General Asset Accounts May Facilitate Repairs Deductions (article)

General Asset Accounts May Facilitate Repairs Deductions (article)

The April 2012 edition of InTouch discussed the new rules relating to dispositions of building structural components and the opportunity to take losses on their retirement. But what if instead of taking a loss on the disposition, you could take a repair deduction on the cost of any replacement component? In many instances, this will produce a better result.

There is an interesting interplay between the rules for dispositions (Temp. Reg. §1.168(i)-8T) and the rules for restorations (Temp. Reg. §1.263(a)-3T(i)). The concept of restorations, which are required to be capitalized, has been around for many years and is still applicable in these new rules.

According to Temp. Reg. §1.263(a)-3T(i)(1), a restoration is an expenditure:

  1. For the replacement of a component of a unit of property and the taxpayer has properly deducted a loss for that component;
  2. For the replacement of a component of a unit of property and the taxpayer 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;
  3. For the repair of damage to a unit of property for which the taxpayer has properly taken a basis adjustment as a result of a casualty loss under Section 165;
  4. That returns the unit of property 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;
  5. That results in the rebuilding of the unit of property to a like-new condition after the end of its class life; or
  6. For the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of a unit of property.

It is the first item above that may yield some unfavorable results. Under the disposition rules of Temp. Reg. §1.168(i)-8T, the taxpayer must report the loss on the retirement of a building system. As a result of taking this loss, the taxpayer would be required to capitalize the cost of the replacement of the component since it would meet the definition of a restoration.

For example, assume a taxpayer updates a portion of its 8-year-old commercial building sprinkler system. The sprinkler system is a building structural component (under the definition in repealed Treas. Reg. §1.48-1(e)(2)). The cost of the new sprinkler system update is $50,000 and the cost of the old system is determined to be $30,000 (after 8 years of depreciation over 39 years it would have a net tax basis of roughly $23,800). Under Temp. Reg. §1.168(i)-8T, the taxpayer is required to write off the $23,800 as a loss and capitalize the $50,000 sprinkler system update and depreciate it over 39 years.

Because of the loss taken on the old sprinkler system, the new sprinkler system update is capitalized under the above restoration rules. Since the new sprinkler system update has a higher cost ($50,000) than the net depreciable basis of the old system ($23,800), a more favorable answer would be to keep the old sprinkler system on the books and continue depreciating it while expensing the new sprinkler system update as a repair.

One way a taxpayer may get to this answer is if the taxpayer had a general asset account election in place for the commercial building. General asset account ("GAA") elections have been relatively rare for small and medium-sized businesses since they typically keep a taxpayer from realizing losses on dispositions of assets in a GAA on a timely basis. Disposition of an asset that is part of a GAA generally does not result in a tax loss to the taxpayer. It continues to be depreciated as part of the GAA, and the GAA continues to be depreciated until the GAA balance is $0. Therefore, with a GAA election in place, the absence of a recognized loss means that the cost of a replacement component does not automatically fall under the restoration rule above.

Each GAA must include only property placed in service in the same year and with the following common characteristics:

  1. Asset life (5-year, 7-year, etc.);
  2. Recovery method (200% double-declining balance, straight-line, etc.);
  3. Averaging convention (half-year, mid-quarter, etc.):
    • If the mid-quarter convention applies, a GAA can only contain assets placed in service in the same quarter;
    • If the mid-month convention applies (e.g., real property), a GAA can only contain assets placed in service in the same month

Note that listed property and automobiles have special depreciation rules so they must be in separate general asset accounts. Also, there is some flexibility in placing assets in separate GAAs even if they otherwise qualify to be in the same GAA.

For illustration purposes, if a GAA election were made, the following types of assets would each have their own separate GAA:

  • Computers (as listed property);
  • Furniture (7-year life);
  • Equipment (assuming a 5-year life);
  • Building

The general asset account election is made by checking a box on Form 4562 in the year the assets are placed in service (line 18 of the 2011 Form 4562). The taxpayer is required to keep records that indicate which assets are in each GAA.

The new tangible property rules provide an opportunity for taxpayers that want to make a late GAA election for assets placed in service before January 1, 2012. Rev. Proc. 2012-20 provides automatic approval for a taxpayer who wants to make a late GAA election for one or more items of MACRS property placed in service in a tax year beginning before January 1, 2012. There is a two-year window for making this change under the automatic approval guidelines in Rev. Proc. 2012-20. The automatic change applies to the taxpayer’s first and second tax years beginning after December 31, 2011.

Using the facts in the earlier example, if the taxpayer had a GAA election in place on the building, and the sprinkler system was included in that GAA, then the loss on the old sprinkler system would not be required to be taken. Then, assuming that the new sprinkler system update would not otherwise be required to be capitalized (i.e., it is not a restoration, a betterment, or does not adapt the property to a new or different use), the sprinkler system update could be deducted as a repair.

In this example, if the taxpayer did not have a GAA election in place, Rev. Proc. 2012-20 allows for a late GAA election to be made within the first two tax years after December 31, 2011. Again, the GAA would allow for the new sprinkler system update to be deducted as a repair as long as it was not otherwise required to be capitalized.

Historically, the greatest drawback of the GAA election was the inability to deduct a loss on disposition of an asset within the GAA. While that inability serves the taxpayer well as it pertains to potentially classifying an expenditure as a repair, it would preclude the taxpayer from deducting the loss in situations where it was advantageous. Fortunately, the new Temporary Regulations (Temp. Reg. §1.168(i)-1T(e)) provide much more flexibility in allowing for losses on dispositions of assets in a GAA. With this greater flexibility, it is likely that more taxpayers will be making the GAA elections on future tax returns and may want to consider making late GAA elections under Rev. Proc. 2012-20.

The new tangible property rules provide opportunities for taking losses on dispositions of building structural components. This could produce an unfavorable result, however, if the cost of the replacement component needs to be capitalized as a result of deducting that loss. Taxpayers may need to make a choice between utilizing the disposition rules in Temp. Reg. §1.168(i)-8T to deduct the loss or making the GAA election and not claiming the loss if there is an opportunity to instead take a repair deduction on any replacement components. Please contact your local CBIZ MHM tax professional with questions on these complex new disposition rules.


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General Asset Accounts May Facilitate Repairs Deductions (article)The April 2012 edition of InTouch discussed the new rules relating to dispositions of building structural components and the opportunity to take losses on their retirement. But what if instead of taking a loss on the disposition, you could take a repair deduction on the cost of any replacement component?...2012-07-26T19:17:00-05:00The April 2012 edition of InTouch discussed the new rules relating to dispositions of building structural components and the opportunity to take losses on their retirement. But what if instead of taking a loss on the disposition, you could take a repair deduction on the cost of any replacement component?