1 / 39

Understanding Section 263(a) Regulations for Improvements and Deductions

Learn about key concepts and safe harbors under IRS regulations 263(a) for capitalizing improvements. Review examples and implications for tax treatments.

olinda
Download Presentation

Understanding Section 263(a) Regulations for Improvements and Deductions

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Capitalize, Amortize or Deduct Adjusting for aNew Recipe (263(a)) Cameron L. Hess, CPA, Esq. Wagner Kirkman Blaine Klomparens & Youmans LLP Sacramento Walnut Creek chess@wkblaw.com (916) 920-5286

  2. Review of 263(a) • 9/19/2013. Final Regs. (2103-13 IRB 331) • Effective 1/1/2014 • 64 pages, including preamble. WKBK&Y 1066733 C. Hess 916-920-5286

  3. Review of 263(a) • Why Important: Shifted the way we divide capitalizing improvements from repair deductions • “New” Concepts • Unit of Property (from Domestic Production Ded’n) • Building Systems WKBK&Y 1066733 C. Hess 916-920-5286

  4. Final 263 Regulations - Overview • Replacing a • Major Component (MP) or • Substantial Structural Part (SSP) usually means capitalization. WKBK&Y 1066733 C. Hess 916-920-5286

  5. Not Improvements – Safe Harbors • De Minimis Safe Harbor (“f”) election • Routine Maintenance (1.263(a)-3(i)) • Small Taxpayer Expenditures (“h”) election WKBK&Y 1066733 C. Hess 916-920-5286

  6. New De Minimis Rule • De Minimis Election • 1.263(a)-1(f): • Optional • Annual election: if elect, covers year’s purchases • Be consistent (financial statements/books) • Apply items on invoice-by-invoice basis. • Not for inventory, land, rotables WKBK&Y 1066733 C. Hess 916-920-5286

  7. New De Minimis Rule • Two Types: • “AFS” • “applicable financial statement” = FS for SEC, gov’t agency, general audit (attest) • $5,000 limit • Witten accounting policy at beginning of yearrequired • “No AFS” – Notice 2015-82 • $2,500 limit ($200 materials/supplies) • Taxpayer must adopt a “policy”, but it need not be written WKBK&Y 1066733 C. Hess 916-920-5286

  8. Not Improvements – Safe Harbors • Routine Maintenance (1.263(a)-3(i)) • Do more than once every 10 years. • Escalator hand rails (4/yrs), HVAC maint. (4./yrs) (repl. condenser). • Allowable for rotables. WKBK&Y 1066733 C. Hess 916-920-5286

  9. Fun Test: Routine Maintenance • Raj Wolowitz Apartments. Owner forgot to certify his elevator. It has not been working for 3 years. Maintenance is usually in 3 year cycles. • Sheldon Cooper complains to Penny, his manager. She gets Raj to do maintenance for $1,100 and to pay a $100 inspection fee. • According Example 12, the $1,100 paid probably is: a) deductible (repair) or b) capitalized. WKBK&Y 1066733 C. Hess 916-920-5286

  10. Not Improvements – Safe Harbors • Small taxpayers expenditures (1.263(a)-3(h) • Ave Gross Receipts < $10 Million (See Rev. Proc. 2002-28) • Un adjusted basis </= $1 million • Total repair/improvements = lesser of: • 2% of unadjusted basis • $10,000/building • All repairs/improvements lumped in for $10K limit WKBK&Y 1066733 C. Hess 916-920-5286

  11. Not Improvements – Safe Harbors • $10 Million Ave Gross Receipts Limit • All sources • Can deduct returns & allowances • Can exclude sales tax (if buyer imposed) – CA. • 3 Prior Year (shorter if < 3 years operating) • Annual election • If elect, but exceeds > $10K, only disqualified for that building WKBK&Y 1066733 C. Hess 916-920-5286

  12. Partial Disposition Election • 1.168(i)-8(d). • If capitalize an improvement, then taxpayer may election to write-off part of existing asset disposed of. • Example: Remodel pool in 2012 – pipe breaks, must do 2nd remodel in 2015. • No form of election required: “Just do it.” WKBK&Y 1066733 C. Hess 916-920-5286

  13. Unit of Property - Building • Buildings: IRS Takes “Split” Approach • Whole Building: Systems = parts of buildings). • Identify 9 common “systems” in buildings • Systems are NOT a Unit of Property; but decide capital improvement at a systems level. • Tenant: Tenant’s Unit – 1 Unit (unless divisions) • Condo/Co-op: (Each Unit = 1 Unit) WKBK&Y 1066733 C. Hess 916-920-5286

