nsac final repair regs update 080414-final b... · the final tangible property regulations and...

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Implementation Issues: The Final Tangible Property Regulations and Proposed Disposition RegulationsNational Society of Accountants for Cooperatives Tax & Accounting Conference

August 4, 2014

San Diego, CA

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG or Teresa Castanias, CPA TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. NDPPS 142311

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p , , , , ytransaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

Agenda

• Status Report on Tangible Property Regulations and related guidance

• Overview of “next steps”: What you should be doing right now

• Specific Coop’s Implementation Strategies and I


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Issues

• Land O’Lakes

• Darigold

• General Discussion of Common Implementation Issues

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Status Report: TangibleProperty Regulations

Long Road to Here

January 20, 2004 Notice 2004-6 announces government’s plan to develop tangibles regs

August 21, 2006 Government issues first set of proposed regulations

March 10, 2008 Government withdraws 2006 proposed regulations and issues new proposal

December 27, 2011 2008 proposed regulations withdrawn and replaced with third proposal (also issued as temporary regulations, so effective immediately)

September 19, 2013 Final regulations published for acquisition costs and for repair and maintenance costs; proposed regulations issued for dispositions

( )


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January 24, 2014 Revenue Procedure 2014-16 issued (repair and maintenance)

February 28, 2014 Revenue Procedure 2014-17 issued (dispositions)

Pending Final disposition regulations; industry guidance for cable TV, natural gas, retailers

Newly opened Industry guidance for restaurants and mining

Final and Proposed Repair Regulations - Overview

The final repair regulations are effective for taxable years beginning on or after January 1, 2014

Taxpayers may early adopt the final repair regulations for tax years beginning on or after January 1, 2012.

Taxpayers may also choose to apply the 2011 temporary regulations for tax years beginning on or after January 1, 2012 and before January 1, 2014

Proposed dispositions regulations


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When finalized, will be effective for taxable years beginning on or after January 1, 2014

Taxpayers may also choose to apply the proposed or temporary dispositions regulations for tax years beginning on or after January 1, 2012 and before January 1, 2014.

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The tangible property regulations

Organization of regulations – three “buckets”

Acquisition costs

– Transaction costs

– De minimis rule – safe harbor election

– Materials and supplies

Repair and maintenance costs

New book conformity election or


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– New book conformity election, or

– File a method change:

Unit of property

Capitalization standards

Dispositions

– Partial dispositions, including building structural components

– General asset accounts

Summary of Significant Changes

Acquisition Costs (Final)

$5000 per item book-conformity safe harbor

Materials and supplies definition includes $200 items (rather than $100)

Focus on facilitative and inherently facilitative costs

Repair and Maintenance Costs (Final)

Election to follow book capitalization policy

Routine maintenance safe harbor


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– Extended to buildings (with a 10-year testing period)

– Network assets ineligible (pipelines)

Casualty loss “double dip” rule relaxed

Treatment of removal costs clarified

Dispositions/GAAs (Proposed)

Disposition rules significantly modified

Losses allowable for MACRS partial dispositions but generally not permitted for GAAs

Common method changes and elections

Election Method Change

Area of focus Item

Election made with affirmative statement

Election made by

reporting on the return

Method change with

481(a) adjustment

Method change with

limited 481(a)

AcquisitionCosts

Book de minimis policy

Materials and supplies

Election to capitalize & depreciate rotable or


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ptemporary spares

Repairs andImprovements

Repairs vs. improvements

Book conformityelection

Dispositions

Partial disposition

Late partial disposition election

Complete assetdisposition

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Automatic method changes - Rev. Proc. 2014-16 and Rev. Proc. 2014-17

Changes qualify for the automatic consent procedures of Rev. Proc. 2011-14

“Scope limitations” waived temporarily (tax years beginning before 2015)

After expiration of scope limitation waiver, changes will still be eligible for automatic consent, but scope limitations will apply (i.e., if under exam must consider window periods; only one automatic change within a 5 year period; etc.)

Additional requirements

The authority for each change must be described in the Form 3115

The unit of property for repairs changes must be described in the Form 3115


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Section 263A

No requirement that 263A methods be in compliance to file an automatic change

Must consider 263A in calculating the 481(a) adjustment

Adds additional changes under 263A to the automatic consent procedures

Section 481(a) adjustment

Cooperatives (within meaning of section 1381(a)) must generally take a section 481(a) adjustment into account in 1 year, whether positive or negative. See section 5.04(3)(b) of Rev. Proc. 2011-14.

