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How the new repairs and maintenance capitalization standards will impact your next remodelRestaurant Finance ConferenceNovember 14, 2012
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© 2012 Baker Tilly Virchow Krause, LLPBaker Tilly refers to Baker Tilly Virchow Krause, LLP,
an independently owned and managed member of Baker Tilly International.
Agenda
> Overview of the temporary regulations– Unit of property– Capitalization standards– De minimis rule and materials and suppliesDe minimis rule and materials and supplies– Changes to depreciation and disposition rules
> Transition guidance and other issues> Next steps> Questions
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Overview of the temporary regulationsOverview of the temporary regulations
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Overview
What are the new repair regulations?> Standards for determining whether and when costs incurred
in acquiring, maintaining, or improving tangible property must be capitalizedp
> Framework for analysis of whether an expense is– Currently deductible as an ordinary and necessary business
expenseexpenseOR
– Treated as a capital improvement and depreciated over a l i dlonger recovery period
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Overview
When are they effective?> The temporary regulations have the same binding effect as
final regulations and are effective for tax years beginning on or after January 1, 2012y ,
Who do they affect?> Companies across nearly all industries with the largest
i t th h i l i t t i t l timpact on those having large investments in property, plants, and equipment
Especially restaurants
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Unit of property
Unit of property = buildings> Building structure> Building systems
– HVAC– HVAC– Plumbing– Electrical– Escalators– Elevators– Fire protectionFire protection– Security– Gas distribution
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Unit of property examples
Real Property Expenditure Unit of Property Building Structure/SystemR l f B ildi B ildi t tReplace roof Building Building structure
Replace roof top HVAC unit Building HVAC system
Drive thru improvements Building Building structureDrive thru improvements Land Improvement Land Improvement
Restroom renovation Building Building structure (finishes) Plumbing system (fixtures)
Dining area renovations Building Building structureFaçade update Building Building structure
Lighting upgrade Building Electrical systemg g pg g y
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Improvement standards
An amount paid must be capitalized if it results in a> Betterment to the unit of property> Adaptation to a new or different use> Restoration to the unit of property> Restoration to the unit of property
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Improvement standards
Examples – restaurant building roof1. General repairs – patching, caulking joints, etc.2. Roof replaced with same materials, remaining cost of
original roof written offoriginal roof written off3. Roof replaced with composite, energy-efficient materials
For #2 and #3, consider relativity – replacing components of relative comparable quality and function
For example, the technology for a 20 year old roof top unit has changed dramatically
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Improvement standards
Common restaurant scenarios1. General building or equipment repairs2. Minor renovation or remodeling3 Re image/re branding3. Re-image/re-branding4. Remodel of dining room and/or kitchen 5. Addition and remodel6. Acquisition & subsequent costs
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R&M flowchart
Unit of property = building
Betterment – capitalize
yes yes
Replacement of a componentfor which a loss on disposition was property recognized?
or
Capitalize
Affects the building structure and/or one or more building
Fixes a material condition or defect present at acquisition or production?
Replacement of a component for which gain/loss on sale properly recognized?
Damage for which a casualty
or
no Directly benefited or was incurred by reason of an improvement to the structure or system?
no
systems:
• HVAC • Plumbing • Electrical• Escalators• Elevators
Results in material addition or expansion?
orloss has already been claimed?
Returned building structure or system to former operating condition after it was no longer functioning?
orSupporting documentation and scope of work supports deductiblerepair treatment?
noyes• Elevators
• Fire protection • Security• Gas distribution
or
Results in material increase in quality,capacity, productivity or efficiency?
functioning?
Rebuilt the property to like new condition after the class life?
or
or
Capitalize
yes
Expense all costs except tangible
Adapts the unit of property to new or different use?
no
Capitalizeno
Replacement of majorcomponent or substantial structural part?
