Final repair regulations impact

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Final repair regulations:

What has changed and how will it impact
you?

Original Broadcast Date: October 2013

© Grant Thornton LLP. All rights reserved.

Presenters

David Auclair

Jim Wittmer

National Managing Principal
Washington National Tax
Office
Washington, D.C.

Northeast Region Leader
Strategic Federal Tax
Services
Philadelphia, Pa.

Joe Brown
Midwest Region Leader
Services
Chicago, Ill.
© 2013 Grant Thornton LLP. All rights reserved.

2

Final repair regulations: What has changed and how will it
impact you?

Learning objectives
• Identify opportunities and challenges in implementing the
new rules
• Determine action steps for applying the
final regulations, temporary regulations
or a combination thereof


3

What was issued?
• Final regulations under 162 and 263(a)

– Amounts paid to acquire, produce, or improve tangible
property
• Re-proposed regulations under 168
– General asset accounts and disposition of depreciable
property
• IRS and Treasury expect to finalize these regulations
in 2014


4

Practical implications

Rules affect any business that owns or leases
tangible property.

Therefore these rules affect all businesses


5

impact you?

Agenda
• Improvements to tangible property

• Dispositions
• De Minimis
• Materials and supplies
• Effective dates
• Next steps

6

Improvements to property

General rule

A taxpayer (TP) must generally capitalize an amount that
IMPROVES a unit of property ("UOP") if the amount:
(1) Is for a betterment;
(2) Restores the UOP; or
(3) Adapts the UOP to a new or different use.


7

Unit of property

• General rule: functional interdependence test
• Special rules: buildings, plant property, network assets, and
leased property
– Improvement standards must be applied separately to
building structure and building system
• Clarification of unit of property for leasehold improvements

– For work done on an addition previously made to a
leased building, consider the entire leased structure, not
merely the addition


8

Unit of property

Building systems include:
- HVAC systems
- Plumbing systems
- Electrical systems
- All escalators
- All elevators


- Fire protection and alarm systems
- Security systems
- Gas distribution systems
- Any other structural components
in published guidance

9

Betterments
• General rule: A TP must capitalize an amount paid for a "betterment"
• An amount is paid for a betterment if it:
– Ameliorates a material condition or defect that either existed prior to
the TP's acquisition of the property or arose during production of the
UOP (regardless of whether the TP was aware of the condition);

– Results in a material addition to or addition of a major component
to the UOP, or a material increase in the capacity of the UOP;
– Results in a material increase in productivity, strength, efficiency, or
quality of the UOP or the output of the UOP.


10

Betterments

New and revised examples
Retail store refresh/remodel
Ex. 6
(refresh):

No significant changes

Ex. 7
(limited improvement):

Significantly different facts, clear
improvement separate from refresh activities

Ex. 8
(major remodel):

Significantly different facts, clear
improvement impacting most of store

Future refresh/remodel guidance in retail Industry Issue Resolution project


11

Betterments

Material increase in capacity/efficiency

Ex. 17:

25% increase in depth of channel = material increase in
capacity

Ex. 20:

10% increase in energy efficiency of 2 out of 10 roof
mounted HVAC units = no material increase in efficiency

Ex. 21:

50% reduction in energy and power costs from new
insulation = material increase in efficiency


12

Betterments

Material addition

Ex. 22:

Drive through service area added = material addition
(physical expansion, extension, and addition of a major
component)


13

Restorations

An amount restores property if the amount:
1) Results in the rebuilding of the UOP to a like-new condition after
the end of its class life;
2) Is for the replacement of a part or a combination of parts that
comprise a major component or a structural part of the UOP;
3) Returns the UOP to its ordinarily efficient operating condition if
the property has deteriorated to a state of disrepair and is no
longer functional for its intended use;


14

Restorations

An amount restores property if the amount (continued):
4) Is for the replacement of a component of a UOP and the TP has
properly deducted a loss for that component (other than a
casualty loss);
5) Is for the replacement of a component of a UOP and the TP has
properly taken into account the adjusted basis of the component
in realizing gain or loss resulting from the sale or exchange of
the component; or
6) Is for the repair of damage to a UOP for which the TP has taken
a basis adjustment as a result of a casualty loss.