Taxpayers that are not cooperatives generally spread positive 481(a) adjustments over 4 years

Rev. Proc. 2014-16 and 2014-17 – Form 3115 Filing Requirements

Generally, a taxpayer filing an accounting method change under Rev. Proc. 2011-14 must:

Complete and file Form 3115, Application for Change in Accounting Method, in duplicate

Original application must be attached to taxpayer’s timely filed (including any extension) original federal income tax return implementing the change in method of accounting for the year of change, and

File copy of Form 3115 no earlier than the first day of the year of change and no later than the date the taxpayer files the original with the federal income tax return for the year of change with:

– IRS in Ogden UT (Ogden copy) – Single Form 3115 for two or more concurrent changes in


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IRS in Ogden, UT (Ogden copy) Single Form 3115 for two or more concurrent changes in certain cases. For example,

Same identified unit of property (UOP) or, in the case of a building, the same identified building structure or building system

Citation of regulatory section that provides proposed method(s) of accounting

Changes of UOP, building structure or building system must include description of the UOP, building structure or building system under current and proposed method of accounting

Section 481(a) adjustments can be netted for adjustments related to the same identified unit of property (UOP) or, in the case of a building, the same identified building structure or building system

Overview of Next Steps: What should I be doing now?

Develop a work plan to evaluate impact of final regulations and safe harbors

Determine company’s objective – compliance, tax benefits, etc.

Review current financial accounting capitalization policies and procedures for tangible property

Review current unit of property definitions for capitalization, retirements, or IFRS readiness and application of current or pending industry specific guidance

Consider potential application and benefits of available safe harbors (de minimis book


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Consider potential application and benefits of available safe harbors (de minimis, book conformity, RMSH)

Consider preferred timing of implementation – 2014, or earlier?

Begin cataloging the various method changes and annual elections that will be required to implement the regulations consistent with company’s objective

Prepare for discussions with financial auditors and IRS CAP team (if applicable)

Consider any method changes needed for 2013 tax year

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Goals and Objectives in Implementation of Regulations

Typical goals for cooperative taxpayers:

Compliance with the law

– What must be done and when? Do I have to file Form 3115’s?

Questions and concerns from external auditors

– What will be required for financial statement purposes?

Potential favorable opportunities

– Impact on patronage income and patronage computation


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Addressing different approaches (e.g. acquired companies, multiple business units)

Simplicity

– What have I done for book purposes? How does it compare to the regulations?

– Many have found book is not that different , and book can be coordinated with tax

Always thoroughly consider the complexities in tracking book and tax differences, not just in depreciation methods now but in what is actually capitalized

Repair Regulations Implementation Panel

Mary Denler, Land O’Lakes, Inc.Sharon Appelt, Darigold, Inc.


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Repair Study Joke

What are the most important factors to consider when undertaking the implementation of the final repair regulations?


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… wait for it

…wait for it

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Repair Study Joke

Location, Location, Location


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Timing, timing, timing

Land O’Lakes Implementation

• LOL had voluntarily capitalized 1.606% of repair expenses since 1999.

• The capitalization rate was an estimation of repair expenditures which should have been capitalized based on the error rate during the 1997-1998 IRS


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audit.

• The conclusion to voluntarily capitalize a portion of the repair expenditures was taken after a very lengthy and contentious IRS audit of the repair expense accounts.

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• Effective, for the tax year 2008 the IRS issued new repair capitalization regulations Prop Reg § 1.162-4 , Prop Reg §1.263(a)-1 , Prop Reg § 1.263(a)-2 , Prop Reg § 1.263(a)-3 IR 2006-130.

• The new regulations provided that an amount paid that materially increased the value of a unit of property, or that


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y p p y,restores a unit of property, is an improvement which must be capitalized.

• The proposed regulations also provided very specific rules that would determine whether a material increase or a restoration has occurred.

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• LOL filed an incidental repair 3115’s for 2005, 2006, and 2007 to expense minor repairs of buildings which were capitalized.

• The UOP concept per the new regulations allowed us to expense immaterial repairs of the UOP.


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• We filed two 3115’s with 2008 return.

• Consolidated 1120C, and

• PAN, LLC 1065 partnership return

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• Results: • More than $13 million recaptured in repair study

• More than $50,000,000 of PPE additions reviewed

• $2 million in cash tax savings in year one

• We closed our 2006 2007 2008 audit without


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• We closed our 2006, 2007, 2008 audit without adjustment to our fixed assets.

• A depreciation engineer reviewed the 3115’s

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• Temporary regulations issued:

• Determined that we have to revisit repair study

• Reviewed the 19 talking points of temporary regulations with fixed asset staff

• Planned to wait on final regulations – too much minutia on GAA etc Hoping that the de minimis mess would be


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GAA, etc. Hoping that the de minimis mess would be clarified.

