2014-12-2 maximize your deductions: the sequel
TRANSCRIPT
Maximize Your Deductions: “The Sequel” …It’s all about the application
Date: December 2, 2014
Speakers: Trinity Bradley-Anderson, CPABuddy Newton, Jr., CPAPatrick Stephens, CPA
This presentation and the material contained herein is the property of Stockman Kast Ryan + Co and may not be copied or used without permission.
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Legislative HistoryOn 9/13/2013, the IRS and Treasury Department released final regulations, effective 1/1/2014, which govern capitalization of:
Materials and supplies
Amounts paid to acquire or produce tangible property
Expenditures relating to the betterment, adaptation, and restoration of tangible property.
De Minimis Expensing Rule
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De Minimis Expensing RuleSafe Harbor
Required to have a written capitalization policy at the beginning of the taxable year expensing amounts paid for:
Property costing $5,000 (Audited Financial Statements) or $500 (no Audit) or less. Per item/invoice or
Property with a useful life of 12 months or less.Consider non-safe harbor policy based on business operation factors (revenues, industry, etc.)
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Capitalization Policy
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Cyber Café Refresh $1,000 Capitalization Treshhold
OTY Cyber Cafe Price per unit Total cost Expensed Capitalized
4 Lounge Chairs 500.85 2,003.40 2,003.40 1 Cocktail Table 135.00 135.00 135.00 2 Tablet Chairs 1,350.00 2,700.00 2,700.00 1 End Table 67.50 67.50 67.50 1 Table Lamp 135.00 135.00 135.00 2 Desks with Returns 1,283.85 2,567.70 2,567.70 2 Table Lamps for Desks 135.00 270.00 270.00 4 Client Chairs 338.85 1,355.40 1,355.40 2 Executive Chairs 291.78 583.55 583.55 1 Console Table 567.00 567.00 567.00 2 Banquettes 492.75 985.50 985.50 1 Cocktail Table 607.50 607.50 607.50 1 Rug 733.05 733.05 733.05 1 Misc. Accessories 405.00 405.00 405.00 4 Barstools 243.00 972.00 972.00 1 Mise. Accessories 270.00 270.00 270.00 1 Desk with Return 1,283.85 1,283.85 1,283.85 2 Filing Cabinets 506.25 1,012.50 1,012.50 1 Table Lamp 87.75 87.75 87.75 2 Client Chairs 338.85 677.70 677.70 1 Executive Chair 291.78 291.78 291.78 1 1 Art Piece 437.40 437.40 437.40
14,874.66 26,866.88 20,315.33 6,551.55
New Capitalization Standards BettermentAdaptationRestoration
as applied to a Unit of Property (UOP)
Gas Distributio
n
Electrical
Elevators
HVACStructural Component
sPlumbing
Escalators
Fire Protectio
n
Security Systems
Unit of Property - Buildings
Building Unit(s) of Property and Common ComponentsBuilding Structure
• Roof• Walls• Floors• Ceilings• Foundation
Heating Ventilation and Air “HVAC”
• Motors• Compress• Boilers• Furnace• Chillers• Pipes• Ducts• Radiators
Plumbing Systems
• Pipes• Drains• Valves• Sinks• Bathtubs• Toilets• Water and
Sanitary Sewer Collection Equip.
• Water Utility Equip.
Electrical Systems
• Wiring Outlets
• Junctions• Lighting
Fixtures & Connectors
• Elec. Utility Equip.
All Elevators
• Elevator boxes
• Control Equipment
• Cables and movement equipment
All Escalators
• Rails• Steps• Supporting
Equipment• Controls
Fire Protection and Alarm Systems
• Sensing & Detection Devices
• Computer Controls
• Sprinkler Heads & Mains
• Piping & Plumbing
• Alarms• Control
Panels
Security Systems to Protect Building and Occupants
• Window & Door Locks
• Security Cameras
• Recorders• Monitors• Motion
Detectors• Security
Lighting• Alarms• Entry
Access
Gas Distr. System
• Pipes• Gas Utility
Equipment
Unit of Property Common Examples of Building System Components
Was the expenditure for the repair or improvement of:
UOP is the portion of each building and building systems
subject to the lease
UOP is the individual unit owned and its
structural components
Is the taxpayer’s ownership interest the
entire building?
