Depreciation
While unfamiliar to many taxpayers, general asset accounts (GAAs) provide a valuable simplification tool for tracking tangible assets and present some planning opportunities. This item aims to bring clarity to the use of GAAs and provide insight into the benefits and risks of adopting GAA treatment for tangible assets.
GAAs in General
A GAA allows taxpayers to treat multiple assets as a single asset, avoiding the need to track every singular disposition from the GAA. For example, a taxpayer that purchases a set of office furniture (desk, chair, and file storage) and places all of the items in the set into service at the same time can elect to treat the set as one asset for depreciation purposes by placing it into a GAA. The taxpayer would simply continue to depreciate the set as a GAA, whether or not the taxpayer disposes of a piece, or even the entire set, in a future year.
How to Establish a GAA
A taxpayer generally establishes a GAA by capitalizing and placing asset(s) into service and then making an irrevocable election on a timely filed tax return (including extensions) on Form 4562, Depreciation and Amortization, subject to the following general grouping rules:
- Each asset in the GAA must have the same applicable depreciation method (e.g., modified accelerated cost recovery system, accelerated cost recovery system, etc.);
- Each asset in the GAA must have the same applicable recovery period (e.g., three-year, five-year, seven-year, etc.);
- Each asset in the GAA must have the same applicable depreciation convention (i.e., midmonth, midquarter, or half-year); and
- Each asset in the GAA must be placed in service in the same tax year.
These general grouping rules are subject to further special grouping rules under Regs. Sec. 1.168(i)-1(c)(2)(ii):
- Assets subject to the midquarter or midmonth convention must be grouped in a GAA with assets placed in service in the same respective quarter or month;
- Passenger automobiles subject to the luxury automobile depreciation limits under Sec. 280F(a) must be grouped into a separate GAA;
- Other listed propertyunder Sec. 280F(d)(4) (aside from passenger automobiles) must be grouped into a separate GAA;
- Assets not eligible for additional first-year depreciation (including assets for which an election to forgo additional first-year depreciation has been made) must be grouped into a separate GAA;
- Assets eligible for additional first-year depreciation (including Sec. 168(k) bonus depreciation) must be grouped into a GAA with assets subject to the same percentage of additional first-year depreciation (i.e., 30%, 50%, or 100%);
- Assets that do not use an optional depreciation table must be grouped into a separate GAA;
- Mass assets must be grouped into a separate GAA; and
- Assets subject to a change in use for which an optional depreciation table is not used must be grouped into a separate GAA.
A GAA can consist of multiple assets or a single asset. Assets not used in a trade or business or assets a taxpayer places into service and disposes of in the same tax year are not eligible for GAA treatment. As the rules above suggest, each GAA is intended to include not only similar assets used in the trade or business, but similar assets for depreciation purposes as well. The intent is to simplify tracking fixed assets by replacing numerous additions with a single line item (i.e., the GAA).
Dispositions From a GAA
For GAA purposes, a disposition occurs when a taxpayer transfers ownership of an underlying asset in a GAA or permanently withdraws the item from use in the taxpayer's trade or business. A disposition includes the sale, exchange, retirement, physical abandonment, or destruction of an asset or the transfer of an asset to a supplies, scrap, or similar account. However, taxpayers that elect to capitalize and depreciate materials, supplies, or rotable, temporary, or emergency spare parts in a GAA may not dispose of such assets by transferring them back into a supplies account without first obtaining the IRS's consent. A portion of an asset may be disposed of, but only under specific circumstances.
Outside a GAA, a taxpayer's disposition of an entire asset would generally result in the realization and recognition of a gain or loss. However, with the goal of simplification in mind, taxpayers generally do not recognize loss on the disposition of a single asset from a GAA. Taxpayers assign the disposed asset an adjusted depreciable basis of zero immediately before the disposition. Thus, the disposition does not affect the unadjusted basis and depreciation expense of the entire GAA.
If a taxpayer realizes any amount upon the disposition of an asset from a GAA (e.g., a taxpayer sells an asset), the taxpayer recognizes the entire amount as ordinary income under Regs. Secs. 1.168(i)-1(e)(2)(i) through (iii). These rules also apply to lessors and lessees of property that place such property into a GAA and dispose of an improvement to the leased property or portion thereof prior to the lease's termination. Also, if a nonrecognition event triggers a disposition, the taxpayer treats the amount of any gain triggered by the nonrecognition transaction as ordinary income pursuant to Regs. Sec. 1.168(i)-1(e)(2)(iv).
Recognition and Termination of a GAA
Certain disposition transactions may trigger the termination of a GAA and thus provide a means to recover basis in some or all of the assets in the GAA. The rules provide for two optional termination scenarios and several mandatory termination provisions.
Under one optional termination scenario, a taxpayer disposes of all of the assets, the last asset, or the remaining portion of the last asset in the GAA (the all-assets option). In this event, rather than recognizing ordinary income on proceeds and having no basis recovery, the taxpayer may choose to terminate the GAA and recognize gain or loss by comparing the proceeds with the adjusted basis of the entire GAA. The taxpayer determines the character of the gain or loss based on the underlying assets and related Code provisions. In addition, termination of a GAA may subject the taxpayer to depreciation recapture provisions under the Code.