• We dispensed with one 3115 in the 2012 return

• We have a second 3115 in our 2013 return for the remainder of the repairs study “claw back” and alignment with final regulations

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• Final regulations issued: • Our repair study “claw back” contemplates the final

regulations

• “Claw back” approximately $3 million

• We are filing the de minimis election in all returns


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g

• We are not filing book conformity elections

• We have incidental repairs and maintenance items in inventory we have to deal with in our 2014 return

• Our inventory of deferreds on all of these exercises is nil.

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Status at Darigold on Implementation

• We are filing the de minimis election

• Most likely not filing book conformity elections

• We are filing a change in accounting method for repair parts

• Expense as supplies repair parts

El i li & d i db


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• Elect to capitalize & depreciate standby emergency spare parts

• We have been expensing repairs for tax purposes for many years creating book/tax differences

• More work to be done for change in accounting method and 481 adjustment related to repairs vs. improvements

General Discussion of Major Implementation Issues

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Big Picture: Compliance

My company doesn’t care about timing. Can I just follow books?

My company is a cooperative. I know we can go back and review prior year’s repairs expense and capitalized amounts, but we don’t need additional income or expense at the cooperative level. Do I have to do anything with the old years?


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Should I wait to see if the IRS issues additional guidance before doing anything?

My company is a cooperative that pays patronage on a “book basis”. Since these rules only affect the tax return, is there anything I should be concerned with for my patronage dividend?

Acquisition/De minimis Costs

1. My company’s minimum capitalization policy is higher than $5,000. Can I still elect the de minimis safe harbor?

2. We have a minimum capitalization policy and we try to follow it, but some plant managers aren’t consistent. Can we still elect the de minimis safe harbor?

3. We have different minimum capitalization policies for different categories of costs. Can I still elect the safe harbor?

4. My company currently follows specific guidance for certain costs, such as smallwares and truck tires Can I keep using these if I make the book conformity safe harbor?


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truck tires. Can I keep using these if I make the book conformity safe harbor?

5. For any given part, we might repair and reuse it, or we might scrap it, depending on a particular part’s condition when it is removed. Are these “rotables”?

6. What if my financial statements are reviewed, not audited, and the coop’s policy is to expense capital items under $1,000?

7. What is the interaction of the de minimis rule with materials and supplies (for example, amounts less than $200)?

8. Can I break the unit of property into smaller, less expensive, components?

Capitalization Standards

1. Can I use a cost or percentage based standard to compute repair costs?

2. How do I treat periodic “refreshes” of our buildings, especially for non-retail space where we don’t have (and aren’t expecting) an IIR?

3. We don’t have a companywide capitalization policy – plant managers make the decisions and send the info to company HQ – so there isn’t 100% consistency. What do I do?

4. The regulations discuss a laundry with various “lines” that do specific functions of the laundry – wash, dry, press, etc. Those individual lines are considered a “unit of property” in the regulations. Can you discuss the practical implications of this?

• What if our GAAP policy does not define the capitalization of items with respect to the same “unit of


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at ou G po cy does ot de e t e cap ta at o o te s t espect to t e sa e u t oproperty” as you do for tax purposes?

• What if our fixed asset system has not been set up to identify things this way?

5. Our cooperative is on the tax basis for computing its patronage income, and has a patronage net operating loss carryover (NOL). A change in accounting method will generate patronage income greater than the NOL. How should this unusual patronage income be distributed to patrons? Or can/should it be kept in the cooperative’s permanent reserves?

6. We know there are items on our fixed asset listing that could have been expensed, but we don’t want to do the analysis or make any changes to our past tax accounting for these items. Can we do that? If so, how do we let the IRS know? If not, how far back do we have to go?

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Systems Issues

My company’s fixed asset systems aren’t configured to track some of the information required by the tangibles regulations. For example, we cannot:

Track the remaining basis of building components

Match or link prior year retirement(s) with the corresponding replacement asset(s)


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( )

Separately identify rotable or temporary spare parts

Distinguish between incidental and non-incidental materials and supplies

Implement changes in the fixed asset system for a large depreciation or repairs study

What are some options we should consider?

Dispositions

1. I didn't read the entire 100-page revenue procedure on method changes for dispositions. Bottom line – what do I need to know?

2. Do we need to consider the General Asset Accounts method anymore? What advantages would there be to doing that?


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General Q & A

What questions do you have?


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APPENDIX -Details of Regulations and Implementation Strategies

Practical ImplementationConsiderations

Practical Implementation Considerations

Implementation Considerations

Should I adopt the temporary, proposed or final regulations?

Do I file a Form 3115 or make an election?

Will I calculate a Section 481(a) adjustment or will it be a “cutoff” method?