  14. Unit of Property - Building • Building systems (examples): • HVAC (heat, ventilation, and A.C.); • Plumbing • electrical systems; • Escalators and elevators; • fire protection, • alarm, security systems; • gas distribution systems; and • other systems identified in published guidance. WKBK&Y 1066733 C. Hess 916-920-5286

  15. Examples • Betterments – Major Component • Gas Stations. New tanks have leak detection. • Sprinkler System. New fire system • 100% Remodel. • All hotel bathrooms over 4 years (including furnishing replaced). • All flooring of public areas of hotel. (b/c not refreshment) WKBK&Y 1066733 C. Hess 916-920-5286

  16. Examples • Not Betterments • Replace 100 of 300 damaged exterior windows • Replace 4 of 10 old sinks (40%) • Replace Top Layer of “Roof” • M = Owner, replaces entire “membrane” (top layer). • Remove “drop ceiling” – paint exposed ducts. • Replace 2 of 10 roof-top worn HVAC systems, even if better! WKBK&Y 1066733 C. Hess 916-920-5286

  17. Fun Problems • The roof leaks. Out of 10 units, 3 are most affected. Just over the 3 units is membrane and 12 sheets of plywood are replaced. • Is this a repair? • Is this an improvement? • Tsakapoulous. • Would the result be different if the whole membrane was replaced, but not the plywood? WKBK&Y 1066733 C. Hess 916-920-5286

  18. Fun Problems • A’s office building (leased) has: • 10 A/C Units, each separately piped. • How many HVAC systems are there? i) 1 or ii) 10. • 1.263(a)-3(e)(2)(ii)(v)(B)(6), Example 1 • 2 banks of 3 lifts (6 total) and two escalators • How many systems are there: i) 1, ii) 2, iii) 3, iii) 7, iv) 8 • Example 2 • Tenant leases 2 Units, each w/ separate A/Cs • How many systems does tenant have: i) 1 or ii) 2. • Example 13 WKBK&Y 1066733 C. Hess 916-920-5286

  19. Purchases/Acquisition Costs • 1.263(a)-2. Basic Rule: Capitalize: • purchases, • build or create an improvement • Pre-development (Von-Lusk T.C. (1995) entitlements) • Repairs before placed in service • Acquisition costs (broker/attorney fees) • Defend/protect title WKBK&Y 1066733 C. Hess 916-920-5286

  20. Not Changed • Section 263A • Capitalization for property produced by taxpayer • Real or personal property (e.g., costs to perfect title) • Capitalization of property acquired for resale • Section 162 • Materials & supplies (under 1.163-3) WKBK&Y 1066733 C. Hess 916-920-5286

  21. Deductible Repairs/Maintenance • Examples (Deductible) 1. T undertakes an asbestos abatement project to remove and replace insulation. The removal does not improve insulation efficiency. 2. T does “Cosmetic” refreshing (minor improvement): • Hotel lobby floor changed (not whole hotel floor); • Retail store shelving changed (no greater storage). • IRS conceding some small cases. WKBK&Y 1066733 C. Hess 916-920-5286

  22. Retirement (New!) • New but it depends: • Before: Roof replaced = no deduction until whole building disposed. (IRC Section 168). • New: Replace part of a system/component: • If repair, may elect instead: • New basis capitalized • Old basis deducted (Section 1250/1231 loss) • Note: Enhances doing cost segregation studies. (still Section 1250 property.) WKBK&Y 1066733 C. Hess 916-920-5286

  23. Retirement (New!) 1.263(a)-3 • Cost of removal: • If not part of major replacement can deduct, rather than capitalize • If for major replacement, must capitalize • Example 30 – elevator. 1 of 4 retired/replaced • Option 1: No cost segmentation of old elevator, but can write-off replacement (not major replacement) • Option 2: Write-off old; capitalize new. WKBK&Y 1066733 C. Hess 916-920-5286

  24. Practical Steps • Spreadsheet – Accountant’s Best Friend • Purchases. WKBK&Y 1066733 C. Hess 916-920-5286

  25. Acquisition Costs • Legal Fees to Purchase • ALTA Survey Costs • Broker Fees (Paid by Buyer) • Deed Preparation WKBK&Y 1066733 C. Hess 916-920-5286

  26. Write It Off! – Failed Purchase • Can Write-off All Costs if a Failed Purchase (Section 165) – Rev. Rul. 79-346; Rev. Rul. 74-104. • General investigation costs – access to Zillow premium; investor subscriptions. WKBK&Y 1066733 C. Hess 916-920-5286

