Chandry Jimenez, Director of LIFO Services

However, recent developments should provide LIFO taxpayers relief and cause less worry about the impact IFRS conversion may have on their business. In a recent memo addressed to The LIFO Coalition, Les Schneider, Tax Counsel to The LIFO Coalition, explains that it is increasingly unlikely that the SEC will fully adopt IFRS or disallow the LIFO method. It is very possible, under the form of convergence currently being contemplated by the SEC, that LIFO will remain an acceptable method in spite of the fact that it is not recognized by IFRS.

LIFO repeal has also been a threat on the legislative front, appearing in President Obama’s budget multiple years. While there is currently no pending legislation calling for the repeal of LIFO for tax purposes, an argument always used by legislators when discussing LIFO repeal is the impending IFRS convergence. With it being increasingly unlikely that a full IFRS adoption and disallowance of LIFO for financial statement purposes will take place, legislator’s LIFO repeal argument has certainly become less valid. Any future legislative efforts arguing the use of LIFO for tax purposes will certainly become more difficult.

LIFO is an established tax method that has been a part of U.S. tax law for over 80 years and is used by hundreds of thousands of companies that carry inventory across all types of industries.

Please contact me for additional information at chandry.jimenez@sourcecorptax.com.

Drector of Cost Segregation and EPAct 179D

A number of our clients have expressed concern about a recent tax court case where the court disallowed reclassification of assets identified by a cost segregation study. After careful review, we concluded that the decision is a narrow one and will likely not apply beyond the facts in this case. We believe that the decision will not readily apply to all purchase price allocations.

In Peco Foods, Inc. & Subsidiaries, Petitioner v. Commissioner of Internal Revenue, Respondent ( T.C. Memo 2012-18) the tax court upheld the decision of the Internal Revenue Service precluding Peco Foods from modifying purchase price allocations of two processing plants it purchased in 1995 and 1998. The court upheld the terms of the respective asset purchase agreements, which the buyer and seller had agreed to at the time of the purchases.

The purchase agreements contained provisions in both allocation schedules stating that “the parties would use these values for all purposes including tax and financial reporting,” making the contracts binding unless Peco could prove they were unenforceable. The court determined that Peco’s decision to allocate the purchase price among machinery, equipment, and furniture showed that it was aware of the specific component assets but chose not to allocate additional purchase price to those assets. Therefore the court determined that Peco intended the asset described as “Processing Plant Building” to be treated as a single asset.

The court also found that Peco believed the term “Processing Plant Building” was ambiguous only after it perceived a benefit could be realized by subdividing the building into component assets. Therefore, the court ruled that there was no ambiguity in the term.

Peco agreed to allocate the purchase price of the plant among three assets: Real Property: Land, Real Property: Improvements,” and “Machinery, Equipment, Furnitures and Fixtures.”

The court determined that the decision to allocate the purchase price separately among these various assets showed that Peco was aware of the existence of subcomponent assets but chose not to allocate additional purchase price to them. The court also determined that had Peco intended to allocate purchase price to subcomponent assets, it would have done so by allocating additional purchase price to the asset described as “Machinery, Equipment, Furnitures and Fixtures.”

In addition, the appraisal for the second plant was dated prior to the date on which Peco entered into the agreement, suggesting that Peco could have adopted a more detailed allocation schedule into the agreement but chose not to.

The second agreement contained a merger clause providing that the contract, accompanying exhibits, and closing documents “constitute the entire agreement between the Parties.” The court determined that this clause creates a presumption that the writing represents a “final and complete agreement of the parties.”

The court never reached the issue of cost segregation when it ruled that the agreements were not ambiguous and that whether the acquired assets may be subdivided into component assets was immaterial because Peco may not deviate from its characterization of those assets as stated in the original allocation schedules.