15

Restorations

• Clarification of distinction between major component and
substantial structural part
Major
component
Substantial
structural part

Part or combination of parts that
perform a discrete and critical
function in the operation of the UOP
Part or combination of parts that
comprises a large portion of the
physical structure of the UOP

• Incidental component, even though performs discrete
function, is not restoration

16

Restorations

Clarified definitions

New definition provided for major component and substantial
structural parts of building
• The replacement includes a part or combination of parts
that comprise a major component or a significant portion of
a major component of the building structure or building
system, or
• The replacement includes a part or combination of parts
that comprises a large portion of the physical structure of
the building structure or building system

17

Restorations

New favorable casualty loss rule

• New casualty loss rule:
– TP permitted to take a deduction, if otherwise
permissible, in excess of adjusted basis of the property
damaged in the casualty event
• Still no deduction for replacement property to extent of
adjusted basis in destroyed property due to the casualty
loss rules in 165 which require the loss to be claimed and
basis reduced, which triggers the restoration rules


18

Restorations

Restoration

Not a restoration

• 1 chiller in HVAC system

• 1 of 3 furnaces

• Entire sprinkler system

• 3 of 10 roof HVAC units

• All wiring in building

• 30% of electrical wiring

• All restroom fixtures

• 8 of 20 sinks

• 200 of 300 windows

• 100 of 300 windows (300
windows cover 25% of building
surface area)

• 100 of 300 windows (windows
cover 90% of building)

• 40% of sq ft of flooring

• 10% of sq ft of flooring
• 1 of 4 elevators


19

New or different use

An amount is paid to adapt a UOP to a new or different use if
the adaptation is not consistent with the TP's ordinary use of
the UOP at the time originally placed in service


20

New or different use

New or different use:

Not a new or different use:

• Manufacturing plant to
showroom space

• 3 leased retail spaces into 1
leased retail space

• Develop land used for
manufacturing plant as
residential housing

• Preparing a building for sale

• Retail drug store converts area
of pharmacy to walk-in medical
clinic


• Grocery store converts existing
store space into sushi bar
• Hospital modifies emergency
room to also provide outpatient
surgery clinic

21

Other costs incurred during improvement
263A retained; new rule for removal costs
• Section 263A standard to be applied:

– Costs that directly benefit or are incurred by reason of the
improvement should be capitalized
• New special rule for removal costs:
– If a TP disposes of a depreciable asset (including partial
disposition) and has taken into account adjusted basis, costs
of removing that asset are not required to be capitalized
• Related amounts:
– Amounts paid over a period of more than one taxable year


22

Routine maintenance safe harbor

Expanded to buildings
• Amount paid for routine maintenance deemed not to improve
property if a taxpayer reasonably expects to perform more than
once during:
– 10 year period from PIS date for building property, or
– The ADS class life for all property other than building property
• Applied to building structure and each building system, or UOP
for non-building property
• Routine activities include: inspecting, cleaning, testing and
replacement of damaged parts


23

New election

Safe harbor for buildings of small taxpayers
• Taxpayers with average annual gross receipts of $10 million or
less may elect not to apply the improvement rules to a building
with an unadjusted basis of $1 million or less if
– Total amount paid during the year for repairs, maintenance,
improvements and similar activities on building cannot exceed
the lesser of $10,000 or 2% of unadjusted basis of the
building and
• Elected annually for each building; and
• Amounts deducted under de minimis and routine maintenance
safe harbors are included.


