Charles Duncan, Director, Cost Segregation & EPAct §179D

Charles Duncan, Director, Cost Segregation & EPAct §179D

As the first tax season under the final tangible property regulations progresses, many tax practitioners have turned their attention to the treatment of environmental remediation costs under the new regulations. Examples specifically addressing environmental remediation costs have been present in the repair regulations since they were first proposed in 2006 and are drawn from three cases and one revenue ruling issued in the 1990s and early 2000s. The final regulations present significant opportunities for tax savings or risk mitigation.

Background:

  • 1994: The Internal Revenue Service (IRS) issued Revenue Ruling 94-38. Here the IRS ruled that a taxpayer who remediates soil and groundwater contamination arising from its manufacturing process did not have to capitalize the remediation costs under §263(a), but rather the costs should be deducted under §162.
  • 1997: In Norwest Corp. v. Commissioner, 108 T.C. 265, the Tax Court held that the cost of removing asbestos was part of a general plan of rehabilitation and renovation of the underlying building and must be capitalized under §263(a). Norwest had constructed the facility in 1969. The initial construction included asbestos-containing materials. The Tax Court found that Norwest decided to remove the asbestos because the removal was essential to remodeling the building to accommodate additional personnel. As part of the remodeling process, the asbestos removal costs were capitalized under the general plan of rehabilitation doctrine.
  • 2000: In Dominion Resources Inc. v. United States, the Fourth Circuit held that a taxpayer must capitalize under §263(a) the costs of environmental remediation that adapt the property to a new and different use. Dominion Resources had operated a facility as a power plant, during which time the site was contaminated. The power plant was decommissioned and put on the market as part of Dominion’s real estate development business. After putting the property on the market, Dominion decided to clean up sludge, asbestos, and other contaminants at the site, ostensibly to limit risk to trespassers and downstream residents if the property flooded. The Court found instead that the clean-up costs allowed Dominion to put the property to new and different uses.
  • 2001: In United Dairy Farmers, Inc. v. United States, the Sixth Circuit held that the costs to remediate soil contamination from leaking underground tanks must be capitalized under §263(a). United Dairy Farmers operated retail gas stations and had unknowingly purchased two locations that had leaking underground gasoline tanks. Since United Dairy Farmers had not contaminated the property through its own business operations, the court held that ameliorating the contamination must be capitalized.
  • 2006: Treasury proposed the “Repair Regulations”. There are two examples under these regulations from United Dairy Farmers and In the first example, a taxpayer purchased land already contaminated by leaking underground tanks. Just as in United Dairy Farmers, the taxpayer had to capitalize the soil remediation costs that ameliorated a pre-existing condition. In the second example, a taxpayer undertook a remodeling project to expand its operations at a facility that it had constructed decades earlier with asbestos-containing materials. Unlike in Norwest, the asbestos-containing materials had not already contaminated the facility, but federal regulations required its removal prior to beginning any remodeling work that could disturb it. The example described the asbestos removal costs as not ameliorating a pre-existing condition. Instead, the costs were capitalized under §263(a) as costs that directly benefit or were incurred by reason of an improvement, the remodeling project.
  • 2008: Treasury issued substantially revised repair regulations. The underground storage tanks example had no substantive change. The asbestos remediation example was revised to state that the asbestos had begun to deteriorate. The example was also revised so that the asbestos removal was no longer required due to a remodeling project. With these differences, the asbestos removal costs were not capitalizable as the amelioration of a pre-existing defect. A new example drawn from Dominion Resources was added. This example required the capitalization of environmental remediation costs where a taxpayer cleans up its former manufacturing facility to sell it to a residential developer. As in Dominion Resources, these costs were characterized as costs that adapt the property to a new or different use.
  • 2011: Treasury issued the temporary Tangible Property regulations addressing not just the repair regulations but a wide variety of tangible property capitalization issues. The examples drawn from the three cases did not change substantively.
  • 2013: Treasury issued in final form some of the Tangible Property regulations, including all of the repair regulations. The underground tanks and asbestos removal examples did not change substantively. The Dominion Resources example was revised so that the taxpayer itself will develop the residential properties.

