Please contact Grant Thornton LLP for in more than 100 countries. Grant Thornton LLP is questions or to discuss how the regulations the U.S. member firm of Grant Thornton International Ltd, one of the six global audit, tax and advisory may affect a specific situation. organizations. Grant Thornton International Ltd and its member firms are not a worldwide partnership, as each member firm is a separate and distinct legal entity. The information contained herein is general in nature and based Tax professional standards statement on authorities that are subject to change. It is not intended and This document supports the marketing of professional services by Grant Thornton should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. LLP. It is not written tax advice directed at the particular facts and circumstances of This material may not be applicable to or suitable for specific any person. Persons interested in the subject of this document should contact circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other Grant Thornton or their tax advisor to discuss the potential application of this subject tax professionals prior to taking any action based upon this matter to their particular facts and circumstances. Nothing herein shall be construed as information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could imposing a limitation on any person from disclosing the tax treatment or tax structure of affect information contained herein. No part of this document any matter addressed. To the extent this document may be considered written tax advice, may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including in accordance with applicable professional regulations, unless expressly stated otherwise, by photocopying, facsimile transmission, recording, re-keying or any written advice contained in, forwarded with, or attached to this document is not using any information storage and retrieval system without written permission from Grant Thornton LLP. intended or written by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed under the © Grant Thornton LLP All rights reserved Internal Revenue Code. U.S. member firm of Grant Thornton International Ltd 4