UOP is the entire building system or building structure
UOP is the portion of the building and/or building system in
which the taxpayer has possessory rights
Lessee Condo
Co-op
Yes No
Unit of PropertyLeased, Co-op or Condo Property
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Unit of PropertyProperty Other Than Buildings
General Rule: Functional Interdependence
Functionally Interdependent:
Comprises a single unit of property
when the placing in service of one
component by the taxpayer is
dependent on the placing in service
of the other component by the
taxpayer
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Real Property Expenditure UOPRetail Store – Stand
aloneStore Refresh – Lighting
replacementElectrical system
Retail Store – Shopping Mall (leased space)
Store Refresh – Lighting replacement
Leased portion of building electrical
system
Office – owned building Remove conference room wall
Building structure
Office – leased space Remove conference room wall
Building structure within leased space
Office condo HVAC Unit replacement Leased portion of building HVAC system
Apartment Building Single Unit Heat/Air replacement
Building HVAC System
Unit of Property ExamplesReal Property – Cost Segregation Guides
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Unit of Property Examples: Personal PropertyPersonal Property: Non
BuildingExpenditure UOP
Restaurant oven Burner replacement Oven
Garbage truck Engine repair/replacement Truck
Apartment unit furnishings New carpet for individual unit
Carpet
Donut bakery manufacturing line – interconnected mixers, ovens,
conveyers, loaf slicer, packaging
Knife replacement/ sharpening
Slicer component
Retail Donut Store Bakery – interconnected mixers, ovens,
conveyers, loaf slicer, packaging
Knife replacement/sharpening
Entire baking line
Power Plant – Coal pulverizer, boilers, turbine and a generator
Boiler tube replacement Boiler – Refer to Industry Guidance Rev. Proc. 2013-
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Improvement to Property
Betterment
Adaptation
Restoration
No bright line tests Driven by Facts and Circumstances
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Factors to consider Impact on size, capacity, efficiency and production
Degree of activities performed
Point in asset life cycle
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Improvement Standards
An amount is paid for a betterment to a UOP if it: Is for a material addition, including a physical
enlargement, expansion, extension, or addition of a major component to the UOP or a material increase in the capacity, including additional cubic or linear space, of the UOP, or
Is reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of the UOP, or
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Improvement Standards
Is to correct a material condition or inherent defect that either existed prior to the taxpayer’s acquisition of the unit of property or arose during the production of the unit of property.
(continued)
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Betterment Examples (continued)Retail Chain Periodic “Refresh” to maintain the appearance and functionality of retail space. Work includes: Lighting relocations, flooring repairs, moving one wall to
accommodate reconfigured tables, patching holes in the walls, repainting, replacing ceiling tiles, cleaning flooring, and power washing the building.
Replacement of display tables and racks
NOT a Betterment because no material increase to the productivity, efficiency, strength, quality, or output of the building structure or system. Taxpayer must capitalize the amounts paid for the Sec. 1245 property (tables & racks).
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Betterment Examples (continued)Retail Chain Periodic “Refresh” with Betterment:
In addition to the maintenance work, storage space, and second loading dock, a second overhead door and electrical system upgrades are added.
These additions are Betterments and must be capitalized. But, as discussed in the previous example, the “refresh” portion of the work is not a betterment and should not be capitalized.
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Improvement Standards
An amount is paid for an adaptation to a UOP if it: Adapts property to a new or different use that is not
consistent with the taxpayer’s ordinary use of the UOP at the time originally placed in service by the taxpayer.
Adaptation
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Adaptation ExamplesRetail Space Reconfiguration: Building retail space designed to be reconfigured.