Elections are different from accounting method changes

No Form 3115 is required (exception for certain “late” elections)

Requirements for making elections are outlined in regulations – no one rule


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Requirements for making elections are outlined in regulations no one rule

White paper statement required? – no one rule

Taxpayers following book with no prior repairs study

In general, taxpayers following book will be overcapitalizing expenditures

Analyze book capitalization policy to identify where taxpayer can accelerate expenditures for tax through current deduction or accelerated depreciation

Can book and tax be the same? What are the implications to cooperative patronage income and patronage deduction of the two being different?

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Implementation Steps

If you haven’t started, now is the time!

Steps to determining impact on your cooperative:

Get a copy of the final repair regulations and latest proposed disposition regulations and

related current Revenue Procedures

Attend a couple of webinars and go to the AICPA or large accounting firm websites for good

information on implementation

Review your GAAP policies on what is capitalized vs expensed


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y p p p

Review your GAAP policies on what you do with materials and supplies and compare to the 4

options you will have for tax purposes

Review your GAAP policies on what you do with rotable and temporary spare parts and

compare to the 3 options you will have for tax purposes

Review your assets to determine what will be the Unit of Property (UOP) for an asset

Implementation Steps (continued)

Review fixed asset listing and repairs and maintenance accounts to determine if you have an

opportunity to change your method of accounting for the item under the regulations.

– Consider carefully whether you want to do that in light of your cooperative’s goals for

patronage

– Impact on patronage dividend if you are on the tax basis

– Impact on tax carryovers or carrybacks if you are on the book basis


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Review your treatment of dispositions for GAAP and tax

Review elections and accounting method changes that may apply in light of what you have found

Consider preferred timing of implementation – 2014 or earlier?

Begin cataloging the various method changes and annual elections that will be required to implement the regulations consistent with your company’s objectives

Set timeline and steps to implement your decisions

The tangible property regulations

Organization of regulations – three “buckets”

Acquisition costs

– Transaction costs

– De minimis rule – safe harbor election

– Materials and supplies

Repair and maintenance costs

New book conformity election or


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– New book conformity election, or

– File a method change:

Unit of property

Capitalization standards

Dispositions

– Partial dispositions, including building structural components

– General asset accounts

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Acquisition costs

Transaction costs

Tax

Facilitative Costs – an amount paid in the process of investigating or otherwise pursuing the transaction

Invoice cost

Inherently facilitative costs (partial list):

– Transportation costs

– Appraisal costs

GAAP

Historical cost – purchase price (less cash discounts); includes sales tax

Transportation charges (e.g., freight)

Installation & assembly

Testing and design

Closing costs


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Appraisal costs

– Sales and transfer taxes

– Architectural

– Installation costs, etc.

Other facilitative costs

– Whether & which test applies to real property only

Employee labor excluded

g

– Attorney fees

– Title

– Recording

Land grading, filling, draining, and clearing

De minimis rule - safe harbor

2011 ceiling replaced with a safe harbor

Requirements to use the safe harbor

Taxpayer has written procedures at the beginning of the taxable year treating as an expense for non-tax purposes amounts paid for property:

– Costing less than a specified dollar amount; or

– Having an economic useful life of 12 months or less

T t t i AFS


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Taxpayer treats as an expense in AFS

Amount eligible for safe harbor may not exceed $5,000 per invoice (or per item on invoice)

– Additional costs (e.g., delivery and installation) not included if not on the same invoice

Requires annual, irrevocable election

– May amend for 2012 or 2013 unless no written policy

Higher amounts allowed if clear reflection of income

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De minimis rule – FAQs

What if my book threshold is less than $5,000 per item?

What if my book threshold is more than $5,000 per item?

How are bulk purchases handled?

Can I break the unit of property into smaller, less expensive, components?

What is the interaction of the de minimis rule with materials and supplies (for example, amounts less than $200)?

Is the annual de minimis election made at the subsidiary level or at the consolidated or group


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level? Can there be one written policy for the group? What if the cooperative has a taxable subsidiary, and wants a different election for the cooperative vs the taxable subsidiary?

What is the definition of an applicable financial statement?

What if my financial statements are reviewed, not audited, and the coop’s policy is to expense capital items under $1,000?

Does section 263A apply to amounts expensed under the de minimis safe harbor?

We have different minimum capitalization policies for different categories of costs. Can I still elect the safe harbor? How do I disclose this?

De minimis rule - safe harbor election

How to make the annual election

Statement attached to the timely filed original income tax return (including extensions)

The statement must be titled “Section 1.263(a)-1(f) de minimis safe harbor election” and include the following:

– taxpayer's name,

– address,

t id tifi ti b


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– taxpayer identification number,

– and a statement that the taxpayer is making the de minimis safe harbor election under §1.263(a)-1(f).