24

New election

Election to capitalize repair and maintenance costs
• TP's may elect to capitalize amounts incurred during the
year as costs of improvements if TP capitalizes the
amounts on its books and records
• Election applies to all amounts treated as capital for books
each year
• Election made by attaching a statement to the return
each year


25

Highlights

Improvements to real property
Significant changes

New elections

• Addition of a major component and material
increase in capacity are betterments

• Election to capitalize repair
costs

• Replacement of significant portion of a major
component of a building is restoration
• Treatment of removal costs

• New and revised examples
• Routine maintenance safe harbor now applies
to buildings

Issues and opportunities
• Annual elections need to be considered each
year – not available retroactively
• New examples under restoration provide
increased replacement percentages over prior
• §263A applies- no plan of rehabilitation

26

What's the effect?
• Safe harbor elections made
each year = no 481(a)
adjustment
• Repair or capitalize
changes = 481(a)
adjustment

impact you?

Agenda

• Dispositions
• De Minimis
• Effective dates
• Next steps

27

Dispositions
• Re-proposed regulations

• Retirement of a structural component no longer mandatory
– Need for general asset account election eliminated
• Disposition includes sale, exchange, retirement, physical
abandonment or destruction of an asset
• Disposition also occurs when asset is transferred to a
supplies or scrap account or when a portion of an asset is
disposed of in sale, casualty event, like-kind exchange,
involuntary conversion or tax-free transfer


28

Dispositions

New election
• TP may elect to dispose of a portion of an asset. Includes:

– Structural components (or components thereof) of a
building
– Components or portions of 1245 assets
• Eliminates the need for TP to determine reasonable and
consistent method for 1245 assets
• Election is made in year of partial disposal by claiming gain,
loss or other deduction on the return


29

Dispositions

New election
• Partial disposition (other than required situations) is a not a
method of accounting.
• Election can only be made in the year of disposition, with
the exception of situations where a taxpayer deducts a
replacement cost as a repair and later has that item
adjusted by the IRS
– Method change can be filed after exam to go back and
claim partial disposition for the basis of asset that was
disposed of in the replacement


30

Dispositions

Determination of asset
• General rule = facts and circumstances
• Special rules:
– Each building is the asset
– Each condo/coop unit is the asset
– Each item in asset classes 00.11 to 00.4 or §168(e) is
the asset
– Each addition or improvement to an asset after placed in
service is a separate asset


31

Dispositions

Identification of asset disposed
• General rule = specific identification
• Special rule for mass assets or partial disposition (where
impracticable to determine the taxable year the asset was
placed in service)
– FIFO
– Modified FIFO
– Mortality dispersion table
– Any other method designated in subsequent guidance
– LIFO is not allowed


32

Dispositions

Basis of asset disposed of
• General rule = adjusted depreciable basis at disposal
• Special rule for mass assets or partial disposition = any
reasonable method
– Discounting the cost of replacement portion of the asset to its
placed-in-service year cost using the consumer price index
– Pro rata allocation of the unadjusted depreciable basis of the
asset based on replacement cost of disposed portion
– Study allocating the cost of the asset to individual
components


33

Dispositions

New example

• TP replaces 60% of roof in 2012- capitalizes replacement and
makes partial disposition election

• In 2022, TP replaces 55% of the roof of the building- capitalizes
replacement makes the partial disposition election for the
replaced portion
• TP cannot determine from its records whether the 55% is part of
the 60% replaced in 2012 or whether it is part of the original 40%
of the roof
• TP uses the FIFO method to identify the asset disposed of


34

Dispositions

New example - conclusion

How is the asset that is disposed of determined when TP
replaces 55% of the roof?
• Building is asset (including original roof) and 60% of roof
replacement in 2012 is a separate asset

• TP disposed of the remaining 40% of the original roof and
25% of the 60% of the roof replaced in 2012


35

Highlights

DISPOSITIONS
Significant changes

New elections

• Asset for disposal purposes is no longer building
structure and building components- building is the
asset (eliminates need for general asset account
election)

Partial disposition election

• Partial disposition election for buildings and
personal property
• Required partial disposition for casualty, tax-free
exchanges and sales

What's the effect?
Awaiting guidance on
availability of retroactive
partial disposition election

• For years starting after 1/1/14, partial disposition election can only be made in
the year disposition occurs- requirement for clients to track each year
• Regs. provide that reasonable methods can be used to determine basis of assets
disposed (i.e. replacement trending, study, allocation methods)

36

impact you?