A qualifying disposition of a GAA asset also provides taxpayers with the option to terminate GAA treatment. A qualifying disposition does not result in all of the assets in a GAA being disposed of, yet it provides for termination of GAA treatment for the specific asset disposed of. To meet the Regs. Sec. 1.168(i)-1(e)(3)(iii)(B) requirements for a qualifying disposition, the transaction must also:
- Directly result from a casualty or theft event;
- Relate to a charitable contribution;
- Directly result from the cessation, termination, or disposition of a business, income-producing process, operation, facility, plant, or other unit (other than by transfer to a supplies, scrap, or similar account); or
- Relate to
a transaction to which a nonrecognition section of the
Code applies, other than the following:
- Contributions/liquidations;
- Transactions subject to Sec. 1031 or 1033;
- Technical terminations of partnerships; or
- A transaction entered into, or made, with a principal purpose of achieving a tax benefit or result that would not be available absent an election under the GAA rules.
Each of the exceptions for optional termination listed above results in a mandatory termination of the GAA as of the date of the transaction, with mandatory gain or loss recognition.
Since a qualifying disposition typically involves a single asset and the GAA will remain for other assets, the effects on the GAA are slightly more complicated than under a disposition of all assets in a GAA. In a qualifying disposition under Regs. Sec. 1.168(i)-1(e)(3)(iii)(B), the GAA treatment for the asset terminates as of the first day of the tax year in which the qualifying disposition occurs; the GAA's unadjusted depreciable basis is reduced by the asset's unadjusted depreciable basis (as of the first day of the tax year); and the GAA's depreciation reserve is reduced by the allowable depreciation of the asset (as of the end of the tax year immediately preceding the year of disposition).
In determining the gain or loss recognized on a qualifying disposition, one must determine the adjusted depreciable basis of, and gain or loss on, the specific asset by applying the appropriate depreciation provisions of the Code. Finally, depreciation recapture is recognized pursuant to Regs. Sec. 1.168(i)-1(e)(3)(iii)(A) in the lesser amount of (1) the depreciation allowed on the asset, or (2) the excess of the original unadjusted basis of the GAA over the cumulative amount of gain previously recognized as ordinary income.
The only elective opportunity for a taxpayer to terminate a GAA with respect to the disposition of a portion of an asset is through terminating the GAA under the all-assets option. It is important to note that while the new tangible property regulations now allow for a partial disposition of an asset at the election of the taxpayer, this generally would not apply to any assets placed in a GAA.
Opportunities Related to GAAs: Demolition of a Structure
While GAAs may present challenges for taxpayers, they also provide opportunities. For example, GAA rules can eliminate the application of Sec. 280B, which disallows a loss or deduction when a taxpayer demolishes a structure. Generally, a taxpayer is required to capitalize demolition expenses and any loss sustained on account of the demolition to the underlying land, a nondepreciable asset. If the structure is in a GAA, there is no loss if the taxpayer does not elect to discontinue the GAA and, therefore, no application of Sec. 280B.
If a taxpayer acquires real property with the intent to demolish any existing structures on the property, the taxpayer may consider placing the structure(s) into a GAA. In this situation, the taxpayer can take advantage of a special provision in Regs. Sec. 1.168(i)-1(e)(3) that allows the taxpayer to ignore Sec. 280B and effectively continue depreciation of the entire structure that the taxpayer placed in the GAA. This would result in the taxpayer's continuing to depreciate the demolished structure rather than capitalizing the demolished structure's remaining basis to land.
Assets that a taxpayer places in service and disposes of during the same tax year do not qualify for GAA treatment. Since this opportunity requires a taxpayer to place a structure into service and then demolish it in a subsequent tax year, the taxpayer should have some certainty regarding the demolition of the structure. As mentioned earlier in this item, the risk of placing a structure in a GAA is that the taxpayer then has to forgo the option to recognize a partial disposition of the structure in the future.
Opportunities Related to GAAs: Simplicity
Imagine that a taxpayer acquires multiple similar assets with an expected high degree of turnover. These assets could prove burdensome to track on an individual basis (e.g., rotable spare parts, livestock with numerous births or deaths, or even items such as laptops). They also could create significant fluctuations in depreciation expense and result in an administrative nightmare when accounting for dispositions. By placing these assets into a GAA, a taxpayer could significantly ease the burden of tracking dozens, hundreds, or thousands of assets individually. Tax planning and forecasting could be significantly easier when depreciation expense is easily calculated based on an entire GAA class with a predictable and recurring annual expense.
Opportunities Related to GAAs: Startup Companies
GAAs can also benefit startup companies projected to incur net operating losses (NOLs) for the first few years of operations. GAAs work especially well under this scenario if the taxpayer intends to have a high turnover of the items in the GAA either through upgrading items or fully consuming them before the end of their class life. Any early dispositions from the GAA would generate ordinary income without offsetting basis, thereby reducing current-year NOLs while continuing to generate depreciation deductions over the class life of the items.
Conclusion
Historically, taxpayers have rarely used GAAs, but the new tangible property regulations provide guidance and illustrate certain situations where using a GAA could benefit a taxpayer. Benefits include simplifying recordkeeping by grouping assets into a single account and easily projecting depreciation expense over the life of a GAA. Risks include the loss of the optional partial disposition opportunity and the optional and mandatory disposition recognition events and GAA terminations that could slip by a taxpayer's recordkeeping systems.
EditorNotes
Mindy Tyson Weber is a senior director, Washington National Tax for McGladrey LLP.
For additional information about these items, contact Ms. Weber at 404-373-9605 or mindy.weber@mcgladrey.com.
Unless otherwise noted, contributors are members of or associated with McGladrey LLP.