Parent must list the name and identification number of each consolidated group member making the election.

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Accounting for materials and supplies

Options for accounting for materials and supplies:

Deduct “non-incidental” materials and supplies when used or consumed, unless they are used in a capital improvement

Deduct “incidental” materials and supplies in the year purchased

Deduct any material and supply in the year

GAAP comparison:

Spare parts (replacement items such as motors) are generally capitalized as part of property

Insignificant spare parts may be treated as prepaid expense or supplies inventory

Spare parts not in use are depreciated over f f /


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Deduct any material and supply in the year purchased if it qualifies under the de minimis rule

Capitalize and depreciate only materials and supplies that are rotable, temporary, or emergency standby spare parts (can’t go back!)

remaining life of equipment/property

Tools, dies, patterns, utensils, etc.

– Expense immediately

– Amortize over life of product or shorter period if short lived or subject to disappearance

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Materials and supplies

Materials and supplies defined:

1. A component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer

2. A unit of property with an economic useful life of 12 months or less

3. A unit of property that has an acquisition or production cost of $200 or less

4. Fuel, lubricants, water and similar items that are reasonably expected to be consumed within 12 months or less, beginning when used in the taxpayer’s operations


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g g p y p

5. Property identified in published guidance as M&S

6. Rotable, temporary, or emergency stand-by spare parts

Rotable and Temporary Spare Parts

Me Method 2

Capitalize and depreciate starting upon acquisition

Method 1

Deduct full basis on final disposition

Important Note

MAY deduct under de minimis rule unless optional method is used or election to capitalize and

Method 3

Optional method –exchange type treatment.

Deducting when placed in service and capitalizing repair costs of broken item

Options for accounting for spares:


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depreciate is madecosts of broken item

If elected, generally applies to entire pool

REQUIRED IF USED FOR BOOKS AND RECORDS

Transition rules for Acquisitions Costs (cont.)

Method Changes

Change 186* – to deduct non-incidental materials and supplies when used or consumed

Change 187 – to deduct incidental materials and supplies when purchased

Change 188 – to deduct non-incidental rotable and temporary spare parts when disposed of

Change 189 – to the optional method for rotable and temporary spare parts

Change 192* – to capitalize acquisition or production costs (and depreciate them)


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Change 193* – to the whether and which test for real property

Annual Elections

De minimis rule (as discussed, requires affirmative statement)

Capitalization of employee compensation or overhead as acquisition cost

Election to capitalize and depreciate rotable, temporary, or emergency stand by spares

*Modified 481(a) - applies to amounts paid or incurred in taxable years beginning on or after January 1, 2014. Certain exceptions may apply (e.g., optional method for rotables)

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FAQs – Materials and supplies

My company currently follows specific guidance for certain costs, such as smallwares and truck tires. Can I keep using these if I make the book conformity safe harbor?

For any given part, we might repair and reuse it, or we might scrap it, depending on a particular part’s condition when it is removed. Are these “rotables”?

Can I use a cost or percentage based standard to compute repair costs?

How do I treat periodic “refreshes” of our buildings, especially for non-retail space where we don’t have (and aren’t expecting) an IIR?

My company’s fixed asset systems aren’t configured to track some of the information required by the tangibles regulations. For example, we cannot:


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– Track the remaining basis of building components

– Match or link prior year retirement(s) with the corresponding replacement asset(s)

– Separately identify rotable or temporary spare parts

– Distinguish between incidental and non-incidental materials and supplies

– Implement changes in the fixed asset system for a large depreciation or repairs study

What are some options we should consider?

I didn't read the entire 100-page revenue procedure on method changes for dispositions. Bottom line – what do I need to know?

Repair and maintenance or capital improvements?

The Second “Bucket” – Repair and Maintenance Costs

Book capitalization election

Book typically over-capitalizes

Applies to amounts capitalized; not expensed

No 3115 required for expenses or if book always followed (IRS public statements)

File Form 3115 – alternatives:


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1. Form 3115 to accelerate tax deductions for previously capitalized improvements

Requires 481(a) adjustment

Statistical sample usually required

2. Form 3115 with zero or minimal 481(a)

Practical way to follow book without filing a Form 3115

Prior method change / study

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Election to follow book capitalization policy

Taxpayer may elect to capitalize otherwise deductible repairs

If incurred in trade or business; and

Capitalized in books and records regularly used in computing income.

Must be applied to all amounts paid for repair and maintenance of tangible property that taxpayer treats as capital expenditures on its books and records in that taxable year.

Note that this doesn’t apply to amounts expensed for book purposes, including under the de minimis rule.


