Minimizing Property Taxes: Leveraging the New IRS Repair Regsmedia.straffordpub.com/products/minimizing... · If you have not printed the conference materials for this program, please

Minimizing Property Taxes: Leveraging the New IRS Repair Regs Strategies for Cost Expensing, Fixed Asset Capitalization Policies, and Avoiding Audit Flags

THURSDAY, MARCH 6, 1:00-2:50 pm Eastern

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© Grant Thornton LLP. All rights reserved. 4

Minimizing Property

Taxes:

Leveraging the New

IRS Repair Regs

Rebekah Feather, Senior Manager – Federal Tax

Sam Kinslow, Director – Property Tax


Questions You May Be Asking Yourself

The new IRS Repair Regulations make for tough

reading and seem confusing, what do they really

mean?

How are these new regulations different from the

prior IRS guidance? Why the change?


Questions You May Be Asking Yourself

My company incorporated the new IRS Repair

Regulations. What impact can they have on our

property taxes?

How can I leverage the new regulations to

improve property tax processes within my

company?


Agenda

What do the IRS Repair Regs Really Mean?

• Improvements to tangible property

• Dispositions

• De Minimis

• Materials and supplies

7


Agenda

What impact can the Repair Regs have on

property taxes? Can I leverage the regs?

• Fixed Asset Accounting

• Real Estate

• Personal Property

• Inventory and Supplies

8


Repair Regs - What was Issued?

• Final regulations under 162 and 263(a)

– Amounts paid to acquire, produce, or improve tangible property

• Re-proposed regulations under 168

– General asset accounts and disposition of depreciable property

– IRS and Treasury expect to finalize these regulations

in 2014

• Revenue procedures issued this year in two parts


What Hasn't Changed

• Unit of Property – the proposed regulations

continue to apply

• Betterments – same as the 2011 temporary regs

but with added clarification and examples

• Restorations – Essentially the same as 2011

temporary regs, however the IRS clarified the

definition for major components and substantial

structural parts of buildings.

10


Practical implications Rules affect any business that owns or leases

tangible property (TP)

Therefore these rules affect all businesses

11


Repair Regs


• Dispositions

• De Minimis


12


Improvements to property

General rule

A TP must generally capitalize an amount that IMPROVES a

unit of property ("UOP") if the amount:

(1) Is for a betterment;

(2) Restores the UOP; or

(3) Adapts the UOP to a new or different use.

13


Unit of property

• General rule: functional interdependence test

• Special rules: buildings, plant property, network assets, and

leased property

– Improvement standards must be applied separately to

building structure and building system

• Clarification of unit of property for leasehold improvements

– Work done on an addition previously made to a leased

building, consider the entire leased structure, not merely

the addition


Unit of property

Building systems include:

- HVAC systems - Fire protection and alarm systems

- Plumbing systems - Security systems

- Electrical systems - Gas distribution systems

- All escalators - Any other structural components

- All elevators in published guidance


Betterments

• General rule: A TP must capitalize an amount paid for a "betterment"

• An amount is paid for a betterment if it:

– Ameliorates a material condition or defect that either existed prior to

the TP's acquisition of the property or arose during production of the

UOP (regardless of whether the TP was aware of the condition);

– Results in a material addition to or addition of a major component

to the UOP, or a material increase in the capacity of the UOP;

– Results in a material increase in productivity, strength, efficiency, or

quality of the UOP or the output of the UOP.


Restorations

An amount restores property if the amount:

1)Results in the rebuilding of the UOP to a like-new condition after

the end of its class life;

2)Is for the replacement of a part or a combination of parts that

comprise a major component or a structural part of the UOP;

3)Returns the UOP to its ordinarily efficient operating condition if the

property has deteriorated to a state of disrepair and is no longer

functional for its intended use;


Restorations

An amount restores property if the amount (continued):

4)Is for the replacement of a component of a UOP and the TP has

properly deducted a loss for that component (other than a casualty

loss);

5)Is for the replacement of a component of a UOP and the TP has

properly taken into account the adjusted basis of the component in

realizing gain or loss resulting from the sale or exchange of the

component; or

6)Is for the repair of damage to a UOP for which the TP has taken a

basis adjustment as a result of a casualty loss.


