Depreciation
Concluding a process that began more than 10 years ago, the IRS released the final set of guidance last summer related to the tangible property regulations. The IRS published the final regulations (T.D. 9689) regarding depreciation and dispositions, including partial dispositions, of tangible depreciable property, and related Rev. Proc. 2014-54 that provides rules for filing method changes related to certain provisions of the final regulations.
These regulations finalize reproposed regulations (REG-110732-13) that were published simultaneously in September 2013 with the final tangible property regulations (T.D. 9636) regarding when costs incurred to acquire, produce, or improve tangible property must be capitalized or may be deducted. Together with Rev. Proc. 2014-16 and Rev. Proc. 2014-17, the two regulation packages and three revenue procedures provided taxpayers and their advisers with a lot of material to wade through to determine what changes they must make to conform to the new rules and the effort required to do so.
The disposition final regulations apply to tangible property subject to modified accelerated cost recovery system (MACRS) depreciation under Sec. 168. They provide:
- A definition of "disposition" as including the sale, exchange, retirement, physical abandonment, or destruction of an asset;
- Rules for determining the asset disposed of, including a specific provision that improvements and additions to an asset made after the asset is placed in service are separate assets for disposition purposes from the property improved;
- An election for taxpayers to apply the disposition rules to most partial dispositions of an asset (e.g., the disposition of a building's roof or a portion of a roof);
- Mandatory application of the partial disposition rule to certain partial dispositions including casualty losses;
- A special partial disposition rule to address the effect of the IRS's disallowance of a repair deduction;
- How to determine the year in which a disposed asset was placed in service and its basis, particularly if the asset is in a multiple asset account or is disposed of in a partial disposition and it is impractical to specifically identify the asset or portion;
- That whether and to what extent gain or loss is recognized is subject to other applicable provisions, including Sec. 280B (demolition); and
- Rules for establishing general asset accounts (GAAs) and treatment of dispositions of assets from a GAA.
One significant change from the reproposed regulations is in the determination of the basis of disposed assets in multiple asset accounts and the basis of the portion of an asset disposed of in a partial disposition where it is impracticable to determine the basis from the taxpayer's records. The final regulations do not include discounting the cost of a replacement asset by the consumer price index as an example of a reasonable method for determining the basis of the disposed asset. Instead, the final regulations provide that taxpayers may discount the cost of the replacement asset using the producer price index for finished goods (and its successor, the producer price index for final demand), but only if the replacement asset is a restoration under Regs. Sec. 1.263(a)-3(k) and is not a betterment under Regs. Sec. 1.263(a)-3(j) or an adaptation to a new or different use under Regs. Sec. 1.263(a)-3(l).
Other examples of reasonable methods for determining basis of a disposed asset from a general or multiple asset account or the disposed portion of an asset in a partial disposition are (1) a pro rata allocation of the unadjusted depreciable basis of the asset based on the replacement cost of the disposed portion of the asset (or asset from a general or multiple asset account) and the replacement cost of the asset (or all the assets in the general or multiple asset account), and (2) a study allocating the cost of the asset to its individual components. For multiple asset accounts, the reasonable method used by the taxpayer must be consistently applied to all assets in the same multiple asset account. The reasonable method used by the taxpayer for partial dispositions must be consistently applied to all portions of the same asset for purposes of determining the unadjusted depreciable basis of each disposed portion of the asset.
Rev. Proc. 2014-54 updates the comprehensive list of automatic method changes in Rev. Proc. 2011-14 by adding or modifying several method changes, which are generally updates of changes that were provided in Rev. Proc. 2014-17. In general, the changes in method of accounting relate to asset grouping rules and disposition rules under the disposition final regulations. Additionally, the IRS added a chart at the end of Rev. Proc. 2014-54 summarizing the changes in method of accounting provided. Many of the changes remain similar to those provided in Rev. Proc. 2014-17, with the IRS updating references to the final regulations and updating certain scope waivers.
One of the most significant opportunities under the disposition final regulations is the ability to recover basis upon the partial disposition of property, for example, when a component of a building is disposed of during a renovation. The regulations provide that the loss upon disposition is allowed if a partial disposition election is made on a timely filed return for the year of disposition. Importantly, the IRS has extended the ability to make a late partial disposition election (including a Sec. 481(a) adjustment) for dispositions made in prior tax years, but only for one more year. Thus, this late election is available as a change in method of accounting for federal income tax returns for tax years beginning before Jan. 1, 2015. Therefore, taxpayers have a limited time to take advantage of this potentially significant cash flow opportunity. Taxpayers that forgo the opportunity are generally trading cash today for locking in depreciation over the remaining recovery period, which may be long-term, especially for building components.
Most of the method changes generally are made using a Sec. 481(a) adjustment. Additionally, certain scope limitations are waived for method changes under the revenue procedure, which generally means taxpayers may file the automatic method changes even though they are under IRS exam or have recently filed the same type of method change. The IRS has also broadened the ability of taxpayers to file concurrent method changes for impermissible to permissible recovery periods for MACRS depreciation under Appendix Section 6.01 of Rev. Proc. 2011-14 on the same Form 3115, Application for Change in Accounting Method.
Taxpayers will want to determine how the new rules provided in the regulations may affect their current methods of grouping assets and recovery of basis upon disposition of property and then determine which changes require a Form 3115 under the revenue procedure or an election. Additionally, taxpayers should consider taking advantage of the limited period to file method changes for making late partial disposition elections and to revoke late GAA elections. The decisions made during this implementation year will affect tax returns for many years to come, so taxpayers should make sure that they have undertaken a well-considered assessment and implementation plan.
EditorNotes
Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or greg.fairbanks@us.gt.com.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.