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The annual election is irrevocable

Book capitalization election

How to make the annual election

Statement attached to the timely filed original income tax return (including extensions)

The statement must be titled “Section 1.263(a)-3(n) election” and include the following:

– taxpayer's name,

– address,

– taxpayer identification number,


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– and a statement that the taxpayer is making the election to capitalize repair and maintenance costs under §1.263(a)-3(n).

Parent must list the name and identification number of each consolidated group member making the election.

File Form 3115 - unit of property

Buildings Everything Else

Default Rule Plant Property Network AssetsSingle UOP


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Functional Interdependence

Discrete and major function

Facts & circumstances -industry specific

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Plant Property – Three Step Analysis

“Plant property” rules particularly important for manufacturing operations

Step one: identify “functionally interdependent” assets

Step two: identify “discrete and major functions” within the property identified in step one

Step three: identify “major components” of the UOPs identified in step two (you will need that later)

Standard is largely factual

I t i ith l t ti l i l bl


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Interviews with plant operations personnel are invaluable

Publicly available information (website, tour materials, educational materials, etc.) describing “what we do” may be useful as well . . . and are likely to be considered by IRS

One more step

After identifying the “unit of property,” the taxpayer must identify any “major components” or “substantial structural parts” of that UOP

This is required for any UOP, not just plant property

Costs incurred to replace either a major component or a substantial structural part of a UOP must be capitalized as a restoration

Major component

A major component is a part or combination of parts that performs a “discrete and critical”


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j p p p pfunction in the operation of the unit of property.

Example: wiring is a major component of a building’s electrical system because it performs a discrete and critical function in the operation of the electrical system

Substantial structural part

A substantial structural part is a part or combination of parts that comprises a large portion of the physical structure of the unit of property

Example: 100 windows are a substantial structural part of a building’s structure, where the building’s 300 windows represent 90% of the total surface area of the building

Plant Property – Regulations’ Examples

Electric power plant

Structure

Boiler

Turbine

Generator

Each coal pulverizer

Commercial laundry facility


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Commercial laundry facility

Sorter

Boiler

Washer

Dryer

Ironer

Folder

Waste water treatment system

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Unit of property – buildings

Entire building

Determine UOPApply

Capitalization Standards

Building structure

Building systems

Capitalize Improvements

to UOP

Entire building


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HVAC

Plumbing system

Electrical system

All escalators

All elevators

Fire protection

Security system

Gas distribution

GAAP capitalization standards

Costs incurred during ownership consist of additions, improvements, alterations, rehabilitations, replacements, repairs, etc.

Capitalized cost -

appreciably extend the life,

increase the capacity, or

improve the efficiency or safety of the property


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Consideration of materiality is always applicable

File Form 3115 - capitalization standards - detail

1. Material condition or defect at acquisition or production

2. Material addition, including a physical enlargement, expansion, extension, or addition of a major

Betterment Restoration

1. Component loss

2. Gain/loss on sale of a component

3. Casualty loss

4. Return to former operating condition – no longer


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component; or a material increase in the capacity

3. Reasonably expected to materially increase the productivity, efficiency, strength, quality, or output

Adaptation

functioning

5. Rebuild to like new condition after the class life

6. Replacement of a major component or substantial structural part

Showroom to manufacturing

Walk-in medical clinic

Grocery - sushi

Hospital emergency room

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Book Conformity Safe Harbor

Taxpayer may elect to capitalize otherwise deductible repair and maintenance costs

If incurred in trade or business; and

Capitalized in books and records regularly used in computing income.

Must be applied to all amounts paid for repair and maintenance of tangible property that taxpayer treats as capital expenditures on its books and records in that taxable year.

Not a pure “book conformity” safe harbor

D t l t t d f b k


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Does not apply to amounts expensed for book purposes

– The annual election is irrevocable

– There are strategic uses, but also downsides

Would this be useful to cooperatives who want to minimize possible book/tax differences?

Exception to general capitalization standard – Routine Maintenance Safe Harbor (RMSH)

Permits a current deduction for certain otherwise capital expenditures that the taxpayer expects to perform at least twice during the unit of property’s “ADS class life”

Key is initial expectation of performing the activity at least twice – even if ultimately that does not happen

Final Regulations extend RMSH to buildings

Must use 10-year testing period rather than 40-year ADS class life for buildings

Potentially useful for planned “refreshes” expected to occur twice within 10-year period


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y p p y p

Be careful not to include the cost of new equipment, furnishings, etc., in the scope of costs deducted under RMSH -- applies only to “repair and maintenance costs”

RMSH continues to be applicable to costs of replacing “major components”