Agenda

• Dispositions
• De Minimis
• Effective dates
• Next steps

37

De Minimis
• Ceiling limitation eliminated

– No need to track expenses
• Replaced with safe harbor election which is based on
policies used for financial books and records at an invoice
or item level

• Taxpayers without an applicable financial statement can
now deduct reduced de minimis amount
• For amounts above safe harbor, taxpayer needs to
demonstrate clear reflection of income


38

De Minimis

• Applicable financial statement

– A financial statement required to be filed with the
Securities and Exchange Commission;
– A certified audited financial statement that is
accompanied by the report of an independent certified
public accountant that is used for credit purposes,
reporting to shareholders, partners or similar persons, or
any other substantial non-tax purpose; or
– A financial statement (other than a tax return) required to
be provided to the federal or state government or any
federal or state agency

39

De Minimis

New election
TP with an applicable financial statement

• Written policy in place at beginning of year
• Policy to expense property costing less than a certain dollar
amount or property with an economic useful life of 12
months or less
• Deducts such amounts in applicable financial statements
• Amount paid does not exceed $5,000 per invoice (or per
item as substantiated by invoice)


40

De Minimis

New election
TP without an applicable financial statement

• Written policy in place at beginning of year
• Policy to expense property costing less than a certain dollar
amount or property with an economic useful life of 12
months or less
• Deducts such amounts in applicable financial statements
• Amount paid does not exceed $500 per invoice (or per item
as substantiated by invoice)


41

De Minimis

New election
• Safe harbor is elective each year

– Must include statement in the return
• Election applies to all eligible materials and supplies
• Labor, overhead, transaction and other costs of acquisition
can be included in de minimis safe harbor provided the
invoice includes such costs
• Section 263A does still apply to amounts deductible under
de minimis if expected to be used in production of other
property


42

De Minimis

New election- applicable financial statements
With AFS

Without AFS

• Written policy to deduct $10,000
or less

• Written policy to deduct $1,000
or less

• Purchase 1,000 computers for
$5,000 each-substantiated by
invoice

• Purchase 10 computers at $600
each

• Deduct each computer as de
minimis

• Cannot use safe harbor
because each item is above
$500

• Would not be able to use safe
harbor if computers over $5,000

• Would be able to deduct if
computers were $500 each


43

De Minimis

Example- additional invoice costs
• TP w/AFS has written policy to deduct amounts under
$5,000
• Purchases wireless routers for office
• Invoice includes price per router of $2,500 and $20,000
total for delivery and installation

• $20,000 allocated on a pro-rata basis to each of the 10
routers
• Total cost for each router is $4,500 and can be deducted
under the de minimis rule


44

Highlights

DE MINIMIS
Significant changes

New elections

• No ceiling limit or tracking requirement
• Safe harbor based on invoice/item price:
– TP w/AFS = $5,000
– TP w/o AFS = $500
• Includes transaction costs and other costs of
acquisition (i.e. labor and OH)
• If elected, applies to all materials and supplies

De Minimis safe harbor

What's the effect?
Only applies to amounts
incurred in the year
adopted: no retroactive
adjustment

• Election must be made each year- statement attached to return
• Taxpayers without audited financial statements can now take advantage of a
de minimis deduction
• Written accounting policy must be in place on first day of taxable year to
which election applies
• Amounts not subject to de minimis must meet clear reflection or capitalize

45

impact you?