Existing tenant to expand to two adjoining spaces.
Landlord pays to remove the walls between the three retail spaces. Unit of Property affected is the building structural components.
NOT AN ADAPTATION since the building is not converted to a new or different use. Potentially different answer if tenant pays for changes.
Note: Any new display cases and counters are Sec. 1245 property and must be capitalized.
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UCCS Parking Garage
Rental Remodel
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Improvement Standards
An amount is paid for a restoration to a UOP if it: Returns a 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, or
Results in the rebuilding of the UOP to a like-new condition after the end of its class life, or
Restoration
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Improvement Standards
Is for the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of a UOP, or
Is for the replacement of a component of a UOP for which the taxpayer has properly deducted a loss for that component. Casualty loss Loss from retirement or replacement Gain or loss from a sale or exchange
Restoration (continued)
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Black Forest Fire
Manitou Flooding
Engine Replacement
St. Patrick’s Cathedral New York
Improvement StandardsApply the following tests to the UOP to determine whether the expenditure is a capital expenditure:
Betterment?
• Correct pre-existing material condition or defect;• Material addition or expansion; or• Reasonably expected to materially increase the productivity, efficiency, strength, quality, or output.
Adaptation?
• New or different use inconsistent with the intended use when originally placed in service by the taxpayer
Restoration?
• Replace and recognize loss on replaced component;• Recognize gain/loss and make a basis adjustment from sale of a component;• Basis adjustment as a result of a casualty loss;• Returns UOP to its ordinarily efficient operating condition if it has deteriorated to a state of disrepair and is no longer functional for its intended use• Returns UOP to “like-new” condition after the end of its class life; or • Replace major component or substantial structural part of UOP
CAPITALIZE Deduct as a repair expense
NO NO
NOYES
YES
YES
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Small Taxpayer Safe Harborwith Buildings
New Safe harbor provided for small taxpayers: Election to not capitalize R & M or improvements Applies to taxpayers whose
Three-year average gross receipts do not exceed $10 million, and
Unadjusted basis of owned or leased buildings does not exceed $1 million, and
Total amount paid during the tax year for repairs, maintenance, and improvements cannot exceed the lesser of: 2% of the unadjusted basis of the building, or $10,000
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Routine Maintenance Safe HarborReal and Personal Property
Amount paid is deemed NOT to improve the Unit Of Property (UOP) if it is for the recurring activities that a taxpayer expects to perform as a result of the taxpayer’s use of the UOP “to keep” the UOP in its ordinarily efficient operating condition
Routine maintenance for non-building property is an activity expected to be performed more than once in the Alternative Depreciation System (ADS) class life
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Routine Maintenance Safe Harbor Real and Personal Property (cont’d)
Expanded to include routine maintenance for buildings over a 10-year period
Does not apply to: Betterments Adaptations Restorations Network assets (pipelines, railroad tracks, etc.) Certain rotable spare parts
Routine Maintenance Safe HarborTaxpayers are permitted to deduct costs as routine maintenance under this safe harbor if the following tests are met:
Were costs incurred for routine
maintenance on a UOP?
Were the activities performed as a
result of the taxpayer’s use of the
property?
Were the costs to keep the UOP in
ordinary operating condition?
Did the activities include costs such as cleaning, inspecting,
testing and replacement of
components with comparable parts
Did the taxpayer expect to incur
these costs more than once during the asset’s class life or if building, more than once during 10-yr
period?
Routine Maintenance Safe Harbor does not
apply
Deductible Expense
YES YES YES YES
YESNO
NONO NO NO
Escalator handrails
replaced in year 4
The cost is DEDUCTIBLE
under the routine maintenance safe
harbor
Routine Maintenance Safe Harbor Example
Investor purchases a shopping mall in 2013.When the shopping mall was placed in service, investor expected to replace escalator handrails every 4 years.