Because Peco Foods attached a statement to Form 8594 allocating specific amounts of the Purchase Price to Processing Plant Buildings and Real Property Improvements, they cast the allocations in stone. The tax court found that the agreements were enforceable, the terms were unambiguous, and all relevant assets were covered. Peco claimed that it could reallocate the useful lives of assets under Code Sec. 338(b)(5), the “residual method,” which applies when the parties do not agree in writing as to the allocation of any part of the consideration. However, since all assets were covered by the agreements, and the agreements were enforceable, the residual method did not apply.

Because the original documents went into the level of detail of identification they are bound to stay within those allocations. In our experience, agreements containing such specificity are rare. Therefore, we don’t expect any significant impact from this ruling nor do we anticipate an appeal.

Chris Henderson, VP Operations

The IRS’ willingness to allow the dealer to move to Safe Harbor methods is in keeping with what IRS Motor Vehicle Specialist Terri Harris relayed late last year when the Safe Harbor guidance came out. Terri’s comments indicated that the IRS would be lenient on dealers for the 2010 and 2011 tax years, giving them time to transition to the Safe Harbors method. After that, dealers may face less forgiving IRS agents.

SourceCorp works with many auto dealers and their CPAs and has developed a seamless solution for the adoption of both safe harbors. We continue to monitor this issue closely and will post additional updates to our blog as they arise. For further information, contact me directly at chris.henderson@sourcecorptax.com.

Chris Henderson, VP Operations

However, this week, IRS author of 179D guidance, Jennifer Bernardini provided clarification with regard to Form 3115. While admitting that ambiguity exists in Rev Proc 2011-14, she stated the Office of Chief Counsel, the IRS division that reviews accounting methods, was unlikely to grant any accounting method change submitted by architects that have not previously claimed the 179D deduction. She also indicated the IRS is working on guidance that would clarify the ambiguity found in Rev Proc 2011-14 but gave no timetable.

While Ms. Bernardini’s comments represent her own opinion and not those of the IRS, her comments can be interpreted as the prevailing thought at the Service. As such, SourceCorp recommends filing amended returns to claim 179D deductions associated with projects completed in prior tax years. To ensure that all 2008 projects are reviewed while still under statute, firms should gather complete blueprints and specifications as well as applicable allocation letters as quickly as possible.

SourceCorp is keeping close tabs on this issue and will communicate further updates.

Chandry Jimenez, Director of LIFO Services

A manufacturer of safety and personal protective equipment had been experiencing steady increases in material costs. The company had utilized the LIFO inventory method in the 1990s, but elected off of LIFO due to the complexities associated with the method. They decided to consider LIFO again as a means to free up cash to reinvest in the business for the 2010 tax year. A no cost analysis by SourceCorp Professional Services showed the company was experiencing 4% inflation, which yielded a first year LIFO Reserve of over $4.1 million – a tax deferral of over $550,000 in year one, which the company used to expand their business. They were also able to eliminate the concerns and complexities presented with their prior LIFO method by utilizing SourceCorp’s services.

Distributor

An aluminum distributor with roughly $20 million in inventory had been on LIFO for 15 years. While their current method had produced a sizeable LIFO Reserve over the years, the company was open to considering other LIFO methods. By changing to the IPIC LIFO method, the company was able to increase their LIFO Reserve by $2.5 million above their prior method for the 2010 tax year. The audit protection received as a result of the method change proved to be an additional benefit of electing IPIC.

Bob McPherson, Director of Cost Segregation and 179D

Background. Bonus first-year depreciation deductions are available for a property if: (1) it is property to which the modified accelerated cost recovery system (MACRS) rules apply with a recovery period of 20 years or less, computer software other than computer software covered by Code Sec. 197, qualified leasehold improvement property, or certain water utility property); (2) its original use commences with the taxpayer; and (3) it is timely bought and placed in service by the taxpayer.