yesyes
except tangible personal property
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Restoration – capitalize
Routine maintenance safe harbor
> Exception to capitalization> Routine maintenance expected to be performed more
than once during the property’s class life (generally 9 years for restaurant equipment) due to the taxpayer’s use of the property and to keep the property in its ordinarily efficient operating condition
> Does not apply toDoes not apply to– Betterments– Certain restorations– Buildings
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Routine maintenance safe harbor
Examples> Condenser replacements for walk ins, control units,
motor systems> Parking lotsParking lots
The safe harbor does not apply to building maintenance costs / repairscosts / repairs
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De minimis rule
Costs to acquire or produce property do not have to be it li d if th tcapitalized if the taxpayer
> Has an “applicable financial statement” (AFS)> Has a written accounting policy for expensing acquisition costs
less than a certain dollar amount> Expenses those costs on its AFS in accordance with its policyCeiling amountCeiling amount> The aggregate amount deducted is less than or equal to the
greater of0 1 percent of gross receipts for federal income tax purposes– 0.1 percent of gross receipts for federal income tax purposes
– 2 percent of total book depreciation and amortization expense
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Changes to depreciation and disposition rulesChanges to depreciation and disposition rules
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Changes to disposition rules
> Expand a disposition to include structural components of b ildibuildings
> Intended to reduce the unfavorable impact of the new capitalization standards on buildings
> Loss deduction is generally mandatory> May choose not to recognize loss with general asset
account electionaccount election> Any reasonable allocation method
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Changes to disposition rules
> Depreciation grouping rules– Single asset account (SAA)– Multiple asset account (MAA)– General asset account (GAA)General asset account (GAA)
> Taxpayers must elect GAA treatment> GAA eligible assets
– Placed in service in the same tax year– Same depreciation method, same recovery period, same
convention> GAA disposition rule – generally, no loss recognized> GAA beneficial for real property
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Changes to disposition rules
> General MACRS disposition rules– Includes retirement of structural components– Loss recognition is mandatory– Potentially significant administrative burdenPotentially significant administrative burden
> Dispositions of property from a GAA– “Qualifying disposition” includes retirement of structural
componentscomponents– Loss recognition is optional– Easier to administer, but no current deduction for retired
components> GAA election is made on current year tax return (line 18
on Form 4562) but accounting method change is
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) g grequired for prior tax years
General asset account election flowchart
Loss recognition on retirement/ disposal is optional
Capitalize new roof membraneYes
disposal is optional
Did taxpayer recognize loss?
Deduct new membrane,continue depreciating original
component
Yes
No component
Capitalize new roof membrane
GAA election in place?
Yes
No
Loss recognition on retirement/ disposal is mandatory
Did t i l ?
Capitalize new roof membraneNo
Did taxpayer recognize loss?Capitalize new roof membrane,
stop depreciating original component, remaining basis
“lost”No
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Impact of disposition rules
• Deduct adjusted basis of disposed structural component
Opportunitystructural component
• Section 481(a) adjustment• How to determine adjusted basis in
structural components?
Risk
• If SAA/MAA used for building and its components, depreciation must stop and loss must be taken or lostRisk and loss must be taken or lost
• Loss would preclude repair deduction• Solution = GAA election
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Relevant issues related to disposition rules
> Cost segregation analysis before change to disposition lrules
– Focus only on segregating personal property and land improvements
– Group all section 1250 real property into one 39-year bucket
> Cost segregation analysis after change to disposition g g y g prules
– Proactively break out major building components on new construction for future R&M and disposal purposesconstruction for future R&M and disposal purposes
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Transition guidance and other issuesTransition guidance and other issues
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Transition rules
Modifications to the automatic consent procedures in R P 2011 14Rev. Proc. 2011-14> Rev. Proc. 2012-19
– Method changes for costs to maintain or improve tangible property
– Method changes for costs to acquire or produce tangible property
• Transaction costs• De minimis rule• Materials and supplies
> Rev. Proc. 2012-20– Rules for accounting for MACRS property including GAAs and
dispositions
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Transition rules
Changes to comply with the regulations are generally ti th d haccounting method changes
> Generally section 481(a) catch up adjustment > Cut-off method for costs incurred after December 31, 2011,
– De minimis rule– Transaction cost exceptions– Materials and suppliesMaterials and supplies
> Item-by-item elections going forward– Capitalize and depreciate supplies
N t t l d i i i l– Not to apply de minimis rule– Capitalize otherwise deductible transaction costs– GAA
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Filing procedures
> Taxpayers may combine certain related and similar h i R P 2012 19 i l F 3115changes in Rev. Proc. 2012-19 on a single Form 3115
> Taxpayers may combine certain related and similar changes in Rev. Proc. 2012-20 on a single Form 3115
> Positive and negative section 481(a) adjustments may be accounted for separately
– 4-year spread of positive (unfavorable) adjustmenty p p ( ) j– No spread of negative (favorable) adjustment
> Duplicate filing requirementOriginal with timely filed tax return by extended due date– Original with timely filed tax return by extended due date
– Copy to Ogden, Utah (not Washington, DC)• May be filed earlier for audit protection
> No user fees
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> No user fees
Late general asset account elections
Make a late GAA electionf 1 2> Must be made for the taxpayers 1st or 2nd taxable year beginning
after December 31, 2011> Section 481(a) adjustmentIncludes making a late election to recognize gain or loss in a GAA> Upon disposition of all the assets or the last asset> Upon disposition of an item in a qualifying dispositionExample> Taxpayer owns restaurant building which had its entire roofTaxpayer owns restaurant building which had its entire roof
replaced> Cost have been capitalized twice since being placed in service> What are the options?