As the history makes clear, slight factual differences can drastically alter the tax treatment of remediation costs.  Ameliorating pre-existing contamination or remediation that adapts the property to a new or different use must be capitalized under §263(a). The presence of a possible contaminant, like underground storage tanks that have not leaked or asbestos in good condition does not create a pre-existing defect. If these possible contaminants require remediation arising from a taxpayer’s use of the property, the costs will often be deductible. Even if the costs are not currently deductible under the final Tangible Property Regulations, taxpayers should be advised to consider alternative routes to deductibility for prior year costs. For example, §198, which sunset after December 31, 2011, allowed a current deduction for qualified environmental remediation expenditures. These expenditures are costs that would otherwise be capitalizable and that are paid in connection with the abatement or control of hazardous substances at a qualified contamination site.  If a taxpayer can meet the requirements for 9100 relief, it can make a late §198 election.

Michael Warady CFP, National Director, Software R&D Consulting

Michael Warady CFP, National Director, Software R&D Consulting

Many companies have difficulty understanding the value of the R&D tax credit to the organization. To help put it in perspective, we recently conducted an equivalency assessment for a custom manufacturer. The chart below compares the additional revenue that would need to be generated from ordinary business operations to equal the value created by the R&D tax credit opportunity.

Gross Receipts $49,500,000
Cost of Goods Sold $40,000,000
Gross Profits $9,500,000
Total Deductions $8,000,000
Net Income $1,500,000
Profit margin 3.03%
R & D Tax credit $300,000
Revenue equivalents $9,900,000

 

The project encompassed approximately 45 hours of time by company employees, including document collection, interview participation and final deliverable review. At the conclusion, two things were worth noting:

  1. The resulting credit amount divided by the number of hours invested equated to an hourly revenue rate of more than $6,500.
  2. The credit equated to a revenue equivalency of $9.9 million. The CFO mentioned that it would take years to generate that type of top line revenue growth and impossible given only 45 hours.
  3. Even if the credit were half this amount, the company would need to grow revenues by nearly $5 million in order to achieve the same $150,000 benefit provided by the R&D tax credit.

The R&D tax credit is one of the most efficient and effective ways to create cash flow that can be reinvested into additional R&D, new equipment, talent or other areas of the business.

The SourceHOV|Tax R&D team has more than 85 years of collective R&D experience at both Big Four and boutique firms. Each member has worked with companies across a wide range of industries to complete more than 1,200 studies totaling more than $1 billion in credits claimed.

For more than 30 years, SourceHOV|Tax has helped companies properly identify and sustain tax incentive strategies including R&D tax credits, cost segregation studies, §179D deductions and LIFO inventory accounting. For more information, please call 800-806-7626 or visit www.sourcehovtax.com.

Michael Warady CFP, National Director, Software R&D Consulting

Michael Warady CFP, National Director, Software R&D Consulting

For more than 10 years, I have been talking to companies about claiming research and development tax credits. But when I learn they are in a loss position, the conversation typically stops. The argument has always been that claiming the credit while in a loss position is pointless since there is no immediate benefit.  While many companies recognize the credit, they don’t value the carryforward opportunity.   Why would a company go through the process now versus waiting until they can use it? The theory is they can always go back and capture past credits and carry the credits forward when they need them.  Plus, time is precious and resources limited.

In the past I agreed with this reasoning.  However, recently I wondered if there wasn’t value being missed. While traditional thinking seems logical, I concluded that the R&D tax credit should be included on a company’s tax return each year even if it is in a loss position. Waiting can be costly.  Here’s why:

Taxes have not gone down.  As your company grows and reverses its loss position, the credit may bring value sooner than anticipated.  Budgeting for taxes can become a very real issue and knowing what you have in reserves can help.  The carryforward of an R&D tax credit will also help with quarterly tax estimates.  When your tax position becomes positive, you will know the value of your R&D tax credits so you can offset your tax liability.

Learn it now versus figuring it out later.  Companies that claim the credit on an ongoing basis will have stronger and cleaner project tracking.  And they will better understand where internal resources are committed and where resources should continue to be dedicated.

There’s value to putting the process in place.  Establishing an ongoing process versus retroactively conducting studies is less labor intensive. Our clients find that conducting current studies simplifies the process.  They know what they need to collect and have implemented processes for data gathering throughout the year.

It’s cleaner than amending tax returns.  Each year a company goes back and captures credits to carry forward requires amending the tax return for that year.  It’s an even bigger issue for flow through companies with multiple shareholders.  In one recent case, a client with multiple shareholders wanted to capture credits from 2011-2013 and carry them forward into the current and future years for utilization. As an S-Corp with nine shareholders, they had to file 30 amended federal tax returns in addition to a similar number of state tax returns to do so.  By claiming the credit currently, you can avoid amended returns, aggravated shareholders and additional tax fees.

