Tangible Asset Regulations

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@deandorton.com or 502.566.1025 if you have any questions.


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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. 

Article Dean Dorton

REMINDER!

To qualify for expensing items under the new de minimis safe harbor regulations, you must have a written capitalization policy in place on the first day of your taxable year. If you do not have a written capitalization policy in place already, you should consider having one in place by January 1, 2015!

For more detailed information, view our recent e-newsletter series regarding Tangible Asset Regulations (TARS).

If you would like additional information or have questions, please contact Faith Crump at fcrump@deandorton.com or by calling 502-589-6050.

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Article Dean Dorton

This week concludes our six-part email series on the new tangible asset regulations which are generally effective for tax years beginning after 1/1/14 and impacts any taxpayer with capitalized assets or supplies.  The following is a summary of the five areas we previously discussed which may impact you.

De minimis Safe Harbor Rule
The de minimis safe harbor rule allows taxpayers to annually elect to expense certain expenditures, if a written policy is in place at the beginning of the tax year, when you spend less than a certain dollar amount on tangible property.

Materials & Supplies
Through the materials and supplies rules, incidental items meeting certain criteria may accelerate deductions by expensing items in the current year, rather than maintaining an inventory and deducting when used. Non-incidental (inventoried) items  are required to be capitalized and deducted when used or consumed, not necessarily in the year acquired.

Unit of Property: Building Systems
The new rules for building systems places the building components into nine different units of property to determine whether an expenditure is a capitalized improvement or a deductible expense.  These components include HVAC, electrical systems, plumbing, escalators, elevators, fire protection & alarm, security, gas distributions or other structural components.

Unit of Property: Non-Building
To determine whether property is subject to capitalization or expense, you must look at the Unit of Property rules.  For non-building property, you must determine if the components are functionally interdependent, and placing one component in service is reliant on placing other components in service.

Repairs vs. Improvements: 3 Tests
The new regulations implement three new tests to determine whether expenditures related to a unit of property should be capitalized or expensed. The three tests are the betterment test, the restoration test, and the adaptation test. If the expenditure meets any of the tests, the cost should be capitalized as an improvement to the unit of property.  All three tests must be done in succession before determining that expensing the cost is appropriate.

Additional guidance was also released that allows for a late partial disposition election in 2014 to claim  a loss on the cost of the component that was replaced, removed or disposed of in prior years.

As the new regulations are complex, we highly recommend that you address these required changes prior to year end and assess any planning opportunities available.

If you would like additional information or have questions, please contact Allison Carter at alcarter@deandorton.com or Faith Crump at fcrump@deandorton.com or by calling 502-589-6050.

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Article Dean Dorton

The new Tangible Asset Regulations (TARS) implements three new tests to determine whether expenditures related to a unit of property (UOP) should be capitalized or expensed. The three tests are the betterment test, the restoration test, and the adaptation test. If the expenditure meets any of the tests, the cost should be capitalized as an improvement to the UOP.  All three tests must be done in succession before determining that expensing the cost is appropriate.

A betterment is an expenditure that does the following:

  • 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
  • Results in a material increase in strength, capacity, productivity, efficiency, quality or output of the UOP

A restoration is an expenditure that does the following:

  • 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
  • Replace major component or substantial structural part of UOP

An adaptation is an expenditure that adapts a UOP to a new or different use that is not consistent with the taxpayers intended ordinary use of the UOP when originally placed in service by the taxpayer.

What this means to you: By applying each of these tests, you will determine if you can accelerate your deductions by expensing the items in the current year, or if you will be required to depreciate the items over the useful life.

If you would like additional information or have any questions, please contact Allison Carter at alcarter@deandorton.com or 859-425-7645, or Faith Crump at fcrump@deandorton.com or 502-589-6050.

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Article Dean Dorton

The rules for Materials and Supplies, the third topic in our series, define materials and supplies to include items costing $200 or less.

These rules require non-incidental items to be capitalized and deducted when used or consumed, not necessarily in the year acquired.  Items are considered non-incidental if an inventory or record of consumption is maintained.  Items that are incidental (not inventoried or tracked) are to be deducted when paid or incurred if the item is one of the following:

  1. Is a component acquired to maintain, repair, or improve a unit of tangible property, that you own, lease or service and that is not acquired as part of any single unit of property, including rotable and temporary spare parts (rotables) and standby emergency spare parts;
  2. Consists of fuel, lubricants, water and similar items that you reasonably expect to  consume in 12 months or less, beginning when first used in your  operations;
  3. Is a unit of property than has an economic useful life of 12 months or less, beginning when first used or consumed in your operations;
  4. Is a unit of property that has an acquisition cost or production cost of $200 or less; or
  5. Is identified in published guidance (such as the Federal Register or in the Internal Revenue Bulletin) as materials and supplies.

What this means to you:  Through the Material and Supplies rules, incidental items meeting the above-mentioned criteria may accelerate your deductions by expensing items in the current year, rather than electing to capitalize them and depreciating over the useful life.

If you would like additional information or have any questions, please contact Jeff Crumpley (jcrumpley@deandorton.com) or Faith Crump (fcrump@deandorton.com).

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