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Recap: De Minimis < $500/$5,000? Yes Expense
Small Taxpayer Safe Harbor? Yes Expense
Routine Maintenance? Yes Expense
Betterment, Adaptation, Restoration? Capitalize
Sec. 179 currently $25,000 for 2014 and no Bonus Depreciation
Depreciate over life of asset.
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Computer Network
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Is the Computer Network the UOP?Are the components functionally interdependent?
What type of stored information?
Is information shared across users and programs?
Relative importance to taxpayer’s production?
What components make up the Network?
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Leasehold ExpendituresCapitalization only required for improvements
Tenant Pays Landlord Pays Initial use of tenant? Adaptation
standard applies – expenditures capitalized.
Continual use? Apply DMSH, RMSH, and BAR to UOP.
Initial purchase? Adaptation standard applies – expenditures capitalized.
Initial use of a particular tenant? Apply DMSH, RMSH, and BAR to UOP.
Continual use? Apply DMSH, RMSH, and BAR to Building.
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Lease Considerations Lease should clearly state who owns improvements if a
tenant allowance is provided. Sec. 109 safe harbor assumes 39 year depreciation.
Outside safe harbor if tenant allowance is used for personal property (5, 7 and 15yr property). Lease should state that tenant is landlord’s agent.
Consider Cost Segregation Study - $1M = $24,610 39Yr vs $1M = $200,000 5Yr.
Consider the taxpayer’s situation: passive investor vs. Real Estate Professional.
Credit: AICPA
Partial Disposition Election
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Partial Dispositions of Property
Taxpayers may elect to treat a partial disposition of an asset as a disposition even if the asset has not been previously depreciated as a separate component. Thus, the taxpayer claims a loss upon the disposition.
For example – replacing a roof that has not been listed as a separate item on the depreciation schedule.
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Why is this important? Current year tax loss on disposition Partial disposition eliminates the potential for 25%
unrecaptured Sec. 1250 gain on the disposed asset upon the sale of the entire building. Sec. 1245 recapture is taxed at ordinary income tax
rates (as high as 39.6%)
Unrecaptured Sec. 1250 gain is taxed at 25%
Plus 3.8% investment tax for certain taxpayers
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Partial Disposition Election Example Taxpayer owns an office building and decides to replace the roof. Taxpayer makes the partial disposition election. Depreciation for the retired roof ceases and a loss is
recognized upon retirement, preventing the taxpayer from depreciating two roofs.
Taxpayer must reduce the basis of the building and the related accumulated depreciation.
Taxpayer must capitalize the new roof.
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Tenant % affected sq ft. sq feet remodeledA 100% 3,169 3,169 B 25% 6,869 1,717 C 40% 2,789 1,116
6,002
Total offi ce space 22,995
Percent remodeled 26%
Cost A/D Loss AllowedBuilding Asset 1,107,700.00 477,733.00
Dispostion (26% of building) 289,117 122,409 (166,708)
Remaining asset 818,582.83 355,324.00
The remodel of 1st floor tenant space was significant. The client identified how much of the building was affected.
How does this affect 2014?
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Compliance Issues Each taxpayer is required to file at least one Form
3115, Change of Accounting Method, to elect new rules.
Multiple Forms 3115 may be required depending on the taxpayer’s situation.
Certain annual elections may be required to be attached.
Additional compliance burden = additional accounting costs. For 2014 only!
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Elections and Method ChangesIssue
Report on the
Tax Return
Attach an Annual Election to the
Tax ReturnAccounting
Method Change
De Minimis Policy XBook Capitalization Policy X
Safe Harbor for Small Taxpayers
X
Partial Disposition XCapitalization vs. Expense X
Materials & Supplies X
Annual Election to Capitalize & Depreciate Rotable & Temporary Spare Parts
X
Thank You for Coming!If you would like to contact us, call us at(719) 630-1186 or email us at:
Trinity Bradley-Anderson, [email protected] Newton Jr., [email protected] Stephens, [email protected]