The credit is an asset.  For companies that are not flow through entities, the credit stays with the corporation.  As companies transition ownership, they recognize the R&D tax credit as an asset.  Many of our CPA firm partners recognize the value of such an asset and recommend their clients capture the credit prior to pricing negotiations.

 

Michael Warady, CFP has been consulting on the R&D tax credit for more than 10 years.  For the past 6 years, Michael has worked with SourceHOV|Tax clients and their CPAs to help them understand the value the credit offers.

SourceHOV | Tax has helped CPA firms and their clients maximize specialized federal and state tax incentives for more than 30 years. We’ve helped thousands of companies save billions of dollars through these lucrative tax strategies.

With the March 15 deadline looming for many of your clients, now is the time to consider any necessary tax elections for clients who plan to evaluate or take the R&D tax credit.

When a company claims a research credit, it can either elect the GROSS credit or the REDUCED credit.  When electing the reduced credit, the company makes a 280C election on the original return. This election cannot be made on an amended return.

The benefit of the 280C election is that there is no AMT impact if the company later goes back and amends the return for this credit.  If the gross credit is elected, the company must reduce its deductions by the amount of the gross credit thereby increasing taxable income.

AMT income also increases by the same amount, so companies closer to the AMT threshold may get pushed further into AMT if they go back and claim a credit under the gross credit method.   While the reduced credit is the preferred method for most companies, some (generally those with NOLs) may benefit from the gross credit method.  So an assessment should be made before making the election.

In order to make the 280C election, a company needs to determine if this election is made using the Regular Credit calculation or the Alternative Simplified Credit calculation.  To make the proper 280C election, an assessment as to which credit method will be most beneficial must be made when making the election.

For 2014, the box on Form 6765 line 17 or 34 must be checked depending on the credit calculation method chosen.

SourceHOV | Tax can analyze the benefits of the 280C election for your clients and recommend which method is most beneficial for those claiming or looking to claim the R&D tax credit.

There is still time to conduct the proper evaluation to meet the March 15 filing deadline for your clients who anticipate claiming the credit and want to make the proper election, but time is of the essence. I welcome the opportunity to discuss further how we might work together to help reduce your clients’ tax burden.

On Friday, February 13 the IRS released guidance on tangible property regulations (TPR) relief for small businesses. Requested by many small businesses and tax professionals, the simplified procedure is available beginning with the 2014 tax return.

New Rules of Rev Proc 2015-20

  • A taxpayer can employ Rev Proc 2015-20 if it’s separate and distinct trade(s) or business(es) is a qualifying taxpayer or has total assets of less than $10M as of the first day of tax year 2014, or if it has average gross receipts of $10M or less. This means that a taxpayer’s total businesses can be more than the limiting dollar criteria and still qualify for Rev Proc 2015-20 if it’s separate and distinct trade(s) or business(es) is a qualifying taxpayer or has total assets of less than $10M as of the first day of tax year 2014.
  • A taxpayer that does not file Form 3115s for 2014 defaults to the provisions of Rev Proc 2015-20 which allow the taxpayer to adopt the new regulations without filing Form 3115s for the available accounting methods.
  • A taxpayer can amend its tax return for 2014, if it already filed with TPR Form 3115s, to withdraw those filed before the due date of the return including any extension.
  • By using Rev Proc 2015-20, a taxpayer reduces the administrative burden associated with implementing the TPRs, but:
    • Does not receive audit protection for its tax years before tax year 2014 for the issues addressed by the TPRs.
    • May not scrub its depreciation schedule as of January 1, 2014 for repairs and maintenance reclassification of prior year expenditures.
    • May not claim any prior year partial asset dispositions under method #196, §6.33 of Rev Proc 2015-14. (Note: Current year dispositions may still be claimed on the tax return without filing a Form 3115.)

Conclusion

Rev Proc 2015-20 is optional for qualifying small businesses. Taxpayers can still choose to file the applicable Form 3115s and comply with the TPRs. We recommend small businesses still file the applicable TPR Form 3115s where they will have a favorable §481(a) adjustment.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

In today’s fast-paced marketplace, software has become an integral part of doing businesses for companies of all sizes and across all industries. Congress recognized the vital role software now plays in day-to-day operations, and on January 20, 2015 the Internal Revenue Service published proposed regulations to address issues regarding the treatment of research expenses related to the development of internal use software (IUS) for purposes of claiming research and development (R&D) tax credits.