Restorations

• Clarification of distinction between major component and

substantial structural part

• Incidental component, even though performs discrete

function, is not restoration

Major

component

Part or combination of parts that

perform a discrete and critical

function in the operation of the UOP

Substantial

structural part

Part or combination of parts that

comprises a large portion of the

physical structure of the UOP


Restorations

Clarified definitions

New definition provided for major component and substantial

structural parts of building

• The replacement includes a part or combination of parts

that comprise a major component or a significant portion of

a major component of the building structure or building

system, or

• The replacement includes a part or combination of parts

that comprises a large portion of the physical structure of

the building structure or building system


New or different use

An amount is paid to adapt a UOP to a new or different use if

the adaptation is not consistent with the TP's ordinary use of

the UOP at the time originally placed in service


New or different use

New and revised examples

New or different use:

• Manufacturing plant to

showroom space

• Develop land used for

manufacturing plant as

residential housing

• Retail drug store converts area

of pharmacy to walk-in medical

clinic

Not a new or different use:

• 3 leased retail spaces into 1

leased retail space

• Preparing a building for sale

• Grocery store converts existing

store space into sushi bar

• Hospital modifies emergency

room to also provide outpatient

surgery clinic


Other costs incurred during improvement

263A retained, new rule for removal costs

• Section 263A standard to be applied:

– Costs that directly benefit or are incurred by reason of the

improvement should be capitalized

• New special rule for removal costs:

– If a TP disposes of a depreciable asset (including partial

disposition) and has taken into account adjusted basis, costs

of removing that asset are not required to be capitalized

• Related amounts:

– Amounts paid over a period of more than one taxable year


New election

Election to capitalize repair and maintenance costs

• TP's may elect to capitalize amounts incurred during the

year as costs of improvements if TP capitalizes the

amounts on its books and records

• Election applies to all amounts treated as capital for books

each year

• Election made by attaching a statement to the return

each year

Slide Intentionally Left Blank


Repair Regs


• Dispositions

• De Minimis



Dispositions

• Re-proposed regulations

• Retirement of a structural component no longer mandatory

– Need for general asset account election eliminated

• Disposition includes sale, exchange, retirement, physical

abandonment or destruction of an asset

• Disposition also occurs when asset is transferred to a

supplies or scrap account or when a portion of an asset is

disposed of in sale, casualty event, like-kind exchange,

involuntary conversion or tax-free transfer


Dispositions

New election

• TP may elect to dispose of a portion of an asset. Includes:

– Structural components (or components thereof) of a

building

– Components or portions of 1245 assets

• Election is made in year of partial disposal by claiming gain,

loss or other deduction on the return

• Partial disposition (other than required situations) is a not a

method of accounting.


Dispositions

Identification of asset disposed

• General rule = specific identification

• Special rule for mass assets or partial disposition (where

impracticable to determine the taxable year the asset was

placed in service)

– FIFO

– Modified FIFO

– Mortality dispersion table

– Any other method designated in subsequent guidance

– LIFO is not allowed


Dispositions

Basis of asset disposed of

• General rule = adjusted depreciable basis at disposal

• Special rule for mass assets or partial disposition = any

reasonable method

– Discounting the cost of replacement portion of the asset to its

placed in service year cost using the consumer price index

– Pro rata allocation of the unadjusted depreciable basis of the

asset based on replacement cost of disposed portion

– Study allocating the cost of the asset to individual

components


Dispositions

New example

• TP replaces 60% of roof in 2012- capitalizes replacement and

makes partial disposition election

• In 2022, TP replaces 55% of the roof of the building- capitalizes

replacement makes the partial disposition election for the

replaced portion

• TP cannot determine from its records whether the 55% is part of

the 60% replaced in 2012 or whether it is part of the original 40%

of the roof

• TP uses the FIFO method to identify the asset disposed of


Dispositions

New example - conclusion

How is the asset that is disposed of determined when TP

replaces 55% of the roof?

• Building is asset (including original roof) and 60% of roof

replacement in 2012 is a separate asset

• TP disposed of the remaining 40% of the original roof and

25% of the 60% of the roof replaced in 2012


Repair Regs


• Dispositions

• De Minimis



De Minimis

• Ceiling limitation eliminated

– No need to track expenses

• Replaced with safe harbor election which is based on

policies used for financial books and records at an invoice

or item level

• Taxpayers without an applicable financial statement can

now deduct reduced de minimis amount

• For amounts above safe harbor, taxpayer needs to

demonstrate clear reflection of income


De Minimis

• Applicable financial statement

– A financial statement required to be filed with the

Securities and Exchange Commission;

– A certified audited financial statement that is

accompanied by the report of an independent certified

public accountant that is used for credit purposes,

reporting to shareholders, partners or similar persons, or

any other substantial non-tax purpose; or

– A financial statement (other than a tax return) required to

be provided to the federal or state government or any

federal or state agency


De Minimis

New election

TP with an applicable financial statement

• Written policy in place at beginning of year

• Policy to expense property costing less than a certain dollar

amount or property with an economic useful life of 12

months or less

• Deducts such amounts in applicable financial statements

• Amount paid does not exceed $5,000 per invoice (or per

item as substantiated by invoice)