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> What are the options?
Scope limitations
Section 4.02 of Rev. Proc. 2011-14 precludes taxpayers from fili d th t ti h d if th tfiling under the automatic changes procedures if the taxpayer:> Is under exam> Has engaged in a section 381(a) transaction in the year of change> Is in its final year of trade or business> Has changed its method of accounting for the same item within the
past 5 yearsRev. Procs. 2012-19 and 2012-20 provide waiver of scope limitations for 2 years (2012 and 2013)> Do not need to be in a window period and may change even if issueDo not need to be in a window period and may change, even if issue
under consideration or pending in exam, appeals, or court> Generally receive audit protection unless issue pending when Form
3115 is filed (i.e., notice of proposed adjustment)
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3115 is filed (i.e., notice of proposed adjustment)
LB&I directive
> Large Business and International (LB&I) Division directive on i ti ti it i d M h 15 2012 fexamination activity issued on March 15, 2012, from
Commissioner of the LB&I to industry directors, director-field specialists, and director-international business compliance
> For tax years beginning before January 1, 2012– All exam activity should cease– No new activity should commencey– Exam should withdraw all IDRs and NOPAs
> Does not apply to issues before appeals, court, or SBSE divisiondivision
– Likely that government will follow suit
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Transition rules – other
> Statistical sampling permitted (Rev. Proc. 2011-42)f– Extrapolation not mentioned but may come out in future
guidance> Automatic consent conditioned on section 263A compliance> Scope limitations waived> Audit protection and LB&I directive> Concurrent Form 3115 filings allowedConcurrent Form 3115 filings allowed
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Next stepsNext steps
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Companies need to take action
> Compliance with the new regulations may require many companies to change their c rrent methods of acco nting forcompanies to change their current methods of accounting for R&M costs
> Regulations are generally unfavorable for companies that h l d fil d ti th d h d t thhave already filed an accounting method change due to the introduction of building systems (but can be mitigated by the new disposition rules)
> Companies that have not filed an accounting method change for R&M will likely benefit from the regulations if they are following GAAP capitalization standards
> Changes to comply with the regulations are accounting method changes made with a section 481(a) adjustment so analysis of assets placed in service before 2012 can be reviewed now
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Next steps
> Determine an effective way to comply with the new l tiregulations
– Companies who have already filed an accounting method change, review prior years’ expenditures for conformity with th l tithe new regulations
– Companies who have not filed an accounting method change, review prior years’ expenditures to determine benefit from the
l tinew regulations.> Determine basis in retired structural components and
analyze the impact of the disposition rules on R&M deductions
> FIN 48 considerations
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Impact
Companies need to analyze the impact of the new l ti if thregulations if they:
> Have recently or are planning to remodel their restaurant(s)> Already filed a method change under section 162 relying on y g y g
prior law> Have an ongoing R&M project> Are involved in IRS controversy for this issue> Are involved in IRS controversy for this issue> Have not yet filed a method change or have been waiting for
this final guidance
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Timing
> Effective for tax years beginning on or after January 1, 2012> Companies can begin reviewing their current method of
accounting and costs incurred prior to 2012 since the accounting method change requires a section 481(a) adjustment
> LB&I stand down order on reviewing capital versus improvement treatmentp
> FIN 48 considerations for 2012
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Questions?QuestionsQuestions?Questions
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Disclosure
The content in this presentation is a resource for Baker Tilly Virchow Krause, LLP clients and prospective clients. Nothing contained in this presentation shall beclients and prospective clients. Nothing contained in this presentation shall be construed as legal advice, opinion, or as an offer to buy or sell any property or services. In conformity with U.S. Treasury Department Circular 230, tax advice contained in this communication and any attachments is not intended to be used, and cannot be used, for the purpose of avoiding penalties that may be imposedand cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code, nor may any such tax advice be used to promote, market or recommend to any person any transaction or matter that is the subject of this communication and any attachments. The intended recipients of this communication and any attachments are not subject to any limitation on thecommunication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
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