Agenda

• Dispositions
• De Minimis
• Effective dates
• Next steps

46

Materials and supplies

• Materials and supplies include:

• Components acquired to maintain, repair, or improve a unit
of tangible property owned, leased, or serviced by the
taxpayer that is not acquired as part of any single unit of
property
• Fuel, lubricants, water and similar items expected to be
consumed in 12 months or less
• Property with economic useful life of 12 months or less

• Property with acquisition cost of $200 or less


47


• Rules largely the same as temporary regulations

• Some changes
– Definition now includes property that has an acquisition
or production cost of $200 or less (increased from $100)

– Definition of standby emergency spare parts included
– Election to capitalize certain materials and supplies now
only applicable to rotable, temporary or standby
emergency spare parts


48


• Non-incidental supplies
– Deductible in the year in which the materials are first
used or consumed in the taxpayer's operations
• Incidental supplies
– Deductible in the year in which amounts are paid
Incidental supplies are those for which no record of
consumption is kept or physical inventories at beginning
and end of year are not taken


49

Highlights

MATERIALS AND SUPPLIES
Significant changes

New elections

• Definition now includes
property with acquisition or
production cost of $200 or
less (increased from $100)

Election to capitalize now only applies to
rotable, temporary or emergency spare parts

• Definition of emergency
spare parts

What's the effect?
Final regulations only apply to amounts incurred
on or after 1/1/14, unless early adopt.
No retroactive adjustment

• Clear definition of materials and supplies
• Can elect to deduct under de minimis, applies to all eligible materials and
supplies

50

impact you?

Agenda

• Dispositions
• De Minimis
• Effective dates
• Next steps

51

Effective dates

• Final and re-proposed regulations effective for years
beginning on or after January 1, 2014
• TP may choose to apply the final, reproposed, temporary or
any combination thereof for 2012 and 2013
• Transitional relief for elections
in 2012 and 2013


52

Transitional rules

• Revenue procedures expected to be issued in November

• Expected to provide for late partial disposition election for
2012, 2013, and 2014 tax years
• Will provide guidance on changes made under the
temporary regulations


53

impact you?

Agenda

• Dispositions
• De Minimis
• Effective dates
• Next steps

54

Next Steps

• Compare current policies
– Acquisition policy (de minimis)
– Capitalization policy (repairs)
• Consider modification to current procurement process
– Capital expenditures request (CER)
– Capital appropriations request (CAR)
• Consider current method change opportunities
• Consider annual elections going forward


55

Next Steps

• Consider state and local tax impact
– Possible sales and property tax differences
• Consider financial statement impact


56

Method change opportunities

• Deduct repair and maintenance costs
– Use the routine maintenance safe harbor to deduct
routine costs
• Possible late partial disposition election to recoup costs
from pre-2012 dispositions
• Depreciation methods and lives
• Possible tax reform impact


57

New annual elections

• Partial disposition
• De Minimis safe harbor (statement required)
• Capitalize repair and maintenance costs (statement
required)
• Safe harbor for small taxpayers (statement required)
• Capitalize and depreciate any rotable, temporary or
emergency spare part


58

Comments?

Questions?


59

Contact

Information

David Auclair

Jim Wittmer

National Managing Principal
Washington National Tax
Office
David.Auclair@us.gt.com

Northeast Region Leader
Services
Jim.Wittmer@us.gt.com

Joe Brown
Midwest Region Leader
Services
Joseph.Brown@us.gt.com

60

Disclaimer
**********************
IRS Circular 230 disclosure: To ensure compliance with requirements
imposed by the U.S. Internal Revenue Service, we inform you that any
U.S. federal tax advice contained in this PowerPoint is not intended or
written to be used, and cannot be used, for the purpose of (a) avoiding
penalties under the U.S. Internal Revenue Code or (b) promoting,
marketing or recommending to another party any transaction or matter
addressed herein.
**********************
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intended as advice directed at any particular party or to a client-specific fact pattern. The information contained in this presentation
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You may contact us or an independent tax advisor to discuss the potential application of these issues to your particular situation. In
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61

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