Does not apply to certain types of activities or property

Betterments or adaptations of property to a new or different use

Certain types of restorations (for example, where a casualty loss was claimed)

Network assets

Example – major component or substantial structural part

Treas. Reg. 1.263(a)-3(k)(7) Examples 25, 26, and 27

300 exterior windows represent 25 percent of surface area of building

The windows represent a major component of the building structure (discrete and critical)

– Replacement of 100 of 300 windows is not a significant portion of a major component

– Replacement of 200 of 300 windows is a significant portion of a major component

Assume that 300 windows represent 90 percent of the surface area of the building


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– Again, the windows represent a major component of the building structure (discrete and critical)

– The windows are also a substantial structural part of the building because they comprise a “large portion of the physical structure” of the building

Replacement of 100 of the 300 windows is considered the replacement of a substantial structural part because the windows represent 30 percent of the surface area of the building

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Building examples (cont.) – major component or substantial structural part

Not a major component or substantial structural part:

Replacement of floors in lobby of hotel (lobby represented 10% of total square footage)

Replacement of 8 of 20 sinks in retail building (restrooms on 2 of 3 floors)

Replacement of 30% of wiring in building

Replacement of a major component or substantial structural part:

Replacement of all floors in public areas of hotel (represented 40% of total square footage)

Replacement of all toilets and all sinks in retail building (restrooms on 2 of 3 floors)

Replacement of all wiring in building


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Replacement of 30% of wiring in building

Replacement of 3 of 10 roof mounted HVAC units

Replacement of 1 of 3 furnaces in single HVAC system

Replacement of entire roof membrane

p g g

Replacement of one chiller unit in single HVAC system

Replacement of sprinkler system

Replacement of entire roof

Building examples – betterments

Not a betterment:

Building refresh – cosmetic & layout changes; flooring repairs, moving a wall; patching holes, repainting; repairing ceiling tiles; flooring repairs

Addition of concrete lining to prevent oil from seeping into meet processing plant

Replacement of roof membrane

Betterment:

Building remodel – replacement of large sections of walls (with windows); rebuilding interior and exterior facades; replacement ceilings and ceramic flooring; rebuilding walls, etc.

Material increase in strength – addition of expansion bolts to building foundation –regulatory requirement for earthquake safety


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Replacement of roof membrane

Replacement of 2 of 10 roof mounted HVAC units (10% more energy efficient)

safety

Material increase in capacity –reinforcement of columns and girders 50% greater load carrying capacity

Material addition and increase in capacity –new stairway and mezzanine to retail building

Material increase in efficiency – addition of new insulation to building

481(a) calculations – stat sampling permitted - Rev. Proc. 2011-42


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Example 1 – Invoice documentation of HVAC repair

“Installed new compressor in Trane roof unit. Checked for

leaks and changed unit”

Acceptabledocumentation:


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Example 2 – Incomplete documentation - electrical

Incomplete documentation:

Per this invoice, the drawings or an interview with facilities would be required

“Begin installation of electrical as per


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pdrawings”

Transition rules for repairs and improvements (cont.)

Method Changes

Change 184 – to deduct amounts paid or incurred for repair and maintenance or a change to capitalize such amounts as improvements (including unit of property determinations)

■ Rev. Proc. 2014-16 requires that the authority for each change be described in the Form 3115

■ Rev. Proc. 2014-16 requires that the unit of property for each change b d ib d i th F 3115


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be described in the Form 3115

Change 185 – to the regulatory accounting method

Annual Elections

Election to capitalize items capitalized for financial reporting purposes (book)

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FAQs and Specific Cooperative Issues

The regulations discuss a laundry with various “lines” that do the specific functions of the laundry – wash, dry, press, etc. Those individual lines are considered a “unit of property” in the regulations. Can you discuss the practical implications of this?

What if our GAAP policy does not define the capitalization of items with respect to the same “unit of property” as you do for tax purposes?

What if our fixed asset accounting system has not been set up to identify things this way?

We know there are items on our fixed asset listing that could have been expensed, but we don’t want to do the analysis or make any changes to our past tax accounting for these items. Can


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we do that? If so, how do we let the IRS know? If not, how far back do we have to go?

Our cooperative makes extensive repairs/major refurbishing (called “shutdowns”) to various production lines on a regular (e.g. every 3 years) basis. For book, these shutdowns are capitalized for book purposes and amortized over 3 years. For tax, these shutdowns are expensed. Will the new regulations impact this treatment? Could we go to the book method with the same amortization period if we want?

Our cooperative is on the tax basis for computing its patronage income, and has a patronage net operating loss carryover (NOL). A change in accounting method will generate patronage income greater than the NOL. How should this unusual patronage income be distributed to patrons? Or can/should it be kept in the cooperative’s permanent reserves?