  27. Write It Off! – Bad Purchase • Obsolescence • Abandonment – Throw away; quit rights • Worthless -- No prospect of future value. Must show event. (softer standard) WKBK&Y 1066733 C. Hess 916-920-5286

  28. Write It Off! - Formation Costs • Section 195 – form New Entity • $5,000 – when formed • Amortize balance over 15-Years WKBK&Y 1066733 C. Hess 916-920-5286

  29. C.H. DeCou (1994) 103 TC 80 • Bought 3 bad buildings – thought could repair. • Discovered Repairs 150%-200% > Replace. (100% Rotted; raw sewage below building) • Court: 1.167(a)-8; Notice 90-21. • Usefulness “Suddenly and unexpectedly terminated” • 280B – Capitalization of demolished structure NOT required. • (Compare Linden Gates v. US (1998)– not sudden & unexpected) – abandoned school building. WKBK&Y 1066733 C. Hess 916-920-5286

  30. Tucker v. Com’r (11th Cir. 2016) • T owned Paragon Homes Corp – S Corp • Paragon: 13 Land Projects – 2008: Loans > FMV • 2008: Great Recession. Took $8.9 million in worthlessness loss. Closed office. • 2009/2010: But, sold lots (3)/built homes (2). • T’s expert witness: lots had “value”/desirable. • Court: No 165 Loss • Not a casualty loss. • Not proven that abandoned/worthless WKBK&Y 1066733 C. Hess 916-920-5286

  31. Hurricane Harvey • Casualty Loss – Section 165 – Demolition of Structure after hurricane or other disaster not subject to Section 280B capitalization to Land. WKBK&Y 1066733 C. Hess 916-920-5286

  32. Remodeling • Rev. Proc. 95-27. Partial Demolition • Capitalize to building • Continue to depreciate (when available for use) • Not subject to 280B. • Same: (i) Certified rehabilitation of historic structure or (ii) 1936 structure (75/75 rule.) WKBK&Y 1066733 C. Hess 916-920-5286

  33. Property Taxes & Interest • 164 Property Taxes • Deduct (not if purchase price credit) • Option to capitalize to unimproved land • Not subject to 280B. • 163 Interest • Special rules during construction • Generally deduct • OID Rules – Seller Carryback – may classify part of purchase price as interest expense. WKBK&Y 1066733 C. Hess 916-920-5286

  34. Construction Projects • Section 1012/263A • Must capitalize during construction • Rules may supersede 263(a) • Capitalize direct/indirect costs during production period: • Interest (avoided cost method) • Taxes • Insurance • Amortized loan fees • Production period – commence/end – regulations prescribe (example – per lot, ends if sufficient pause) WKBK&Y 1066733 C. Hess 916-920-5286

  35. Subdivision Development • Basic Rules • Capitalize direct/indirect costs during construction • Allocate community expenses to all lots ratably • 461(h): Expense not part of basis until paid. • Problem –Community expenses done in stages. e.g., club house not begun until ½ way done. • Alternative Cost Method (Rev. Proc. 92-29) • Allows greater allocation to earlier sold (completed) homes than otherwise allowed. WKBK&Y 1066733 C. Hess 916-920-5286

  36. Alternative Cost Method • Developer allocates expenses to bases of lots using “estimate” of community costs. • Limit: For lots sold, total community costs allocated to lots sold cannot exceed actual spent community costs. WKBK&Y 1066733 C. Hess 916-920-5286

  37. Alternative Cost Method • Example: John will build 10 houses. Community costs (streets, lighting) total $400,000. John elects Alternate Cost Method under Rev. Proc. 92-29. • Year 1. Sold 4; spent $200,000 common costs • Year 1. Allowed costs added to basis. Lesser of: • $40,000/per home x 4 = $160,000 • $200,000 • $160,000 of expenditures is treated as added to basis to reduce gain on sale. WKBK&Y 1066733 C. Hess 916-920-5286

  38. Alternative Cost Method • Note. (Example: If not elected, John would have only been allowed $80,000 [4 X ($200,000 spent X 10%)]. • Election • Due 1st year of sale – by return/extension date • Elect separately for each project; • Election:(i) separately file + (ii) copy with return. • Required information: Taxpayer, EIN, where filing, description, expense schedules, declaration – Statue of Limitations waiver Form 921. • Annual statements required. WKBK&Y 1066733 C. Hess 916-920-5286

  39. Thank You • Cameron L. Hess chess@wkblaw.com Wagner Kirkman Blaine Klomparens & Youmans LLP (916) 920-5286 WKBK&Y 1066733 C. Hess 916-920-5286

More Related