Because IUS must meet the more onerous 7-part test to qualify for R&D tax credits, it is often excluded, preventing many companies from claiming the credit. However, under the proposed regulations, the definition of IUS is narrowed.  Software that is developed to enable a taxpayer to interact with third parties or allow third parties to initiate functions or review data on the taxpayer’s system is now considered external use software and subject only to the less restrictive 4-part test. Narrowing the definition of what constitutes IUS versus external use software opens the door for many non technology-based taxpayers, especially service-based companies, to now successfully claim R&D tax credits.

The proposed regulations limit the definition of IUS to software developed for general and administrative functions that facilitate or support a taxpayer’s trade or business. This includes any system used to run the business such as financial management, human resources management or support services software. For software that may serve a dual function (i.e. be used for both internal purposes and also by third parties), a taxpayer may classify certain components of an integrated system as non-IUS if they can demonstrate that an objective and reasonable method was used to determine the components of software that would be used by third parties.

The 3-part test for IUS is also clarified.  The “unique or novel” standard that was introduced in the 2001 regulations is eliminated, and the original definition of “innovative” is confirmed in these proposed regulations.  The regulations provide that the high threshold of innovation test is satisfied if:

  • The software is innovative, meaning that the software results in a reduction in cost or improvement in speed that is substantial and economically significant.
  • That the software development involves significant economic risk, meaning that the taxpayer commits substantial resources to the development and there is substantial uncertainty because of technical risk and that such resources would be recovered within a reasonable period.
  • That the software is not commercially available for use by the taxpayer without modifications that would satisfy the first two requirements.

These regulations are applicable for tax years ending on or after the publication date of the Treasury decision adopting these rules as final regulations in the Federal Register.  However, the IRS will not challenge positions consistent with the proposed regulations for taxable years ending on or after January 20, 2015.

For more than 30 years, SourceHOV | Tax has helped companies properly identify and sustain tax incentive strategies including R&D tax credits, cost segregation studies, 179D tax deductions and LIFO inventory accounting.  For more information, please call 800-806-7626 or visit www.sourcehovtax.com.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

This $65 million HVAC/sheet metal engineering firm was engaged to create the design and manage construction of a ventilation system for an underground parking facility at an historic site. The facility was the main entrance for buses, trucks and other vehicles visiting the site and was to include x-ray devices and other high-security systems to detect explosives or other potential security risks.

In this case, the design was to effectively ventilate exhaust fumes from the facility rather than provide consistent, fresh breathing air as is typical when ventilating a building. The job was made more complex due to the facility having 70 purge zones, each with its own control.

There was uncertainty as to how technical personnel could most efficiently design and install the ventilation system while the concrete contractor was simultaneously building walls in the same area. The underground facility consisted of an exterior slurry wall that was designed to hold back soil from the river bank. Inside the slurry wall was a four to five foot cavity and then a second, interior wall. The second wall was three feet thick and required interior and exterior metal forms to hold everything in place during construction. In some places, steel was placed over the second wall as an added blast-proofing security measure. As a result, there was little room for the ductwork to be installed between the walls.

Through the use of computer aided design, the teams experimented with multiple ductwork designs. In the process of calculating the most efficient way to install the ductwork, the initial design called for the technical team and the concrete contractor’s team to alternate going first in either pouring walls or hanging ductwork. However, this design was deemed to be ineffective because the concrete contractor would have difficulty removing the wall forms and steel rebar after the ductwork was in place.

An alternative CAD design included pouring the walls first and then installing the ductwork. This required technical personnel to design various sizes of duct to fit in the crevices left after the walls were formed. The CAD designers created numerous alternative designs in an attempt to achieve optimal layout of the ventilation system. Technical personnel were required to resize and rebuild various pieces of ductwork to accommodate the new designs. And, production staff worked with project management and CAD designers to redesign the shape and size of numerous key components of the ventilation system.

SourceHOV | Tax has worked with the firm and its CPA to claim R&D tax credits for tax years beginning in 2007. Over the past seven years, the firm has claimed annual credits of $135,000.