De Minimis

New election

TP without an applicable financial statement

• Written policy in place at beginning of year

• Policy to expense property costing less than a certain dollar

amount or property with an economic useful life of 12

months or less

• Deducts such amounts in applicable financial statements

• Amount paid does not exceed $500 per invoice (or per item

as substantiated by invoice)


De Minimis

New election

• Safe harbor is elective each year

– Must include statement in the return

• Election applies to all eligible materials and supplies

• Labor, overhead, transaction and other costs of acquisition

can be included in de minimis safe harbor provided the

invoice includes such costs

• Section 263A does still apply to amounts deductible under

de minimis if expected to be used in production of other

property


De Minimis

New election- applicable financial statements

With AFS Without AFS

• Written policy to deduct $10,000

or less

• Written policy to deduct $1,000

or less

• Purchase 1,000 computers for

$5,000 each-substantiated by

invoice

• Purchase 10 computers at $600

each

• Deduct each computer as de

minimis

• Cannot use safe harbor

because each item is above

$500

• Would not be able to use safe

harbor if computers over $5,000

• Would be able to deduct if

computers were $500 each


De Minimis

Example- additional invoice costs

• TP w/AFS has written policy to deduct amounts under

$5,000

• Purchases wireless routers for office

• Invoice includes price per router or $2,500 and $20,000

total for delivery and installation

• $20,000 allocated on a pro-rata basis to each of the 10

routers

• Total cost for each router is $4,500 and can be deducted

under the de minimis rule



Repair Regs


• Dispositions

• De Minimis



Materials and supplies

• Materials and supplies include:

• Components acquired to maintain, repair, or improve a unit

of tangible property owned, leased, or serviced by the

taxpayer that is not acquired as part of any single unit of

property

• Fuel, lubricants, water and similar items expected to be

consumed in 12 months or less

• Property with economic useful life of 12 months or less

• Property with acquisition cost of $200 or less


• Rules largely the same as temporary regulations

• Some changes

– Definition now includes property that has an acquisition

or production cost of $200 or less (increased from $100)

– Definition of standby emergency spare parts included

– Election to capitalize certain materials and supplies now

only applicable to rotable, temporary or standby

emergency spare parts




• Non-incidental supplies

– Deductible in the year in which the materials are first

used or consumed in the taxpayer's operations

• Incidental supplies

– Deductible in the year in which amounts are paid

Incidental supplies are those for which no record of

consumption is kept or physical inventories at beginning

and end of year are not taken


Repairs - Current IRS Examinations

• LB&I directs agents to discontinue exam activity on repair issues

• The intent of the Directive is to discontinue examination of the issue

and provide taxpayers with a two-year waiver period to adopt the

appropriate methods of accounting provided in the revenue procedures

• Current examinations for tax years beginning before January 1, 2012

are to be discontinued and no new exams should be started

• If a 3115 was filed on or after December 23, 2011, examiners will

perform a risk assessment


Companies Should Do The Following:

• Compare current policies

– Acquisition policy (de minimis)

– Capitalization policy (repairs)

• Consider modification to current procurement process

– Capital expenditures request (CER)

– Capital appropriations request (CAR)

• Consider current method change opportunities

• Consider annual elections going forward

• Consider financial statement impact

• Consider property tax impact


Repair Regs Impact on Property Tax


• Real Estate




Use the Repair Regs as an opportunity to improve fixed

accounting for property taxes

• Greater level of detail for the following:

– Acquisitions

• Freight, installation, and sales tax

• Indirect costs: appraisals, engineering, title fees

• Less bundling of assets or mass asset accounting

• Capitalization thresholds and policies

• The component for Financial Statements can drive change

Fixed Asset Accounting




• Real Estate



© 2010 Grant Thornton LLP. All rights reserved. 51

Real Estate

What experience has shown in recent tax years and forecast for 2014

– Political pressure on assessors has made them reluctant to reduce

assessments; even in light of economic data demonstrating lower market

values

– Due to 2010 economic downturn, in some cases, assessments were

reduced a small percentage, but were they reduced down to true market

value?