The bonus first-year depreciation allowance is:

• 50% of the cost of qualified property acquired and placed in service after Dec. 31, 2007, and before Sept. 9, 2010;
• 100% of the cost of qualified property acquired and placed in service after Sept. 8, 2010 and before Jan. 1, 2012 (before Jan. 1, 2013 for certain longer-lived and transportation property); and
• 50% of the cost of qualified property acquired and placed in service after Dec. 31, 2011 and before Jan. 1, 2013 (after Dec. 31, 2012 and before Jan. 1, 2014 for certain longer-lived and transportation property). (Code Sec. 168(k)(2), Code Sec. 168(k)(5))

Note that 50% bonus depreciation also applied for certain qualified property acquired after May 5, 2003 and before Jan. 1, 2005, and 30% bonus depreciation applied for certain qualified property acquired after Sept. 10, 2001, and before May 6, 2003.

MACRS property may be acquired (1) in exchange for MACRS property in a Code Sec. 1031 like-kind property exchange, or (2) to replace involuntarily converted MACRS property in a Code Sec. 1033 involuntary conversion. (Reg. § 1.168(i)-6(c)(1)) The replacement property is for depreciation purposes divided into the depreciable exchanged basis (i.e., remaining basis of the relinquished property carried over to the replacement property), and the depreciable excess basis (i.e., additional consideration to acquire the replacement property). Where the properties share the same recovery class and depreciation method, the depreciable exchanged basis is written off over what’s left of the relinquished property’s recovery period; and the depreciable excess basis is in effect treated as a separate property with a recovery period that begins anew. (Reg. § 1.168(i)-6(c)(3)(ii))

Double helping on bonus depreciation. When otherwise eligible MACRS property or computer software is acquired via a Code Sec. 1031 like-kind exchange or as a result of a Code Sec. 1033 involuntary conversion, both the carryover basis and the excess basis, if any, of the acquired property are eligible for bonus depreciation. (Reg. § 1.168(k)-1(f)(5)(iii)(A)) What’s more, it doesn’t matter if bonus depreciation was claimed on the old property. (Reg. § 1.168(k)-1(f)(5)(vi), Ex. 3)

RIA illustration: In January of 2010, ABX Corp. bought a new refrigerator truck (5-year MACRS property) for $100,000 and placed it in service that year. In 2011, ABX acquires another new, higher-capacity refrigerator truck in exchange for the truck bought in 2010 by trading in that truck and paying $50,000 cash. ABX uses the optional rate tables to compute depreciation and is subject to the half-year convention in 2010 and 2011.

For 2010, ABX claimed 50% bonus first-year depreciation for the truck bought and placed in service that year. As a result, its 2010 depreciation deduction for the truck was $50,000 of bonus depreciation (.50 × $100,000) plus $10,000 of regular first-year depreciation allowance (.20 recovery year one table percentage for 5-year property × [$100,000 − $50,000 bonus depreciation]), for a total of $60,000.

For 2011, ABX claims an $8,000 depreciation deduction (.32 recovery year two table percentage for 5-year property × [$100,000 − $50,000 bonus depreciation] × 6/12 [half-year convention applies]) for the relinquished truck.

ABX may claim a 100% bonus first-year depreciation deduction for the $32,000 remaining depreciable basis of the relinquished truck, i.e., the depreciable exchanged basis ($100,000 cost − $60,000 − $8,000). ABX also may claim a 100% bonus first-year depreciation deduction for the $50,000 in cash that it pays to acquire the upgraded refrigerator truck.

RIA observation: In essence, for bonus depreciation purposes, the regs treat a taxpayer like ABX as if it had sold the old truck for its remaining depreciable basis and then used the proceeds, along with additional cash, to purchase a new one.

RIA caution: This won’t work if the older-model truck was acquired in January of this year and the newer model in December. Under Reg. § 1.168(k)-1(f)(5)(iii)(B), bonus depreciation isn’t allowable for the exchanged (or involuntarily converted) MACRS property if the exchanged (or involuntarily converted property) is placed in service and disposed of in a like-kind exchange or involuntary conversion in the same tax year.

Chandry Jimenez, Director of LIFO Services

• In the last year, Petroleum, lubricating oils, and greases, along with kerosene, jet fuels, and gasoline have experienced significant amounts of inflation.

