2014-Issue 42—As soon as the September 15th extended tax filing deadline recently passed for calendar-year corporate taxpayers, the Internal Revenue Service (IRS) released Revenue Procedure (Rev. Proc.) 2014-54, to modify the guidance set forth in Rev. Proc. 2014-17 and 2011-14, regarding changes in the method of accounting for certain dispositions of tangible depreciable property under the proposed repair regulations issued in September 2013. This new Rev. Proc. addresses some of the more complicated issues surrounding partial disposition elections and notably extends the ability to make a late partial disposition election. These elections allow a taxpayer to obtain an immediate deduction for “disposed” assets still on a taxpayer’s tax books.
Previously, Rev. Proc. 2011-14 gave instructions for obtaining automatic consent to retroactively apply the partial disposition election for calendar tax years 2012 and 2013. The latest guidance allows the same election opportunity for the 2014 tax year. For example, if you replaced your roof but did not recognize a loss on retirement (i.e., the portion of the roof that was disposed is still being depreciated for tax purposes), you may qualify for a late election to recognize the loss for such disposed portion on your 2014 tax return. Beyond the one-year extension, most of the provisions from Rev. Procs. 2014-54 and 2011-14 remain unchanged. A&M Tax Advisor Weekly recently wrote about the IRS’s finalized rules on capitalization and disposition of tangible personal property (see “A Capital Idea — Present and Future Ramifications of the IRS’s Final Repair Regulations” and “Final Repair Regulations — Introduction to the Unit of Property"), which will affect nearly all taxpayers. This edition of Tax Advisor Weekly expands on the discussion of such dispositions and touches on some of the more practical aspects and applications of the newly issued guidance.
As a brief background, generally when a group of assets is placed into service in the same period, taxpayers can elect to establish a General Asset Account (GAA), as long as they have the same depreciation method, recovery period and convention. This allows taxpayers to depreciate multiple assets as a single asset, and upon disposition of a single asset from within a GAA, the GAA continues to be depreciated without any gain or loss recognition. The only way to elect out of GAA treatment is in the event of a “qualifying disposition” — that is, disposal of all assets in a GAA, or disposal of the last asset in the GAA.
Under the final regulations, the disposition of a component of an asset included in a GAA (e.g., an aircraft’s engine replacement or a building’s roof replacement) is not considered a disposition, and thus no gain or loss would be recognized. This is in contrast to the temporary regulations, whereby GAAs would have allowed for the recognition of gains or losses from the disposition of assets or components of assets from GAAs, and so taxpayers may have elected both to establish a GAA and to recognize certain gains or losses relying on the temporary regulations. As a result, under the final regulations, the partial disposition election is a taxpayer’s only means of receiving loss treatment on the disposition of a portion of an asset in a GAA.
This is where Rev. Proc. 2014-54 steps in to give taxpayers another year to retroactively adjust recognition of such partial dispositions and elections with respect to established GAAs. Given that there is now a one-year extension to 2014 — and from what we have seen, many taxpayers did not take advantage of the opportunity to make such an election on their recent 2013 tax filings — taxpayers should strongly consider making a late partial disposition election for 2014 for assets that have been partially disposed of but are still being depreciated, as this extension provides an opportunity for a potentially significant acceleration of such a tax deduction. As we are surprised to see this additional year extension, this may very well may be the last one available.
This added flexibility will allow taxpayers to look back at their 2012 and 2013 tax positions and re-evaluate their current tax positions with respect to tangible depreciable assets. Those who made elections relying upon temporary regulations may revoke those elections and have the option to make new ones. Those who were not previously able to recognize dispositions have one additional chance to do so in 2014.
Asset Disposition Analysis
Having come to the realization that a late partial disposition is available for the 2014 tax year, the next question is whether or not it is beneficial to undertake an asset disposition study. Rather than moving forward immediately with a full disposition analysis, it is often more prudent to first conduct a high-level assessment to ascertain if the potential deduction is sufficient to warrant conducting a full-blown asset disposition analysis. As a full-blown disposition analysis could become costly (depending on the number of properties, types of structures, condition of records, and history of repairs and renovations), conducting a diagnostic test provides an indication of potential financial benefits and may produce valuable information necessary to make an informed decision.
One approach to assess the potential benefit of such an election is to perform an initial analysis or “diagnostic.” Such an analysis includes performing a high-level due diligence to determine the likelihood that any disposition deductions would be material and measurable, thus providing insight into the reasonableness of either moving forward with a full analysis or conducting additional diligence. The information required to conduct this diagnostic is very basic and readily available:
- Tax fixed-asset ledger; and
- High-level building specifications: year built, number of stories, structure class, roof type, renovations/repairs, etc.
