The IRS issued final regulations providing rules for how to determine gain or loss when property subject to depreciation is disposed of, how to determine the asset disposed of, and how to account for partial dispositions of depreciated property (T.D. 9689). The regulations apply to property that is subject to depreciation under the modified accelerated cost recovery system (MACRS) and to tax years beginning on or after Jan. 1, 2014 (but taxpayers may choose to apply them to tax years beginning on or after Jan. 1, 2012). The regulations represent a final piece in the IRS's overhaul of the regulations governing the treatment of expenditures incurred in acquiring, producing, or improving tangible assets.
The new final regulations generally follow proposed regulations that were issued in 2013 (REG-110732-13). Regs. Sec. 1.168(i)-1 covers the establishment of general asset accounts, depreciation of general asset accounts, and disposition of assets in a general asset account. Regs. Sec. 1.168(i)-7 governs partial dispositions of MACRS property. Regs. Sec. 1.168(i)-8 governs dispositions of MACRS property.
Dispositions of MACRS Property
Under the regulations, a disposition includes the "sale, exchange, retirement, physical abandonment, or destruction of an asset" and occurs when the taxpayer either transfers ownership of the asset or permanently withdraws the asset from use in the taxpayer's trade or business or in the production of income. The regulations provide rules for determining what the disposed asset is for these purposes, including special rules for certain types of property. For example, each building, including its structural components, is generally an asset for tax disposition purposes, although exceptions exist.
The disposition rules also apply to partial dispositions of an asset. This allows taxpayers to claim a loss on the disposition of a component without identifying the component as an asset before the disposition. The partial disposition rule also reduces the circumstances requiring simultaneous depreciation of an original part and its replacement part.
The partial disposition rule is usually elective; however, when a partial disposition results from a casualty, as part of a like-kind exchange, or in certain other circumstances, the partial disposition rule must be used.
Finally, if the IRS disallows a taxpayer's repair deduction for an amount paid or incurred for the replacement of a portion of an asset, the taxpayer can make the partial disposition election for the disposition of the portion of the asset affected by the IRS's adjustment.
Determining Gain or Loss
The final regulations' rules on determining gain or loss are generally consistent with the proposed regulations that were issued under the old accelerated cost recovery system. These proposed regulations have generally been applied to MACRS property. Under these rules, if an asset's disposition is the result of a sale, exchange, or involuntary conversion, gain or loss is recognized under the applicable Code section. If an asset is abandoned, loss is recognized in the amount of the asset's adjusted depreciable basis at the time of abandonment (unless the abandoned asset is subject to nonrecourse indebtedness; then the abandonment is treated as a sale).
When an asset is disposed of by some way other than sale, exchange, involuntary conversion, physical abandonment, or conversion to personal use, gain is not recognized, but loss is recognized in the amount of the excess of the asset's adjusted depreciable basis over its fair market value at the time of disposition.
If disposed-of assets are in a multiple-asset account and it is impracticable for the taxpayer to determine the unadjusted depreciable basis of the disposed-of asset, the regulations allow the taxpayer to use any reasonable method that is consistently applied to all assets in the same multiple asset account to determine the asset's basis. The regulations provide several examples of reasonable methods.
General Asset Accounts
Taxpayers are allowed to maintain general asset accounts for any MACRS property (Sec. 168(i)(4)), and when property in a general asset account is disposed of, the taxpayer includes the proceeds in ordinary income.
The regulations provide rules for establishing, depreciating, and disposing of assets from general asset accounts. In effect, each general asset account is treated as an asset.