Dispositions

Dispositions

A “disposition” is a transfer of ownership of the asset or the permanent withdrawal of an asset from the trade or business.

Includes:

– Sale or exchange

– Retirement

– Physical abandonment

D t ti


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– Destruction

– Transfer to a supplies, scrap, or similar account

– A portion of an asset

Including elective treatment for building structural components

– Involuntary conversion

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Completely revised disposition rules

Temporary Regulations relied heavily on general asset accounts to permit partial dispositions of building components

Taxpayers expressed various practical concerns about the GAA rules

Treasury and IRS have proposed a completely different approach

Proposed rules are designed to give taxpayers the same flexibility in recognizing (or forgoing) a loss upon the disposition of a component of a MACRS asset (a “partial disposition”) regardless whether the property is held in a GAA


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Recognizing a loss upon partial dispositions generally is elective, but is mandatory in four specific circumstances (e.g., casualty loss, involuntary conversions)

Treatment of partial disposition determined on original return – not as a method change

– Limited exception where IRS disallows repair deduction related to partial disposition of asset still owned by taxpayer as of beginning of the year of change

Basis considerations

Allows use of a reasonable method, and provides non-exclusive examples

Partial Dispositions under 2013 Proposed Regulations

Default Treatment General Asset Account Election

General rule:

– Depreciation stops

– Gain or loss recognized on disposition of entire asset, or

– Partial disposition from casualty, sale certain non-recognition

General rule:

– Depreciation continues - no immediate recovery of basis

Exceptions:

Disposition of all or last asset in the


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sale, certain non-recognition transactions

Partial disposition - optional annual election*

– any portion of an asset

*Amended return or method change for 2012 or 2013

– Disposition of all or last asset in the account

– Qualifying dispositions:

Casualty

Charitable Contribution

Termination or sale of business

Non-recognition transactions

Observations

Planning considerations:

Partial disposition election made on a timely filed return in the year of disposition

Limited partial dispositions for assets in GAAs (building structural components)

Simplified methods for identifying adjusted basis disposed of

Need income? Consider making the GAA election

Method change to recover stranded basis (ghost assets) available after 2013?


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Transition rules for Dispositions (cont.)

Method Changes (partial list)

Change 176 – changes (GAA or non-GAA assets) in identification or grouping

Change 177 – disposition of a building structural component or partial disposition

Change 178 – disposition of tangible depreciable assets (other than buildings)

Change 179 – disposition of tangible depreciable asset in GAA

Change 180 – late general asset account elections


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Change 196 – late partial disposition election

Change 197 – revocation of general asset account election

Change 198 – Partial disposition upon IRS adjustment

Annual Elections

Partial disposition election

Example – dispositions method change

Roof replacement

X, a calendar year taxpayer, acquired and placed in service a building and its structural components in 1990

In 2000, X replaced the entire roof of the building

X did not recognize a loss on the retirement of the original roof and continues to depreciate the original roof.

X also capitalized and depreciated the cost of the replacement roof


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X also capitalized and depreciated the cost of the replacement roof

X may file an automatic change to make a late partial disposition election for the original roof to recognizing a loss upon its retirement. The § 481(a) adjustment is the adjusted basis of the roof as of the beginning of the year of change.

Alternatively, X may file an automatic change under the temporary regulations to treat the building as an asset and each structural component of the building as a separate asset for disposition purposes and also to change from depreciating the original roof to recognizing a loss upon its retirement. The § 481(a) adjustment is the adjusted basis of the roof as of the beginning of the year of change.

Rev. Proc. 2014-17: GAAs

Late GAA Elections

May file a method change for 2012 or 2013 to make a late GAA election for assets that were placed in service before 2012 and that the taxpayer still owns as of the year of change

Precludes new “CBS changes” for assets no longer owned

– Does not affect existing CBS changes and related section 481 adjustments

– IRS will respect late GAA elections made under early guidance for property not owned at the time of the election


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Opportunity:

– Use of GAA elections may be administratively attractive to taxpayers with large volume of small dollar assets and dispositions: park it and forget it

– Late GAA elections provides limited window to “clean up” fixed asset records to group such assets if desired

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KPMG External Website


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Contact information

Eric Lucas, Principal

KPMG LLP

(202) 533-3023

[email protected]

Teresa Castanias, CPA

916) 761-8686

[email protected]

James Bell, Senior Manager

KPMG LLP


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Mary Denler, Tax Manager

Land O’Lakes

(651) 375-2746

[email protected]

Sharon Appelt, Tax Director

Darigold, Inc.

(206) 286-6790

[email protected]

[email protected]


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