Scott Humphrey, BKD, LLP
Effective for tax year 2014, and going forward,the IRS has issued new regulations on the treatment of improvements to real and personal property that may drastically affect many real estate developers’ and investors’ current tax accounting methods. The regulations include a betterment, adaptation and restoration test for determining whether a tangible property expenditure has to be capitalized. The IRS also has finalized regulations and issued guidance for partial dispositions and general asset accounts. The ability to make a partial disposition or include certain real estate in a general asset account could offer tax savings opportunities for investors and developers.
Prior to the new regulations, a taxpayer was required to depreciate a capitalized repair as an improvement and continue to depreciate the replaced component, e.g., roof, windows or HVAC unit after the disposition or replacement of the component. The final regulations offer taxpayers the option to make an annual partial disposition election for qualifying dispositions occurring during the tax year. If a qualifying disposition occurs, taxpayers may elect to deduct the replaced component or portion of the undepreciated balance of component in the tax year in which it was replaced. In general, a partial disposition is elective; however, it is required when any of the following occurs:
• Sale of a portion of an asset
• Disposition as a result of a casualty event
• Disposition of a portion of an asset in a like-kind exchange or involuntary conversion
• Transfer of a portion of an asset in a nonrecognition transaction
So, for example, if you replaced a 20-year-old roof in 2014 that was being depreciated over 39 years, you can now expense the undepreciated balance of the old roof in 2014. Whereas in the past, the rules required you to continue to depreciate the old roof even though it was out of service.
Partial Dispositions Tax Planning Opportunity
Rev. Proc. 2014-54 extends the ability to make a late partial disposition election by filing an automatic accounting method change to tax years beginning before January 1, 2015. Taxpayers should analyze capitalized repairs and improvements to determine if they would benefit from making a late partial disposition election.
General Asset Accounts
A taxpayer may place an asset or group of assets in a general asset account (GAA) to ease record-keeping requirements or for tax planning purposes. Disposition of an asset in a GAA generally is ignored and the entire balance of the account is depreciated as though the disposition has not occurred. A GAA is not terminated until its last asset is fully disposed. A taxpayer may make a qualifying disposition election for a GAA in certain situations, including:
• A disposition as the direct result of a casualty event
• A charitable contribution
• A direct result of a cessation, termination or disposition of a business, manufacturing or other income producing process operation facility, plant or other unit, other than by transfer to a supplies, scrap or similar account
• Disposition in a nonrecognition transaction
GAA Tax Planning Opportunity
In light of a new provision contained within the final regulations, taxpayers should consider placing a building in a GAA if they plan to purchase and demolish a building in the future. If a building is not placed into a GAA and demolished, the remaining basis in the building is capitalized into the land and not depreciated. If the building is placed into a GAA, the building would continue to be depreciated until the building is disposed or fully depreciated. Also, a fiscal-year taxpayer may be eligible to make a late GAA election under the temporary regulations. Consult your tax advisor before placing an asset in a GAA, as there are potential disadvantages of making the election.
The final regulations offer taxpayers opportunities to accelerate or defer tax deductions. It is important to analyze the regulations as they apply to your specific facts and circumstances. To learn more about how these regulations could affect your business, contact your tax advisor.
Article reprinted with permission from BKD, LLP
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This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances.
Consult your advisor or legal counsel before acting on any matter covered in this update.
This article appeared in our quarterly newsletter from March of 2015. The full newsletter is available at http://files.investorsomaha.com/download/online_newsletter_3-2015.pdf