Charles Duncan, Director, Cost Segregation & EPAct §179D

Charles Duncan, Director, Cost Segregation & EPAct §179D

On April 18, 2014, the Service released Private Letter Ruling 201416006. In this letter ruling, the Service permitted multiple, related parties to utilize the same exchange accommodation titleholder to park the same property involving separate qualified exchange accommodation arrangements. Even though only one of the taxpayers could successfully complete the reverse like-kind exchange, the Service ruled that the successful taxpayer would be able to defer gain recognition.

Gain deferral utilizing a §1031 like kind exchange typically involves the simultaneous or deferred exchange of like-kind properties.  Under rules issued by the Service in Revenue Procedure 2000-37, taxpayers can also use an exchange accommodation titleholder to purchase a replacement property prior to selling the relinquished property. This is called a reverse like-kind exchange. Since the exchange accommodation titleholder (and not the taxpayer) is treated as the owner of the property, the taxpayer is still able to exchange the relinquished property and defer gain recognition. In this type of arrangement, the exchange accommodation titleholder must acquire the replacement property under an qualified exchange accommodation arrangement, which generally requires both the taxpayer and the exchange accommodation titleholder to treat the property consistently as owned by the titleholder and as part of a reverse like-kind exchange.

In this letter ruling, the taxpayer and two of its affiliates owned separate commercial office buildings, each of which they were interested in exchanging. Each entity entered into a qualified exchange accommodation agreement with the same, unrelated exchange accommodation titleholder. Under these agreements, the taxpayer and its affiliates each had the right to acquire the property as part of the agreement, but that this right would terminate upon prior notice by the taxpayer or either affiliate to acquire the property. The parties represented that the requirements of Revenue Procedure 2000-37 would be met.

In this situation, the Service ruled that Revenue Procedure 2000-37 does not prohibit this related, multi-party arrangement. Even though the taxpayer’s or its affiliates’ right to acquire the property terminates upon notice by another one of the parties, the Service ruled that this would not be an impediment to the parking arrangement. By using this technique, the taxpayer and its affiliates can buy itself additional time to identify the best property to relinquish.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

With filing deadlines past and next year’s tax planning on the horizon, understanding recent changes that impact the R&D tax credit may help companies decide to claim credits that they may have opted against in the past. Following are the three events SourceHOV|Tax believes are most noteworthy:

  • New regulations issued in June pertaining to the alternative simplified credit (ASC) allow companies to retroactively claim R&D tax credits on amended returns using the three prior years’ expenditures as a baseline. Before this change, a company that wanted to claim credits for past years was forced to use the regular credit calculation, which significantly increased the burden of documenting baseline spending, often requiring use of a 1984-1988 baseline. Forced to use decades old data that may no longer be in existence, many companies determined that filing was simply too onerous. However, now having the ability to use the ASC on amended returns with a current baseline spending period opens up the opportunity for those companies to more easily claim credits and realize potentially significant benefits.
  • In July 2014, clarification regarding §174 of the tax code was issued. The regulations determined that the material cost to build prototypes, models or samples, even if ultimately sold or placed in service, is a deductible R&D expense as long as the technical uncertainty persists throughout the build phase. Since the first hurdle in qualifying for the research credit under §41 is that the expenses must meet the definitions under §174, these new regulations increase the R&D tax credit opportunity for many companies incurring labor and material costs for prototypes, models, tooling or other assets. In short, clarifying the definition of §174 also helped clarify the §41 definition of qualifying expenses.
  • The recent court case, Eric G. Suder v. Commissioner, was a favorable taxpayer win on many fronts.  First, it rejected one of the most common IRS objections stating that the taxpayer’s research was not “routine” engineering.  Second, it affirmed that even owners or CEOs could be spending substantial amounts of time on research efforts.  The owner in this case was qualified at 75 percent, and the courts made no adjustment to this amount.  Another important item addressed by the court was the issue of reasonable compensation for an owner for purposes of computing the research credit. While the court ultimately decided that the wages paid to the owner in this case were unreasonable under the circumstances, it did provide an encouraging framework upon which reasonable “under the circumstances” could be determined.  In this case, the court relied on the testimony of an expert in executive compensation and defined reasonable “under the circumstances” to be based on comparable compensation from owners of a similar size company in a similar industry with a similar growth pattern.   As with all the court cases surrounding the R&D tax credit, being able to articulate and document each person’s involvement in R&D through credible testimony and supporting documentation is critical.

