Property

Article Dean Dorton

Question:

If you spend money to change a capital asset used in your business this year, then is the expenditure a capitalized improvement or an expensed repair?

Answer: 

Under the new Tangible Asset Regulations (TARS), you must capitalize all betterment, restoration, and adaptation expenditures as improvements to the unit of property (UOP). The regulations define these three terms as follows:

  1. A betterment is an expenditure that:
  • Corrects a material condition or defect that existed prior to acquisition or arose during production of the UOP,
  • Results in a material addition to the UOP, or
  • Results in a material increase in strength, capacity, productivity, efficiency, quality or output of the UOP.
  1. A restoration is an expenditure that:
  • Replaces a component of a UOP,
  • Repairs damage to a UOP,
  • Returns UOP to its ordinarily efficient operating condition if it deteriorated to a state of disrepair and is no longer functional for its intended use,
  • Rebuilds UOP to a like-new condition after the end of its ADS class life, or
  • Replaces major component or substantial structural part of UOP.
  1. An adaptation is an expenditure that adapts a UOP to a new or different use that is not consistent with the taxpayer’s intended ordinary use of the UOP when originally placed in service by the taxpayer.

Otherwise, the expenditure is a repair, and you can expense it in the current year.

Contact your Dean Dorton advisor or Faith Crump at fcrump@deandortonstg.wpenginepowered.com or 502.566.1025 if you have any questions.

Article Dean Dorton

Question:

Last year we heard about the new tangible asset regulations and how they would impact prior years in addition to tax year 2014. What about 2015? Is “TARS” still an issue for 2015?

Answer:

These new rules created a new method of determining whether changes to tangible assets should be capitalized or expensed. The major conceptual change is the new “unit of property” concept. The unit of property differs for buildings and non-buildings, and provides more clarity than previous IRS regulations.

The regulations state that a single Unit of Property includes components that are functionally interdependent. (There are specific rules for buildings which will be addressed in our next enewsletter.) Two components are functionally interdependent when one component’s in-service date depends on another component’s in-service date. In other words, you cannot use the first component without the second.

Improvements to a Unit of Property are NOT a separate Unit of Property, unless a lessee makes the improvements. There are special rules for plant property, leased property, and network assets.

Grasping the Units of Property rules can help you maintain appropriate fixed asset records for tax purposes. Having such records can make it easier to decide whether payments are for improvements or repairs.

The smaller the Unit of Property, the more likely the costs incurred to change the Unit of Property will be capital.

Contact your Dean Dorton advisor or Faith Crump at fcrump@deandortonstg.wpenginepowered.com or 502.566.1025 if you have any questions.


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Article Dean Dorton

When it comes to deducting charitable gifts, all donations are not created equal. As you file your 2015 return and plan your charitable giving for 2016, it’s important to keep in mind the available deduction:

Cash. This includes not just actual cash but gifts made by check, credit card or payroll deduction. You may deduct 100%.

Ordinary-income property. Examples include stocks and bonds held one year or less, inventory, and property subject to depreciation recapture. You generally may deduct only the lesser of fair market value or your tax basis.

Long-term capital gains property. You may deduct the current fair market value of appreciated stocks and bonds held more than one year.

Tangible personal property. Your deduction depends on the situation:

  • If the property isn’t related to the charity’s tax-exempt function (such as an antique donated for a charity auction), your deduction is limited to your basis.
  • If the property is related to the charity’s tax-exempt function (such as an antique donated to a museum for its collection), you can deduct the fair market value.

Vehicle. Unless it’s being used by the charity, you generally may deduct only the amount the charity receives when it sells the vehicle.

Use of property. Examples include use of a vacation home and a loan of artwork. Generally, you receive no deduction because it isn’t considered a completed gift.

Services. You may deduct only your out-of-pocket expenses, not the fair market value of your services. You can deduct 14 cents per charitable mile driven.

Finally, be aware that your annual charitable donation deductions may be reduced if they exceed certain income-based limits. If you receive some benefit from the charity, your deduction must be reduced by the benefit’s value. Various substantiation requirements also apply. If you have questions about how much you can deduct, let us know.

Article Dean Dorton

Congress finally passed an extenders package that includes some key tax provisions that go beyond 2015. While there are numerous provisions, the ones we are frequently asked about include:

  • Section 179 deduction for up to $500,000 of qualifying business property is made permanent and the amount will be indexed for inflation in future years.
  • Bonus depreciation is extended through 2019 – 50% for 2015, 2016 and 2017, 40% for 2018, and 30% for 2019. And, starting in 2016, improvements to an interior portion of a nonresidential building made after the building was placed in service will also qualify.
  • For S corporations, the period for avoiding the built-in gains tax is “permanently” made 5 years.