– At the first glimmer of market improvement in 2012, many assessors

increased assessments immediately. They were not as quick to respond

when the markets were poor (if they reduced assessments at all)


Real Estate

What experience has shown in recent tax years and forecast for 2014

– The Repair Regs new methods of accounting for indirect costs such as

appraisals, title work, appraisals, engineering, etc. could be used by

assessors to increase assessments

– The Repair Regs new methods of accounting for leasehold improvements

could be used by assessors to increase assessments on real estate or

personal property depending on the state – especially in audit states

– With government budget shortfalls and renewed investor participation in

markets, assessments will likely increase for 2014





• Real Estate




Personal Property

Scrutinize the Fixed Asset Ledger

• Remove assets which are no longer in service from the

fixed asset ledger. Anything on books is taxed at a 10-20%

residual value (No zero NBV in property tax)

• Assets booked to headquarter holding accounts that are

actually in the field. These may be taxed in both locations.


Personal Property

Scrutinize the Fixed Asset Ledger

• Look for items that are non-taxable or that no longer

have situs at the facility

Sort Cost from High to Low

Sort by Acquisition Date

Sort by Account Category and Number

Sort by Asset Description


Personal Property

Keep the personal property assessment date in mind

when making large equipment purchases

Example:

The assessment date in Arkansas is Jan. 1st. Rather

than taking delivery of a large manufacturing line on

Dec. 18th, 2012, the company takes delivery on Jan.

14th, 2013. This eliminates one year of property tax.


Personal Property

Develop customized physical depreciation tables

• Facility engineers can help you determine Total

Economic Life of your company’s specific asset

classes

Do your facilities operate 2 or 3 daily 8 hour shifts?

Then, your assets should qualify for shorter lives

Use Age/Life Method for depreciation in contrast to

assessors' standard tables


Personal Property

Report assets on returns using sub-categories

• Example: 2011 computer-controlled extruder with an

attached conveyor

If the equipment is booked as one asset, sub-

categorize the asset by computer, software, M&E, and

conveyor

In this way, the short-lived portions of the total asset

benefit from accelerated depreciation. Contrast this

with reporting all portions under M&E category


Personal Property

Incorporate Functional Obsolescence into returns

• Loss in value due to the inability of an asset to perform

adequately the function for which it was designed

Example:

A nail manufacturing unit cannot run at full

capacity due to a lower-rated sorter and

conveyor system at the end of the line


Personal Property

Incorporate Economic Obsolescence into returns

Loss in value due to an impairment in utility and/or

desirability that is caused by factors external to the asset

Example:

Due to loss of product demand, a plant that formerly

ran 3 daily shifts is now down to 2 shifts, only 4 days

per week.


Personal Property

Tips for Facility Tours:

First, visit facility without assessor to visit Engineers/Managers

Ask them, “If you could start over with a vacant shell, how would the flow

of the equipment be set up?” (Functional Obsolescence)

Ask them, “Is current product demand allowing you to run at full capacity?

(Economic Obsolescence)

Say, “The assessor says our conveyors should last at least 15 years, then

ask, “Do you agree?” (Physical Depreciation)

Second, bring in the assessor and point out these valuation items for

appeal. Quantify the issues and apply reductions to returns.




• Real Estate




Inventory

Consider and file for loss in value of inventory due to:

Spoilage, theft, and returned items

Seasonal discounting

Markdowns due to lack of demand, poor mix, off-spec items

Unavailable Inventory of petroleum products (tank heel or pipe line-fill)

Expenses related to inventory maintenance (roll, brush, spray of pipe)

File for inventory exemptions:

Freeport, Interstate Commerce, Foreign Trade Zones


Rebekah Feather, Senior Manager – Federal Tax

1717 Main St., Suite 1500

Dallas, TX 75201

[email protected]

Sam Kinslow, Director – Property Tax

700 Milam St., Suite 300

Houston, TX 77002

[email protected]


The foregoing slides and any materials accompanying them are educational materials prepared by Grant Thornton LLP and are not intended as advice directed at any particular party or to a client-specific fact pattern. The information contained in this presentation provides background information about certain legal and accounting issues and should not be regarded as rendering legal or accounting advice to any person or entity. As such, the information is not privileged and does not create an attorney-client relationship or accountant-client relationship with you. You should not act, or refrain from acting, based upon any information so provided. In addition, the information contained in this presentation is not specific to any particular case or situation and may not reflect the most current legal developments, verdicts, or settlements.

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© 2013 Grant Thornton LLP, the U.S. member firm of Grant Thornton International. All rights reserved. Printed in the U.S.A. This material is the work of Grant Thornton LLP, the U.S. member firm of Grant Thornton International, Ltd.

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Minimizing Property Taxes: Leveraging the New IRS Repair Regsmedia.straffordpub.com/products/minimizing... · If you have not printed the conference materials for this program, please