With regard to extension of the currently expired R&D tax credit, as anticipated, no action is expected until after the November elections. While the House passed the Jobs for America Act (HR4) in September making the R&D tax credit permanent, it has yet to be passed by the Senate who has created its own bill, the Expire Act, which also has yet to be voted on. The Senate bill would extend the credit another two years. SourceHOV|Tax will post additional updates as these bills continue to progress through the legislative process.

Charles Duncan, Director, Cost Segregation & EPAct §179D

Charles Duncan, Director, Cost Segregation & EPAct §179D

On September 18, 2014 the Internal Revenue Service released an advance copy of Rev. Proc. 2015-54. This revenue procedure describes how to implement the final regulations of Treasury Decision 9689. We will provide brief overviews of the final regulations and Rev. Proc. 2014-54, identify key changes and describe important opportunities.

Treasury Decision 9689 Overview

The final regulations generally retain all of the provisions of the 2013 proposed reliance regulations on the disposition of MACRS property. They also amend the rules for general asset accounts and accounting for MACRS property.  These final regulations generally apply to tax years beginning on or after January 1, 2014, but may be early adopted for tax years beginning on or after January 1, 2012.

Accounting for MACRS Assets Overview

MACRS assets generally are treated as single asset accounts or multiple asset accounts. Consider an office desk treated as a single asset account. The desk is placed into service under the applicable depreciation convention (half-year), using the designated depreciation method (200% declining balance), and recovering its cost over the designated recovery period (seven years). When assets are placed in service in the same taxable year and use the same depreciation convention, depreciation method and recovery period, they can be combined into a multiple asset account. For example, a taxpayer may purchase 150 desks in 2014 for use in its corporate offices and treat the 150 desks as a multiple asset account, i.e. multiple assets treated as a single account in the taxpayer’s books and records. A multiple asset account is conceptually similar to a general asset account.

A general asset account (“GAA”) is an irrevocable election where at least one and usually many assets are treated as a single asset. Taxpayers make GAA elections on the Form 4562 of a timely filed tax return (including extensions). Though they share the same general rules for qualification, the primary difference between multiple asset accounts and general asset accounts is how assets are treated upon disposition. Since the entire GAA account is treated as a single asset, gain or loss on disposition of an individual asset generally is not recognized. Disposing of assets in a multiple asset account, however, would generally result in the recognition of gain or loss. GAA elections became popular after the 2011 temporary regulations required their use for taxpayers to recognize losses on the retirement of building structural components. (The 2013 proposed reliance regulations created a partial disposition rule that removed the need for the GAA election in this context).

Disposition Rules for MACRS Property Overview

Asset dispositions occur when ownership of an asset is transferred or when an asset is permanently withdrawn from use in a trade or business or income-producing activity. Dispositions include sales, exchanges, retirements, physical abandonments, or asset destruction. If a taxpayer makes a partial disposition election, dispositions also include the retirement of a building structural component or a portion of a structural component.  Once a disposition occurs, the taxpayer must determine the appropriate disposed asset and determine the basis of that asset. The latter determination applies only to multiple asset accounts, GAAs and portions of an asset. Where taxpayers are not able to identify a disposed asset specifically, it may use a first-in-first-out identification method or a mortality dispersion table to identify the asset.

Major Changes in the Final Regulations

The final regulations clarify: (1) how to make certain disposition elections for assets in a GAA when section 280B applies; (2) how to treat the disposition of a building structural component; and (3) how to determine the unadjusted depreciable basis of an asset in a GAA or multiple asset account or a portion of an asset.

  1. Section 280B and GAA Elections. Under section 280B, the adjusted basis and demolition costs of a demolished building are capitalized to a non-depreciable land account. If a demolished building is in a GAA and the taxpayer elects to terminate the GAA election, the final regulations clarify that no loss is recognized on the disposition, but rather that the building’s adjusted basis is capitalized to a non-depreciable land account. A taxpayer may elect out of GAA treatment:  (1) following the disposition of the last asset (or portion of an asset) in the GAA, or (2) a qualifying disposition election. A qualifying disposition includes: (1) casualty or theft losses; (2) charitable contributions; (3) business cessations that do not include transfers to supplies, scrap or similar accounts; or (4) certain non-recognition transactions.
  1. Disposed Building Structural Components.  The final regulations, like the proposed regulations, use a narrower definition of qualifying dispositions for assets included in a GAA than the temporary regulations, which had included events such as the sale of an asset. The final regulations also treat a building and its structural components as the disposed asset, breaking the conformity with the improvement standards under section 263(a). If a taxpayer would like to recognize gain or loss on the disposition of assets in a GAA, the taxpayer must revoke its GAA election for those assets. The taxpayer may then make a partial disposition election to recognize a loss on the disposition of the building structural component.
  1. Determining the Unadjusted Depreciable Basis of Certain Assets. The final regulations follow the proposed regulations and require taxpayers to use any reasonable method to determine disposed assets in a GAA or multiple account or portions of a larger asset. The primary change is that using the CPI to deflate the cost of a replacement asset is no longer a reasonable method. Taxpayers may instead use the Producer Price Index (PPI) for Finished Goods. Taxpayers that previously used the CPI should file a Form 3115 using change number 205 to use the PPI.