What will we do for drama between Thanksgiving and New Year’s next year?

Below are some articles with more information on  the Act’s provisions:

Article Dean Dorton

For tax years beginning after January 1, 2014, there are final regulations in effect which address the application of the net investment income tax (additional 3.8% on investment income, also referred to as “Medicare Tax”) to self-rentals.

If a taxpayer rents a property for use in a business in which the taxpayer materially participates, the rental activity is considered “self-rental” under regulation 1.469-2(f)(6) and is converted from passive rental income to nonpassive income.  Regulation 1.1411-5(B)(S)(i) clarifies that due to the conversion from passive to nonpassive, the self-rental income is NOT considered investment income and, therefore, is NOT subject to the net investment income tax. Through properly classifying your self-rental income, you may save yourself from paying this tax unnecessarily.

If you have any questions regarding these rules, please contact your tax advisor or Faith Crump at 502-589-6050 or fcrump@deandortonstg.wpenginepowered.com.

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Article Dean Dorton

If you own real estate and pay federal income taxes, you can benefit from the results of a cost segregation study.  A cost segregation study is an analysis performed by trained professionals to identify property that should be classified as tangible personal property or land improvements, rather than real property that is depreciated over 27.5 or 39 years.  This allows the taxpayer to identify property that can be depreciated over 5, 7 or 15 years instead of the 27.5 or 39 years that typically apply to real estate.  This acceleration of deductions results in substantial tax savings benefits. 

Cost segregation studies apply to both newly acquired or constructed property, leasehold improvements/fit-ups and property that was placed in service in prior years (post 1986).  For property placed in service in prior years, the IRS allows a “catch up” deduction in year 1 for the additional depreciation deductions that are identified in a cost segregation study that you were entitled to but did not claim in previous years.  This can generate substantial tax savings in the first year of the study.

There is no limitation on the cost of property that is eligible for a cost segregation study.  The benefit of a study for a smaller building will be less than that of a larger property but may still be very beneficial.  We have worked with several industries to provide cost segregation studies including auto dealerships, banks, commercial and residential property owners, medical facilities and manufacturing facilities.

For property placed in service in years 2014, additional tax incentives available include 50% bonus depreciation and the increased limit in section 179 expense to $500,000.  Bonus depreciation allows taxpayers to write off 50% of qualified tangible property with a recovery period of 20 years or less and certain qualified leasehold improvement property that is placed in service in 2014.  Thus, the 5, 7 and 15 year property that is identified in a study may qualify for this additional depreciation deduction that wouldn’t normally be identified if the property was being depreciated over 27.5 or 39 years.  These tax incentives for 2014 make cost segregation studies even more beneficial for the current tax year.  Similar tax incentives are also available for property placed in service in tax years 2008-2013.

One of Dean Dorton’s most recent cost segregation studies on a $9.4 million apartment complex that was constructed in 2013 generated tax savings in the first year of $827,000. The present value of accelerated deductions (discounted at 8%) exceeded $690,000. The return on investment for this study was 127.8 to 1.

Tangible Assets Regulations and Cost Segregation Studies

The new tangible assets regulations expand the definition of a disposition of property to include the retirement of structural components of a building, resulting in tax benefit opportunities to the taxpayer.  Prior to these regulations, taxpayers were required to capitalize and depreciate the costs to replace a structural component of the building while continuing to recover the cost of the original structural component.  The regulations now expand the definition of a disposition to include the structural component that is being replaced using a reasonable method of identification of the replaced component.  If the taxpayer had a cost segregation study completed on the property upon acquisition, the cost of each building component would be segregated within the report.  Upon disposition of each component, the value of the replaced property is easily identified using this study.

For example – A taxpayer replaces the roof of a building.  Under the old regulations, the taxpayer could not take a loss on the retirement of the old roof that was replaced.  Rather, the taxpayer would continue depreciating the replaced roof and would be required to capitalize and depreciate the cost of the replacement roof.  Under the new regulations, the cost of the original roof would be identified and a disposition loss claimed in the year that the replacement roof is placed in service.  A cost segregation study breaks down each building component, making it easy to identify the cost of the replaced unit of property.

Dean Dorton most recently identified a $260,000 disposition deduction on a replacement of an HVAC chiller by utilizing the cost segregation study that was performed on the original acquisition of the building. 

Dean Dorton uses an Atlanta-based engineering firm to provide cost segregation studies to our clients.  This engineering firm conducts studies that conform to the Cost Segregation Audit Techniques Guide issued by the IRS.  They have performed over 15,000 studies and have successfully defended all challenges brought forth by the IRS.

If you believe that you may be a candidate for a cost segregation study, please contact Brandi Marcum by calling 859-425-7678.  We would be happy to provide you with a free estimate of the cost and benefits of a study of your property.