The first step in determining if there are assets that are no longer in use but still being depreciated is to conduct a “trend analysis” on the fixed-asset ledger to estimate how much it would cost to replace the entire building today. This step provides the cost to rebuild the structure based specifically on the assets that are contained on the fixed-asset ledger, whether or not all of the assets are actually still in use, or in other words whether there are “ghost assets” that are still on the books and being depreciated.
The second step is to estimate how much it would cost to replace the entire building based on the factors mentioned above, (i.e., structure class, number of stories, etc.). This approach measures the cost to rebuild the structure without any regard to the assets contained on the fixed-asset ledger; thus in this approach the cost to replace the entire building excludes any assets that were previously disposed of but still remain on the fixed-asset ledger (thus it excludes any “ghost assets”).
The results of these steps are then compared. For example, if the cost to rebuild the structure in step one (based on the fixed-asset ledger) is $15 million, while the cost to rebuild the structure in step two is $10 million, the diagnostic indicates that there could be $5 million in replacement costs of assets that have been disposed of but are still present on the fixed-asset ledger. While the deduction is based on the carrying value of the disposed assets rather than the cost to reconstruct the building, the diagnostic provides a directional assessment as to the reasonableness of conducting a full disposition analysis.
If a full analysis is undertaken, the study will:
- Analyze renovations and repairs, with focus on the specific costs incurred and the nature of the renovations and repairs;
- Based on the detailed analysis of the renovations and repairs, identify assets that have been disposed of but are still being depreciated on the tax fixed-asset ledger for federal income tax purposes;
- Identify the carrying value of the assets that have been disposed of and thus can be deducted for federal income tax purposes; and
- Prepare a narrative report and schedules that detail assets that are still being depreciated but have been disposed of and the amount that can be deducted.
To ensure an efficient approach, the following steps should be implemented when conducting a disposition analysis:
- Conduct an inspection of the property (a sample number of properties can be visited if there are numerous properties);
- Review construction drawings, cost information and available blueprint sets;
- Analyze the history and nature of the various renovations and repairs at the property;
- Review and categorize contractor and supplier invoices to determine detailed cost schedules associated with renovations and repairs. This is used in preparing the appropriate documentation for identifying assets that were replaced and thus disposed of previously;
- Estimate the cost to reconstruct the building that was part of the original acquired property and the cost of all replacements and renovations to estimate the portion of the original property carrying value related to prior dispositions; and
- Estimate the carrying value of assets currently being depreciated that should instead be deducted.
For illustrative purposes, consider the following examples of late partial disposition elections:
Example #1 (Basic Example of a Late Partial Disposition Election):
Company A acquired and placed into service a truck in 2009 and depreciates the truck as a MACRS (Modified Accelerated Cost Recovery System) property. In 2012, Company A replaced the truck’s engine. Under temporary regulations (Treas. Reg. Section 1.168(i)-8T), the truck is the asset for disposition purposes, and so Company A did not recognize a loss on the retirement of the engine and continues depreciating the truck, and capitalizes the new engine as a new asset. After application of final regulations (Treas. Reg. Section 1.168(i)-8) in 2013, the partial disposition rule results in the retirement of the engine being a disposition, and so Company A makes the late partial disposition election and recognizes a loss.
Example #2 (Late General Asset Account Election/Revocation & Late Partial Disposition Election):
Company B acquired and placed into service a building and its structural components in 2000. Company B replaced the entire roof in 2010, but did not recognize a loss on the retirement of the original roof, and capitalized the cost of the replacement roof. In 2012 and according to temporary regulations, Company B made a late General Asset Account election and a late qualifying disposition election for the retirement of the original roof. After applying the final regulations, Company B should not have recognized a loss, and so files a late GAA revocation as well as a late partial disposition election in order to take a current deduction on the disposed asset(s).
Alvarez & Marsal Taxand Says:
For many of us, the last tax season resulted in yet another year of increasing tax compliance and reporting demands on tax departments. As we move into year-end planning, a thorough review of the opportunity afforded in Rev. Proc. 2014-54 related to a partial disposition election should be given serious consideration. The ability for many taxpayers to obtain an immediate and significant tax deduction could result in considerable current tax savings, and now we have one more chance to take advantage of this “bite at the apple.”
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Brian Rudelson, Director, contributed to this article.
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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