Important Opportunities in the Final Regulations

The final regulations highlight a number of areas that may require immediate action.

  1. Late Partial Disposition Elections. Taxpayers generally must make a partial disposition election on their timely filed, original tax return (including extensions). The final regulations permit taxpayers to file a current accounting method change application to make a late partial disposition election for the 2012 and 2013 tax years. Taxpayers may also file an amended return for 2013 to make a late partial disposition election. Rev. Proc. 2014-54 allows taxpayers to file a Form 3115 under change number 196 to make a late partial disposition election for assets disposed of in pre-2012 tax years. This opportunity only applies through the 2014 tax year (tax years beginning before January 1, 2015).

Key Takeaway: Calendar-year taxpayers must have pre-2014 disposition studies completed and the related Forms 3115 filed by the extended due date of the 2014 tax return.

  1. Section 280B and Late GAA Elections. An important consequence of the GAA election rules is that taxpayers can continue to depreciate a demolished building. If a building is in a GAA, however, depreciation continues until the GAA election terminates. Rev. Proc. 2014-54 permits taxpayers to make late GAA elections under change number 180 through the 2013 tax year (tax years beginning before January 1, 2014).

Key Takeaway:  Unless your client is a fiscal year taxpayer or reports their property on Schedule E, they cannot take advantage of this opportunity retrospectively. Clients should be advised of this opportunity for 2014 tax year and later building acquisitions.

  1. Late Revocation of GAA Election. Since a GAA election is no longer required to recognize loss on the retirement of building structural components, taxpayers who do not plan on demolishing a building during its remaining recovery period should consider filing a method change application to revoke their building GAA elections. Rev. Proc. 2014-54 allows taxpayers to file a Form 3115 using change number 197 to revoke a GAA election through the 2014 tax year (tax years beginning before January 1, 2015).

Key Takeaway: Most taxpayers who filed changes for retired structural components under the temporary regulations should consider revoking their building GAA elections. If they do decide to revoke the GAA election, a late partial disposition election is optional. So taxpayers that need income in 2014 should weigh their options on whether to make a late partial disposition election.

Rev. Proc. 2014-54 Overview

Revenue Procedure 2015-54 updates the automatic accounting method change procedures for GAA elections and asset dispositions under the final, temporary and proposed regulations. Important changes include:

  1. In light of the other asset disposition procedures, change number 107 for landlords disposing of tenant improvements at lease termination is redundant and has been obsolete.
  2. If section 280B applies to the disposition of a building, change number 177 has been clarified so that it can no longer be used to recognize loss on the building demolition.
  3. As with Rev. Proc. 2014-17, this revenue procedure includes a comprehensive chart that lists all changes under the final, proposed, and temporary regulations.

Summary

The final disposition regulations and Rev. Proc. 2014-54 primarily carry over the rules announced in the proposed regulations and their related revenue procedure. The below chart summarizes the important action items for taxpayers going forward.

Situation Action When
Taxpayer completed disposition study under the temporary regs. Revoke building GAA election and make late partial disposition election. No later than the 2014 tax year
Taxpayer disposed of original building structural components or portions of other assets in pre-2014 years. Make late partial disposition elections for structural components by filing Form 3115 in the current year No later than the 2014 tax year
Taxpayer disposed building structural component improvements or whole assets not in a GAA in prior years. Change method to identify asset disposed of in the current year. No later than the 2014 tax year
Taxpayer plans to demolish an entire building that it currently owns. Make late GAA election for the building. No later than the 2013 tax year
Taxpayer plans to acquire and demolish a building. Make GAA election for building in year of acquisition. No limit
Taxpayer completed disposition study under the proposed regs using the CPI to determine the unadjusted basis of the disposed assets. Change method to use the PPI. No later than the 2014 tax year