• Copper, nickel ores and nonferrous metal ores are experiencing 31%-41% inflation so far in 2011.

Other industries experiencing inflation are:
• Recyclable Materials – Inflation was very high in 2010, and is still at 20% – 30% in 2011
• Animal and Pet Food manufacturing – Dog and cat food, along with other animal feeds are on the rise and currently at about 12% inflation.
• Yarn, thread, and fabrics – These have been consistently rising since early 2010, and inflation in 2011 is currently showing as much as 13% inflation.
• Grocery Items — Grocery items have been consistently on the rise for the last year and are currently experiencing 15% plus inflation.
• Paint and painting supplies and Wallpaper – Inflation has been on the rise and is about 7%.
• Cigarettes – Inflation averaged 6% in 2010, and is showing 8% in 2011.

While the word inflation generally has a bad connotation, in today’s economy inflation is a positive sign of growth. I’ll be making additional posts in the coming weeks outlining specific case studies of how inflation benefits many companies.

DesignColumbus2011 is an opportunity to learn about and engage in the transformation of the Central Ohio built environment to be more healthy, prosperous, and sustainable. With 16 educational seminars and a two-floor trade show, the event will highlight current and future development of technologies for all leaders in Central Ohio responsible for creating building and communities that promote economic growth and sustain the health and vitality of all life. SourceCorp’s Bob McPherson and Jeanne Briggs will lead an educational seminar on the EPAct 179D tax deduction.

This full day of continuing education and informational displays is organized to attract hundreds of professionals involved in the building industry. Attendees and participants are representatives of the entire project team, including architects, designers, engineers, owners, developers, government officials, municipal planners, facility managers, contractors, construction managers, construction specifiers, manufacturers, product representatives, and others.

For all attendees, the continuing education component includes opportunities for AIA and GBCI/ USGBC continuing education units (CEUs). These CEU opportunities are of tremendous value to AIA and LEED Accredited Professionals interested in maintaining their credentials in an ever more competitive marketplace.

WHERE: COSI, Center of Science and Industry 333 West Broad Street Columbus, OH 43215
WHEN: Monday, April 18, 2011 from 10:30 AM – 6:00 PM (ET)
INDUSTRY: Building Design and Construction

REGISTRATION:
Attendees: http://designcolumbus2011.eventbrite.com
Sponsors: http://designcolumbus2011sponsorship.eventbrite.com

Chris Henderson, VP Operations

However, in January 2011, the IRS issued Revenue Procedure 2011-14 that provided an alternative accounting method. Rather than amending tax returns, architectural firms that have not previously taken the deduction may go back as far as 2006 and claim the deduction on their current year’s return using a Form 3115. A certification report and allocation letter must be filed with the Form 3115.

In most cases, claiming the §179D deduction on a Form 3115 is the preferred method. However, if a firm has already claimed the deduction on amended returns, their accounting method is established and should remain the same. For more information on the EPAct §179D tax deduction, please contact me at chris.henderson@sourcecorptax.com.

Bob McPherson, Director of Cost Segregation and 179D

For businesses with projects that qualify for tax incentives such as cost segregation, the benefits for 2011 will be substantial. A taxpayer must meet specific requirements to utilize this tax deduction. Qualifying property generally includes: depreciable property with a recovery period of 20 years or less; water utility property; computer software; and qualified leasehold improvements. A cost segregation analysis is a method of identifying the maximum amount of qualifying property (property with a recovery period of 20 years or less) and separating those costs from the real property assets associated with a new building or expansion project.

Also, included in the tax relief act is a two-year extension of the 50 percent, first-year additional bonus depreciation allowance which applies to qualifying property acquired by a taxpayer from January 1, 2008 through December 31, 2012, and placed in service before January 1, 2013. The bonus depreciation rate increases from 50 percent to 100 percent in the case of qualifying property acquired after September 8, 2010, but before January 1, 2012, and placed in service before January 1, 2012.

To learn more about a no-cost estimate for a cost segregation analysis, please contact me at Bob.McPherson@sourcecorptax.com.